THE TENNESSEAN
Reprinted with permission

By STACEY HARTMANN
Staff Writer

Waller Lansden Dortch & Davis is a loyal backstage crew member in Nashville's blockbuster show of growth.

The longtime Nashville law firm recently surpassed the 100-lawyer mark, moving it from the sixth-largest firm in town a decade ago to second-largest behind Bass, Berry & Sims.

"We haven't grown because we wanted to get big," said Ames Davis, chairman.

What the 93-year-old firm has focused on is growing with purpose and meeting needs, especially those of Nashville businesses. As those businesses have grown, Waller Lansden has supported them in everything from relocation to tax matters.

"It's very much a question of little acorns growing into big oaks," said Davis, a member of the firm since 1971, when it had about a dozen lawyers.

As a result, Waller Lansden has boosted its revenue an average of 15% a year for the past five years. It now occupies more than three floors of the Nashville City Center.

Waller Lansden has many clients outside Middle Tennessee, but its areas of expertise mirror what is most notable in Nashville business, including health care, investment banking and music.

The firm has received accolades from corporate clients for its talents in corporate law, employment law, environmental law, litigation, mergers and acquisitions and tax law.


Its most notable client is Columbia/HCA Healthcare Corp., which it has represented in certain legal matters since Hospital Corporation of America was founded in the 1960s.

"We represented Dr. [Thomas] Frist [Sr.] when he acquired Park View Hospital, the very first hospital," Davis said.

Other important local clients include PhyCor, Bridgestone, Saturn, Nissan, J.C. Bradford & Co. and Equitable Securities Corp.

In a sign of the times, Davis notes: "Heck, we even have an NFL football team."

That team is, of course, the Oilers, which used the firm for relocation assistance in its move to Nashville.

Despite its large health-care practice, no one client accounts for more than 10% of the firm's business. It has continued to diversify by adding new areas of legal expertise, including environmental, labor and intellectual property.

The firm shoots for 10% growth a year in lawyers, and recently added its 104th, meaning it is closing in on Bass Berry & Sims_ 113-lawyer total.

George Bishop III, a specialist in health-care law and a member of the firm's executive committee, said the number of lawyers isn't important.

"What is important is what it means, which is this is a firm that is experiencing increasing demand from existing and new clients for a variety of services.

"Having 100 lawyers in a vacuum wouldn't mean much of anything," he said.
Along the way, the firm has hired not just law school graduates, but experienced lawyers, especially in its newer areas of expertise.

They include:

Robert J. Martineau Jr., who came to the firm in 1995 after serving as a senior attorney with the U.S. Environmental Protection Agency. His key practice areas include environmental law, administrative law and litigation.

James B. Bristol, who joined the firm in 1996 from a practice in Seattle. His key areas are employee benefits and executive compensation.

William H. Farmer, who joined in 1990 from another Nashville firm. His areas of expertise include civil litigation, tort litigation, criminal litigation and administrative law.

In its hiring practices and corporate culture, Waller Lansden has tried to buck the legal industry's reputation as ego-driven and self-serving.

"Several of us who have been here in the 70s and '80s saw the more individualized types of practice and realized that a more cooperative environment was more conducive to growth," said J. Chase Cole, a specialist in corporate and securities law and an executive committee member.

That means creating a flexible and progressive workplace, for instance, accommodating new parents. It also means building a work-force that is diverse and able to work in teams.

"With the complexity of the things we work on, it would be impossible for us to function in any other way," said Brian C. Booker one of the firm's younger lawyers.

"The law firm has been interested in getting a real mix of people," Bishop said. "We have a very good spread in terms of experience and diversity."

More than 20 of the firm's lawyers are women and at least three are African-American.

The Tennessee Department of Environment & Conservation ("TDEC"), Division of Underground Storage Tanks ("DUST"), in conjunction with TDEC's Office of General Counsel, has issued at least one formal letter assuring the prospective purchaser of a piece of property that had been the site of a petroleum release from an underground storage tank ("UST") that the prospective purchaser would not be responsible for any response costs that may be required at the site in the future. Though the letter states that it is "circumstance specific," its very issuance establishes a precedent for the issuance of future letters in appropriate circumstances.

In the current instance, DUST gives assurance to a prospective purchaser of a site that had a release discovered in 1988 from a registered UST system. After removal of the leaky USTs in 1988, the tank owner performed all investigatory and remedial actions at the site required to date by TDEC in response to the release. Further, the prospective purchaser was unrelated to the current owner or operator of the site, did not cause or contribute to the leaks, and agreed to reasonably cooperate with the DUST in any further investigation or remediation of existing contamination at the site, including the granting of reasonable access to the site.

Given the circumstances, DUST, while recognizing that the prospective purchaser arguably falls within the definition of a responsible party under the UST law, nevertheless determined that the prospective purchaser would have no exposure under the UST law because its apportioned share of liability would be zero. The apportionment of liability under the UST law is based on each responsible party's share of the total volume of petroleum at the site. Under the circumstances addressed in the letter, the equities at the site favor the imposition of zero liability (would impose no apportioned share) on the prospective purchaser.

The DUST prospective purchaser letter is consistent with TDEC's department-wide efforts to facilitate the redevelopment of brownfields when the circumstances warrant, which also benefit TDEC while promoting environmental remediation (it is to the benefit of TDEC, and environmental remediation is not hindered). This may be a useful tool for prospective purchasers of sites (particularly sites ineligible for the UST Fund) with known or suspected UST leaks.

Army Corps Of Engineers Nationwide Permit 26 Set To Expire; More Narrow Replacement Permits To Be Issued

Nationwide Permit 26 (NWP 26), which regulates discharges into above headwater non-tidal rivers, streams and adjacent wetlands or into above headwater lakes and isolated lakes and adjacent wetlands, is set to expire on December 13, 1998. The Corps of Engineers is currently conducting a rulemaking on NWP 26 to decide whether the present restrictions that prohibit the use of NWP 26 for any projects affecting over 500 linear feet of streambed and prohibit the "stacking" or use of NWP 26 with another general permit should be maintained. General mitigation for all projects impacting over one third of an acre to any water of the United States will continue to be required for the new general permits.

In addition, the Corps is proposing two new general conditions to all NWPs: (1) a prohibition on any substantial increase in downstream or upstream flooding; and (2) additional measures to preserve water quality in states where water quality standards are deemed by the Corps to be inadequate or unenforced. The Corps is seeking public comments on these various proposals. Comments are due on the NWP 26 rulemaking by February 24, 1998.

The Corps of Engineers is also scheduled to begin a rulemaking to develop replacement permits for the NWP 26. The replacement permits will be issued for only sixteen specific activities. Examples of these sixteen activities are residential and commercial development, stormwater management facilities, oil and gas development, aggregate mining, hard rock mining, stream restoration and enhancement, and agricultural activities. Within each regulated activity, however, numerous conditions are listed including a maximum number of acres or fractions of acres of non-tidal waters or wetlands that may be impacted, along with notification requirements. These acreage limitations vary widely amongst the sixteen listed activities. Activities excluded from this list will require an individual permit. The replacement permit rulemaking is scheduled to begin in March and will include a sixty-day comment period.

TDEC Reengineering Enforcement Program


TDEC has undertaken an ambitious effort to "reengineer" its enforcement process from the ground up. An internal TDEC committee is examining the entire enforcement process and has developed initial proposals for consideration. TDEC recently presented the proposals to a select group of external stakeholders, including Waller Lansden attorney Bob Martineau.

Among the proposals being considered:

1. creation of "certified field inspectors" empowered with much greater authority to issue notices of violation;
2. implementation of consistent enforcement processes and procedures among all media to foster multi-media enforcement; and
3. creation of an environmental court by the legislature to handle all appeals from TDEC enforcement actions in lieu of administrative contested case proceedings before the various pollution control boards. The TDEC committee tasked with this responsibility hopes to finalize its recommendations this spring and then begin steps to implement the proposals.

TDEC Reengineering Public Participation Processes

TDEC is also reengineering the public participation processes for both its permitting and rulemaking activities. TDEC's internal Public Participation Team recently outlined its draft recommendations to, and solicited comments from, a small group of "external stakeholders," including Waller Lansden attorney Mike Pearigen (who also serves on the TDEC Steering Committee for Environmental Permitting).

Among the proposals outlined at the external stakeholders_ meeting: (1) instituting a 3-tier system for permitting, with a sliding scale of public notice and participation (for example, new facilities and those perceived to present a higher risk to public health and environment or with a bad compliance record would be afforded more public notice/participation than others); (2) shifting public participation responsibilities from TDEC's Central Office to Regional Offices; (3) standardizing public participation requirements across divisional lines; (4) encouraging more participation in rulemaking proceedings from those outside the regulated community; and (5) perhaps the most novel, establishing a Citizen Advocate who would provide legal assistance to private citizens to appeal departmental decisions and assist in their participation in permitting and rulemaking proceedings. Other issues, such as "environmental justice," are still being evaluated and a revised public participation proposal is anticipated to be issued by TDEC's Public Participation Team around mid-March.

EPA Region IV Examines TDEC Title V Transition Variances

Enforcement officials from EPA Region IV recently examined the TDEC Division of Air Pollution Control files of companies which have triggered Title V air permit "transition variances" during the Title V application process. The Title V transition variance is a mechanism developed by TDEC to allow sources to report a discrepancy between regulatory requirements and source operations discovered during the preparation of a Title V operating permit application. In triggering the variance, the source must commit to remedying the discrepancy, but the source can continue to operate while doing so. EPA has never officially sanctioned the transition variance and the purpose of EPA's file review is unclear.

TDEC, Division Of Solid Waste Management, Issues Policy On Reporting Requirement For Disclosure Of Unpermitted Disposal Sites

TDEC, Division of Solid Waste Management ("DSWM"), issued a "policy" document on December 15, 1997 outlining the DSWM's position on reporting of "unpermitted disposal sites." The policy is attached. Reporting obligations for certain releases in Tennessee exist under the federal Clean Water Act and CERCLA, and there are certain reporting obligations imposed on "small" and "large" generators of hazardous waste and Treatment, Storage and Disposal (TSD) facilities under RCRA and analogous state law. The statutory authority for the purported reporting obligation referenced in Section 1 of the DSWM policy is unclear.

Update On TDEC, Division Of Water Pollution Control, Culverting Policy Aquatic Resource Alteration Permits

Waller Lansden's October 7, 1997 Environmental Bulletin reported on a new policy by which TDEC, Division of Water Pollution Control ("DWPC"), would evaluate all Aquatic Resource Alteration Permit ("ARAP") applications involving the use of culverts. The ARAP culverting policy was the subject of discussion at the December 1997 and January 1998 meetings of the Tennessee Water Pollution Control Board ("the Board"), at which questions were raised regarding the substance of the policy and the manner in which it was adopted. At it's January meeting, the Board voted to receive further input on this subject from DWPC staff at its March meeting and to decide whether to institute a rulemaking process which would address the subject of the ARAP culverting policy and perhaps other ARAP issues as well.

Environmental Legislation In 1998 Tennessee General assembly

A large number of environmental and conservation bills introduced in the 1997 Session of the Tennessee General Assembly have been held over to the 1998 Session and a number of new bills have been introduced since the first of the year. You will receive a legislative summary and status report as a special issue of Waller Lansden's Environmental Bulletin in the near future.

If you have any questions about any of the matters discussed herein, please do not hesitate to call Walter Crouch, Bob Martineau, James Weaver, Ed Callaway or Michael Stagg.

Certification as an Environmental Law Specialist is not currently available in Tennessee.

JCAHO Sentinel Events Policy: Advantages, Disadvantages of Self-Reporting
by Patsy Powers
The Joint Commission on Accreditation of Healthcare Organizations_ (JCAHO) revised Sentinel Events Policy is now in effect. The revised policy became effective April 1 despite widespread concern by hospitals and other facilities about waiving privileges on disclosing otherwise confidential information when an organization self-reports.

The Sentinel Events Policy encourages accredited facilities to self-report certain "sentinel events" within five days of their occurrence. A facility that fails to report a sentinel event risks being placed on Accreditation Watch, a publicly disclosable attribute of an organization's existing accreditation status. A sentinel event is defined as:

*An unanticipated death.
*A patient's major permanent loss of bodily function.
*An infant abduction.
*An infant discharged to the wrong family.
*A patient's rape by another patient or staff.
*Patient's hemolytic transfusion reaction.
*Surgery on the wrong patient or body part.

Although the JCAHO Board of Commissioners did not delay the effective date, it did take certain steps in acknowledgment of those concerns. For instance, JCAHO advised health care organizations to remove patient or caregiver identifiers when reporting sentinel events. The board also stated all copies of the root-cause analysis documents should be returned to an organization after they have been reviewed.

The mere disclosure of this sensitive information, however, breaches some legal protections such as attorney-client privilege. The board also established a task force to explore, on a state-by-state basis, how confidentiality of information, prepared by an organization after experiencing a sentinel event which is then shared with JCAHO, can be preserved. The task force will seek to identify specific mechanisms for maintaining the confidentiality of event-related information prepared by healthcare organizations.Self-Reporting

The advantages and disadvantages of following the policy are as follows:

Advantages - JCAHO will not disclose to the public the occurrence of the sentinel event at a given facility during the 30 days in which the root cause analysis is pending. Theoretically, the facility will maintain goodwill and a cooperative relationship with JCAHO. Further, it will not be placed on Accreditation Watch unless the facility fails to submit a root cause analysis within 30 days.Disadvantages - Increased risk of discoverability and admissibility of documentation because root cause analysis, once given to JCAHO, is no longer protected by state law as an attorney-client privileged document, a "peer review" document or confidential patient medical record; it may be subject to discovery by plaintiffs in a lawsuit against the hospital or a physician.A root-cause analysis, if not protected adequately, may serve as a road map to a plaintiff's attorney suing a hospital. A document, prepared by a hospital, highlighting its weaknesses, will substantiate a plaintiff's argument and could result in higher and more frequent payment of claims. Under either scenario, regardless of whether the root cause analysis is submitted to JCAHO, it can be prepared in a manner which protects the confidentiality of hospital records to the extent permitted by state law, i.e., patient medical records and attorney/client privileged information.Not ReportingOnce a sentinel event is reported, a risk exists that event information may become available to the public.Advantages - Even if a facility does not report an event, a root-cause analysis should be prepared and retained in the file. That way, in subsequent surveys where sentinel events are discussed, a root-cause analysis will be available for disclosure to a surveyor on a limited basis. This maintains the confidentiality of information so that it is not discoverable in a lawsuit.Disadvantages - If JCAHO learns of an undisclosed sentinel event, it will make known publicly its intent to review the event. If JCAHO confirms the occurrence of a sentinel event and the facility has not prepared a root-cause analysis, the facility will be placed on Accreditation Watch. The Joint Commission has initiated procedures to protect the confidentiality of sentinel event information shared by an accredited organization, including the destruction of all copies of the root-cause analyses after abstracted information is entered into the Joint Commission database; and after July 1, 1998, facilities may request an on-site review of a root-cause analysis.A Sentinel Events Legal Issues Task Force continues to address potential remedial strategies that might be employed to minimize the risk of discoverability of specific confidential information.Certainly, JCAHO wants all accredited organizations to participate in the sentinel event program as the integrity of the information gathered will be more useful; whether or not a facility reports a sentinel event is a decision each one should make in consultation with legal counsel and its risk manager following a close review of the requirements of state law.

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How Durable is Your Supply Business?New HCFA Rules Put it to the Test
Business already is plenty complicated for durable medical equipment (DME) suppliers; the federal government has just made it more so.Already a target of government agencies investigating false claims against Medicare and Medicaid, DME suppliers now face a new maze of proposed rules regulating Medicare reimbursement of their industry. The proposed rules were published Jan. 20 by the U.S. Health Care Financing Administration, (HCFA). Medicare Program; additional Supplier Standards, 63 Fed. Reg. 2926 (1998)(proposed to be codified at 42 C.F.R. Sec. 424.57).HCFA's new proposed rules, which rewrite the brief section of the Code of Federal Regulations governing payments to DME suppliers, promise significant changes for many, though not all, suppliers. Essentially, the regulations create a new set of trip wires for suppliers to be excluded from Medicare. None of the proposed regulations, however, appear likely to have a significant impact on ongoing government investigations of DME suppliers for previous violations.JCAHO Hotline, Website AvailableThe JCAHO Sentinel Events Hotline is 630-792-3700; for individuals to request report forms, request updates on the status of a sentinel event or to speak with a representative of JCAHO. For more information, visit JCAHO's website at: www.jcaho.org.The major proposed rules include:Provision of Information to HCFA . Proposed 42 C.F.R. Sec. 424.57(c)(5) gives HCFA wide-ranging authority to demand, without resort to subpoena, that DME suppliers provide:

• All documentation used in processing or adjudicating Medicare claims.
• Copies of contracts with third parties for furnishing Medicare-covered items to Medicare beneficiaries.
• Documentation of notices to consumers concerning product warranties and equipment rental/purchase options.
• Documentation of equipment delivery to Medicare beneficiaries.
• Documentation of purported equipment repairs, including contracts with third parties.
• Proof of liability insurance.
• Any other information required of any Medicare provider.

Information submitted in response to the first and last items would likely form the basis of an Office of Inspector General (OIG) audit.Surety Bonds - Section 4312(a) of the Balanced Budget Act of 1997, Pub. L. 105-33, requires DME suppliers to post an annual surety bond against debts to the Medicare program. HCFA's proposed rule, promulgated pursuant to Sec. 4312 of the Balanced Budget Act, limits the scope of these surety bonds to overpayments, interest and civil money penalties and assessments and not, as yet, penalties imposed as a result of investigations by the OIG.HCFA specifically sought comments on the advisability of including unpaid OIG fines and assessments within the scope of the supplier's surety bond. Under the proposed rule, the face amount of the bond would equal 15% of the supplier's Medicare billings for the previous fiscal year, with a minimum of $50,000 and a maximum of $3 million.Prescription Drugs - New 42 C.F.R. Sec. 424.57(c)(20) would prohibit DME suppliers from charging Medicare for prescription drugs dispensed along with their medical devices, unless the DME suppliers also has an applicable state license to dispense drugs. Further, the DME supplier must bill and receive payment for any drugs it dispenses in its own name. If a supplier fails to abide by these requirements, its billing number will be revoked. Proposed 42 C.F.R. Sec. 424.57(d).Compliance with All Medicare Statutes and Rules - On its face, this proposed rule would appear to bring the related-party prohibition, 42 C.F.R. Sec. 413.17, within the scope of DME supplier regulation. However, 42 C.F.R. Sec. 413.1(a)(2) states that the chapter of regulations, including the related-party rules, does not apply to DME suppliers. Hence, it remains unclear whether DME suppliers are subject to related-party transaction prohibitions.Other proposed HCFA rules would require DME suppliers to:

• Comply with all applicable federal and state licensure requirements.
• Make no misrepresentations on Medicare supplier number applications. Criminal penalties for violations.
• Designate an individual with authority to bind the supplier to sign the firm's supplier number application.
• Provide consumers information related to costs of equipment, operating instructions and purchase/rental options.
• Avoid contracting with entities or persons already excluded from Medicare.
• Avoid charging Medicare for repairs of equipment still under warranty.

Three new rules aim at keeping fly-by-night operations out of the DME business. Under the proposed rules, DME suppliers must:

• Refrain from conveying or reassigning a supplier number.
• Operate their businesses from a physical facility suitable for business operations with a dedicated business phone line.
• Carry liability insurance.

The proposed rules make no mention of retroactive effect. Absent evidence of clear Congressional intent to the contrary, however, courts regard statutes and regulations as not retroactive. Landgraf v. USI Film Products, 511 U.S. 244, 114 S. Ct. 1483, 128 L. Ed. 2d 229 (1994).

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Physical Therapy Services Criteria Strict for Physician Clinics
By Nora Liggett
A physician clinic providing physical therapy services to Medicare or Medicaid patients must be extremely cautious. If the physical therapy services aren't billed and supervised correctly by the clinic's physicians, the clinic could find itself unwittingly in violation of the false claims statute and the Stark law.Physician clinics get into this business in various ways. Most often, a physician group purchases the assets of a physical therapy company, employs physical therapists and bills the physical therapy services under the physician group's billing number. In billing physical therapy services to Medicare, there are two main sets of laws with which physician clinics should be familiar. The first is the federal physician self-referral law - the Stark law. The other is the Medicare billing rules.Stark LawThe Stark law prohibits physicians from referring Medicare and Medicaid patients for "designated health services," including physical therapy, with which the physicians have a financial relationship. A clinic's ownership of physical therapy assets and employment of physical therapists constitutes such a financial relationship. Therefore, the clinic physicians would be prohibited from making referrals to those physical therapists unless the referrals fit within an exception to Stark.One of the main Stark exceptions physician groups rely on is the in-office ancillary services exception. Under this exception, a physician can refer Medicare patients to a physical therapy center owned and operated by the physician's clinic as long as those services are either performed in the same office suite in which at least one member of the physician group has a physician practice or are performed in a location that is used for the centralized provision of the physical therapy services. In either case, the physical therapists must be directly supervised by a physician in the group practice. This direct supervision requirement disqualifies many physician clinics. To provide the necessary direct supervision to comply with the Stark law, there must be a supervising physician present in the same building. This physician must be readily available to provide supervision at all times when physical therapists are providing services to Medicare and Medicaid patients.In addition to following the Stark law, a physician clinic providing physical therapy services to its patients must also comply with the Medicare billing rules. Under Medicare Part B, there are only a few ways in which physician clinics can bill physical therapy services. These include:Incident to billing - The easiest and most common way for a physician group to bill physical therapy services to Medicare is to bill those services as incident to physician services. To bill under this method, however, the physical therapist must be employed by the physician group or at least be a leased "common law" employee of the physician group.Moreover, the physical therapy services must be "incident to" that physician's services. That means the physician must have seen the patient at some time to initiate the plan of care. This can be accomplished by having the initial visit be between the physician and the patient. The physical therapist then performs follow-up physical therapy pursuant to the physician's designated plan of care.The physician must also supervise the physical therapists_ services adequately. This means the supervisory physician must be available in the same office building during the time Medicare patients are receiving services from the physical therapist. This is very important. U.S. Health Care Financing Administration (HCFA) officials have stated publicly on several occasions that HCFA believes the incident-to rules are being abused. HCFA has indicated it will look closely at any incident-to billing arrangements to ensure that a physician is involved in the plan of care and that physician supervision requirements are being met. If a physician group does not have a physician on site and involved in the plan of care and it attempts to bill the physical therapist's services to Medicare as incident to the supervising physician's services, the consequences may be severe. If successfully challenged by the government, the clinic may end up not being paid for the services, and having to repay amounts the carrier may have paid inadvertently to the clinic during times a physician was not present. Even worse, the clinic could find itself facing criminal or civil charges for filing false claims.Billing "under arrangements" - An alternative plan may be to try to qualify the physical therapy facility as a rehabilitation agency under HCFA and state law. This probably will involve forming a separate wholly owned subsidiary of the clinic and operating the physical therapy facility out of that subsidiary. If the clinic is successful in qualifying the facility as a rehabilitation agency, it is possible for the clinic to bill Medicare for physical therapy services pursuant to the "under arrangements" Medicare billing rule. However, this is not common. The local Medicare carrier and the regional HCFA office may not be familiar with the process. Even if they are, the certification is by no means assured. The clinic may be rejected for any number of reasons. For example, the physical therapy facility will have to be surveyed and may not meet the state's site specifications.In addition, to qualify as a rehabilitation agency the clinic also must provide more than just physical therapy services. It also must provide speech or occupational therapy or some other type of rehabilitative service. Most physician clinics aren't willing or able to satisfy these requirements.CORF Services - Physical therapy services can also be billed to Medicare under Medicare Part B as comprehensive outpatient rehabilitation facility services (CORF). A CORF must be certified by Medicare and must meet the Medicare conditions of participation. The rules governing CORFs are extensive and most physicians would be unwilling or unable to meet them. Conditions include at a minimum:

• Physicians_ services rendered by physicians who are available at the facility on a full-time or part-time basis.
• Physical therapy.
• Social or psychological services.

The laws and rules governing a physician clinic's provision of physical therapy services to Medicare patients are complex. Before beginning to provide physical therapy services, a physician group must be careful to insure it both fits within an applicable Stark exception and is billing Medicare properly for the physical therapist services under the Medicare billing rules.

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PT Q & AThe following are commonly asked questions with respect to a physician group's provision of Medicare reimbursed physical therapy services.Q.Must the clinic employ the physical therapists in order to bill physical therapy services as "incident to" the physicians_ services?A.Generally yes, but not necessarily.In the past years, the Health Care Financing Administration (HCFA) has required all incident-to services be provided by employees of the physician. In the past two years, however, HCFA issued a program memorandum that states incident to services may be provided by a clinic's leased employees as long as there is a written lease agreement and the relationship otherwise fits within HCFA's leased employee parameters.Q.Must a physician be present at the same location as the physical therapists?A.Yes, if the clinic intends to bill the physical therapists_ services to Medicare as incident to services. The incident-to rules are clear. There must be a supervisory physician in the same office suite and immediately available to provide supervision during the times the physical therapists are providing Medicare reimbursable physical therapy services.Q.Can an employed physical therapist bill Medicare directly as an independently practicing physical therapist?A.No. The Medicare billing rules state a physical therapist who is employed by a physician or a physician clinic cannot bill independently.Understanding Patient RestraintsA hospital's decision to use restraints on patients is a difficult one, involving complex issues which can pose significant risks to a hospital. A hospital may be sued for negligence for not taking adequate precautions to protect impaired, elderly, incapacitated or unstable patients. On the other hand, hospitals also have been sued for false imprisonment when patients were restrained against their wishes.Federal Medicare regulations and policies, as well as the Joint Commission on the Accreditation of Healthcare Organizations (JCAHO), impose restrictions on how facilities may use physical or chemical restraints. Most states also have laws regarding patient restraints. Although the statutes differ slightly from state to state, such laws generally require the restraint to be:

• Authorized in writing by a physician.
• Used for only a specified period of time.
• Applied only by a physician or other qualified licensed nurse or personnel under the supervision of the physician.

The liability risk in using restraints can be reduced significantly if the hospital has a written policy that is stated clearly and followed consistently. A written policy helps hospital personnel understand when restraints can and cannot be used. Any adopted policy should:

• Strike a good balance between the need for the judicious use of restraints to protect the patient from injury and the avoidance of the misuse or overuse of such restraints.
• Provide that restraints be used sparingly and only when no less restrictive means is available.
• Never be used for a period greater than 24 hours without the attending physician's reassessment of the patient's condition and need for further restraint.
• Prohibit the use of PRN or as-needed patient restraint orders.
• Require the physician to make the determination a restraint is needed. If an oral order is the basis of the restraint, the physician should evaluate the patient and sign the order within 24 hours. In all cases, the physician should certify in writing that the patient's life or health could be seriously jeopardized unless restraints are used, and that no less restrictive alternative is realistically possible.

A patient should never be restrained solely for the convenience of the hospital staff or as punishment. Such punitive or convenience restraint use is prohibited expressly by most state laws, Medicare regulations and JCAHO standards.Liability risk for restraint use can be further reduced by having the incompetent patient's guardian or family member sign a release form.

Waller Lansden's November 3, 1997 Environmental Group Bulletin informed you of a Tennessee Department of Environment & Conservation ("TDEC") "policy" regarding Aquatic Resource Alteration Permits ("ARAPs") for culverts. Controversy surrounding this culverting policy resulted in discussion of its provisions at the Tennessee Bar Association Environmental Law Section's November 20, 1997 Environmental Law Forum and at the December 16, 1997 and January 27, 1998 meetings of the Tennessee Water Quality Control Board (the Board). The Board requested that TDEC's Water Pollution Control Division (the Division) review the culverting policy and report on any recommendations for possible rulemaking proceedings.

The Division has now proposed the initiation of a rulemaking proceeding by the Board relative to the overall ARAP Program which is not limited just to culverting situations. At the Board's April 28, 1998 meeting, the Division presented the Board with an outline (copy attached) regarding the background of the ARAP Program and possible subjects for regulations to govern that Program. The Board requested that the Division present additional information regarding the ARAP Program at an upcoming Board meeting, and it is likely that the Board will make a decision at that time whether to proceed with the rulemaking process.

The regulated community - particularly persons, business entities or organizations with property management, construction, and development interests - should be aware of this potential rulemaking initiative. TDEC has not previously developed regulations specific to the ARAP Program and, if the Board proceeds with an ARAP rulemaking proceeding, we anticipate that the environmental community will extensively participate in the development of those regulations. The end product of such a process could have far-reaching effects on the regulated community. TDEC Issues Draft Menorandum Of Agreement Between Superfund And Solid Waste Remedial Programs In an effort to clarify the appropriate state remedial program for contaminated sites in Tennessee, TDEC has issued a draft Memorandum of Agreement ("MOA") between the Division of Solid Waste Management ("DSWM") and the Division of Superfund ("DSF"). The concurrent development of DSF's Voluntary Cleanup Oversight and Assistance Program ("VOAP") and DSWM's State Remediation Section ("SRS") has caused some confusion as to which program should regulate specific inactive disposal sites in the state. Additionally, some concern has been expressed that responsible parties could "shop" sites to both divisions in search of more favorable treatment from one. Certification as an Environmental Law Specialist is not currently available in Tennessee. The draft MOA establishes the goal of attaining comparable protection of human health, safety, and the environment at all sites. This is to be achieved by the development of common soil standards (or a common methodology for their development); consistent procedures for identification and investigation of sites, and the selection of remedies; and procedures for implementing the new groundwater classification rules. The MOA also establishes guidelines for assigning sites to the remedial programs. Old solid waste dumps are generally assigned to DSWM, unless they were never permitted or closed under DSWM supervision, and did not receive hazardous substances from industrial activities. Other hazardous substance sites are roughly assigned by the date on which disposal ceased: if it was before November 19, 1980, DSF governs the site; if after that date, DSWM handles the site. If a site has begun investigation with one division or the other, however, it will not change tracks because of the MOA. Additionally, the division directors may agree upon an assignment of any specific site. TDEC is currently receiving public comment on the draft MOA. It is expected to be finalized in the near future. If you have any questions regarding TDEC's ARAP Program, the potential ARAP rulemaking, or TDEC's draft MOA, please contact Walter Crouch, Bob Martineau, James Weaver, Ed Callaway or Michael Stagg.

By Todd Shryock
Small Business News, Inc.
Cleveland, OH
Reprinted with permission

How nepotism can benefit your family when tax time arrives

Hiring family members at your business could have more benefits than you're aware of. With some careful planning and documentation, your family members can avoid taxes on some of their income. Not only will it help reduce the family tax burden come April, but they can gain valuable business experience.

One of the most common tax strategies of hiring family, particularly children, is moving out of a higher income bracket into a lower one.

"If you have a child in the business who is performing services at a reasonable compensation level, you can split the income into a lower bracket," says Richard Johnson, chair of the tax group for the Nashville-based law firm of Waller, Lansden, Dortch & Davis.

Consider the following numbers:

A married couple filing jointly with taxable income over $155,950 will be in the 36 percent tax bracket. A single child earning up to $25,350 will be in the 15 percent tax bracket. That's a difference of 21 percent of additional taxes that is avoided on the child's income. It also allows you to transfer some of your wealth without worrying about federal gift or estate taxes.

"If the child working is under the age of 18, there is no Social Security withholding requirement at all," notes Johnson. This also means the business does not have to pay the employer's share of those Social Security taxes either.

The services performed by the child must be part of a legitimate job within the business that otherwise would have been held by an unrelated person. The compensation must also be reasonable compared to others at the company doing similar tasks. Paying your child $25,000 a year to sort mail once a week will not be looked on favorably by the IRS.

If young children are working at the business, any money they make is considered earned income and is not subject to the "kiddie tax" that normally is applied to those under age 14. The kiddie tax affects all unearned income-from sources such as stocks and interest-in excess of $1,300. This income is taxable to the child at the parent's highest income-tax rate.

If the child works in the business, you could pay him or her $4,250 a year, which is equal to their maximum deduction. After the deduction, there would be no taxable income left, and you can still claim the $2,700 dependent child deduction on your income taxes.

Retirement planning

Experts will tell you that it's never too early to start planning for retirement, so why not have your children who work for the business contribute to an Individual Retirement Account? Each child can contribute $2,000 or their total income, whichever is less. The IRA deduction can be combined with the standard deduction of $4,250 to yield $6,250 total of tax-free income.

Like any tax break, make sure everything is documented to answer any IRS inquiries. Write a job description for each of the children working in the business and be able to demonstrate they are worth what they are being paid.
Johnson recommends paying children on the same schedule as other employees to help avoid IRS suspicion.

"It's probably easier, record-keeping wise, to pay them with the rest of the employees, and if you do it at the end of the year as a lump sum, it may appear you are guessing what they are worth rather than paying them as you would an unrelated party," notes Johnson.

Depending on what work the child is doing, he or she may qualify to go on business trips with you and you can deduct their expenses, as long as the trip is relevant to the job. One possibility for adult children is to serve on your board of directors.

"They can receive reasonable fees for attending directors_ meetings, and it will also give them a feel for how things are operating and what is going on," says Johnson. This can be especially important if you plan on handing over control of the business to the child at some point. "If they work in the company, it's better to have them work for a trusted manager and hold them accountable for their work. They'll learn to take responsibility and will get more out of the employment experience."

Talk with your accountant to find out what tax benefits your business can achieve through employing members of your family.

Copyright 1998, Small Business News

By Angela Wibking NASHVILLE BUSINESS JOURNAL
Reprinted with permission


Property owners scramble to check their insurance coverage following the damage cased by the April 16 tornado. In some cases the coverage was adequate to cover the loss, but in others it was not. But help may come from an unexpected source - the tax code.

One way of making up the difference between insurance reimbursements and the actual cost of the property damage may come for some business owners through their 1997 tax return.

According to Leigh Griffith of Waller Lansden Dortch & Davis, Nashville's largest law firm, certain property owners may be able to claim an immediate loss for property damaged by the tornado by amending their 1997 tax return without having to wait until they file their 1998 return.

"Business owners can take the loss that occurred (due to the storm) and compare it with the insurance payment they have received or expect to receive. The difference may be deductible as a casualty loss and they have the ability to file on the previous year's claim," he says.

This provision in the tax code is called the Special Relief for Casualty Losses. It applies only to taxpayers who have suffered property damage or loss due to certain disasters. In the ease of the Nashville storm victims, to be eligible the losses must have occurred in an area officially declared by President Clinton as eligible for federal disaster assistance. These areas include Davidson, Williamson, Wilson, Cheatham, Dickson, Robertson and Sumner counties.

"Say I have a 100 percent, business-used vehicle that a tree landed on during the tornado," explains Griffith, using a hypothetical example. "Its fair market value is $15,000 but its depreciated value - and maximum tax loss value - is $10,000. If my insurance policy pays $10,000, fine. But if they only pay, say, $5,000, then I have a $5,000 casualty loss I may be able to claim on my taxes."

Whether one chooses to take that deduction on the 1997 tax return or on the 1998 return may depend on one's anticipated level of income for 1998. Griffith also adds that one must have filed a timely claim for insurance reimbursement to be eligible to claim a casualty loss. Individuals who are eligible have until April 15, 1999 to file. The deadline for corporations to file is March 16, 1999.

As a public service, the Nashville law firm is offering free information about tax relief for victims of the April tornado.

"Our offices are in the Nashville City Center which was at the heart of the destruction," says Richard Johnson, Chairman of the tax group at the law firm. "We realized the depth of the financial loss and the pressure it has caused property owners, and we saw an opportunity to help out by sharing some of our tax knowledge."

For information, including a summary of applicable tax laws and a toll-free IRS number to call for additional specifies, call Waller Lansden Dortch & Davis at 244-6380.

Note: The information in this article is date sensitive and may be superceded by subsequent events.

Commercial Property News

Environmentally Distressed Properties?
by Eric Waters, Assistant Editor

City of Industry, CA- In early 1996, Carrier Corp. needed to sell its 55-acre industrial site in the City of Industry. The heating-and-air-conditioning equipment manufacturer occupied only a small portion of its 600,000-square-foot warehouse, attached to 28 acres of undeveloped but polluted prime industrial land. Contamination of the soil and groundwater hindered Carrier's ability to dispose of the property. It called in Cherokee Investment Security, which acquired the asset and during the next two years cleaned up the land and sold it to a number of developers and users. It renovated the building, making it a multi-tenant facility and pushing occupancy from 30 to 96 percent. Eastgroup Properties Inc., a REIT, bought the building in May 1998.

Cherokee's investment in the Carrier site brought a significant return, a happy ending to the story. But Cherokee founding partner Randall Clark pointed out that investment in and development of environmentally distressed properties is not simple, nor is it for the faint-of-heart. Insiders active in this industry-including real estate investors like Cherokee, developers, brokers, environmental engineers, consultants and lawyers-underscored the sometimes daunting complexity of taking on commercial properties with environmental problems. Nevertheless, real estate organizations with sufficient expertise in the variety of disciplines necessary to get these projects on line can realize serious returns on the right site.

"If you have the requisite specialized ability in risk assessment and repositioning, this is an extraordinary area of investment opportunity," said Clark. "There is significant yield compression in the traditional real estate market, so there's a big spread between traditional and environmental investment."

Cherokee seeks at least to double its money in environmentally impacted property transactions, and a few factors make this possible. Many corporations have been feeling pressure to divest themselves of impacted real estate assets, due to both consolidation and new Securities and Exchange Commission disclosure requirements regarding contaminated property. Corporations generally do not want to undertake cleanup themselves but need it done so they can unload the real estate. For a discounted sale price, Cherokee takes on the environmental liability of the property and indemnifies the seller against future liability. "We gain an economic benefit by providing liquidity to a previously illiquid asset," Clark explained.

Part of what allows Cherokee to enter what can be an extremely sticky liability situation is subsidiary Cherokee Environmental Risk Management. This entity, closely tied to the investment group, assesses the risk factors involved in an environmentally impacted property. If the project is a "go," it outsources the cleanup effort to a specialized environmental engineering firm with a guaranteed remediation program. Guaranteed remediation is a relatively new phenomenon available from some environmental engineers that protects all parties in an environmentally impacted transaction, from sellers to buyers to lenders. ARCADIS Geraghty & Miller, for example, will fix a guaranteed price for the environmental work necessary to obtain a signoff from government regulatory agencies and enable troubled transactions to close. The firm also insures its own work, not to mention offering insurance on undiscovered contamination and future spills. In short, ARCADIS Geraghty & Miller takes on the environmental risk itself, trusting in years of cleanup experience to estimate and control costs. "We move quickly, and have rescued many transactions that were in due diligence," said ARCADIS Geraghty & Miller vice president of real estate services Gary Keyes. According to Keyes, the ARCADIS Geraghty & Miller program has seen plenty of interest during the past two years: The firm has fumed more than $500 million in troubled real estate transactions into done deals.

"The unknowns in an impacted deal are usually what makes it go south-the question becomes whether the buyer or the seller is going to take on the risk," said James Weaver, chairman of the environmental practice group of Nashville, Tenn., law firm Waller, Lansden, Dortch & Davis. "Brokers and others involved in a transaction like third-party environmental firms with guaranteed remediation because they accept the risk."

Evaluating and minimizing risk is the key to making an environmentally challenged property work as an asset. Within the universe of environmentally impacted real estate, there is a broad spectrum in terms of both property type and level of contamination and a parallel spectrum of risk. KEERA, a partnership between CB Richard Ellis Inc. and ENSR (an international environmental consulting firm) that is also soon to include a major opportunity fund, takes a different approach than Cherokee to minimizing risk. While Cherokee focuses on shopping for underused corporate properties, KEERA seeks to avoid excessive entanglement with land cleanup and government agencies by targeting facilities with good real estate fundamentals that are currently income property or can become income property within a year or two.

"The economics of environmentally impacted properties make sense only in a very limited number of cases," said KEERA president Jim Korinek. "You have to be careful to balance risk against yields." The partnership acquired its first property approximately 18 months ago in Washington state. The 151,000-square-foot mixed-use facility was occupied but had some soil contamination that had to be remediated. Essentially, it was an existing property in a strong submarket that needed cleanup to make it more attractive. KEERA finds more opportunities that match its profile overseas, according to Korinek. "The lowest-hanging fruit in the U.S. is already being harvested, and we will be going offshore to find more opportunities using the base of real estate knowledge we have in place here," he remarked.

Cherokee also plans to move its operations abroad: "The U.S. market (for environmentally impacted real estate) pales in comparison to the international opportunity," Clark added.

But Dames & Moore/Brookhill L.L.C. has found plenty of work at home in the United States since its inception in mid-1996. Consisting of international environmental engineering firm Dames & Moore and developer The Brookhill Group, D&M/B started off with $200 million in debt and equity and the goal of investing in environmentally impacted sites. With a low cost of capital made possible by an association with Credit Suisse First Boston, D&M/B has acquired more than 30 of these properties around the country. Most recently, the partnership bought a vacant 550,000-square-foot former furniture manufacturing complex in Chocowinity, N.C., about 100 miles east of Raleigh.

In this case, industrial development incentives available in North Carolina are helping D&M/B put the project together, and a tenant has already signed on to purchase the building when remediation is complete. Premier Auto Glass, a division of Amilite Corp., will move its headquarters from Cleveland, bringing 200 jobs to a depressed area-an outcome that meets the partnership's strategy of making its deals both public and popular.

"With this property type, you often have to remove a stigma attached to a building and improve its reputation," said D&M/B chairman and Brookhill president Ronald Bruder. "We like to get a lot of publicity, come in as the white knight and put money where it shows."

D&M/B, like other investors in environmentally impacted real estate, assesses risk carefully using in-house environmental and legal specialists. But the partnership also spreads risk simply by involving itself in a lot of transactions. Bruder pointed out that a loss can be offset by a big win in this inherently risky class of property.

D&M/B's Chocowinity deal raises another important point relevant to investment in environmentally impacted properties: Many cities and states around the United States are trying to make these sites attractive for purchase. Chicago is one current hotbed of activity, according to Arthur Andersen L.L.P. senior manager Jon DeVries. "City governments in general and Chicago's in particular are being more proactive in assembling brownfield sites and making them available to developers," DeVries noted.

The city authorities have taken an interest in slowing the flight of industry to outlying areas and cleaning up polluted sites. Chicago has created tax incremented financing districts in various areas to spark development of abandoned and polluted sites. A recently negotiated $50 million loan from the Department of Housing and Urban Development under HUD Section 108 will work alongside the TIF zones and help the city assemble land and create industrial parks rather than isolated sites.

Colliers, Bennett & Kahnweiler Inc. is one of Chicago's most prominent investor-developers of environmentally impacted sites. Recent deals include a 350,000-square-foot industrial redevelopment sold to the Chicago Transit Authority and a 325,000-square-foot industrial building sold to Pepsi-Cola Co. "There are many downtown or fringe downtown spots with unbeatable locations. If you get the right price, they're great deals," said Colliers, Bennett & Kahnweiler president David Kahnweiler.

Many of the Chicago sites are not heavily contaminated, and both the federal EPA and Illinois_ EPA have relaxed their regulatory stance somewhat. But Kahnweiler says the obstacles to making these deals a reality remain complex. "Midway through these projects, you may say to yourself that it's not worth the headache; there are so many moving pieces to integrate, and you need a strong stomach," he commented. Colliers, Bennett & Kahnweiler requires a projected yield 50 percent better than that expected on traditional real estate investment before it will get involved in a property with environmental issues. This reflects the firm's "expect the unexpected" stance on this type of investment: Unforeseen problems cost money.

Another big Chicago player in the environmental field is Centerpoint Properties Trust. Although Centerpoint is active in the city itself and buys contaminated property from both corporations and landlord, its most recent brownfield project is in suburban Oakbrook, III.-and is the location of the REIT's new headquarters. Acquired from Xerox Corp. approximately 18 months ago, the 150,000-square-foot manufacturing/warehouse building had contaminated soil under one-third of its space. After nailing down approval from the state of Illinois and an indemnification from Xerox, the REIT demolished the tainted 50,000 square feet and excavated and cleaned up the earth beneath. Redevelopment of the building's remaining 100,000 square feet as office/flex product took place concurrently. Centerpoint itself occupied 40,000 square feet upon completion and leased the rest to an Internet provider.

Like Kahnweiler, Centerpoint CEO John Gates warned of the complications and risks inherent in environmentally impacted investment. "With all the extra pieces, time becomes the enemy. It can take forever to assess a property and then take it through the relevant agencies and through remediation. It's not easily undertaken by the neophyte," Gates said. "On the other hand, remediation technology is becoming more efficient, and government agencies are becoming more realistic."

Gates also feels that the universe of opportunity in environmental investment is not large enough to make it worthwhile as a core business. Too many sites are simply so polluted or poorly located that they make no sense from a real estate perspective. "You have to identify demand just like you do in any real estate transaction, and on top of that you have to quantify your risk exactly," Gates added.

Chicagoland is a big environmental redevelopment market, but there are also one-off opportunities in rural areas, like D&M/B's North Carolina project, and in smaller metropolitan areas, like Jamestown Development Corp.'s project outside Buffalo, N.Y. That site had been a wood-treatment factory and was a hazardous-waste site. According to Jamestown president Jon Williams, there was plenty of paperwork on the property but not much hard fact. Jamestown researched the site and then took the front-end risk by cleaning up the property through a subsidiary. This helped keep the project time frame to a reasonable 18 months. The developer erected a custom-built 130,000-square-foot industrial building and leased it to Dowcraft Corp., which supplies office interiors. Had Jamestown not redeveloped the facility, Dowcraft probably would have relocated, taking jobs with it, so Chautauqua County assisted the developer in its push for regulatory signoff on the site.

The firm aimed to obtain a regulatory stamp of approval on a cleanup plan that did not involve making the asset a piece of virgin land again. Rather, the idea was to make the property clean enough for certain uses and then restrict the product type that could be constructed there, allowing development to proceed. An industrial site, for instance, does not have to be as clean as a residential area.

"From a development standpoint, this project was a lot of fun. It was a challenge instead of a cookie-cutter building," Williams said. "Of course, you need to be motivated and have the ability to orchestrate the different groups involved. There's lots of bureaucracy you have to weave through.__

LAW Engineering and Environmental Services Inc. can help both buyers and sellers through the maze. According to LAW executive vice president Leonard Ledbetter, the national environmental firm balances an understanding of the business and real estate side of an environmentally impaired transaction with extensive knowledge of the regulatory side. "What we do is come up with a cleanup strategy and take it to the regulators," Ledbetter said. "The next step is to create an exit strategy for all parties in the deal, from regulators to buyers to sellers to lenders."

But in spite of environmental and regulatory advances, national developers who become involved in environmentally impacted real estate arc not terribly plentiful. "Developers like to avoid potentially sticky situations," said Cushman .& Wakefield Inc. associate director Jeff Cahill. "The mainstream development community has not found brownfields profitable except on a select basis. But they are becoming more popular as a local or region firms focus on the area. If you can make these projects work the returns may be dramatic. The firm is involved 10 properties with projected rates of return ranging from 30 percent up to 100 or 200 percent.

Cushman & Wakefield is currently working on 29 fairly heavily contaminated sites around the United States, according to Cahill. Most are industrial with a sprinkling of multi-family and retail. One site is a 1.5 million-square-foot former factory in a Midwestern City which Cushman & Wakefield is putting together a $28 million public financing package including federal, state and city grants as well as tax abatements. The building is being marketed to users and could bring as many as 3,000 jobs, according to Cahill.

As the popularity of investment in and redevelopment of environment distressed properties slowly increases, a change is occurring in what was and is the largest type of financing. Although equity is readily available in today's hot traditional real estate marketing, venture capital is only now starting to become available for environmental transactions. "You must have the capacity to educate and motivate equity dollars to show them how they can realize returns, on top of dealing with the environmental issues," said Grubb and Ellis, vice president Rich Ranalli. Grubb & Ellis is currently involved in a 100 year old rail yard and utilities site in Middlesex County, N. J. Located on the waterfront the property is slated to become a master-planned mixed-use commercial development back by private money.

Robert Lane, co-chairman of the real estate department for law firm Morgan & Bockius L.L.P., has seen a heightened overall level of interest in environmental distressed real estate during the past few years, even if firms are not yet ready to commit. An owner-developer client recently asked Lane to come in and brief it on the pros and cons of this type of investment and expressed interest, although it chose to hold off on environmental investment until traditional real estate tightens up. "It's an intimidating issue. Clients need deep pockets, expertise and guts. But there is great potential there for the upside," Lane remarked.

Note: The information in this article is date sensitive and may be superceded by subsequent events.

Natural Resources & Environment Volume 13, Number 2, Fall 1998
Reprinted with permission


By David P. Novello and Robert J. Martineau

By June 1999, tens of thousands of companies will need to submit extensive plans to comply with a provision of the Clean Air Act (CAA) that many may have overlooked until fairly recently. Section 112(r), 42 U.S.C. Sec. 7412(r), which was added by the 1990 CAA Amendments, P.L. No. 101-549, requires facilities to adopt accidental release prevention plans (112(r) plans) that are similar in some ways to chemical process safety management plans under the Occupational Safety and Health Act (OSHA). The 112(r) plans, however, are far more extensive and have raised concerns that the public availability of sensitive information will increase the likelihood of terrorist sabotage at facilities. The program also has been controversial in that many states have resisted delegation of authority from the U.S. Environmental Protection Agency (EPA) to implement it.

Section 112(r), which alone is more than four times longer than the entire pre-1990 version of Section 112, is in some ways the most unusual part of the amended CAA. Unlike the rest of the Act, it does not limit air emissions resulting from the normal course of operations; instead, it is designed to prevent disastrous accidental releases of hazardous substances. The accidental release prevention requirements in Section 112(r) are part of the mosaic of federal environmental and occupational safety programs developed in the 1980s and 1990s to prevent and minimize the consequences of unintended releases. Several states also have developed their own regulations to prevent such releases. The tragic chemical release that in 1984 killed thousands of people in Bhopal, India, served as the primary impetus for these various programs.

The Section 112(r) regulations also are unusual in that they will likely affect more plants than any other rule issued under the 1990 CAA Amendments, including numerous facilities previously not subject to CAA mandates. Many facilities that will be regulated under Section 112(r) do not emit air pollutants in the ordinary course of business but only handle or store regulated substances. For example, public drinking water systems and chemical wholesalers will be required to prepare and file Section 112(r) risk management plans (RMPs). EPA estimates that its accidental release rules could affect over 66,000 facilities, many of which are in non-manufacturing sectors. In January 1994, EPA issued a list of substances to be regulated under Section 112(r), along with quantity thresholds for these substances. 59 Fed. Reg. 4478 (1994). The agency then amended that list in early 1998 in response to an industry judicial challenge to EPA's rules. 63 Fed. Reg. 640 (1998). EPA issued final rules implementing the core accidental release prevention provisions under Section 112(r)(7) in June 1996. 61 Fed. Reg. 31,668 (1996).

The rules governing accidental release prevention under the Clean Air Act are codified at 40 C.F.R. Part 68. This article provides an overview of the statutory provisions, including the general duty clause, discusses the final regulations, including regulated substances, and discusses concerns that states and the regulated community have raised in connection with this new program.

Overview of the Statutory Provisions

Section 112(r) includes a paragraph known as the "general duty" clause, which applies even to those facilities not subject to EPA's rules. Section 112(r)(1) provides in part:

The owners and operators of stationary sources producing, processing, handling, or storing [certain listed and other extremely hazardous] substances have a general duty to identify hazards which may result from [accidental] releases using appropriate hazard assessment techniques, to design and maintain a safe facility taking such steps as are necessary to prevent releases, and to minimize the consequences of accidental releases which do occur.

The statute specifies that companies have this general duty in the same manner and to the same extent they do under OSHA's general duty provision requiring employers to maintain a safe workplace. EPA has stated that the general duty clause under Section 112(r) applies not only to the regulated substances listed by EPA but also to any other extremely hazardous substance. 59 Fed. Reg. at 4481.

EPA has already begun to enforce the general duty clause. In June 1998, EPA filed its first complaint under this provision. The parties simultaneously lodged a consent decree under which the defendant companies agreed to pay a penalty of $500,000 and undertake supplemental environmental projects (SEPs) to settle Section 112(r) and other claims. See United States v. Terra International, Inc. and Terra Industries, Inc., Civ. Action No. C98-4070MWB (N.D. Iowa). The action stemmed from a fatal 1994 explosion at the defendants_ Port Neal, Iowa, ammonium nitrate plant, and inspections following that explosion. As of June 1998 EPA also had several other investigations underway for violations of the general duty clause.

The Section 112(r)(1) general duty also does not appear to be qualified by the quantity of listed and other extremely hazardous substances that a facility uses or stores; the de minimis threshold quantities, discussed below, seem not to apply to this provision. Moreover, EPA has at least implied that the general duty provision is self-implementing.

Section 112(r)(3) directs EPA to promulgate a list of at least one hundred substances "which, in the case of an accidental release, are known to cause or may reasonably be anticipated to cause death, injury, or serious adverse effects to human health or the environment." Congress itself wrote sixteen substances into the list. Paragraph 4 specifies the factors that EPA must consider in listing the substances. Under Paragraph 5, EPA must establish a "threshold quantity" for each substance, meaning the amount that may cause death, injury, or serious adverse effects to health or the environment.

Paragraph 7 is the heart of CAA Sec. 112(r), both in terms of reflecting the congressional goal of avoiding accidental releases and in adding new regulatory requirements for sources. Under subsection B, the owner or operator of a facility that has more than a specified threshold amount of an EPA-listed substance must prepare and implement an accidental release risk management plan (RMP). Congress specified that the plan must include: (1) a hazard assessment to assess the potential effects of an accidental release; (2) a plan for preventing accidental releases of regulated substances, including safety precautions and maintenance, and monitoring; and, (3) a response plan describing specific actions to be taken in the event of an accidental release, including procedures for informing the public and local agencies responsible for responding to accidental releases, emergency health care, and employee training measures. Thus, the RMP must contain three main elements: a hazard assessment; a prevention program; and, a response program. The OSHA process safety management standard, in contrast, focuses only on prevention of accidental releases. 29 C.F.R. Part 1910.

Regulated Substances and Risk Management Plan Rules

To carry out Section 112(r) EPA has issued two major rules: (1) the list of "regulated substances" and their threshold quantities, and (2) requirements for accidental release RMPs. The rules build on related requirements of the Emergency Planning and Community Right-to-Know Act of 1986 (EPCRA). 42 U.S.C. Sec.Sec. 11001 et seq. EPA's Chemical Emergency Preparedness and Prevention Office, in the Office of Solid Waste and Emergency Response (OSWER), administers the rules under EPCRA. The agency therefore gave the lead for developing the Section 112(r) program to this office rather than the Office of Air and Radiation.

EPA's list of regulated substances under Section 112(r), along with the threshold quantities for these substances, is codified at 40 C.F.R. Sec. 68.130. EPA selected the regulated substances based on the three statutory criteria: the severity of acute adverse health effects associated with accidental releases of the substance, the likelihood of a release, and the potential magnitude of human exposure. To date, EPA's list includes seventy-seven substances that the agency considers to be acutely toxic and sixty-three flammable gases and volatile flammable liquids. Following settlement agreements with explosives manufacturers and the American Petroleum Institute to judicial challenges brought by those groups, EPA in January 1998 deleted from the list explosives that the Department of Transportation designates as "high explosives." 63 Fed. Reg. at 640.

The threshold quantities for the various substances range from 500 to 20,000 pounds. The January 1998 amendments to the list also clarified threshold determinations for regulated flammable substances in mixtures and exempted from threshold quantity determinations certain regulated flammable substances in gasoline and in naturally occurring hydrocarbon mixtures. The threshold quantities apply to particular processes at the source and not to the facility as a whole.

The risk management program is the center of the Section 112(r) program to avoid Bhopal-type accidental chemical releases. EPA's final RMP rules establish a "tiering system" under which the stringency of requirements for the RMP is related to the perceived risk of accidental releases and resulting harm posed by different types of facility processes. Under this tiering system, processes are placed in Programs 1, 2, or 3, with Program 3 being the most rigorous. A source can have processes in one or more of the three programs, and thus the stringency of requirements at a single facility may vary from process to process.

The preamble to the final rules summarize applicability criteria for Programs 1, 2, and 3. See 61 Fed. Reg. at 31,670. Program 1 applies to a process that has had no accidental releases with off-site consequences in the five years prior to the submission date of the RMP and that has no public receptors within the distance to a specified toxic or flammable endpoint associated with a worst-case release scenario. Program 3 applies to processes in certain Standard Industrial Classification (SIC) codes, specifically, 2611 (pulp mills), 2812 (chloralkali), 2819 (industrial inorganics), 2821 (plastics and resins), 2865 (cyclic crudes), 2869 (industrial organics), 2873 (nitrogen fertilizers), 2879 (agricultural chemicals), and 2911 (petroleum refineries). Program 3 also applies to all processes subject to the OSHA Process Safety Management standard, 29 C.F.R. Part 1910.119, unless the process is eligible for Program 1. Program 2 requirements apply to all other covered processes. For the three main elements of the RMP-the hazard assessment, the prevention plan, and the response plan-the requirements depend on whether a facility's particular process falls under Program 1, 2, or 3.

EPA's RMP rules build on similar requirements under the OSHA process safety management standard (codified at 29 C.F.R. Part 1910) and EPCRA. Of the more than 66,000 facilities that EPA believes will be subject to Section 112(r)(7), many are already covered by the OSHA process safety management standard. EPA predicts that facilities in compliance with the OSHA rule also will be in compliance with the release prevention aspects of EPA's proposed rules. The OSHA standard, however, is designed to protect workers and therefore requires an analysis of potential impacts only on workers. The EPA's rules, on the other hand, include significant requirements for off-site assessment and response as well as for process hazard analysis elements similar to those found in the OSHA rule.

The Section 112(r)(7) rules also include other important requirements not covered by the OSHA standard. For many sources, the emergency response plan will have to be more extensive (e.g., facilities will have to conduct drills and exercises). In addition, unlike EPA's Section 112(r)(7) rules, the OSHA standard does not require registration, submission, and auditing of the RMPs. Thus, many facilities will be subject to significant new obligations even if they are already in compliance with the OSHA standard.

The first element of the RMP is the hazard assessment. Although all processes are subject to hazard assessment mandates, the provisions for Program 2 and 3 processes are the most stringent. Perhaps the most controversial aspect of EPA's rules has been the requirement, applicable to all processes, to conduct a "worst case release scenario." EPA's proposed definition of the term "worst-case release" caused an uproar in the regulated community because of its breadth. EPA essentially withdrew its broad definition of the term after industry sharply attacked it as unrealistic. The final rule defines worst-case release as, "the release of the largest quantity of a regulated substance from a vessel or process line failure that results in the greatest distance to an endpoint defined in Section 68.22(a)." 40 C.F.R. Sec. 68.3. Section 68.22(a), in turn, contains a number of technical descriptions of various endpoints. Many industry officials believe that EPA's final definition of "worst case release" is still overly broad and unrealistic. The regulations require that one worst-case scenario be included for each Program 1 process. For Program 2 and 3 processes, the rules are more complicated. Among other things, a company needs to conduct for these latter processes separate worst-case scenarios including all toxic substances and all flammable substances.

Another component of the hazard assessment is a five-year accident history. This requirement, which applies to all processes, includes all releases during the previous five years that resulted in deaths, injuries, or significant property damage on site, or known off-site deaths, injuries, evacuations, sheltering in place, property damage, or environmental damage.

The second element of the RMP is the prevention program. Under the proposed rules, EPA would have required all sources to put in place a comprehensive "prevention program" to evaluate potential hazards and determine the best way to control them. In the final rule, the agency essentially dropped this requirement for Program 1. For these processes, the company need only certify that no such measures are necessary to prevent off-site impacts from accidental releases. Programs 2 and 3 include different accident prevention mandates. Subpart C of the rules governs the Program 2 prevention program. Facilities with processes subject to Program 2 must incorporate the following requirements in their release prevention plans:

• Compile and maintain safety information and ensure that the process is designed in compliance with recognized and generally accepted good engineering practices;
• Conduct a review of hazards associated with the process and regulated substances;
• Prepare written procedures for safely operating the process;
• Institute training programs;
• Prepare and implement maintenance procedures;
• Conduct compliance audits;
• Carry out and document incidents that resulted in (or could reasonably have resulted in) a catastrophic release.

The prevention planning requirements under Program 3, found in subpart D of the rules, are even more extensive.

Related to the prevention program is a requirement to develop and maintain a management system to oversee implementation of RMP requirements. For Program 2 and 3 processes, the owner or operator must put the system in place and designate a qualified person to assume overall responsibility.As with the prevention program, the emergency response element of the rule applies only to Programs 2 and 3. Unlike the prevention program regulations, however, the rules governing emergency response plans are fairly brief and general in nature. Section 68.95 sets forth required plan elements, such as: procedures for notifying the public and local emergency response agencies; documentation of emergency treatment that may prove necessary; procedures for the use, inspection, and maintenance of response equipment; and, training for employees.

All sources that produce, process, handle or store listed substances in excess of the applicable threshold quantity must prepare and submit by dates specified in Sections 68.10 and 68.150 a RMP containing the required elements.These provisions specify that the plan shall be submitted and the source must be in compliance with it by no later than the latest of the following dates: June 21, 1999; three years after the date on which a regulated substance is first listed under Section 68.130; or, the date on which a regulated substance is first present above a threshold quantity in a process. The third of these deadlines could pose serious hardships for sources that decide to quickly change operations and surpass the applicability threshold sometime after dune 1999 since under the rules the company would be out of compliance unless it submitted the RMP at the same time it brought the substance to the facility. As a general matter, sources must also update their RMP every five years, although under certain circumstances a quicker revision is required. Each affected facility will need to submit its RMP to a central location identified by EPA-most likely an EPA office. The owner or operator will be required to sign a certification, the language for which is specified in the rules. Providing false or misleading information could be grounds for criminal liability.

EPA plans to make RMPs publicly available in several ways, including over the Internet. EPA hopes that, by making this information publicly available, it will prompt a dialogue between affected industries, the public, and emergency response authorities and improve release prevention and response practices at the local level. See Final Report of the Electronic Submission Workgroup to the Accident Prevention Subcommittee of the Clean Air Act Advisory Committee, June 18, 1997 at 17. Public availability of this information raises numerous issues that are discussed in more detail below.

State Implementation Issues

In most federal environmental programs where state delegation is available, states seek delegation as a matter of course. The Section 112(r) program, however, has not met with the usual efforts by states to seek control of this program. As of June 1998, only nine states had formally requested partial or total delegation: California, Florida, Georgia, Louisiana, Mississippi, Nevada, New Jersey, Ohio and South Carolina. There are a number of reasons for this lukewarm response by the states, and EPA and others have recently attempted to address some of these stumbling blocks.

In 1997, the National Governors_ Association Center for Best Practices released a report entitled State Considerations and Strategies for Implementing the Chemical Accidental Release Prevention Program (NGA Report). This report highlighted some of the concerns and issues facing states in implementing the pro-gram. One of the "problems" with Section 112(r) is the issue of which state agency or agencies can, or should, implement the program. In most cases, the 112(r) program does not fit neatly in a single environmental agency bureaucracy. On the other hand, state emergency management agencies typically do not have experience in implementing and enforcing an environmental regulatory program. Moreover, many of the more than 66,000 facilities that must implement 112(r) are not those sources who typically interact with an environmental agency. As a result, states are approaching implementation at the state level in a variety of ways. According to the NGA Report, states such as Georgia and Minnesota have looked to a single agency approach to implement the program, while others, such as Illinois, are taking a multi-agency approach. Where sources subject to 112(r) are also subject to Title V, it may make the most sense to have the agency implementing Title V permitting also include the 112(r) program for at least those sources. In fact, in its efforts to encourage delegation, EPA is taking the position that, for Part 70 Title V program approval, states must undertake implementation of some aspects of the 112(r) program for affected Title V sources.

Another issue that concerns some states is the fear of liability. According to the NGA Report, some state officials have questioned whether a state might be vulnerable to a lawsuit if an accident occurs at a facility where the state has not conducted an audit of the facility's 112(r) plans. Funding is, of course, also always a concern for states. While states can collect Title V fees sufficient to cover the cost of implementing a program for the Title V sources, in most instances those sources make up only a fraction of sources covered by the program. For example, in Tennessee, EPA estimates over 1,200 facilities are subject to the 112(r) program (a figure estimated to be very low), but only one-third of those are Title V sources.

Because of the various implementation issues, states are also considering less than full delegation of the program. The NGA report highlights the different strategies taken by Florida and Michigan. Florida's 112(r) program is designed to take full delegation and to be administered by one lead agency with an established funding mechanism to pay for it.

In contrast, Michigan is looking to take delegation that focuses on only those facilities regulated under the existing federal air permitting program.

EPA is concerned about the states_ limited response to taking delegation of the 112(r) program. The agency is aggressively trying to encourage delegation and offering to work with, and in some cases pro-vide money for, outreach, education, implementation and auditing activities. In February 1998, EPA released a document entitled Guidance for Implementing Agencies. The guidance document is an encouragement piece designed to entice states to seek delegation by outlining all the advantages of doing so and promising extensive cooperation and assistance. EPA also has established a World Wide Web site for Section 112(r) and set up a list of available "tools" for state and local officials including a bulletin board for state agencies to share information on implementing the program. The web site is located at http://yosemite.epa.gov/oswer/ceppoweb.nsf/content/index.html.

Sources subject to 112(r) need to consider whether they would rather deal with the state and local officials in auditing and inspections and other aspects of the program or have EPA as the implementing agency. If sources are concerned about the state and local role vis-a-vis EPA, they need to be discussing those issues with those state officials now. Typically, most regulated sources prefer to work with regulators at the state or local level.

In addition to encouraging states to enter the 112(r) world by offering carrots, EPA is also pushing delegation by suggesting it may use sticks to move states along. EPA has indicated that it may withhold grant money, such as Clean Air Act Sec. 105 dollars, from states that fail to implement the program. EPA also has, in at least one instance, informed a state air pollution control board that if the state did not take delegation of the program EPA would consider opening a satellite office in the state in order to carry out the 112(r) program.

As the 1999 compliance dates approach, sources subject to the RMP requirements must be aware of whether a state or local program will take delegation of the 112(r) program. This task may be more difficult than in other cases of federal/state delegation because of the many different types of implementation strategies being developed by states. Moreover, even if a state takes full delegation of the 112(r) program, companies should be aware that certain aspects of the program are nondelegable and thus will still be handled by EPA. For example, the RMP must still be submitted to EPA in the form and manner specified, although states may require sources to submit the RMP to them as well. Likewise, the general duty clause under Section 112(r)(1), discussed above, is nondelegable.

Security, RMPs and Terrorism

In light of recent well-known tragic events, such as the bombings at the World Trade Center, Atlanta's Olympic Park and Oklahoma City's federal building, and an ever-increasing fear of terrorist activity, a significant concern has arisen over the public availability of key components of the Section 112(r) RMPs. In particular, a number of companies required to prepare RMPs have expressed concern about putting out RMP information on the Internet. They argue that this increases the risk that terrorists would target specific companies based on the readily accessible information. Of particular concern is the off-site consequence analysis (OCA) portion of the RMP. As noted above, the OCA requires an assessment describing the potential impacts that an accidental release would have on the public and the environment around the facility. With this information, terrorists or others could determine how many people living within a certain distance of a facility might be harmed in a deliberate attack on the facility.

These assertions were bolstered by two incidents-while not well known like the events highlighted above-which brought the issue close to home. In February 1991, six pipe bombs were found in chemical tanks near the Norfolk Naval Base at the Allied Terminals, Inc. facility in Virginia. The timers on the bombs failed, however, and explosive ordnance personnel were able to remove and neutralize the devices without incident. In 1997, three men and one woman allegedly planned to blow up a gas refinery in Bridgeport, Texas, releasing what they thought would be a lethal cloud of hydrogen sulfide gas. Authorities allege that during the chaos the men hoped to rob an armored car of $2 million in the small town of Chico and use the money to finance other terrorist actions. With information provided by an informant who was part of the group, they were arrested quietly before the bombs were set.

The security concerns raised by these events were discussed by the Accident Prevention Subcommittee of the Clean Air Act Advisory Committee. In response to the Committee's concern, EPA commissioned a security study conducted by Aegis Research Corporation, ICF and Systems Applications International Corporation. In December 1997, EPA issued the report entitled An Analysts of the Terrorist Risk Associated with the Public Availability of Offsite Consequence Analysts Data under EPA's Risk Management Program Regulations, EPA 55-R97-003. After reviewing the benefits of the RMP rule, the core of the report outlined the potential for terrorist threat and the incremental risk associated with making the OCA data available on the Internet. The report also looked at the relative risk of various alternative methods of disclosing information. The security report focused on the terrorist threat to the estimated 66,000 facilities covered by the RMP program and the impact OCA data on the Internet might have on them and the communities surrounding these facilities. The report did not look at sources not covered by the rule, where in fact, the more well-known tragedies have occurred (e.g., Atlanta Olympic Park, federal office building in Oklahoma City and the World Trade Center).

The purpose of the study was to define only the increased likelihood of a terrorist targeting an RMP facility due to the availability of the additional OCA information. The study evaluated how a terrorist might otherwise obtain various key pieces of information useful in planning an attack, such as the presence of certain chemicals at a facility or the number of persons living within a certain radius of the facility. The report concluded that while the risk of attack was still small, Internet availability of the RMP with OCA data more than doubled the risk of a terrorist threat. According to the report, the primary utility of the Internet data is the capability to look at information from across the country to identify "best targets."

The security reports also compared the relative risks associated with five alternative means of disseminating information including the Internet, CD-ROM, computer bulletin boards, upon request in hard copy, or in reading rooms around the country. In the comparative analysis, full Internet access presented substantially greater risk than any of the other alternatives. Finally, the study explored ways to minimize risk while still providing Internet access including technology measures to make wholesale retrieval of data from the Internet more difficult.

In response to the security study, the advisory subcommittee recommended that all RMP data be posted on the Internet but that "speed bumps" should be employed to minimize terrorist risk. For example, RMPs will be available but searches would be restricted. Likewise, a CD-ROM of all RMPs would be available, but only to those who register with EPA. EPA is developing guidance to implement these principles, but has not yet issued a final decision on the issue.

Industry groups such as the American Petroleum Institute and the Chemical Manufacturers Association remain concerned about the security issue. They contend that the security report confirms a three- to seven-fold increase in the risk of terrorism and that the security does not adequately address the risks and benefits of various information dissemination options. They have also urged that the federal national security authorities have a greater role in any regulatory decision, which has this significant of a security issue. Some members of Congress also have recently raised concerns about the security issue. Senator Trent Lott (R-Miss.) and Representative Sherwood Boehlert (R-N.Y.), among others, have sent letters to EPA Administrator Carol Browner seeking assurance that all security issues will be addressed.

Regardless of how the security issues are resolved, facilities subject to the Section 112(r) RMP requirements will have to submit their plans by June 1999. Other facilities under the applicability thresholds of the risk management plan rule will need to assess their compliance with the Section 112(r) general duty clause. There seems little doubt that companies will be kept busy complying with the CAA's accidental release provisions in the years ahead.

Copyright 1998 American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

Hospital & Healthcare News Philadelphia Edition
Volume 12 No. 9
Reprinted with permission

About three years ago, a delightful pair of young, Canadian physicians was recruited by a hospital in the rural South. Not having yet experienced a typical American summer, this married couple agreed to relocate to the United States. Their employer applied for legal permanent residency for them, the famous "green card," and permission was granted immediately. The normal process was even short-circuited because this couple agreed to serve in a rural, health professional shortage area.A couple of months later, on advice of their attorney, they applied for a temporary visa at the frontier and moved to the United States. After their arrival, they filed the second application actually seeking the green card. Eight months later, they received a response to this second application. It was denied, they were told to leave the country and were told that they would never ever be permitted to return again.

This case demonstrates most of the advantages, problems and pitfalls of the use of foreign physicians for medical staffing. If you learn the lessons of this case, you will be well prepared to face the challenges and opportunities of recruiting foreign physicians.

First, why bother? In this case, the husband became the only doctor in the entire rural county. His wife became one of the few primary care practitioners in a neighboring county and the only woman. Needless to say, the recruiters had spent a fortune trying to lure qualified practitioners to the area but, until they met these Canadians, had had no success. And, the recruitment was a great success! When news of their problems reached their patients and state and local political leaders, there was an outpouring of support. These physicians filled a need and were warmly accepted in their community.

What went wrong? Simply put, immigration law contains many complex and ever-changing traps for the unwary. The immigration system might be described as an enforcement scheme which relies upon the death penalty to deter speeders. Not many police are hired and so it is rare to be caught speeding but the consequences are extraordinarily severe.

The two most common sources of foreign physicians who come to practice in underserved areas of the United States are Canadians and J-1 residents and fellows, all of whom graduated from medical schools abroad. Bringing in a foreign citizen physician who graduated from an American medical school is much simpler.

Canadians are in many ways the best source. In addition to being competent generally in English, their medical education is usually recognized in the United States as equivalent to an American medical education. Therefore, they can apply for and receive an immigrant visa and be licensed in most states. The immigrant visa normally requires a complex process called labor certification in which the Labor Department verifies that there are no Americans able and willing to take the job. However, in shortage areas, that process is often waived, as it was in the case of the Canadian physicians, in the "national interest." The problem is that it takes a very long time to complete all processing.

Therefore, a common strategy is to bring physicians here on a non-immigrant visa which generally takes far less time. Then, if things work out, an immigrant visa can be sought. The immigrant visa allows a person to remain here indefinitely and to become a citizen. The non-immigrant visa is a temporary work visa which for medical personnel is generally the H-1b and permits clinical practice in this country for up to six years.

However, believe it or not, to come here temporarily requires higher qualifications than to come here permanently. To receive the H-1b visa, any foreign physician must be what is called FLEX equivalent. That is, he or she must have taken the FLEX exam or parts I, II and III of the USMLE or other equivalent exams. To immigrate permanently, that is not necessary.

The two Canadian physicians in our story, like most Canadian physicians, did not need to take the FLEX exam or its equivalent. Therefore, while the U.S. government welcomed their willingness to come to a rural area and granted expedited processing, it would not grant them a temporary H-1b to come and begin to work during processing. Had they taken the FLEX exam, they could have received the visa, begun a clinical practice almost immediately and applied for their green card at the very same time.

Acting on the advice of their attorney, they applied for another visa called an TN or Trade NAFTA visa. This visa does not require the physician to have taken the FLEX exam or its equivalent. However, it also does not permit clinical practice, but only teaching and research. Their employer prepared to have them do some teaching, and they arrived in the United States.

Once again on the advice of their counsel, immediately after their arrival, they applied to adjust their status to that of legal permanent resident. They were granted temporary work authorization on the basis of having filed that request and began their practice. Folks in the county who had been without medical care now had it and the system seemed to have worked.

Eight months later, they were told their application had been rejected because they had committed fraud. When they came into the country on the TN visa, INS officials said that they had really intended to be legal permanent residents or immigrants, not non-immigrant TN physicians. Of course, in addition to coming temporarily to teach, it was obvious that that was also their intent since they had already filed an application to become legal permanent residents which had been granted by the INS. However, unlike the H-1b which they could have received had they taken the extra exam, the TN visa does not permit one to come temporarily and apply for legal permanent residence at the same time.

Confused? So were the physicians. They had applied to come to the United States permanently, had been granted permission to do so on an expedited basis because they had agreed to serve people who had limited access to medical care. Then, when they came to this county following the advice of their attorney, and began to do exactly what they had been granted permission to do, they were suddenly told that they had violated the law and were to be banned from the United States forever.

What are the lessons to be learned? First, the system is often confusing and rapidly changing. Expert advice is needed. Second, plan ahead and develop the patience of Job. Third, be extremely cautious of those who prescribe short cuts. There are those who cater to clients. impatience and counsel high-risk strategies. These sometimes seem to work, but often only because they are not detected. As the doctors in this story will testify, shortcuts can lead to extraordinarily difficult situations, even when the physician or hospital administrator is simply following legal advice.

In the end the doctors were finally granted permission to remain leading to a happy ending for both the physicians and their patients.

As Governor Don Sundquist's Administration transitions toward a second four-year term, the Tennessee Department of Environment & Conservation (TDEC) is moving from planning to implementation of its program to "reengineer" Tennessee's environmental regulatory programs. These changes may have significant impacts on the regulated community in areas ranging from permitting to enforcement to regulatory fee payments. This article explains the background of TDEC's ongoing reengineering program, explains its significant elements, and suggests the impacts it may have on the regulated community. What Is Reengineering? On March 21, 1997, TDEC Commissioner Milton H. Hamilton, Jr. announced a "bold new initiative to strengthen environmental protection and provide better customer service." TDEC's reengineering effort involves two basic changes to the State's administration and enforcement of environmental programs:

• A structural reorganization of TDEC from its historical emphasis on centralized bureaucracy and decision making to a new emphasis on decentralized bureaucracy and decision making.
• Procedural changes in the way TDEC permits regulated entities, solicits public involvement in permitting and rulemaking activities, and enforces environmental statutes and regulations.

Certification as an Environmental Law Specialist is not currently available in Tennessee. Historical Background TDEC's current reengineering effort can be traced to April 1996, when then-TDEC Commissioner Justin P. Wilson appointed an external, 8-member "Steering Committee on Environmental Permitting" (including Mike Pearigen of Waller Lansden's Environmental Group), subsequently expanded to 13 members, to provide input and oversight in streamlining (simplifying and expediting) TDEC's environmental permitting processes. Among the External Steering Committee's initial activities was the formulation of the following "Guiding Principles for Improved Environmental Permitting":

• Exceed current levels of environmental protection;
• Reduce burden of unnecessary permitting and record keeping requirements on the regulated public;
• Exceed current level of public participation;
• Reduce burden on regulatory agency resources while improving regulatory agency efficiency; and
• Make changes that benefit the Department, public and the regulated parties.

The External Steering Committee also assisted with the review and finalization of the Tennessee Industry Permits Handbook, which became available on the internet at TDEC's web page on January 1, 1997 and has been available from TDEC in printed form since May 1997. At the External Steering Committee's request, TDEC undertook to inventory and evaluate the type of permits it administers. Such an inventory had never previously been made and it was determined that, as of 1997, TDEC issued approximately 47 different types of permits. In addition, input from the Tennessee Association of Business (TAB) was solicited through a TAB members_ survey regarding permitting problems encountered by the regulated community and requesting recommendations for improvement. Commissioner Hamilton's March 1997 public announcement of the reengineering effort, approximately one year after the External Steering Committee was established, represented an expansion of TDEC's initial focus on permit simplification. Using EPA-Region IV grant monies, TDEC contracted with AT Kearney, Inc., a private management consulting firm, to analyze and redesign the agency's "core business processes." During the ensuing six months, the primary role of the External Steering Committee was to serve as a stakeholders_ sounding board; after September 1997, the External Steering Committee ceased to function and its role as a forum for stakeholder input was replaced with single-issue stakeholders_ meetings. As the year progressed, the evaluation and design effort shifted from AT Kearney to internal TDEC reengineering "teams" in the areas of "single point of entry," permit simplification, enforcement, information technology, and environmental fees. On-going decisions on specific components of the reengineering effort are being made by an internal TDEC Steering Committee which includes the following officials: Commissioner Milton H. Hamilton, Jr.; Deputy Commissioner Rick Sinclair; Assistant Commissioner Wayne Scharber; Director of Administrative Services Chuck Arnold; Director of Support Services Janey Blackburn; and Director of Human Resources Tom Callery. TDEC has established an Office of Reengineering to administer the overall reengineering effort, with veteran TDEC staffer Wayne Gregory serving as its Director.

Nashville Bar Journal
Volume 7, Issue 10

By now you have certainly heard of what is variously referred to as the "Year 2000 Problem" or the "Millennium Bug" or "Y2K." In short, come January 1, 2000, many computers may stop functioning or functioning in unexpected and therefore undesirable ways, based on their inability to process exactly what year it is.

From a comprehension standpoint, this computer problem is easy to grasp. Primarily in order to save memory space (which used to be a much more critical issue in programming than it is now) most computers were designed to recognize two-character designations for years . 89 meant 1989, 97 meant 1997, etc. This convention was carried forward, even as memory space became available to process four-digit year designations.

Unfortunately, this means that soon many computers will, at best, recognize 00 as 1900, not 2000. At worst, some computers will stop functioning completely while others will experience malfunctions that fall short of a complete shutdown.

From a technical standpoint, the issue is more complex. In many cases, entire computer systems, both operating systems software and programs, have to be rewritten to fix this problem. This may require the entry of new information in hundreds of thousands of lines of computer code.

In some industries, the problem is particularly acute. For example, some life insurance companies have been forced to rewrite information on each policy they have. They began the process of rewriting code several years ago. Insurance companies, heavy industry and even the New York Transit Authority have major problems.

The estimates of the cost of repairs vary, but $1 for each line of code is a fair guess, and that price is going up as the end of 1999 approaches. If you extrapolate that by, say, the number of policies held by a major insurance company you can get a feel for the scope of this problem. The repair cost is expected to exceed about $600 billion.

Some entities are ahead of the curve . bank regulators have been working on the problem for years; the U.S. Air Force is expected to announce that it is compliant any day. An initial test on major Wall Street brokerage houses went off without a hitch.

Other entities have larger problems. California Congressman Steve Horn issues a periodic "report card" of federal agencies. efforts to become Year 2000 compliant. Some are not projected to be ready until 2003.

Local courts getting ready

Because so many different types of businesses are using computers as an integral part of their operations, the scope of the problem is vast. Locally, the court systems are well advanced in their Year 2000 preparations.

"We are in the process of testing our software for Year 2000 compliance right now," said Claudia Bonnyman, the Davidson County Chancery Court Clerk and Master. "We have gotten a lot of technical help. We get a memo about every two weeks. We are testing our case management software right now and that testing is almost complete." She said.

Roger Milam, Clerk of the U.S. District Court for the Middle District of Tennessee, also reports that testing and correction is well underway.

"We are doing upgrades now. We have some patches that will need to be installed. We have a couple of hardware issues as well," he said. "We are no different than any other business or a big law firm - we have to be prepared."

As Milam mentions, law firms (of whatever size) are not immune to the Year 2000 problems. For example, let's presume you use a program to handle accounts receivable. You tell the computer to calculate amounts owed and then issue a statement for the client each calendar month beginning July 1998 and ending when the case is closed or the account payable amount reaches zero.

The program may send statements until December 1999 and then stop, because it was not instructed to send a statement before July 1, 1998 and the computer now calculates that it is January 1900. (Some computers will calculate other dates. A major air traffic control computer still in operation was set to calculate dates for years 1-37 beginning 1970; its problem will occur in 2007).

More likely than not, the account payable system in this example will simply refuse to respond at all.

Forward-looking transactional programs, such as those that calculate interest or make schedules, may already be hitting Year 2000 problems. However, even software that is not particular date-intensive, such as word processing software, could still crash when faced in January 1, 2000.

Steps to take

You should be taking steps now to handle Year 2000 problems. First, you should make sure than any new software you obtain is Year 2000 compliant. Do not assume that it is. Carefully negotiate your software license or inquire with your vendor to make sure you are not acquiring a new problem.

Second, determine if your existing software is compliant. Many software producers have web sites that state the Year 2000 readiness of their various products. If you have stopped paying for support and maintenance on a particular piece of software, or never had support, it is advisable to contact the manufacturer of the software to see if there is a problem and to see if there is a fix.

You should also allocate some time to investigate whether it is more cost-effective to buy new Year 2000 compliant software than to fix the old software. Take the same steps with your computer hardware - after all, if the operating system shuts your central processing unit down, all that compliant software is just so much worthless code.

Third, the biggest problems come with software you created yourself or had created for your firm. The older such software is, the more likely it has a problem. Try to have your programmer investigate the issue. Independent computer experts are available to test and resolve problems. Those experts are going to become less and less available as we get closer to the end of 1999.

Fourth, beware of a hidden virus-like problem that exists underneath the Year 2000 bug. Even if all of y our software is compliant, in certain situations your compliant software can be "infected" with the problem by interaction with other programs not compliant or by importing information from non-compliant sources. If your computer system interacts with other computer systems, such as those operated by clients, make sure they are compliant as well.

Governor's Tax Worksheet Corporations complete Parts I, II, and III. Partnerships, sole proprietorships, limited liability companies and other businesses not in corporate form use Part II only to calculate the tax cost applicable to the business. I. Most recent computed Tennessee Franchise Tax $ Most recent computed Tennessee Excise Tax $ Baseline Tax = $ II. Net Income for such year less $50,000 Tennessee Allocation Percentage x % Net Income Subject to Governor's Tax = $ Compensation expense for such year less $50,000 Tennessee Allocation Percentage x % Net Compensation Subject to Governor's Tax = $ Sum of Net Income and Net Compensation $ x 2.5% Governor's Tax = $ III. Governor's Tax minus Base Line Tax = $

Introduction

On February 24, 1999, Governor Sundquist's "Tax Relief and Fairness Act" was formally introduced in the Tennessee General Assembly as House Bill 1683 (the "Bill"). The Bill is estimated to increase business taxes in Tennessee by more than $1 billion. The Bill provides for a new business tax which replaces the current corporate franchise and excise taxes. The new business tax is a tax on all businesses equal to 2.5% of the compensation paid by the business to its employees (less $50,000) and 2.5% of the "net earnings" of the business (less $50,000).

This Memorandum summarizes the key components of the Bill. You can obtain a copy of the Bill, along with commentary, from our website at www.wallerlaw.com. Please click on "Resource Center" and then click on "Articles."

Tax On Net Earnings

General

The Bill imposes a tax on "business net earnings." Net earnings are generally equal to the businesses_ net income as determined for federal income tax purposes. As a result, a number of the special adjustments to federal taxable income currently required by T.C.A. Sec. 67-4-805 to calculate business earnings under the excise tax are eliminated.

Business earnings are broadly defined under the Bill. Business earnings include all earnings arising from the regular course of a trade or business. Generally, the taxpayer has the burden to prove that earnings should be classified as non-business earnings. Business earnings will include rental income from real property, revenues from an owner's interest in oil and gas property, farm earnings, songwriter royalties and the gain on the sale of real estate that is used in a trade or business. An individual, for example, who owns several duplexes which he rents will be subject to the business tax with respect to the rental income and any gain on the sale of those properties.

Tax-Exempt Bonds

Interest on tax-exempt bonds, including Tennessee state and local bonds, held by a business are required to be included in the business. net earnings.

Net Operating Loss

A company which has a net operating loss carryforward available under the excise tax can carry that net operating loss forward and deduct it against net earnings for purposes of the business tax. A business that recognizes a net operating loss after the effective date of the business tax can carry that net operating loss forward and offset it against future net earnings. Net operating losses can be carried forward for 15 years from the date the loss is incurred. Surprisingly, and contrary to federal tax law, a net operating loss does not survive a merger or consolidation if the company which incurred the loss is not the survivor in the transaction.

Apportionment

Net earnings of a multi-state business are apportioned among Tennessee and other taxing jurisdictions under apportionment formulas which appear virtually identical to the apportionment formulas currently found in the excise tax. The Bill, like the current excise tax, provides for a standard apportionment formula and special apportionment formulas for industries such as common carriers, financial institutions filing as a unitary group, and insurance companies.

Anti-Abuse Provisions - Commissioner's Authority

The Commissioner is empowered to modify the apportionment formulas if the compensation or apportionment does not fairly represent the extent of the taxpayer's business activity in Tennessee. In addition, the Commissioner is given the power to distribute, apportion, or allocate income, deductions, credits or allowances among businesses owned or controlled by the same interests "in order to prevent evasion of taxes, excessive use or abuse of exemptions, or to clearly reflect the income." The Commissioner may disregard any entity created or transaction made which has no business purpose or is created or made with the primary purpose of evading federal or state taxes. While similar authority exist under current law, that authority is expanded by the Bill.

Tax on Compensation

General

The new business tax is imposed on all "compensation" paid for "Tennessee service."

Compensation Defined

Compensation includes all remuneration, from whatever source derived. Specifically included are salaries, commissions, bonuses and tips. In addition to cash based compensation, "compensation" includes stock based compensation and many fringe benefits which are not taxable as income for federal income tax purposes as well as the fair market value of other remuneration in any medium other than cash.

1. Fringe Benefits. Taxable compensation includes (a) employee's salary reduction contributions to a 401(k) Plan, (b) employee salary reduction contributions to a cafeteria plan created pursuant to Section 125 of the Internal Revenue Code (c) employer paid parking (d) employer provided automobile or automobile allowances and (e) disability payments made to an employee during the first six months of disability. Payments for medical care or hospitalization by a self-insured employer are excluded from compensation. The Bill appears to include as taxable compensation, amounts paid by an employer to a third party insurance company for healthcare coverage for employees.

2. Stock Based Compensation. Taxable compensation will include the value of all stock received by an employee and appears to include the value of all options delivered to an employee, regardless of whether those options are non-qualified options or incentive options for federal income tax purposes. Discounts on stock purchased through an Employee Stock Purchase Plan, which is not taxable for federal tax purposes, will be taxable compensation in Tennessee.

3. Tips. Tips must be included in compensation to the extent the tips are required to be reported to the Internal Revenue Service.

Cap on Compensation Included in the Business Tax Base

The business tax only applies to the first $300 million of a businesses. compensation. The cap applies separately to each member in a group that files a combined return. The Governor has announced that the cap will affect ten or fewer businesses in Tennessee. Administration officials have indicated, as reported by The Tennessean on February 23, that the aggregate tax savings of all of the corporations affected by the cap is approximately $20 million. However, The Knoxville News-Sentinel reported on February 1 that Federal Express would pay $32.5 million in compensation tax without the cap and only $7.5 million with the cap, a tax savings of $25 million for Federal Express alone.

Domestic Service Excluded

Payments made for domestic services in a private home are excluded from compensation for purposes of the business tax.

Tennessee Services

Compensation is only subject to the Tennessee tax if paid in respect of "Tennessee services." An employees_ compensation is in respect of Tennessee services if the services are performed entirely within Tennessee or if any services performed outside of Tennessee are incidental to the services performed in Tennessee. All of the compensation paid to an employee will be deemed paid in respect of Tennessee services and taxable in its entirety, even if the employee only performs minimal services in Tennessee if any of the following circumstances exist: (A) employee's base of operation is in Tennessee; or (B) the employee has no base of operations in Tennessee but the employee's services are directed or controlled in Tennessee; or (C) the individual's base of operations or place from which such service is directed or controlled, is not in any state in which some service is performed and the individual's residence is Tennessee. All of the compensation paid to an employee will be Tennessee service taxable in its entirety even if the employee performs no services in Tennessee if the employer has no place of business in the United States and the employer is (A) an individual who is a Tennessee resident, or (B) a corporation organized under the laws of the State of Tennessee, or (C) a partnership or trust which has more Tennessee residents as partners or trustees than there are partners or residents of any other state.

For example, a company which is doing business in Tennessee, whose corporate headquarters is in New York, who employs a traveling salesman who lives in Tennessee, has one client in Tennessee but who only principally services Alabama, Mississippi and Georgia exclusively will have to include the compensation of that salesman in the compensation tax base.

Exemptions

The business tax generally does not apply to organizations exempt under sections 401(a), 501(c) and 501(d) of the Internal Revenue Code, which include qualified pension plans, charitable and educational institutions, labor unions and religious organizations. Compensation and net earnings attributed to activities unrelated to and outside the scope of the activity giving rise to exempt status is , however, taxable All earnings of a charity which is unrelated taxable income and all compensation attributable to the activities generating that income will be subject to the business tax. In addition, industrial development corporations and certain regulated investment companies and investment funds whose principal assets are federal and Tennessee bonds are exempt. Insurance companies are phased out of the business tax just as they were being phased out of the franchise and excise taxes.

Credits

Hospital Companies

A company which owns and operates ten or more hospitals and which qualified as a hospital company under current law on or before January 1, 1999 will, for tax years, beginning before December 31, 2006 be entitled to an annual credit of up to $9,000,000 equal to the sum of:

1. The lesser of (a) 2.5% of its compensation or (b) 2.5% of its net earnings; and
2. Four percent of its cost of medical supplies and equipment.The hospital company credit is similar to that which exists under current law.

Other Credits The business tax preserves the gross premium credit for insurance companies, the job creation credit and the industrial machinery credit. Formulations of the credit, and limitations on the amount of the credit are slightly different than under current law. While capital is not taxed under the Bill, minimum capital investment still continues to be a requirement for the jobs credit. Filing Requirements and Quarterly Estimated Tax Payments Annual tax returns must be filed on or before the 15th day of the fourth month following the close of the taxpayers_ tax year. A "fair business" tax return is not required for accounting periods ending on or before June 30, 1999. Taxpayer's with periods ending on or after July 1, 1999, must file a "fair business" tax return based on such period. Taxpayers with periods beginning before July 1, 1999 and ending on or after July 1, 1999 and who are currently subject to the franchise and excise taxes, must file a franchise/excise tax return with the taxes due prorated accordingly. Businesses with a tax liability of $5,000 or more for the prior tax year or the current year must make four equal quarterly estimated tax payments for the current year. The due dates for estimated tax payments have been accelerated by the Bill. Payments are due on the 15th day of the fourth, sixth and ninth months of the company's fiscal year and the 15th day of the first month of the next fiscal year. Mandatory Combined Returns The Bill directs the Commissioner to conduct a study to determine whether combined returns should be mandatory for all affiliated entities for purposes of the business tax. This study is to be completed by October 1, 2000. Allocation to Cities and Counties The Bill includes a schedule for the distribution of a portion of the new business tax to cities and counties. The scheduled amounts for the 1999 fiscal year are intended to approximate the local option portion of the sales tax on food. The amount distributed to the cities/counties is increased by 4.5% for the 2000 fiscal year. Thereafter, the amount is increased by the overall percentage increase in business tax collections. A similar distribution is made to each city and county in lieu of the bank excise tax it previously received. The Bill also provides that different amounts shall be distributed to premier resort areas. Conclusion The new business tax is a material change in the taxation of business operations in Tennessee. As with all tax changes, there are winners and losers. It is clear, however, that, in the aggregate, businesses in Tennessee will pay approximately $1 billion more in taxes under the Bill. The ramifications to future job growth and job retention in Tennessee should be understood and carefully considered.

The deadline for introduction of new legislation in the 1999 Tennessee General Assembly has passed and this issue of the Waller Lansden Environmental Group Bulletin includes a summary of environmental, natural resources, and other regulatory bills of interest that have been introduced. Among other legislative proposals is a bill (SB 1854 / HB 1681) to establish a formal "Brownfields Program", which has the support of the Tennessee Homebuilders Association, and a bill (SB 1221 / HB 274) that would suspend the effectiveness of a water quality permit during the time that a citizen complaint filed under the Tennessee Water Quality Act is being investigated. If you would like more information about any of these bills, feel free to contact any of the attorneys listed at the end of this Bulletin.

TDEC Holds First Public Hearing in ARAP Rulemaking Process

Prior issues of this Bulletin have discussed Aquatic Resource Alteration Permit (ARAP) regulations proposed by TDEC. Following the Tennessee Water Quality Board's decision on December 15, 1998 to initiate formal rulemaking proceedings, a draft of the proposed rules was published in the January 15, 1999 issue of the Tennessee Administrative Register. TDEC held its first public hearing on the proposed rules on February 25, 1999 in Nashville. At that public hearing, a number of environmental community representatives and activists provided comments for the rulemaking hearing record, generally criticizing the proposed rules as not being strict enough and criticizing TDEC for developing a new draft of the proposed rules (which was first distributed at the public hearing) without public input since the January 15 TAR version was published. No representatives of the regulated community spoke at the public hearing. Public hearings on the ARAP rulemaking proposal will also be held as originally scheduled in Knoxville on March 2, 1999 and in Memphis on March 4, 1999. In addition, environmental community representatives requested that additional public hearings be held and TDEC announced at the February 25 hearing that another round of public hearings (presumably also in Nashville, Knoxville, and Memphis) will be scheduled, with some or all to take place in the evening to avoid conflicting with normal working hours of members of the public. TDEC Proposes New Draft General ARAP Permits for Public Comment TDEC also unveiled 9 new draft general ARAPs at the February 25 ARAP rulemaking hearing, as follows:

• Relocation of Intermittent Streams
• Impoundment of Intermittent Streams
• Culverting of Small Streams
• Maintenance Activities
• Surveying & Geotechnical Exploration
• Wetlands Restoration & Enhancement
• Dredge & Fill in Reservoirs
• Bank Stabilization Activities
• Development of Springs

Pursuant to the Tennessee Water Quality Control Act, the Commissioner of TDEC is authorized to issue general permits without a rulemaking proceeding to regulate "a category of activities." Nevertheless, TDEC announced at the February 25 public hearing that it planned to accept public comment on the proposed general ARAP permits and to further develop them into final form in conjunction with the ARAP rulemaking process. Manager of Waste Processing Facility Pleads Guilty to Illegal Disposal The manager of Environmental Waste Reductions, Inc., recently pleaded guilty to two counts of illegally dumping medical waste and animal carcasses at a waste processing and consolidation facility in Wilson County. Environmental Waste Reductions was formerly based in Atlanta, but no longer exists due to being sold in bankruptcy. The company's Lebanon facility had contracts with Metro Nashville and several Middle Tennessee companies to process and dispose of waste. The violations occurred during the summer of 1997 when employees of the company cleaned out medical waste containers in a parking lot. The waste, which included human blood, gauze, a used syringe, and animal carcass wastes, subsequently ran into a storm drain and then into an open ditch. In announcing the guilty plea, then-Tennessee Attorney General John Knox Walkup said, "Environmental crimes are serious matters and should concern everyone." EPA and U.S. Fish & Wildlife Service Propose Memorandum of Agreement on Clean Water Act Consultation The U.S. Environmental Protection Agency (EPA) and the U.S. Fish and Wildlife Service (FWS) recently issued a public notice and requested comments on a proposed Memorandum of Agreement (MOA) calling for EPA to consult with FWS on various programs and decisions under the Clean Water Act (CWA). See 64 Fed. Reg. 2742 (Jan. 15, 1999). If this MOA is implemented, EPA would enter into formal consultation with FWS on the impact to endangered and threatened species: (i) when EPA establishes national water quality criteria; (ii) when EPA approves state water quality standards; (iii) when EPA approves state NPDES permit programs; (iv) when EPA reviews state-issued NPDES permits; and (v) when EPA issues federal NPDES permits. This MOA represents a significant intrusion of endangered species concerns into CWA programs. In states with numerous listed species that live in or depend on water, this MOA will likely make it more difficult to obtain discharge permits, impose more stringent permit limitations, and increase burdens on state agencies implementing CWA programs. Comments on this proposed MOA must be submitted to EPA by March 16, 1999. Sealed Sources of Radioactivity to Be Further Regulated The U.S. Nuclear Regulatory Commission (NRC) has proposed new regulations that would require companies that own sealed sources of radioactivity to take additional steps to prevent these sources from being disposed of improperly, lost, or stolen. The regulation would affect companies that possess such sources of radiation as exit signs, calibration standards, thickness gauges, and level gauges. The NRC proposal includes registration requirements, compliance verification procedures, storage time limitations, inventory performance, and appointment of a responsible individual. The NRC proposal contains provisions that affect holders of both specific and general licenses. SEC Imposes Sanctions on Company and Officers for Failure to Disclose Environmental Liabilities The Securities and Exchange Commission (SEC) imposed sanctions on and issued cease and desist orders to a company and some of its officers for failing to disclose the existence of known environmental liabilities in the company's periodic reports to the SEC. Lee Pharmaceuticals, a California manufacturer of dental and cosmetic products, learned of high levels of contamination in its soil and groundwater in 1987. The California Regional Water Quality Control Board ordered Lee to investigate the contamination in 1988 and 1989, and Lee's consultant confirmed the contamination in written reports and letters to Lee in 1989 and 1990. A second environmental consultant observed Lee spilling chemicals at an area already confirmed to be highly contaminated, and the Water Board identified hazardous chemicals leaking into the soil from industrial waste equipment. In addition, Lee was named as a potentially responsible party (PRP) at a California Superfund site. The SEC found that Lee's Chairman of the Board, President and Chief Executive Officer, and Vice President of Finance and Chief Financial Officer violated or willfully violated provisions of the Securities Exchange Act of 1934 and the rules promulgated thereunder. Lee committed the violations by filing 10-K and 10-KSB reports to the SEC from 1991 to 1996 that contained misrepresentations and omissions about Lee's environmental contamination, investigation, cleanup responsibilities, and liabilities. Specifically, the SEC found that Lee materially understated its environmental responsibilities, misstated that EPA did not require a cleanup, falsely stated that it had no information about cleanup costs, failed to disclose that it was conducting an environmental investigation, falsely claimed that it had complied with environmental protection laws, failed to disclose environmental test results, and falsely denied it was a PRP at an EPA Superfund site. The SEC concluded that Lee's misrepresentations and omissions were material because reasonable investors would deem it important that Lee owned highly contaminated property, continually failed to comply with environmental laws, was named a PRP and had not been excused by EPA of cleanup obligations, and possessed estimates of the cleanup costs at its own property and the potential liability estimates at the Superfund site. The SEC, concluding that Lee used its SEC filings from 1991 to 1996 to mislead investors about the nature and extent of Lee's environmental responsibilities and liabilities, sanctioned and issued cease and desist orders to the company and its officers. The SEC's Order against Lee and its referenced officers was issued contemporaneously with its acceptance of an Offer of Settlement made by the company and officers. If you have any questions about any of the matters discussed herein, please do not hesitate to call Walter Crouch, Bob Martineau, James Weaver, Ed Callaway or Michael Stagg.

Healthcare legislation pending before the Tennessee General Assembly

We have grouped the major pieces of healthcare legislation currently pending before the Tennessee General Assembly into the below listed categories. This list is not intended to be an exclusive listing of all healthcare legislation; rather, it is our attempt to organize the majority of healthcare bills by category into a user-friendly manner for our clients and friends.

Due to space limitations, we have only included the bill numbers, rather than a complete bill summary. Please click on a category to see the corresponding bill numbers for that issue. Bills are listed by Senate Bill (SB) or House Bill number (HB). In Tennessee, in order to become law, a bill must be passed by both houses of the General Assembly, which is why you will see Senate and House bills grouped together (i.e. SB 65/HB 56 represents one piece of legislation).

To see the full text of a bill, please go to the General Assembly’s home page at http://www.legislature.state.tn.us which is linked to this document. Just click on "Legislative Information" and then "Bills Search" in order to pull up a bill by its bill number. If you have any questions please call or e-mail one of the attorneys in our Healthcare Group. Board Certification & Licensure: SB 477/HB 578; SB 524/HB 650; SB 593/HB 565; SB 602/HB 607; SB 627/HB 1251; SB 695/HB 691; SB 740/HB 1461; SB 764/HB 884; SB 773/HB 1460; SB 814/ HB 1057; SB 969/HB 1245; SB 1031; SB 1032/HB 1368; SB 1042/HB 1792; SB 1191/HB 1308; SB 1290/HB 783; SB 1376/HB 1614; SB 1378/HB 1354; SB1568/HB 1257; SB 1621/HB 1236; SB 1648/HB 1353; SB 1652/HB1622; SB 1701/HB 1484; SB 1721/HB 1679; SB 1834/HB 1564; SB 1848/HB 1456; SB 1922/HB 1457; HB 531; HB 890. Certificate of Need: SB 320/HB 1229; SB 323/HB 1230; SB 406/HB 1227; SB 906/ HB 497; SB 1103/HB 1047; SB 1112/HB 1069; SB 1409/HB 1256; SB 1674/HB 1637. General Health Care: SB 31; SB 64/HB 55; SB 161/HB 910; SB 284/HB 579; SB 285/HB 580; SB 290/HB 1177; SB 295/HB 256; SB 296/HB 257; SB 309/HB 227; SB 311/HB 233; SB 213/HB 1364; SB 315/HB 537; SB 320/HB 1229; SB 323/HB 1230; SB 339/HB 315; SB 347/HB 214; SB 402/HB 1467; SB 404/HB 1465; SB 406/HB 1227; SB 408/HB 1228; SB 409/HB 1163; SB 416/HB 299; SB 426; SB 435/HB 540; SB 454/HB 1386; SB 456/HB 445; SB 460/HB 114; SB 548/HB 681; SB 566/HB 1511; SB 593/ HB 565; SB 600/HB 606; SB 605/HB 570; SB 682/HB 1410; SB 652/HB 1088; SB 672/HB 334; SB 681; SB 686/HB 791; SB 697/HB 687; SB 698/HB 692; SB 705/HB 304; SB 774/HB 1302; SB 783/HB 543; SB 790/HB 273; SB 817/HB 1345; SB 841/HB 502; SB 842/HB 1145; SB 846/HB 949; SB 851/HB 1513; SB 884/HB 1641; SB 893/HB 672; SB 932/HB 647; SB 951/HB 807; SB 967/HB 1639; SB 978/HB 879; SB 1018/HB 562; SB 1020/HB 943; SB 1038/HB 1621; SB 1039/ HB 1623; SB 1040/HB 906; SB 1041/HB 1561; SB 1051/HB 1376; SB 1052/HB 595; SB 1058; HB 1800; SB 1070/HB 560; SB 1071/HB 1673; SB 1072/HB 1373; SB 1085/HB 1728; SB 1102/HB 1420; SB 1103/HB 1047; SB 1112/HB 1069; SB 1158/HB 1218; SB 1177/HB 944; SB 1231/HB 972; SB 1245/HB 644; SB 1251/HB 932; SB 1255/HB 1437; SB 1280/HB 1377; SB 1290/HB 783; SB 1377/HB 1054; SB 1405/HB 1348; SB 1405/HB 1348; SB 1409/HB 1256; SB 1419/HB 1598; SB 1460/HB 628; SB 1494/HB 1225; SB 1499/HB 803; SB 1500/HB 801; SB 1512/HB 820; SB 1526/HB 866; SB 1554/HB 1277; SB 1560/HB 1293; SB 1582/HB 1468; SB 1605/HB 1121; SB 1606/HB 1122; SB 1625/HB 1075; SB 1672/HB 1657; SB 1674/HB 1637; SB 1678/HB 1326; SB 1696/HB 1802; SB 1699/GB 1638; SB 1748/HB 1827; SB 1752/HB 1686; SB 1756/HB 1620; SB 1759/HB 1645; SB 1760/SB 1893; SB 1776/HB 1855; SB 1799/HB 1878; SB 1804/HB 1615; SB 1829/HB 1762; SB 1908/HB 1595; HB 1685; SR 005. Health Care Insurance: SB 79/HB 170; SB 360/HB 310; SB 376/HB 714; SB 598/HB 146; SB 779/HB 1213; SB 789/HB 703; SB 811/HB 695; SB 1046/HB 1226; SB 1106/HB 894; SB 1117/HB 673; SB 1172/HB 847; SB 1225/HB 973; SB 1284/HB 881; SB 1495/HB 822; SB 1562/HB 1073; SB 1573/HB 1192; SB 1677/HB 1821; SB 1690/HB 1772; SB 1814/HB 1820; SB 1873/HB 1710. Kickbacks: SB 606/HB 544. Nonprofit Hospitals: SB 65/HB 56; SB 454/HB 445. Nursing Care: SB 402/HB 1467; SB 403/HB 1466; SB 409/HB 1163; SB 814/HB 1057; SB 1799/HB 1878. Outpatient Facilities: SB 1377/HB 1054. Patient Bill of Rights: SB 376/ HB 1192; SB 602/HB 607; SB 705/HB 304; SB 789/HB 703; SB 790/HB 273; SB 811/HB 695; SB 841/HB 502; SB 1117/HB 673; SB 1225/HB 973. Payment to Providers: SB 1046/HB 1226; SB 1106/HB 894; SB 1495/HB 822 (Most Favored Nation Bill); SB 1567/HB 1462; SB 1573/HB 1192. Taxes: SB 66/HB 54; SB 384/HB 733; SB 405/HB 1084. Telemedicine: SB 652/HB 1088. TennCare: SB 233/HB 235; SB 235/HB 1021; SB 317/HB 1360; SB 324/HB 318; SB 325/HB 332; SB 328/HB 484; SB 329/HB 483; SB 364/HB 320; B 457/HB 1387; SB 461/HB 1081; SB 550/HB 487; SB 551/HB 486; SB 553/HB 485; SB 594/HB 87; SB 696/HB 512; SB 719/HB 1098; SB 778/HB 680; SB 935/HB 893; SB 1047/HB 1211; SB 1054/HB 116; SB 1107/HB 810; SB 1127/HB 1434; SB 1224/HB 913; SB 1249/HB 1352; SB 1253/HB 1435; SB 1254/HB 1436; SB 1256/HB 1432; SB 1324/HB 984; SB 1338/HB 1011; SB 1340/HB 1013; SB 1381/HB 1536; SB 1407/HB 1076; SB 1451/HB 1535; SB 1541/HB 1624; SB 1557/HB 1805; SB 1633/HB 467; SB 1643/HB 1421; SB 1644/HB 1617; SB 1733/HB 1725; SB 1738/HB 1658; HB 1037; SJR 100.

On February 8, 1999, in his State of the State address, Governor Don Sundquist proposed the elimination of the Tennessee sales tax on groceries and a radical new business tax structure. In the governor's own words: "What I propose are the most sweeping business tax changes Tennessee has undertaken in three-quarters of a century." The purpose of this article is to familiarize the reader with the governor's proposal (the "Fair Business Tax") and present some initial observations concerning the proposed tax. Each businessman, employee and business owner needs to clearly understand the implications of the Fair Business Tax to the business in which he or she is involved and the businesses of Tennessee. A critical element of the governor's proposal is a tax on the compensation of Tennessee's private sector employees and represents a massive (over a billion dollar) business tax increase providing an aggregate effective excise (income) tax rate on corporations doing business in Tennessee of approximately seventeen percent (17%). In addition, there are many important subtle ramifications. Many Tennessee businesses will find that the cost of doing business will greatly increase and that the raising of capital will be more difficult and expensive. In addition, the governor proposes a July 1, 1999, effective date for the new tax. There is no phase-in of the proposed tax nor phase-out of the existing franchise and excise taxes. As a result, many, if not most, businesses will have significant unforeseen and almost immediate need for cash this year. Business must project their cash flow needs in light of the governor's proposed tax plan. As illustrated in this article, some capital intensive businesses will find that the cost of doing business in Tennessee will decrease as a result of the governor's proposal. For those who believe that a repeal of taxes on capital and the imposition of a tax on payroll is the proper route, they should speak out. For those who believe that a repeal of taxes on capital and the imposition of a tax on payroll is not proper, they should speak out. The social and economic costs of casting aside the fundamental model of business taxation used by the surrounding states (and up to now, Tennessee) and adopting a new one that is not compatible with the tax structure of surrounding states are very high. Once that cost is incurred, it will be very hard to go through the process to return to the historic business taxation structure and/or adopt a different business tax structure. Fundamental changes in the tax structure are unsettling to the economy and to business in general. The proposed tax should be taken seriously and all business owners should be encouraged to review their business plans with respect to capital expenditures and employment starting with the second half of the year. For better or worse, radical changes in Tennessee's business tax model will significantly impact Tennessee's future economic development, i.e., businesses attracted to Tennessee, the kinds of jobs created, and the general economic condition of Tennessee. The future prosperity of Tennessee's citizens and the opportunities of their children will be altered. The new tax - In the governor's own words At the time this article was originally written, the Fair Business Tax proposed statutory language had not been released. Even though the legislation is now released, the best way to understand the tax proposal and why the governor says it is necessary is to review the governor's exact words from the State of the State speech: "...A vast and growing amount of economic activity is taking place beyond the reach of our state's principal business taxes, and those who do pay the tax, pay one of the higher tax rates in the southeast. This is the situation I propose to remedy - not by raising business tax rates -- but by cutting them, and applying them fairly and broadly as a part of a package of tax reduction, simplification, and reform: the Tax Relief and Fairness Act of 1999. I call on the General Assembly:

• To repeal the sales tax on grocery food;
• To repeal the franchise and excise taxes; and
• To replace them with a single, simplified and lower business tax rate, applied fairly to all businesses in Tennessee, regardless of how they are organized...

The Tax Relief and Fairness Act also repeals the franchise & excise taxes and replaces them with what we call the fair business tax. It represents tax savings for many and tax fairness for all. It is also simple; the return fits on the front of a single sheet of paper. It involves a straight-forward calculation: 2.5 percent of a company's compensation and 2.5 percent of the profit it reports for federal tax purposes. We will exempt the first $50,000 in each category. With those exemptions, more than 100,000 small businesses -- sole proprietorships, family farms -- will owe no tax and won't even have to file a return. The fair business tax treats all businesses alike, regardless of how they choose to organize themselves. And because the fair business tax applies to all businesses, we can afford to sharply reduce the business tax rate. At 2.5 percent, it will be one of the lowest business tax rates in America. For companies looking for a fair deal, our state will be even more attractive as a business location. But those looking for tax loopholes should look elsewhere. You will hear the outcry of those who have had a free ride and now object to paying their fair share. You will hear from those who say we ought to preserve special breaks for some businesses and impose an income tax on working Tennesseans. That is not tax relief; it's not tax reform; it's not tax simplification; and it's not tax fairness. All an income tax does is raise the tax burden on Tennesseans and create a way to finance the easy and endless expansion of government. Tennessee does not need a state income tax. I know you will be heavily lobbied -- especially since our tax applies to lobbyists, too -- but make sure the lobbyists aren't the only ones you listen to. Listen as well to the softer and more numerous voices of those who will pay less; the thousands of businesses for whom we provide fairness and lower rates; the millions of families for whom we provide sales tax relief. What I propose are the most sweeping business tax changes Tennessee has undertaken in three-quarters of a century. The Tax Relief and Fairness Act of 1999 accomplishes what Austin Peay's reforms did in the 1920s - they adapt our business tax structure to the way business is done today:

• We treat every business the same
• We close loopholes
• By making the business tax simple, we make it harder for people to game the system, and by cutting the tax rate, we vastly reduce their incentive to try

The governor also stated: "F&E taxes apply to corporations. In the 1920s, that is how the vast majority of businesses organized themselves. Today, however, businesses have other options; they can organize as limited liability companies or LLCs, as limited partnerships; as sole proprietorships -- all entities which operate outside the boundaries of our F&E taxes. What's more, the passage of time and changing business practices have revealed the F&E tax to be full of loopholes. For example:

• One business in this state reorganized itself in 1997 and cut its state taxes from about $195,000 to just $10 -- not $10,000 -- $10.00!
• In another instance, a national chain with outlets in Tennessee reorganized and lowered its state taxes from nearly $1 million to $7,000.

Many businesses are able to essentially zero-out their tax liability with the stroke of a pen -- and increasing numbers of them are doing just that. As a result, at a time when our economy is strong -- in fact, in the midst of the best economic year we've ever had -- F&E tax collections this fiscal year are running 8 percent below actual collections from the previous year. And it will get worse. Our F&E tax is projected to erode by more than $100 million annually for years to come." (Note: The footnotes are the author_s.) The new tax - Components and initial observations on some of its potential ramifications The governor's tax proposal is a massive increase in the corporate tax burden as well as the imposition of tax on entities (and sole proprietors) that Tennessee has not heretofore taxed. The tax bill does four things. First, it eliminates the tax on capital through the repeal of the franchise tax. Second, it reduces the tax on corporate net income by reducing the rate applicable to corporate net income from 6 percent to 2.5 percent. Third, it imposes on corporations a tax based on the compensation each corporation pays. Fourth, with respect to business conducted in other than corporate form (including business directly conducted by a sole proprietor), it imposes the tax on net business income and the tax on compensation. As presented, the result of these four things is the removal of tax on capital, the imposition of a tax on the income of labor, and a massive tax increase on business of over a billion dollars. First, the repeal of the franchise tax means business is not taxed on the capital it deploys in Tennessee. This will be an incentive for the expansion of plant and equipment in Tennessee. However, the governor's tax proposal may also be an incentive for business to invest capital for the purpose of reducing employment in Tennessee and thereby reducing the tax the business pays. Second, under the current excise tax, corporations are taxed at 6 percent on their net income which will be reduced to 2.5 percent. In calculating net income, the excise tax starts with federal taxable income and then makes adjustments. In addition, corporations doing business in Tennessee and one or more other states "apportion" their income between Tennessee and the other state(s). This apportionment is required under the United States Constitution. The governor's proposal, including the "simple form" that was released in conjunction with the proposal does not provide for apportionment. Presumably such basic refinements and complexities will be added or Tennessee will have no tax on business or at least businesses with some component outside of Tennessee. If the same apportionment formulas are used (with or without making the adjustments that are presently provided for in the excise tax), the proposal will reduce the portion of Tennessee taxes corporations pay based on their net income. At a 2.5 percent rate on all net income above $50,000, corporations will be encouraged to source earnings to Tennessee as its tax rate would be lower than most other states. Third, the governor's proposal places a 2.5 percent tax on all compensation paid by corporations less the $50,000 exclusion. Unlike the traditional tax base of net income and capital, nearly all other taxing jurisdictions do not extend the tax base to include compensation. The immediate and direct cost to corporate business is huge and is the reason the corporate tax burden measured in dollars is almost doubled. Unless the corporation's compensation expense (less $50,000) is 140 percent or less of the business_ net income, the governor's proposal will exceed the corporation's excise tax. This cost can be minimized by corporations expanding their employment outside of Tennessee and by reducing their employment in Tennessee. Fourth, with respect to those forms of business that are currently not taxed by Tennessee, such as partnerships and limited liability companies, and which are not taxed for the most part by other states (and are not taxed by any of the states adjacent to Tennessee), the governor's proposal will be a new, immediate and significant cost of doing business in Tennessee. This is a cost which can be avoided by not hiring people to work in Tennessee. With respect to these unincorporated businesses headquartered in other states and with significant operations in other states, the proposal will mean new compliance requirements imposed upon them that are not imposed by the other states. Will foreign unincorporated businesses (particularly sole proprietorships, general partnerships and trusts which are not required to register to do business in Tennessee or virtually any other state) actually report and pay the new tax to Tennessee? Again, these forms of businesses are not taxed by any of the states surrounding Tennessee and just as people will go across state lines to buy groceries, businesses will go across state lines to operate. Issues in analyzing those businesses which will be required to pay taxes Comparing which businesses are required to pay taxes under current law (consistent with the taxing structure of other states in which Tennessee must compete for economic growth) and the magnitude of those taxes to which businesses will be required to pay under the governor's proposal are very important and quite involved. Unless one believes that businesses are insensitive to how many dollars in taxes they pay but are only sensitive as to the rate of the tax, the amount of tax in absolute terms and as a percentage of net income will modify business behavior. Conceptually, there are several levels of analysis.

1. Impact on corporations. Since corporations are currently required to pay taxes, how the Fair Business Tax affects them will involve an analysis of the following:
• Will the corporate tax as a whole increase or decrease
• Corporations in what industries generally will have reduced taxes and which generally will have increased taxes?
• What is the long-term economic growth and employment implication of incentivizing those corporations which will pay less tax and deincentivizing those corporations who will pay more tax?
• What are the investment and lending implications on corporations primarily doing business in Tennessee as a result of the new tax?
2. Impact on business entities other than corporations.
• What will a sudden large tax on businesses that currently are not subject to tax and which do not pay tax in the surrounding states mean?
3. Impact on multi-owner businesses other than corporations.
• These businesses will suddenly have a new and often very significant cost of doing business in Tennessee.
• What is the long-term economic impact (reduction of existing business and/or reduction in growth of new business) of imposing a tax on these businesses when tax is not imposed by the adjacent states?
• What are the investment and borrowing implications of the new tax on Tennessee business?* What will be the level of compliance of these businesses, particularly those primarily based out of Tennessee, with this tax?
4. Impact on sole proprietorships.
• Sole proprietorships in Tennessee will pay tax. Since a sole proprietorship is a "Schedule C" business, the Fair Business Tax equates to an individual income tax with respect to the business income of the individual. There is no entity form of business - just a self-employed individual who, having employed other Tennesseans, may be required to pay tax even if the individual loses money. If the instructions on the "sample form" released in conjunction with the governor's speech are correct, the individual will not receive a deduction for FICA and pension contributions as those are not deducted on Schedule C. Basically, between the Hall Income Tax and the Fair Business Tax proposal, only capital gains and excluded interest and dividends will not be taxable to the individual proprietor. The proprietorship that has $50,000 or more in compensation will have a tax based on compensation whether or not it is profitable.
5. Impact on government.
• Labor expense to government will not increase as a result of the tax proposal, as federal and state compensation will not be taxed.
• Since the portion of the new tax levied on compensation will raise the economic burden on Tennesseans and create a way to finance the easy and endless expansion of government, Tennessee state government should be expected to grow.

Preliminary analysis of the impact of the governor's tax on various forms of business

1. Impact on corporations.
• Lower tax rate - Twice the tax cost. On February 11, 1999, The Tennessean in Nashville reported that the Fair Business Tax would almost double the tax that corporations are currently paying. This was a surprising revelation. The governor in his State of the State address refers to low tax rates, not low taxes. However, his charts demonstrated that corporations would pay less and unincorporated entities would pay more. I assume that those charts were correct for the specific corporations illustrated; however, with an almost doubling of the corporate tax collections, those two corporations illustrated by the governor's charts would be exceptions and not representative of what will happen.
• Industry winners and losers. Given the almost doubling of the tax cost to corporations, it is unclear as to whom will be the real world winners. If there are real world winners, they will be corporations with a large capital investment and relatively low compensation compared to profits. Service businesses are losers and the proposed tax will be a disincentive for them to locate in Tennessee or to grow in Tennessee. A worksheet that businesses can use to determine the net tax effect accompanies this article.
• Examples:
1. Software business - Highly paid labor with little capital deployed. A software business is located in Tennessee and earns $1.05 million pre -tax each year. It has compensation expense of $6.05 million and property, plant and equipment of $2 million. Under present tax law, without the use of loopholes, its Tennessee tax would be a $63,000 excise tax and a $5,000 franchise tax for a total tax of $68,000. Under the governor's proposal, its "fair tax" would be $175,000 ($25,000 with respect to its $1 million of net earnings and $150,000 with respect to its $6 million of compensation. This is equivalent to a 16.7 percent tax on profits). This is almost a tripling of the Tennessee tax burden imposed on a hypothetical corporation that was not "playing games." For service businesses such as this, it would appear to represent the highest effective tax rate in the southeast.
2. Durable manufacturing business. A corporation in the durable manufacturing business is modernizing its facilities and looking for a new location in which to build the plant. It will invest $50 million in property, plant and equipment and have compensation of $9.05 million per year and estimated pre-tax profits of $10.05 million per year
1. Under the existing franchise and excise tax:
• Excise tax of $603,000
• Franchise tax of $125,000
• Tax on compensation of $0
• Total tax of $728,000
2. Under the governor's proposed tax:
• Tax on net income of $250,000
• Tax on capital of $0
• Tax on compensation of $225,000
• Total tax $475,000
3. Under the proposed tax, the corporation would save $253,000 in annual taxes or 35 percent.
3. Example of substitution of capital for labor. The same durable manufacturing corporation illustrated above can spend an additional $50 million and reduce its annual compensation by $5 million. What is the tax incentive for the corporation's action?
1. If the corporation does nothing, its Tennessee tax bill is as set forth above.
2. If the corporation makes an additional capital investment of $50 million and reduces its payroll by $5 million, i.e., fires employees that work in Tennessee, its Tennessee tax bill will be:
1. Under existing franchise and excise tax:
• Excise tax of $603,000
• Franchise tax of $250,000
• Tax on compensation of $0
• Total tax of $853,000.
2. Under the governor's tax proposal:
• Tax on net income of $250,000
• Tax on capital of $0
• Tax on compensation of $100,000
• Total tax of $350,000
• Result
The traditional franchise and excise tax structure would increase the tax on the business, reflecting the additional capital investment in Tennessee imposing a small annual cost on the substitution of capital for labor. The proposed tax would reduce the taxes as compensation is reduced and no tax is imposed on capital.
2. Impact on business entities other than corporations. Obviously, it is going to be much more expensive for unincorporated business entities to do business in Tennessee if the Fair Business Tax is enacted. Whether this is fair or not is a complex analysis that will be the subject of future debate. There is certainly a superficial fairness. If two or more people form an entity to conduct business, why should one form have a tax cost and another form not have a tax cost? The issue of fairness, however, is much more complicated than first impressions would suggest.
• Will business located in other states and not even required to qualify to do business file Tennessee tax returns and pay tax? Will a complex system of reporting who pays compensation to Tennessee residents be required in order to audit for noncompliance?
• Will the imposition of a different business tax structure, regardless of the theoretical merits or demerits, have a tendency to discourage out-of-state business from relocating to Tennessee?
• What impact will a tax structure that is not integrated with or compatible with the tax structure of adjacent states have on the ability of unincorporated Tennessee business to raise equity?* What is the ramification of imposing a significant tax on a business not earning profits? How many businesses will fail? How many jobs will be lost?
3. Impact on individual's operating a business.
• The proposed tax is based on business income and compensation. A sole proprietorship is not a business entity. A single individual with no employees or independent contractors and pretax net profits in excess of $50,000 will be subject to the 2.5 percent tax on net profits. In this form, it is truly an individual 2.5 percent income tax on business income. If, however, the individual hires one or more employees or independent contractors and has total compensation in excess of $50,000, that individual will be subject to an additional element of 2.5 percent tax on such compensation. There is, however, no business entity in a sole proprietorship - only the individual.
• Will Tennessee's Supreme Court determine this to be a constitutional tax or an unconstitutional income tax? A portion of this tax is based upon a portion of the income of the individual, i.e., the tax on business net profits. However, a portion of the proposed tax is based on compensation paid to others. An individual can have a business loss and still be liable for taxes because he or she made the mistake of hiring Tennesseans. (As previously discussed, if the employees do not work in Tennessee, their compensation will have to be fairly apportioned out of Tennessee and not taxed by Tennessee.) It is hard to see a tax imposed on an individual without income as an income tax. The Tennessee Supreme Court may well declare it constitutional.
• Possible lack of compliance by individuals in other states. The issue of fairness also has a practical aspect. Will sole proprietors who are otherwise not required to register anywhere to do business in Tennessee and who have employees (such as salesmen) to do business in Tennessee report and pay the proposed tax? If they do, they most likely will not receive a tax credit against the income tax their state of residence imposes as this is not an income tax.
4. Impact on Tennessee businesses_ ability to attract capital from outside Tennessee.
• Closely-held businesses and family businesses. Generally, most closely-held and family businesses require investor capital if they grow beyond the financial means of the few initial individual owners to support growth. Unless the business is very substantial or unusual circumstances exist, the investment bankers and professional venture capital fund managers will not invest in the business. Therefore, investment is often made by individuals (often acquaintances, friends and family, or sometimes through a private placement by "financial advisors"). It is very common that the businesses have been organized as a pass-through entity (partnership, "S" corporation or more recently an LLC). The federal double taxation of corporate income makes the traditional closely-held and illiquid "C" corporation unattractive to individual equity investors. The proposed Fair Business Tax will make it harder for such Tennessee businesses to obtain capital from outside of Tennessee. Since the tax will not be an individual income tax (assuming that the attorney general opines and if litigated, the Tennessee Supreme Court so holds as to make the tax constitutional in Tennessee), the tax will not be eligible as a credit against the income tax, if any, imposed by the state of residence of the investor. While this will not be a problem for investors in other states without an income tax, it may be a problem for investors located in most states. In the unlikely event that the proposed tax is competitive with the taxes imposed by other states (almost by definition these are not capital intensive industries), this double taxation of business income to the owners will be a significant economic penalty for investing in the Tennessee business. It is doubtful that these non-Tennessee investors will be ignorant of the proposed tax and not understand that in essence they are being taxed twice on their share of the businesses_ income.
• Closely-held "C" corporation businesses. Even these corporations will be at a competitive disadvantage to closely-held corporations located in other states. As discussed above, it appears that most corporations will be paying significantly more taxes under the proposed tax than under Tennessee's traditional franchise and excise tax structure. This is obviously unattractive to investors. Another unattractive feature of the proposed tax is that if the corporation has a sizable payroll and is losing money, the investors will not only need to invest additional cash to cover the losses, they will have to invest additional cash to pay the taxes while the business suffers losses. This is a detriment to the raising of equity capital from in-state or out-of-state investors and may cause such businesses to fail, thereby increasing the risk to the investor considering the making of an investment.
5. Impact on Tennessee's image as a pro-business state.
• There is an economic reality that must not be overlooked. None of the surrounding states impose such a tax. Michigan and New Hampshire are not generally considered to be "business friendly." By adopting this business tax structure, will Tennessee change its image? Very few other states impose such a tax. What will this mean to future business development? The analysis of which corporate businesses are tax winners and losers is relevant here. If a business is relocating and the effective tax on net income is higher than surrounding states, why would a business choose to locate in Tennessee? To overcome this, if incentives must be given to generate new jobs for employers to move into the state, then our existing businesses are being penalized. If incentives are given to all businesses to create new jobs, then stable but non-growing businesses are penalized.
• The governor can argue that a business tax measured by income is not used by other taxing authorities because they have an income tax. Many have already concluded that the Fair Business Tax is really a hidden or stealth income tax which is owed (as opposed to withheld) and remitted by business on the compensation of its employees and that overtime business will simply reduce the compensation otherwise paid to employees and independent contractors. If the governor and legislature decide that an income tax is needed, the case should be taken to the public, the Tennessee Constitution amended, and all citizens, those working in the private sector and those working in government and for nonprofits, should pay their fair share of such taxes.

Tax structure of other states As far as the author has been able to determine, there are only two states that impose a tax on the business use of labor. Those are Michigan and New Hampshire. New York City also imposes a tax on compensation paid. In 1997, a complex tax method which included a business tax measured by compensation was proposed in Texas by Governor Bush, but after a turbulent five months in the Texas legislature, legislators refused to pass such a radical tax structure. An in-depth study of the interaction of the tax structures of the surrounding states with the proposed tax is needed. Conclusion The Fair Business Tax would indeed be the most sweeping business tax change in three-quarters of a century. Change can be good and change can be bad. The far-reaching implications of the proposed tax or any other radical change should be completely understood lest Tennessee's economy boards a plane for a night flight without instruments. There may be a soft landing or there may be a fiery crash. In the interim, the loopholes that the governor spoke of should be closed and should be closed as quickly as possible. The merits and demerits of a new tax structure, modifications to the existing tax structure or a billion dollar tax increase can be studied while the state revenue is stabilized and not hemorrhaging. The governor astutely has tied the Fair Business Tax to the repeal of the sales tax on groceries, which removal has long been favored by many. The governor has correctly identified a formalistic legal, but abusive, corporate tax avoidance structure that already has cost Tennessee tens of millions of dollars in lost tax revenue and if unabated could impair the corporate tax itself. This "loophole" can be closed by relatively simple amendments to the current tax structure, just as most other states have done. In conjunction with this "loophole," the governor has articulated a purported fairness issue: The form of business should not control the amount of tax that a business pays. The administration has not addressed the fact that this is a massive tax increase; that it creates a tax structure unlike those of surrounding states; that it penalizes the use of labor; and it provides what appears to be the highest business tax burden in the southeast.

"Tax Relief and Fairness Act" -Tax Relief? Fairness?
by J. Leigh Griffith

On February 8, 1999, in his State of the State address, Governor Don Sundquist proposed a $1.1 billion dollar a year business tax increase; the repeal of the sales tax on certain groceries; the repeal of the corporate franchise and excise taxes; and the imposition of a new tax on all businesses (including sole proprietorships, partnerships, limited liability companies and corporations) composed of a 2.5% tax on net income and a 2.5% payroll tax. There is a $50,000 exemption on net income and the first $50,000 of compensation is not subject to the tax.

This new business tax structure will impose an immediate and significant burden on lawyers, accountants, physicians, engineers, architects, contractors, plumbers, painters, real estate agents, insurance salesmen and other service providers. Companies with large payrolls relative to capital investment will find that they are service providers - for example certain kinds of trucking companies. The immediate result will be lower distributable income to the owners followed by lower wages to the employees and perhaps higher charges for services if the market will permit. For service providers considering moving to Tennessee or service providers with multi-state locations considering expanding, Tennessee may not be very attractive. The new tax structure may decrease the tax of a few companies with relatively low payroll and high capital investment.

The following chart shows what forms of businesses will have the largest tax increases. Surprisingly, corporations, which one would have thought were paying too much tax as other forms of business were not paying any or enough, would be the biggest losers. Corporate taxes will increase approximately $820 million dollars for a total tax payment of $1.7 billion. All other forms of business will only pay approximately $313 million in taxes or 15% of the total projected taxes to be collected, demonstrating that most of these other forms of businesses are really relatively small. This raises the question: Is the economic dislocation of taxing individuals and entities not subject to a business tax in other states worth the relatively small amount of revenue to Tennessee?

†

GOVERNOR

Pollution Engineering
Reprinted with Permission


As the demand for traditional services dwindles, environmental consultants are adding a number of non-traditional services to their repertoire.
by Kathie Canning, Associate Editor

The environmental field has undergone radical changes during the past decade. As a market, it is shifting from "one dominated by activities making up for the past to one dominated by preparations for the future," according to a report recently released by the U.S. Department of Commerce's Office of Technology Policy. With the decrease in regulation-induced demand, "Meeting the Challenge: U.S. Industry Faces the 21st Century, The U.S. Environmental Industry," states that the market for environmental products and services is evolving from the traditionally pre-dominant offerings related to pollution control, waste management and remediation to those associated with resource productivity and environmental improvements that enhance a client's competitive advantage.

Faced with decreasing demand for conventional domestic consulting, engineering and remediation services, U.S. environmental consultants are being forced to "spin their creative wheels" as they prepare to compete in the 21st century. As a result, they are beginning to offer a diverse range of non-traditional services and approaches to help both private-sector and government clients improve resource efficiency, increase productivity and focus on sustainable growth.

Non-traditional services

Jon Plaut, chairman of the North American Free Trade Agreement (NAFTA) Environmental Committee's Joint Public Advisory Committee and former corporate director of environmental quality for Allied Signal, believes environmental management systems (EMSs), including ISO 14000, Responsible Care and company-specific quality programs will continue to comprise a major service area for environmental consultants. Such systems are designed to improve the management of process, product and waste flow, and are becoming a prerequisite for doing business, he maintains.

These concepts apply to waste and products even after they leave a company's property. If a company sends its hazardous waste to licensed disposers but doesn't monitor those waste sites, for example, it could send the waste to sites that will pose real problems in the future, says Plaut. And if a company doesn't screen future products in terms of the environmental consequences of their use-whether these be disposal problems, public perception concerns or other issues-the company may find itself in trouble. A good environmental consultant can help a company become "pro-competitive," Plaut says, using the EMS as a tool.

Municipalities are only beginning to understand the importance of environmental management, Plaut notes, and have been slower to adopt such systems. Although EMS implementation would help them avoid significant costs and liabilities, "Politics doesn't deal well with short-term costs and long-term benefits," he explains.

"A second area where consultants can help tremendously is in terms of environmental auditing-putting in a process of monitoring the environmental management system to ensure it's doing what you think it's doing," Plaut says. "It's very easy for management to say 'do it_ and for people in the operations to say _We've done it,'" he says, "but there needs to be a system in place to check that it really has been done and is working."

Joseph Fallon, president of Princeton, NJ-based Environmental Liability Management Inc., also believes that pollution prevention-type programs, including EMS and ISO 14000 programs, will provide industry with tremendous benefits in the years to come. However, while such programs may require a consultant's expertise for initial startup and periodic auditing, he says it is important for them to be implemented by staff instead of by an outside consultant so "people will buy into the process."

Information management is another area where environmental consultants appear to shine. Over the next few years, environmental consultants will help clients more effectively use information technology, predicts Fallon. "The applications of new developments in managing information are critical in making more informed, and therefore better, decisions," he says, "and the opportunities for information sharing and gathering through the Internet are almost limitless."

Michael Kennedy, regional operations president for the global consulting firm CH2M Hill, agrees, insisting that today's environmental consultants can bring an enormous value to a client's shareholders or a municipality's citizens by helping them manage data more efficiently. "The kinds of things I'm seeing consultants getting into are systems that gather and categorize data," says Kennedy, "whether it's data on emissions, compliance data, process data-basically any type of data that comes from the operations of the entity."

According to Kennedy, environmental consultants have some very unique, specialized skills related to decision process and analysis tools-skills that typically are not duplicated in industry or municipalities. CH2M Hill personnel recently exercised such skills when they looked at all the emissions data, compliance data and the entire capital asset program of a large global manufacturer. Capital assets were projected into the future to target areas where the company needed to manage emissions.

The manufacturer reduced its capital expenditures as a result of the project, says Kennedy. "They were overspending their capital assets," he explains. "They were actually doing more than they needed to. And some things they were doing in the wrong place-they had no systematic way to bring together all of the environmental data, their capital plan and the business strategy as a company, and integrate those."

Matthew Dominy, director of Managed Competition Services for the international consulting firm HNTB Corp., says the public's demand for keeping taxes and local fees in check is driving municipalities and federal agencies to take a hard look at the efficiency of their operations. Privatization of services traditionally provided by municipalities-such as wastewater treatment plant operation-is on the rise. To meet such needs, environmental consultants increasingly are adding capabilities such as contract operations, financial resources and construction, he says.

"Alternate service delivery mechanisms such as design/build, design/build/operate and the ultimate-design/build/own/operate-may offer municipalities and industrial clients opportunities for significant savings," says Dominy. "The number of states that are enacting enabling legislation increases every year. Municipalities should objectively evaluate these evolving mechanisms."

With fewer and fewer "greenfields" available for development, environmental consultants also are finding themselves indispensable in the brownfield redevelopment arena. "Brownfield work is interesting because it allows [the consultant] to get pretty creative, taking old _bottles_ and turning them into new _bottles.'" offers Dr. Marwan Sadat, owner of the environmental consulting firm Sadat and Associates, Princeton, NJ His company successfully tackled the largest brownfield redevelopment project in New Jersey's history and is currently undertaking an even larger one in the same state.

An environmental consultant's initial assessment work is key to a client's decision to develop a brownfield, insists Sadat. There must be a balance between cleanup costs and the property's value. A consultant takes the client through the permitting and comes up with solutions for contamination, so the end result is a site that not only protects public health, but also makes economic sense for the client.

Another emerging service area may have the capacity to change the way environmental liability disputes are resolved. Pioneered by Dr. Richard Greenberg of Parsippany, NJ-based Environmental Waste Management Associates LLC, plume dating involves dissecting site information to establish the functional issues that are critical to contaminant source, fate and transport. This approach includes chemical "fingerprinting" of the contaminant(s), an assessment of site-specific geology and hydrogeology and their impacts on contaminant transport, an evaluation of microbial degradation parameters and an engineering site analysis.

According to Greenberg, "dating and aging say that organic chemicals, by their nature, break down over time. So depending on the site-specific characteristics, you can say, _Okay, this gasoline was dumped in the ground 20 years ago, 40 years ago or 10 years ago._ You can tell who put it there based on how old it is-matching up the facts of the case and the circumstances with science."

"The most interesting types of cases are usually mixed contamination," says Greenberg. "We worked in an industrial park, for instance, and had about 10 different manufacturers. The case turned on the usage dates of certain chemicals. In other words, one particular industry turned from TCE to I-1-TCA, so that gave me a date. I know if I find TCA in the ground it has to be after a certain date," he explains.

Plume dating is just coming into acceptance now, after being challenged in courts for some time, says Greenberg. Other consulting firms are beginning to offer this highly specialized service. However, cautions Greenberg, "The client can't hire a firm to be a witness. He has to hire the person."

Innovative approaches

New approaches to existing problems can benefit project stakeholders, and environmental consultants are serving up several of these with promising results. One such approach involves the concept of "ecocapitalism," the idea that an organization can "do good and do well" at the same time.

James Weaver, an environmental attorney with Nashville, TN-based Waller Lansden Dortch & Davis, says the concept involves designing some "good" into a project-positives that could include things such as brownfield redevelopment, green spaces, conservation easements and buffers-without adversely impacting project goals. Regardless of whether the project involves the construction of a factory, a quarry or a pipeline, the concept must be worked in as part of the initial design, says Weaver. Therefore, the project team needs to spend a good deal of time in the beginning figuring out exactly what it wants to accomplish. "And you've really got to have a consultant who's willing and able to think outside of the box-someone who's willing to be innovative," he adds.

The Turkey Creek Development in Knoxville, Tenn., is one example of an ecocapitalism success story. The project involved a 450-acre piece of prime, undeveloped property with a 30-acre wetland area on it. "The client came to us and said, 'We really want to do this right,'" said Weaver. With the help of several environmental consultants representing different areas of expertise, he says, the project team came up with a design that worked into the site a 58-acre permanent conservation easement. Among its many amenities, the easement includes a nature center and native tree plantings.

Companies also can find success by partnering with experts to solve specific problems. Although not an environmental consulting firm in the truest sense of the word, the Electrotechnology Applications Center (ETAC) in Bethlehem, Pa., offers clients customized solutions for environmental and process-related problems. Formed five years ago as a partnership between Northampton Community College and Pennsylvania Power and Light, ETAC resolves concerns related to heating, drying, coating and curing processes.
ETAC's director, Dr. Michael Vasilik, says the center applies a variety of technologies-including infrared, ultraviolet, microwave and radiofrequency-to help industries improve productivity and energy efficiency while achieving and maintaining environmental compliance. "For example," says Vasilik, "we have been helping [many companies] convert from solvent-based coatings to water-based coatings, which have low VOCs, or powder coatings, which have no VOCs."

Under a grant awarded by the Pennsylvania Department of Environmental Protection, ETAC currently is helping small-and mid-size Pennsylvania businesses achieve and maintain compliance with air quality regulations. "These are the companies that often don't know where to start, but they've got to do it," explains Vasilik. ETAC currently is helping a foundry produce environmentally friendly metal castings.

Companies often come to ETAC when they have no idea how to solve a given problem, says Vasilik. "As far as they're concerned, we have a black box, a bag of tricks. We help apply the technologies to solve the problems, and then we help implement the solutions and train people."

Vasilik says that only a handful of electrotechnology centers now exists across the country, but he believes such centers will offer tremendous opportunities for the future. To learn more about ETAC, e-mail Vasilik at vasilik@etctr.com.

Mixing the old with the new

Of course, not all traditional environmental consulting areas are on the decline. Air issues are expected to remain a focus of consultants as the need to reduce carbon dioxide and other greenhouse emissions forces many companies seek outside help, says Sadat. Recycling issues also will be big.

Environmental Liability Management's Fallon believes the next decade also will bring significant engineering and planning work to consultants, as many of the wastewater treatment and conveyance systems built in the 1970s under the Construction Grant program reach the end of their design life. "As long as the economy remains healthy, there will be a need for facility upgrades and new facilities," he says.

No matter which traditional consulting areas remain healthy, however, rest assured the modern environmental consultant will continue to evolve. "The role of the environmental consultant is not just compliance-driven, but also [one of] looking at environmental solutions to really help clients from a competition point," Sadat points out.

On Choosing a Consultant...

"The most important question [for a consultant] is _have you done something like this before?_ The experience they can bring to you from similar projects is invaluable." James Weaver

"Qualifications-based selection processes continue to offer clients the best opportunity to get the best service for their particular needs. More and more clients are recognizing the blind reliance on _low-bid' as counterintuitive." Matthew Dominy

"Understand the problem you are trying to address. The more you understand about the problem, the better you will be able to select the appropriate consultant and monitor their activities." Joseph Fallon

"Look at the kind of service the firm has provided to others in terms of meeting budgets, meeting schedules, being responsible and accessible, fixing mistakes-call around and talk to companies." Michael Kennedy

"Get in touch with professional organizations. Talk with a few of the leading consultant firms. Remember that it's important for environmental consultants not to be too specialized-they've got to know what's going on in the greater world." Jon Plaut

Shopping Center Executive
Reprinted with permission


The issue of urban sprawl has arrived. It is not limited to big cities with enormous populations. Urban sprawl will affect areas across the United States with any potential for growth.

To deal with the consequences, developers need to be aware of trends in zoning legislation that are having an impact from coast to coast. A key question is: "Can there be a balance between smart growth and sensible economic development?"
The alleged impacts on quality of life stemming from urban sprawl are usually described by the media in terms of increased traffic congestion, increased pollution and a loss of open space.

While the loss of open space may appear to be a looming issue, in reality only 4.8 percent of the total land area in the United States is actually developed. Nonetheless, the perceived negative impacts on quality of life have pushed the issue of urban sprawl into the forefront of local, state and national politics.

Forced Planning

In 1998, the Tennessee General Assembly passed a comprehensive growth planning law. It requires all counties to devise a growth plan to be approved by local officials no later than July 1, 2001. The plan must identify all areas to be set aside for preservation (rural areas), and to identify those areas where growth should be targeted (planned growth areas). All land-use decisions after approval of the plan must be consistent with the plan. Interestingly, the law was not the result of a massive grass roots effort by an environmental or preservation group. Rather, it was proposed and passed on the initiative of state lawmakers, partly in response to local annexation wars.

The fight in Tennessee is just shaping up. Many rural counties are faced-for the first time-with zoning and other land-use planning issues. This planning process will dictate where development may occur in the future.

Alleged Sprawl in National Politics

In November 1998, there were more than 200 state and local ballot measures aimed at promoting conservation, preservation of parklands and smart growth. A whopping 72 percent of these ballot measures were approved. It is estimated that in 1998, at least 38 percent of all states had established land use or open space task forces.

Vice President A1 Gore announced the administration's Livability Agenda in September 1998, which will likely play a role in the upcoming presidential campaign. The agenda's stated goals are: preserving green space; easing traffic congestion; restoring a sense of community; promoting collaboration among communities; and enhancing economic competitiveness.

The administration proposes to implement the Livability Agenda in part, by a planned shift in federal investments. It's proposing Better America Bonds that will offer tax credits to preserve green space, create urban parks, improve water quality, and clean up brownfields. President Clinton also recently announced the Lands Legacy Initiative, that will set aside $1 billion to protect land resources, green spaces and parks.

Urban sprawl appears to be a bi-partisan issue. In January 1999, Sen. James Jeffords, R-Vt., and Sen. Carl Levin D-Mich., announced the creation of the Senate Smart Growth Task Force. According to Jeffords and Levin, the purpose of the task force is to "give Senators a forum to discuss and coordinate efforts concerning unsustainable growth patterns." The task force has announced two initial objectives: the identification and investigation of federal policies that hinder communities "sustainability and quality of life"; and stimulating of federal policies that will assist local and regional efforts to promote smart growth. Although land-use decisions are historically of local concern, the discussion of sprawl at the federal level shows the importance of this issue to politicians, and the likelihood that it may play a role in the Year 2000 elections.

In 1995, the Bank of America, along with the Greenbelt Alliance, the California Resources Agency and the Low-Income Housing Fund, released a report entitled Beyond Sprawl: New Patterns of Growth to Fit the New California. This report concluded that sprawl had hurt California's competitiveness by creating enormous costs, making the state less attractive to prospective business. The concept of smart growth is seen by some as a tool to encourage and foster economic growth, but in a way that also preserves the quality of life in a region. Considerations concerning an owner/developer's right to realize the full benefit of an investment have yet to be adequately addressed.

Smart Growth Options/Pitfalls

Many proposed growth-management strategies appear draconian and have the potential to adversely affect the economic of current holdings. There are many alternatives that can achieve the goals of smart growth without creating economic disadvantages. Growth boundaries are not the only solution to urban sprawl. Open-space tax credits, or transferable development rights are two examples of voluntary, market-based incentives that can be successful tools in combating urban sprawl without sacrificing future development or adversely affecting an owner's right to reap the rewards of an investment. The tools are available to promote both smart growth and sensible economic development. Beginning the dialogue with local officials should be the first step in identifying which tools are not only politically viable, but will enable a region to meet the goals of fostering economic development and preserving quality of life.

The legislative agenda of the 101st Tennessee General Assembly was dominated by revenue considerations. Both the legislature and the Executive Branch wrestled with spending cuts and taxes. Many alternative tax structures and overlays to the existing tax structure were considered, including: imposing a payroll tax, increasing the sales tax, imposing the franchise tax and an excise tax on compensation above $72,000 per employee on all forms of businesses and enacting a personal income tax. The end result, however, was the Tax Revision And Reform Act of 1999, which expands the franchise and excise taxes to limited liability companies ("LLCs"), limited partnerships ("LPs") and limited liability partnerships ("LLPs") (hereinafter collectively referred to as "limited liability entities"). The attorneys of Waller Lansden Dortch & Davis, A Professional Limited Liability Company, were very active in the process - testifying before both the House and Senate finance committees; meeting with the Executive Branch; providing public information as to various tax proposals; drafting statutory language for the consideration of the legislature and the Executive Branch; and consulting with individual legislators, the Treasurer's office, the Controller's office and others in the Executive Branch as the process continued. Many technical aspects of the final bill were developed from or revised due to such efforts, including: (1)†the elimination of multiple franchise and excise taxation on tiered limited liability entities, (2)†the subtraction of income subject to self-employment taxes and pension plan contributions from the taxable income of limited liability entities, (3)†audit limitations to prevent the breach of client confidentiality on the audit of professionals, (4)†the adoption of the federal definitions for the classification of business entities, (5) the exclusion of decedent's estates from entity level taxation and (6)†the use of federal authority in the application of the commissioner's authority to recharacterize transactions, impose arms_ length standards, etc. We attempted to be a thoughtful and constructive force in the process bringing our technical expertise and the real world concerns of our clients to the attention of the legislature and the Executive Branch. We appreciated the willingness of the leadership of the legislature and the Executive Branch to listen to our thoughts and concerns, whether or not they were adopted. While we do not agree with many of the aspects of the law as passed or with various proposals that were considered, we do believe that the Executive Branch and the legislature attempted to do the best job possible under difficult circumstances. Major revisions to a state's tax structure can have serious results with respect to job retention, job growth and economic prosperity of both the citizens of the state and the state itself. The legislature and the Executive Branch were mindful of these concerns. The Tax Revision and Reform Act of 1999 will not solve Tennessee's long term financial needs and it is likely that more changes will be in store in a special session in November or during the regular session next year. We believe that it is possible that the fixing of the "Kroger Loophole" will generate substantially more revenue than the Executive Branch and the legislature currently project. If so, it may be a few years before Tennessee's tax structure requires revisiting. In the interim, we encourage a careful study of Tennessee's existing tax structure and consideration of what a different tax structure would look like if it were to provide a much better mix of elasticity and stability without imposing an undue burden on Tennessee's businesses or citizens. Regardless of the timing, we urge that this effort be undertaken in a thoughtful manner and not in the midst of a financial crisis. 1999 Legislative Events The road that led to the passage of the Tax Revision and Reform Act of 1999 began in February of this year when Governor Don Sundquist proposed his "Tax Relief and Fairness Act" which provided for (1) a sweeping new business tax to replace the current franchise and excise taxes and (2) the elimination of the sales tax on grocery food. Under the Governor's "fair business tax," all businesses, regardless of their form (from sole proprietorships to multi-national corporations), would be subject to a tax of 2.5% of all compensation paid and a 2.5% tax on business profits reported for federal income tax purposes. The first $50,000 in compensation and the first $50,000 of profits, however, would be exempt. The Governor identified certain "loopholes" in the system that have allowed many businesses to avoid paying franchise and excise taxes, specifically through the use of limited liability companies and limited partnerships. The specific structure focused on by the Governor was the "Kroger Loophole" and there was always a consensus from the outset that it would be closed. Although it was estimated that the elimination of sales tax on grocery food would cost the state $550 million in revenue, the new business tax would, however, generate $1.8 billion in revenue. Of the $1.8 billion generated, $550 million would replace the lost revenue from the elimination of the grocery tax and $900 million would replace the revenue lost from the repeal of the franchise and excise taxes on corporations, with $350 million left for new programs. It was estimated by some that the Governor's fair business tax would double the tax bill of most corporations and would multiply it several times for others. The Governor subsequently made several changes to his fair business tax. Administration officials stated that the new business tax would begin to apply to businesses as early as July 1 of this year. In addition, the Governor placed a cap on the amount of tax that would be paid under the new business tax by larger employers in the state. Only the first $300 million of a business_ total payroll would be subject to the 2.5% payroll tax. However, the Administration later conceded that ten or fewer companies would be affected by this cap. Opposition to the Governor's plan soon began increasing as labor-intensive businesses realized the impact the new business tax would have on them. Almost one month after the Governor announced his new tax plan, the legislature began to talk of closing certain loopholes in the franchise and excise tax system and subjecting all forms of businesses to these taxes and spending cuts as an alternative to the Governor's 2.5% payroll tax on businesses. As a result of mounting opposition, on March 29th, Governor Sundquist unveiled to a special session of the legislature an alternative tax plan entitled "The Tax Reform Act of 1999." Under this $1.78 billion tax proposal, the Governor's new plan extended the franchise and excise taxes to proprietorships, general partnerships, limited partnerships, limited liability companies and limited liability partnerships and removed the sales tax exemption on architectural and engineering services. The prior proposal for the removal of the sales tax on grocery food remained but would not be effective until January 1, 2000. Under the new plan, there would be a 6% excise tax on compensation above $72,000 per employee and the franchise tax would be lowered to 12.5 cents per $100 of net worth. It was estimated that under this new plan, $1.2 billion in excise taxes and $543.7 million in franchise taxes would be generated. Opposition to the new plan began soon after it was unveiled, and consideration of various alternatives including a personal income tax, an increase in the sales tax rate except for certain food items and various forms of employment taxes began. The special session of the legislature subsequently ended without any consensus to any tax reform or a specific tax proposal and the debate was continued in the regular session. The Tax Revision and Reform Act of 1999: On May 28, 1999, the legislature adopted a $16.4 billion budget for 1999-2000 which included a combination of budget cuts and revenue raisers. The Tax Revision and Reform Act of 1999 repealed the existing franchise and excise tax in its entirety and replaced it with a new franchise and excise tax. As discussed below, various provisions have different effective dates. Much of current law was simply restated, although in certain places there are changes in the wording that could be significant to specific taxpayers or in certain specific situations. The major changes include:

• The extension of the franchise and excise taxes to limited liability entities.
• Entity taxpayers with a combined annual franchise and excise tax liability of $5,000 or more are required to make quarterly estimated tax payments. Quarterly payments for the excise tax were accelerated and are now required to be made on the 15th day of the 4th month, 6th month, 9th month and 1st month, rather than 4th, 7th, 10th and 1st month. In addition, the franchise tax is now subject to the same quarterly payment rules.
• In what was referred to as a "Geoffrey" provision, revenues from patent and copyright royalties are included in the Tennessee "sales" factor for companies doing business in Tennessee.
• Entity taxpayers who are now subject to the franchise or excise tax but who were not required to register or file returns in the past must register with the Tennessee Department of Revenue within the greater of 60 days from July 1, 1999 or 15 days after the date the entity becomes subject to the franchise and/or excise tax.
• A new criminal felony penalty (a Class E felony which carries a term of one to six years in jail plus a monetary fine) is imposed on any person who willfully attempts to evade or defeat any tax due the state of Tennessee. Each act done in violation is a separate offense.
• The exception to "doing business" in Tennessee for certain limited partners and members of limited liability companies was repealed. This exception was the basis for what the media and press called the "Kroger Loophole." With the direct tax on limited liability entities, however, this change may be largely irrelevant.
• The charter or certificate of a taxpayer may be revoked if the commissioner certifies to the secretary of state that the taxpayer has refused to file any franchise or excise tax return or to pay such tax. The charter or certificate may be reinstated upon filing of all reports and the payment of all fees, taxes and penalties and interest due "unless title has been taken by another taxpayer." The new "unless" exception creates serious uncertainties. For instance, what happens if an administratively dissolved entity sells its stock or assets and the buyer discovers the administrative dissolution? How is good title ever to be passed? This is a major trap for the unwary.
• Gain or loss on assets distributed from an "S" corporation or limited liability entity and then sold within 12 months of such distribution shall be recognized by the distributing corporation or limited liability entity. This will be hard to administer and represents an interesting "impossibility" for property distributions in the liquidation and termination of an entity.
• The commissioner is given expanded powers to apply federal concepts of "arms-length," "assignment of income" and "fair market value" among persons identified in section 267(b) of the Internal Revenue Code. Other anti-abuse powers are also specifically given to the commissioner. The legislature has sent a strong message to the Department of Revenue to look at the substance as well as the form of transactions.
• The NOLs and credits generally are lost when a corporation or limited liability entity merges into another entity. Properly planning mergers to meet the exceptions may be significant in some transactions.
• For corporations and limited liability entities doing multi-state business, the entity's share of sales, compensation and assets of a general partnership are specifically included in the apportionment formula base.
• Generally accepted accounting principles are incorporated in several places in the franchise tax. If enforced, this may present accounting problems for all but the public companies and the largest private companies. The overwhelming number of corporations and limited liability entities do not keep books and records in accordance with GAAP.
• Confidentiality provisions were enacted to maintain the client information privilege when an attorney, accountant, etc. is audited by the Department of Revenue. With the expansion of the franchise and excise tax to limited liability entities, most professional firms will now be subject to audit by the Department of Revenue.
• A credit against the excise tax is given for Hall Income Taxes paid by an entity. This prevents double taxation of certain interest and dividends.
• With respect to the franchise and excise tax, if an extension is obtained but less than 100% of the tax due is paid at the time of the extension, penalties and interest shall be imposed as if no extension was obtained. This will discourage corporations and limited liability entities to file for extensions if they are unable to pay the full amount of the tax. If an entity's estimated tax payment was off, a great deal of pressure to adopt an aggressive position to avoid the penalty will be placed on the taxpayer.
• The (i) activity of a not-for-profit entity constituting unrelated trade or business income or activities unrelated to and outside the scope of the activities that gave it an exempt status and (ii) assets used in such activity will be subject to the franchise and excise tax. Tax exempt entities should pay particular attention to this provision and attempt to determine what is meant by "activities unrelated and outside the scope of the activities that gave the entity its exempt status." This appears to be broader than unrelated trade or business income. For example, will the ownership and operation of a medical office building be related to the activities of providing medical care and operating a hospital?
• The Jobs Tax Credit has been extending to both the taxpayer's franchise and excise tax liability.
• The Department of Revenue was directed to study the impact of adopting the unitary method of taxation of corporations and limited liability entities.
• All exemptions from the sales tax, the franchise and excise tax, and the gross receipts tax with projected annual revenue costs of $1,000,000 or more are to be reviewed every four years. With respect to exemptions granted after January 1, 2000, the exemption will automatically "sunset" on June 30 of the fourth calendar year following the year in which the exemption was created. Criteria for evaluating exemptions are enumerated.
• Via separate bills, the sales tax was expanded to cable television fees in excess of $15 per month and was also applied to items costing $5 or more sold in vending machines.

Franchise and Excise Tax Expansion to Limited Liability Entities: In the State of the State address, the Governor unfairly identified LLCs and LPs as the cause of the State's revenue shortfall, when the real "culprit" was the ability to use them in an abusive manner. The legislature, with this concept in mind, targeted limited liability entities for taxation from the outset. While the Kroger Loophole could have been closed in a number of ways other than by extending the franchise and excise tax to limited liability entities, the Governor and legislature elected to tax limited liability entities. The result is a taxing pattern that differs from that of the surrounding states - a phenomena that caused Florida and Pennsylvania to repeal all or most of their entity level taxes on LLCs. This will place an additional burden on a multitude of small businesses which have been creating a broad base and range of jobs and are using the LLC form. Significant problems are posed by the extension of the franchise and excise tax to limited liability entities taxable as partnerships for federal income tax purposes. The owners of such entities generally do not receive compensation but share in the profits. Corporations pay executive compensation; however, partnerships split profits as compensation. Tennessee's excise tax base starts with federal taxable income and, unless the equivalent of compensation and pension contributions were subtracted, the entity would be subject to a greater tax than a corporation. In addition, because federal taxable income of an owner of a limited liability entity includes a portion of the limited liability entity's income, the same income would be subject to simultaneous multiple taxation unless it was subtracted from the owner's income. Fortunately, our comments were heard and some of these problems were alleviated or minimized. Specifically: 1. Income of limited liability entities will only be taxed once. The net income of an entity taxpayer derived from a limited liability entity is subtracted from the net income of the entity taxpayer and the net loss of the entity taxpayer derived from a limited liability entity is added back to the net income of the entity taxpayer in determining the entity taxpayer's excise tax base. Through this addition and subtraction mechanism, the net income of a limited liability entity is only taxed once. This tax is imposed on the entity that actually produces the net income. The situation where the limited liability entity was taxed and the corporate owner was then taxed on the same income at the same time was eliminated. The situation where one limited liability entity owns an interest in another, which would lead to an even higher multiple of taxation, was also avoided. 2. Deduction by entity owner of value of limited liability entity for franchise tax. The value of an entity taxpayer's interest in a limited liability entity doing business in Tennessee is subtracted from the franchise tax base. The value of the assets of the limited liability entity have already been subject to the franchise tax. This prevents multiple taxation. 3. Deduction of self-employment income. Limited liability entities may deduct self-employment income and pension contributions from the excise tax base. With the exception of guaranteed payments, limited liability entities do not pay compensation to the members or partners who work in the business but rather those members or partners receive distributions and are taxed on their share of entity income. Since the legislature desired to treat limited liability entities in a manner similar to that of corporations, the self-employment income and pension contributions of the limited liability entity is subtracted from the excise tax base. This makes a limited liability entity subject to a tax equivalent to, not greater than, a corporation. 4. Capital gains and losses may be excluded from limited liability taxation. The specific language in the statute appears to exempt capital gains from the excise tax imposed on multi-owner limited liability entities. The term "net earnings" or "net loss" is defined as "the amount of ordinary income or loss & increased or decreased by additional items of income or expense specifically allocated to partners or members . . . which additional items are not already included in ordinary income or loss." Another section, however, states that gain on property distributed by a taxpayer treated as a partnership and sold within 12 months of the distribution shall be recognized by the partnership. This infers that gains of the partnership are subject to tax. Single member LLCs, however, have a slightly different definition of net earnings or net loss which is less clear, but which ought to have the same meaning. If capital gain is exempted from the base, many limited liability entities holding stocks and bonds, real estate and other investments to continue to be viable. The primary cost will be the franchise tax and the imposition of the excise tax on operating income. 5. Limited liability entities specifically excluded from franchise and excise tax a. "Venture capital funds" which are defined as a limited liability company, limited liability partnership, or limited partnership, formed and operated for the exclusive purpose of buying, holding and/or selling securities, including debt securities, primarily in non-publicly traded companies on its own behalf and not as a broker, and the capital of which fund is primarily derived from investments by entities and/or individuals which are neither related to nor affiliated with the fund. b. Certain "bankruptcy remote" limited liability entities in existence on May 1, 1999, with notes, receivables, other evidence of indebtedness obtained in the ordinary course by one or more members of an affiliated group which directly or indirectly secures loans made by or debt securities acquired by third parties. The existing financing arrangements of Tennessee's corporations with indirect access to capital markets are not to be disturbed. c. Certain limited liability entities owning farms and/or personal residences. EFFECTIVE DATES: The Tax Revision and Reform Act of 1999 has various effective dates. Although generally the franchise and excise tax provisions are effective for tax years beginning on or after July 1, 1999, there are major exceptions. Limited liability entities which are 80% or more owned by affiliated corporations, directly or indirectly doing business in Tennessee, will be subject to the franchise and excise tax for tax years ending on or after June 30, 1999. In addition, the provisions applying to royalties related to patents and copyrights are effective for tax years ending on or after June 30, 1999, regardless of whether the taxpayer is a corporation, a limited liability entity or another entity. Provisions relating to fraud and anti-abuse are also effective for tax years ending on or after June 30, 1999 and apply to all taxpayers, including individuals. Other 1999 Legislation Related to Limited Liability Companies Two bills impacting LLCs in which the tax group of Waller Lansden was active and which were sponsored by the Tennessee Bar Association were also passed. 1. One bill permits single member LLCs to be created under Tennessee law. This development is effective on becoming law. 2. The second bill makes various technical corrections and modifies certain default rules including rules concerning the automatic dissolution of the LLC for LLCs created on or after July 1, 1999. Existing LLCs may elect to come under the new provisions. Existing Limited Liability Entities Existing limited liability entities will need to look at their business, the cost of Tennessee's new tax and determine if the business needs restructuring or other modifications. Family limited liability entities (other than farms) and non-service limited liability entities need to take a particularly hard look at what this legislation means to them. Corporate structures will need to be reviewed in light of the single member LLC provisions, federal consolidated return rules, net operating losses and economic and business goals. In addition, for existing LLCs, the revisions to the Tennessee Limited Liability Company Act may be significant. Many LLCs may wish to revise their operating agreements to take advantage of the new rules. Future Tax Legislation A special session of the Tennessee General Assembly may well take place in November of this year with an income tax at the center of attention. It is fair to assume, however, that the various proposals considered by the legislature this spring will be back on the table. The information contained in this document should not be construed as legal advice. The information contained herein is provided for general information purposes only. Although the information contained herein is believed to be an accurate general description, it is possible that the Tennessee Department of Revenue and the courts could have different interpretations with the result that such information may change. Before acting on any matter contained herein, you should consult with your tax advisor with respect to your particular circumstances.

On June 22, 1999, the United States Supreme Court announced decisions in three cases that are certain to change the way the Americans with Disabilities Act ("ADA") affects management of your business and its employees. We anticipate the following immediate benefits:

• Greater certainty in human resources management
• Narrower population of ADA-eligible employees and job-seekers
• Disabilities measured by impact on life activities, rather than per se classifications
• Increased likelihood of dismissal of many ADA cases through summary judgment, avoiding the potential for costly verdicts

The ADA provides that an individual with a "disability" is protected against adverse employment decisions, such as termination or failure to hire, based upon the individual's disability. "Disability" is a term of art, defined by Congress as a mental or physical impairment that substantially limits the ability to perform a major life activity, such as working or caring for oneself. An individual without a "disability" is not covered by the ADA and cannot sue an employer for discrimination on the basis of a disability. Until June 22, it had been unclear whether someone who has a condition that is routinely corrected is "disabled." For example, if an airline requires that pilots have 20/20 vision, is a badly near-sighted person who nevertheless has 20/20 vision so long as she wears her glasses "disabled?" Or if an employee has high blood pressure that is controlled by medication, is he "disabled?" Is an employee "disabled" if he has a condition for which he has been able to compensate without artificial corrective measures, such as monocular vision? The Supreme Court said the answer to these questions is "no." In two of these cases, Sutton v. United Airlines and Murphy v. United Parcel Service, the Court held that persons whose impairments are corrected by medicine or other devices cannot claim a substantial limitation of any major life activity. In other words, they are not "disabled" and cannot sue under the ADA. Similarly, the Court decided in Albertsons v. Kirkinburg that mitigating measures such as the individual's ability to compensate for his impairment must be taken into account in judging whether he has a disability under the ADA. These decisions change the law in some parts of the country. Courts had been split as to whether employers should take corrective measures into account when determining whether an individual has a "disability." Employee groups and the individual plaintiffs in the Supreme Court cases argued they should not. They claimed that employees should be considered "disabled" without respect to any corrective measures. For example, in the Sutton v. United Airlines case, identical twin sisters had applied for pilot positions at United Airlines. The sisters had uncorrected vision of no better than 20/200. When wearing glasses, however, they had 20/20 vision. United Airlines_ company policy requires pilots to have uncorrected vision of at least 20/100 in each eye. The sisters claimed their uncorrected eyesight was a disability and that United had discriminated against them. But, as the Supreme Court noted, the sisters_ interpretation would make all glasses-wearing Americans "disabled," a definition Congress surely did not intend. The Supreme Court's decisions do not affect an employers responsibility to provide reasonable accommodations to those employees who are, indeed, disabled and can perform the essential functions of their jobs with such accommodations. Nevertheless, we view the decisions as helpful to management in the following ways:

1. The Court has narrowed the field of potential ADA plaintiffs.
2. We anticipate courts will focus ADA eligibility decisions on the individual's ability to perform his or her major life activities, including working, rather than reliance upon artificial classifications, i.e., nearsightedness.
3. We believe plaintiffs will have greater difficulty in avoiding summary judgment unless they are able to present evidence that they are, in fact, substantially limited in a major life activity.
4. Proper applicant screening processes and management of current employees in accord with yesterday's holdings may reduce an employer's risk of ADA litigation even further.
5. While the ADA remains a complex challenge in many other respects, employers will have greater certainty in identifying job-seekers and employees who are eligible to seek the protection of the federal courts if they are aggrieved by an employment decision.
6. All of which permits the employer the opportunity to manage its human resources needs with more confidence.

As focus shifts to actual limitations, rather than per se classes of disabilities, we do expect courts will expect more from employers in the way they manage persons who are, indeed, substantially limited in their ability to work and perform other major life activities. Nevertheless, we believe The Supreme Court's decisions offer exciting opportunities for human resources management.

On July 20, 1999, President Clinton signed into law the Y2K Act (the "Act") which in President Clinton.s words "is a narrow, time-limited legislation aimed at a unique problem." We all now know that problem is the potential inability of some computer software and systems to function properly when processing calendar date data beyond December 31, 1999 (also referred to as the "Millennium Bug"). The intended goal of the Act is to "head-off" disruptions to interstate commerce and the avalanche of litigation resulting from the Millennium Bug. The logic behind the Act in achieving this goal is that if it is harder and monetarily less desirable for potential Y2K plaintiffs to sue potential Y2K defendants, the plaintiffs won't sue (at least not right away) and the plaintiffs and defendants will then devote their energy and resources toward fixing their Millennium Bug problems. The purpose of this article is to identify some of the means used in the Act to achieve its goal. The Act applies to any "Y2K Action" brought after January 1,1999 for an actual or potential "Y2K Failure" occurring before January 1, 2003. To achieve its goal, the definition of Y2K Action in the Act is very broad, covering civil actions in federal and state courts even if the plaintiff is the a government entity acting in a "commercial or contracting capacity." The Act will also apply to civil actions where the defense "is related to an actual or potential Y2K Failure." The definition of Y2K Failure is equally broad, covering Y2K related failures in any devise, system, microchip, integrated circuit, software or firmware. The Act does not apply to claims for personal injury or wrongful death or if the underlying claim arises under the federal securities laws. Except where a plaintiff is seeking an injunction from the court, the Act requires prospective plaintiffs to provide written notice to the prospective defendant(s) in a Y2K action before the action is filed with the court. This notice must detail the material defects being claimed, the harm caused by the material defects, the remedy the plaintiff's seeks from the defendant to solve the problem, and the plaintiff's basis for seeking the remedy. One can see that this notice requirement is attempting to focus the dialog between the parties toward mutually solving the Y2K problem rather than litigating over it. Within thirty days after receiving such notice, a prospective defendant must respond to the plaintiff with a written statement detailing what the defendant has done or will do to solve the plaintiff's problem, and stating whether the defendant is willing to resolve the problem using alternative dispute resolution (arbitration or mediation). If the defendant does not respond within the thirty day period, the plaintiff may file a Y2K Action. If the defendant responds with a solution, or a statement of its willingness to use alternative dispute resolution, the plaintiff must allow the defendant an additional sixty days from the end of the thirty day period to fix the problem or resolve the dispute using alternative dispute resolution. If there is no fix or resolution to the problem after sixty days, the plaintiff may file an action. As a final note to the issue of notice and postponement of bringing a lawsuit, if the prospective plaintiff and defendant have a valid contract that provides for notice and delay of bringing a lawsuit, the contract provisions will control over the Act. On the issue of damages, the Act adds some interesting twists to the common law. With respect to a plaintiff's duty to mitigate damages, the Act provides that damages awarded in a Y2K Action will exclude those the plaintiff could have reasonably avoided in light of information or disclosures made by the defendant of which the plaintiff was aware or should have been aware. In light of the Y2K Disclosure Act of last year, it is likely that defendants having made Y2K disclosures either directly to plaintiffs or indirectly through their use of a Year 2000 Internet Website, will be able to take advantage of such disclosures to reduce their liability to plaintiffs. The Act also reinforces the law of contracts in that prevents a plaintiff from recovering damages that are not expressly allowed under the contract. This means that if a provision of a contract expressly disallows certain types of damages, a court cannot disregard the contract and award such damages. If the contract is silent on the issue of certain damages, the court may only award damages that are allowed by operation of state or federal law at the time the contract was effective. Regarding punitive damages, the Act requires plaintiffs to prove by clear and convincing evidence that the legal standard for awarding such damages has been met. Also, the liability of certain individuals and small organizations for punitive damages is capped at the lesser of three times compensatory damages, or $250,000. The Act addresses a number of other issues that are beyond the scope of this article.

Office of Inspector General Special Advisory Bulletin

Payments to Physicians to Reduce or Limit Services to Beneficiaries

A. Introduction

The Office of Inspector General (OIG) was established at the Department of Health and Human Services by Congress in 1976 to identify and eliminate fraud, abuse and waste in the Department's programs and to promote efficiency and economy in departmental operations. The OIG carries out this mission through a nationwide program of audits, investigations and inspections.

The Fraud and Abuse Control Program, established by the Health Insurance Portability and Accountability Act of 1996, authorized the OIG to provide guidance to the health care industry to prevent fraud and abuse, and to promote the highest level of ethical and lawful conduct. To further these goals, the OIG issues Special Advisory Bulletins about industry practices or arrangements that potentially implicate the fraud and abuse authorities subject to enforcement by the OIG.

This Special Advisory Bulletin addresses the application of sections 1128A(b)(1) and (2) of the Social Security Act (the Act) to gainsharing arrangements.(1) The civil money penalty (CMP) set forth in section 1128A(b)(1) of the Act prohibits any hospital or critical access hospital from knowingly making a payment directly or indirectly to a physician as an inducement to reduce or limit services to Medicare or Medicaid beneficiaries under the physician's care.

While the OIG recognizes that appropriately structured gainsharing arrangements may offer significant benefits where there is no adverse impact on the quality of care received by patients, section 1128A(b)(1) of the Act clearly prohibits such arrangements. Moreover, regulatory relief from the CMP prohibition will require statutory authorization.

Some hospitals and physicians may have already implemented programs that involve Medicare or Medicaid beneficiaries. In exercising its enforcement discretion, and in the absence of any evidence that a gainsharing arrangement has violated any other statutes or adversely affected patient care, the OIG will take into consideration whether a gainsharing arrangement was terminated expeditiously following publication of this Bulletin.

B. Prohibition on Hospital Payments to Physicians to Induce Reduction or Limitation of Services

Under section 1128A(b)(l) of the Act, a hospital is prohibited from making a payment, directly or indirectly, to induce a physician to reduce or limit services to Medicare or Medicaid beneficiaries under the physician's direct care. Hospitals that make (and physicians that receive) such payments are liable for CMPs of up to $2,000 per patient covered by the payments (section 1128A(b)(2) of the Act).

The statutory proscription is very broad. The payment need not be tied to an actual diminution in care, so long as the hospital knows that the payment may influence the physician to reduce or limit services to his or her patients. There is no requirement that the prohibited payment be tied to a specific patient or to a reduction in medically necessary care. In short, any hospital incentive plan that encourages physicians through payments to reduce or limit clinical services directly or indirectly violates the statute.

The breadth of the prohibition was intentional. As initially enacted by Congress, section 1128A(b)(l) of the Act prohibited payments by both hospitals and Medicare managed care plans to induce physicians to reduce clinical services.(2) Section 1128A(b)(l) of the Act was subsequently amended to delete the reference to Medicare managed care plans, and to add a new subsection to section 1876 of the Act that permitted Medicare managed care plans to implement physician incentive plans, provided the managed care plan did not induce the reduction of medically necessary care to individual patients and did not place the physician at substantial financial risk for services not provided by the physician.(3) Further, Congress explicitly gave the Secretary authority to regulate physician incentive plans offered by Medicare risk managed care plans. Because the resulting two provisions address the same issues and were drafted together, the stark difference in otherwise parallel language reflects a congressional decision to prohibit any payment arrangement between hospitals and physicians that is intended to induce a reduction or limitation in services.

This reading of the statute is also consistent with the legislative history surrounding the enactment of section 1128A(b)(l) of the Act. The prohibition was prompted in part by a General Accounting Office (GAO) report for the Chairman of the Subcommittee on Health of the House Ways and Means Committee regarding the physician incentive plans being implemented by hospitals in response to the then-recently enacted diagnostic related group prospective payment system and their potential detrimental effects on quality of care for Medicare patients.(4) The report analyzed four types of hospital-physician incentive plans, of which at least two bear strong similarities, and contain safeguards comparable, to the gainsharing arrangements currently being marketed by the healthcare consulting industry.(5) While the GAO report discussed several features in these plans that reduced the incentive to give substandard care, it concluded that no combination of features could guarantee that such plans would not be subject to abuse.(6) Congress concurred.The House Committee Report that accompanied the House provision that became section 1128A(b)(l) of the Act stated that "[t]he Committee believes that such incentive payments may create a conflict of interest that may limit the ability of the physician to exercise independent professional judgment in the best interest of his or her patients."(7) In explaining the inclusion of the prohibition in the final budget reconciliation bill that became OBRA 1986, the Chairman of the Subcommittee on Health of the House Ways and Means Committee, who was also a member of the Conference Committee, stated on the floor of the House that:

"[T]he House held firm in its insistence on outlawing certain physician incentive plans. We must not tolerate hospitals paying physicians to reduce or limit services to the elderly."(8)

In sum, we believe that section 1128A(b)(l) of the Act prohibits any hospital payments that induce physicians to reduce or limit clinical services to the physicians_ patients.

C. Gainsharing Arrangements

While there is no fixed definition of a "gainsharing" arrangement, the term typically refers to an arrangement in which a hospital gives physicians a percentage share of any reduction in the hospital's costs for patient care attributable in part to the physicians_ efforts. In most arrangements, in order to receive any payment, the clinical care must not have been adversely affected as measured by selected quality and performance measures. In addition, many plans require a determination by an independent consultant that the payment represents "fair market value" for the collective physician efforts. Medicare Part B and Medicaid payments to physicians generally are unaffected by a gainsharing arrangement.

Gainsharing arrangements seek to align physician incentives with those of hospitals by offering physicians a share of the hospital's variable cost savings attributable to Medicare and Medicaid reimbursement. Since the institution of the Medicare Part A DRG system of hospital reimbursement and with the growth of managed care, hospitals have experienced significant financial pressures to reduce costs. However, because physicians are paid separately under Medicare Part B and Medicaid, physicians do not have the same incentive to save hospital costs. Gainsharing arrangements are designed to bridge this gap by offering physicians a portion of the hospital's cost savings in exchange for identifying and implementing cost saving strategies.

The OIG recognizes that hospitals have a legitimate interest in enlisting physicians in their efforts to eliminate unnecessary costs. Savings that do not affect the quality of patient care may be generated in many ways, including substituting lower cost but equally effective medical supplies, items or devices; re-engineering hospital surgical and medical procedures; reducing utilization of medically unnecessary ancillary services; and reducing unnecessary lengths of stay. Achieving these savings may require substantial effort on the part of the participating physicians. Obviously, a reduction in health care costs that does not adversely affect the quality of the health care provided to patients is in the best interest of the nation's health care system. Nonetheless, the plain language of section 1128A(b)(1) of the Act prohibits tying the physicians_ compensation for such services to reductions or limitations in items or services provided to patients under the physicians_ clinical care.

D. Application of Section 1128A(b)(1) of the Act to Gainsharing Arrangements

Gainsharing arrangements that directly or indirectly provide physicians financial incentives to reduce or limit items or services to patients that are under the physicians_ clinical care are precisely the kind of physician incentive plans that Congress prohibited when it enacted section 1128A(b)(1) of the Act. The language of the statute, the language of the companion statute on managed care physician incentive plans, and the legislative history compel the conclusion that section 1128A(b)(1) of the Act prohibits any hospital-physician incentive plan that compensates a physician directly or indirectly based on cost savings on items and services furnished to patients under the physician's clinical care. We can perceive no meaningful difference between the kinds of incentive plans proposed in 1986 at the time of enactment of section 1128A(b)(1) of the Act (as reflected in the GAO report) and the variants being promoted by hospitals and health care consultants today.

Moreover, given the clear statutory prohibition on hospital-physician incentive plans, the OIG cannot provide any regulatory relief absent further authorizing legislation. Where Congress intended the Department to regulate physician incentive plans, such as plans offered by risk-based Medicare managed care plans, it did so explicitly. Congress_ omission of comparable regulatory authority for the Secretary over hospital-physician incentive plans represents its considered judgment that such plans are flatly prohibited.

We note, however, that hospitals may align incentives with physicians to achieve cost savings through means that do not violate section 1128A(b)(l) of the Act. For example, hospitals and physicians may enter into personal services contracts where hospitals pay physicians based on a fixed fee that is fair market value for services rendered, rather than a percentage of cost savings. Such contracts must meet the requirements of the anti-kickback statute (section 1128B(b) of the Act).

Notwithstanding the statutory prohibition, the OIG has given extensive consideration to whether it would be appropriate to protect individual gainsharing arrangements from OIG administrative sanctions through the issuance of favorable advisory opinions. Based on our review of a number of requests, we have concluded that they contain common elements that preclude our issuance of any favorable opinion. First, to date, the OIG has exercised its discretion to protect various arrangements from sanction only where such arrangements pose a minimal risk of fraud or abuse. By contrast, gainsharing arrangements pose a high risk of abuse. In order to retain or attract high-referring physicians, hospitals will be under pressure from competitors and physicians to increase the percentage of savings shared with the physicians, manipulate the hospital accounts to generate phantom savings, or otherwise game the arrangement to generate income for referring physicians. Given these pressures and the potential adverse impact on patient care from gainsharing arrangements, the OIG believes that immunizing such arrangements from sanction would be imprudent and inappropriate.

Second, gainsharing arrangements will require ongoing oversight both as to quality of care and fraud that is not available through the advisory opinion process. Apart from the potential for fraud and abuse, a critical inquiry is whether the arrangements have adequate and accurate measures of quality of care that would provide assurance that there is no adverse impact on patient care. Based on discussions with experts both within and without the Federal Government, the OIG has determined that any performance measures would require extensive verification through audits or review by an independent party on a continuing basis. The Office of Counsel to the Inspector General, which issues advisory opinions, has neither the resources nor the expertise to police a multitude of such arrangements on an ongoing basis.

Third, case by case determinations by advisory opinions are an inadequate and inequitable substitute for comprehensive and uniform regulation in this area. Were the OIG to issue a favorable opinion to one provider, that provider would have a significant competitive advantage in recruiting and attracting physicians to admit patients to its facility, since the physicians would have the opportunity to earn significant additional income not available at other institutions. The consequences would be that every hospital in the country would request an advisory opinion for its own program, and many would implement their own programs in the hope that their programs were close enough. Given the potentially serious adverse effects on patient care from improperly designed or implemented gainsharing arrangements, regulation of gainsharing arrangements requires clear, uniform, enforceable and independently verifiable standards applicable to all affected providers and not case by case decision-making.

E. Application to Other Arrangements

We are aware of reports that hospitals and physicians are engaging in a number of clinical joint ventures, including both freestanding specialty hospitals (e.g., heart, orthopedic, or maternity hospitals), and arrangements in which a high revenue generating unit or service (e.g., cardiology or cardiac surgery) of an existing hospital is restructured and legally incorporated as a separate hospital.

Typically marketed only to physicians in a position to refer patients to the venture and structured to take advantage of the exception in the physician self-referral law for physician investments in "whole hospitals", these ventures may induce investor-physicians to reduce services to patients through participation in profits generated by cost savings in clinical care. Accordingly, we believe such arrangements may also violate section 1128A(b)(l) of the Act, in at least some circumstances. In addition, such arrangements may implicate the anti-kickback statute (section 1128B(b) of the Act).

F. Conclusion

Absent legislative relief, section 1128A(b)(1) of the Act prohibits any gainsharing arrangements that involve payments by or on behalf of a hospital to physicians with clinical care responsibilities, directly or indirectly, to induce a reduction or limitation of services to Medicare or Medicaid patients. Parties interested in pursuing gainsharing arrangements that are currently prohibited by section 1128A(b)(1) of the Act should seek legislative relief. In the light of reports that some hospitals may already have such arrangements in place, the OIG will, in the absence of any evidence that an arrangement has violated any other statutes or adversely affected patient care, take into consideration in exercising its enforcement discretion whether a gainsharing arrangement was terminated expeditiously following publication of this Bulletin in the Federal Register.

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(1) Gainsharing arrangements may also implicate the anti-kickback statute (section 1128B(b) of the Act) and the physician self-referral prohibitions of the Act (section 1876 of the Act).

(2) Section 9313(c) of the Omnibus Budget Reconciliation Act (OBRA) of 1986 (P.L. 99-509).

(3) Sections 4204(a) and 4731 of the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508) (codified at section 1876(i)(8) of the Act).

(4) U.S. General Accounting Office, Physician Incentive Payments by Hospitals Could Lead to Abuse, GAO/HRD-86-103 (July 1986).

(5) Id. at 14-21.

(6) Id. at 23.

(7) H.R. Rep. No. 99-727, at 441 (1986).

(8) 144 Cong. Rec. H11,446 (October 17, 1986).

Tax, Probate & Trust
The Newsletter of the Tennessee Bar Association's Tax, Probate & Trust Section
Reprinted with permission

A tax-qualified retirement plan provides substantial tax benefits, allowing employers to deduct contributions while permitting employees to defer taxation on those contributions until distribution. In addition, earnings on trust assets accumulate tax-free. However, to achieve and maintain qualified status a plan must satisfy a series of complex and burdensome requirements. These requirements, generally set forth in section 401(a) of the Internal Revenue Code, include amending the plan document for all applicable law changes, meeting testing requirements to ensure that the plan does not unfairly discriminate in favor of highly compensated employees, and operating the plan in compliance with the plan document. Under a literal reading of the Code, failure to satisfy any requirement of section 401(a), even a relatively minor condition with insignificant effects, results in the disqualification of the plan and a loss of all tax-favored benefits.

Until recently, plan sponsors who had unintentionally breached section 401(a) were forced to choose between ignoring the problem in the hope that the plan would never be audited, treating the plan as disqualified, or voluntarily disclosing the failure to the IRS and facing an uncertain future. Most sponsors chose to "hide in the weeds," hoping the IRS would never examine their plans.

Understanding the disproportionality of the penalty to the crime, and the difficult decisions this presented for plan sponsors, the IRS took steps in the early 1990s to allow some flexibility. From 1991 to 1994, the IRS created various correction methods for plans that had failed section 401(a) in some way. These corrections methods were recently consolidated and revised in Revenue Procedure 98-22, designated as the Employee Plans Compliance Resolution System (EPCRS). EPCRS includes three voluntary correction programs.

Administrative Policy Regarding Self-Correction (APRSC) allows plan sponsors to self-correct qualification failures that arise solely from the failure to follow plan provisions (known as "operational failures). If the operational failures are significant, the failures must generally be corrected before the last day of the second year following the plan year in which the failures occurred. Because APRSC does not involve the IRS, there is no guarantee that the correction method chosen by the plan sponsor will satisfy an audit. Fortunately, the IRS has provided model self-correction methods for the more common operational failures.

Voluntary Compliance Resolution (VCR) enables a sponsor to voluntarily disclose to the IRS operational failures and to propose a correction. The VCR application must include a compliance fee that ranges from $500 to $10,000, depending on the size of the plan. If the IRS agrees with the proposed correction method, the IRS will issue a compliance statement addressing the terms of correction and providing that the IRS will not treat the plan as disqualified on account of the operational failures.

Walk-in Closing Agreement Program (Walk-in CAP), like APRSC and VCR, can be used to cure operational failures. In addition, Walk-in CAP can be used for plans whose provisions, on their face, violate section 401(a), and for plans that have failed the nondiscrimination and minimum coverage requirements. Plan sponsors seeking relief under Walk-in CAP must submit a detailed description of the plan failure to the IRS, along with a proposed methodology for correcting the failure. Once the IRS and the plan sponsor agree upon the method of correction, the parties sign a closing agreement. Upon the signing of the closing agreement, the plan sponsor must pay a compliance correction fee that can range from $500 to $70,000, depending on the size of the plan.

It should be noted that VCR and Walk-in CAP are not available for plans and plan sponsors that are under examination by the IRS. Further, VCR and correction of significant operation failures through APRSC are available only for plans that have received a current determination or opinion letter.

EPCRS provides relatively simple and inexpensive programs for voluntarily correcting plan failures. Plan sponsors who have unintentionally violated the plan qualification requirements for the Internal Revenue Code should consult their tax advisors to determine if they are eligible for EPCRS.

Note: The information in this article is date sensitive and may be superceded by subsequent events.

Tax, Probate & Trust
The Newsletter of the Tennessee Bar Association's Tax, Probate & Trust Section
Reprinted with permission

Final regulations were issued by the IRS this year that require tax-exempt organizations to make available for public inspection certain information about the organization.¹ Effective June 8, 1999, all tax-exempt organizations, except private foundations², are subject to the new disclosure requirements. The organization generally must provide copies of its annual information return and application for tax-exemption to any member of the public who requests such a copy or, in the alternative, make such documents widely available on the Internet. Specific rules are provided in the final regulations that outline: (1) the place and time the organization must make these documents available for public inspection, (2) conditions the organization may place on requests for copies of the documents, and (3) the amount, form and time of payment of any fees the organization may charge. In addition, the final regulations also prescribe the appropriate method for posting the documents on the Internet. Certain standards are prescribed in determining whether an organization is the subject of a harassment campaign with respect to document requests and the applicable procedures for obtaining relief from such harassment.

A tax-exempt organization must make available the exemption application form (Form 1023 or Form 1024) and any supporting documents filed by, or on behalf of, the organization in connection with its application. Any letter or document issued by the IRS in connection with the application must also be made available. In addition, the organization must make available its three most recent annual information returns (Form 990), including all schedules and attachments filed with the IRS. The organization, however, is not required to disclose the parts of the return that identify names and addresses of contributors, nor is it required to disclose Form 990-T. Public inspection must be made available without charge at the organization's principal, regional and district offices during regular business hours. An exception applies for certain sites that will not be considered a regional or district office. Generally, when a request for copies is made in person, the copies must be provided on the day of the request. If the request for copies is made in writing, the organization must mail the copies within 30 days from the date it receives the request. Certain exceptions apply. An organization is permitted to charge a reasonable fee for the cost of copying and mailing documents in response to a request for copies (currently $1 for the first page and $0.15 for each subsequent page, plus the actual cost of postage).

The final regulations provide that a tax-exempt organization is not required to comply with requests for copies if the organization has made the requested documents "widely available." An organization can make its application for tax exemption and/or its annual information returns widely available by posting such documents on the organization's World Wide Web page on the Internet or by having the applicable document posted on another organization's World Wide Web page as part of a database of similar materials. Certain requirements must be met, including: (1) the World Wide Web page through which the document is available clearly informs readers that the document is available and provides instructions for downloading it; (2) the document is posted in a format that, when accessed, downloaded, viewed and printed in hard copy, exactly reproduces the image of the application for tax exemption or annual information return as it was originally filed with the IRS, except for any information permitted to be withheld from public disclosure; and (3) any individual with access to the Internet can access, download, view and print the document without special computer hardware or software required for that format (other than software that is readily available to members of the public without payment of any fee) and without payment of a fee to the tax-exempt organization or to another entity maintaining the World Wide Web page. Organizations that have posted their application for tax exemption and/or an annual information return on the Internet must notify the person requesting a copy where the documents are available on the Web. If the request is made in person, the organization must provide notice to the individual immediately. If the request is made in writing, the notice must be provided within 7 days of receiving the request.

If the organization can demonstrate to the IRS that it is the subject of a harassment campaign and compliance with the request for documents that are part of the harassment campaign would not be in the public interest, the organization is not required to fulfill a request for copies of its information returns or application for exemption that it reasonably believes is part of the campaign. Requests for an organization's application for tax exemption or annual information returns is indicative of a harassment campaign if the requests are part of a single coordinated effort to disrupt the operations of the organization, rather than to collect information about the organization. Specific procedures for organizations that believe they are being harassed are detailed in the final regulations.

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¹ See T.D.8818, 64 F.R. 17279. ² Proposed regulations that provide for essentially identical disclosure requirements for private foundations were issued on August 9, 1999. Final regulations for private foundations are expected to be released by the end of this year.

Storytelling Magazine

Recently enacted federal legislation has created small changes in a wide range of issues related to the U.S. Copyright Act. The two separate acts, officially known as the Sonny Bono Copyright Term Extension Act and the Digital Millennium Copyright Act, are lengthy and difficult to wade through. The good news is that very few of their provisions impact storytellers directly.

The Sonny Bono Act does have a major effect on storytellers. The purpose of the Act is the extension of the term of U.S. Copyright Law. Previously, the official term of U.S. Copyright (at least for works created since 1989) was life of the author plus fifty years. The Sonny Bono Act extended this term to the life of the author plus seventy years for works created after 1978. For works created before that date, there is a flat 75 year term from the date of first publication, if the copyright in the work was renewed as necessary. Other information about the term of copyright and renewals for registered copyrights is dreadfully complex, terribly dull, and fortunately beyond the scope of this article.

The change in the term of copyright was opposed by practically no one except those who make a living reissuing public domain works. The change brought the United States into line with the copyright term that has been in existence for decades in most of the European countries. However, the change had failed to pass several sessions of Congress because of a long-running feud between the musical performing rights societies (ASCAP, BMI, and SESAC) and the owners of restaurants and bars who have long objected to paying the performing rights societies_ fees for using copyrighted music in their audio systems. When at long last the Act was passed, it was named in honor of the late Congressman Sonny Bono, who had been heavily involved in the proceedings.

The Digital Millennium Copyright Act (DMCA) contains one provision that is of some interest to storytellers. The DMCA specifically limits the liability of Internet service providers for copyright infringement. In short, an Internet service provider (such as America Online) cannot be held liable for copyright infringement simply because one of its users posts copyrighted material on the Internet. An Internet service provider does have certain obligations to remove such material when it has notice that the material has been posted, but it is largely relieved of any liability for the actions of its users. This is seen not only as a victory for those Internet service providers but as a comment on the relative lobbying power which those groups now have on Capitol Hill.

The DMCA's intentionally inscrutable title allows it to cover a general mishmash of other amendments to the Copyright Act. For example, the Act has a specific provision related to the copyrights of individuals who design vessel hulls (yes, we mean the part of a boat that goes in the water).

In conclusion, the Sonny Bono Act and the DMCA have little impact on storytellers outside of extending the protection for original works. Nonetheless, if you have specific questions about the protectability of your own work or the protectability of the work of another, which you contemplate using, it is always best to consult with legal counsel. The "term" of copyright, though simply expressed, is a difficult concept in application.

On October 29, 1999, the Department of Health and Human Services ("DHHS") proposed broad new privacy regulations to protect patient health information. The regulations are required as a result of the Health Insurance Portability and Accountability Act of 1996. Comments on the proposed regulations will be accepted by DHHS until January 3, 2000. Final regulations are expected no later than February 21, 2000. Once the regulations are final, health organizations and providers will have two years in which to reach full compliance. Federal officials estimate that compliance with the proposed rule would cost the health care industry $3.8 billion over 5 years, but the insurance industry says the cost could be 10 times that amount. Federal officials estimated that it would cost doctors, hospitals and health maintenance organizations more than $400 million to issue notices informing patients of their privacy rights, as required by the proposed rules. In addition, Federal officials have predicted thousands of patients will try to correct their medical records, and it will cost the health care industry more than $2 billion to deal with these requests over the next 5 years. The summary below provides an overview of the proposed regulations. The final rules are likely to differ to some degree, based on comments received by DHHS. 1. General Rule The proposed regulations prohibit the unauthorized use and disclosure of protected patient health information for anything other than treatment, payment, health care operations, emergencies, and limited public policy-related purposes. Written patient authorization is required for any uses or disclosures of protected information for any other purpose. The regulations also give patients the right to review and make copies of their health care records, to request that corrections be made, to request limitations on disclosure, and to obtain an accounting of any uses or disclosures made by the plan or provider for purposes other than treatment, payment, or health care operations. Covered health plans and providers must give each patient written notice regarding the types of uses or disclosures that may be made regarding the patient's individual health care information. 2. Covered Entities The proposed rule applies to three types of entities: health plans, health care clearinghouses, and to any health care provider who transmits health information in electronic form. These entities are referred to as "covered entities" under the proposed rule. A health plan is defined to be an individual or group plan that provides for, or pays the cost of, medical care. The definition includes employee welfare benefit plans, state-regulated insurance plans, managed care plans, and essentially all government health plans, including Medicare, Medicaid, the veterans health care program, and plans participating in the Federal Employees Health Benefits Program. A health care provider is a provider of institutional services as defined by Medicare, including hospitals, skilled nursing facilities, home health agencies, and comprehensive outpatient rehabilitation facilities; other Medicare facilities and practitioners, including assorted clinics and centers, physicians, clinical laboratories; various licensed/certified health care practitioners, and suppliers of durable medical equipment, appropriately licensed or certified health care practitioners or organizations, including pharmacies and nursing homes and many types of therapists, technicians, and aides. Health care providers who themselves do not directly conduct electronic transactions would become subject to the proposed rule if another entity, such as a billing agent or hospital, transmits health information in electronic form on the behalf. A health care clearinghouse is an entity that processes or facilitates the processing of nonstandard data elements of health information into standard data elements. Clearinghouses are exempt from most provisions of the proposed regulations because they do not deal directly with individuals. 3. Protected Health Information The standards apply to individually identifiable health information that is or has been electronically transmitted or maintained by a covered entity, regardless of its current form. For example, the information may be verbal or in paper form, but if it has ever been transmitted electronically, it is subject to the regulations. The proposed regulations do not apply to information that has never been electronically maintained or transmitted by a covered entity, nor does it apply to information that has been "de-identified" by removing all identifying data. Health information mean any information that relates to the past, present, or future physical or mental health or condition of an individual, the provision of health care to an individual, or the past, present, or future payment for the provision of health care to an individual. Individually identifiable health information means health information that contains data from which the identity of the patient can be ascertained. Electronically transmitted information means any information exchanged with a computer using electronic media, even when the information is physically moved from one location to another using magnetic or optical media (e.g., copying information from one computer to another using a floppy disc). Transmissions over the Internet (i.e., open network), Extranet (i.e., using Internet technology to link a business with information only accessible to collaborating parties), leased lines, dial-up lines, and private networks would all be included. Telephone voice response and "faxback" (i.e., a request for information from a computer made via voice or telephone keypad input with the requested information returned as a fax) systems would be included because these are computer output devices similar in function to a printer or video screen. The definition does not include "paper-to-paper" faxes, or person-to-person telephone calls, video teleconferencing, or messages left on voice-mail. The key is whether the source or target of the transmission is a computer. The medium or the machine through which the information is transmitted or rendered is irrelevant. De-Identified Information. The privacy standards applies only to "individually identifiable health information," and not to information that does not identify the individual. Information would be presumed to be successfully "de-identified" if:

• all of the following data elements have been removed or otherwise concealed: name; address, including street address, city, county, zip code, or equivalent geocodes; names of relatives and employers; birth date; telephone and fax numbers; e-mail addresses; social security number; medical record number; health plan beneficiary number; account number; certificate/license number; any vehicle or other device serial number; web URL; Internet Protocol (IP) address; finger or voice prints; photographic images; and any other unique identifying number, characteristic, or code (whether generally available in the public realm or not) that the covered entity has reason to believe may be available to an anticipated recipient of the information, and
• the covered entity has no reason to believe that any reasonably anticipated recipient of such information could use the information alone, or in combination with other information, to identify an individual.

The regulations are apparently intended to encourage greater use of de-identified information because such a practice would reduce the confidentiality concerns that result from the use of individually identifiable health information. The regulations state, "For example, providing de-identified information to a pharmaceutical manufacturer to use in determining patterns of use of a particular pharmaceutical by general geographic location would be appropriate, even if the information were sold to the manufacturer." 4. Use and Disclosure Without Authorization Covered plans and providers could use or disclose protected health information without authorization for (1) treatment, (2) payment, and (3) health care operations. The terms "treatment" and "payment" are relatively self-explanatory. The term "health care operations" means services or activities provided for the purpose of carrying out the management functions necessary for the support of treatment or payment, such as quality assurance, utilization review, audits, and similar activities. In addition, protected information could be used or disclosed without written authorization for the following purposes:

• Oversight of the health care system
• Public health functions
• Research
• Judicial and administrative proceedings
• Law enforcement
• Emergency circumstances
• To provide information to next-of-kin
• For identification of the body of a deceased person, or the cause of death
• For government health data systems
• For facility patient directories
• To banks, to process health care payments and premiums
• For management of active duty military and other special classes of individuals
• Where other law requires such disclosure and no other category of permissible disclosures would allow the disclosure

The proposed regulations include stringent requirements for verifying the identity and authority of anyone requesting health information for any of the above purposes. In many cases, court orders must be obtained. Covered plans and providers wishing to use or disclose protected health information for research without individual authorization must obtain documentation that a privacy board has reviewed the research protocol and has determined that specified criteria have been met. 5. Use and Disclosure With Authorization Written authorization would have to be obtained from the patient before protected health information could be used or disclosed for other purposes.Examples of activities requiring written authorization would include but would not be limited to:

• the use of protected health information for marketing of health and non-health items and services;
• the disclosure of protected health information for sale, rent or barter;
• the use of protected health information by a non-health related divisions of the
• same corporation, e.g., for use in marketing or underwriting life or casualty insurance, or in banking services;
• the disclosure, by sale or otherwise, of protected health information to a plan or provider for making eligibility or enrollment determinations, or for underwriting or risk rating determinations, prior to the individual.s enrollment in the plan;
• the disclosure of information to an employer for use in employment determinations; and
• the use or disclosure of information for fund raising purposes.

6. Who Can Give Authorization or Exercise Patient's Rights? Competent Adult: If the patient is a competent adult, he or she must give any required authorization. Incompetent Adult: If the patient is an incompetent adult, a legal representative may sign authorizations and exercise other rights (such as access, copying, and correction) on the patient.s behalf. For example, some state laws establish a hierarchy of persons who may make medical decisions for the incapacitated person (e.g., first a person with power of attorney; if not, then next-of-kin; if none, then close friend, etc.). In other states, health care providers may exercise professional judgment about which person would make health care decisions in the patient.s best interest. Minors. In general, a minor.s rights could be exercised by the minor.s parents, a parent, guardian, or person acting in loco parentis. However, in cases where a minor lawfully obtains a health care service without the consent of or notification to a parent, the minor would be treated as the individual for purposes of exercising any rights established under this regulation with respect to protected health information relating to such health services. 7. What has to be in the authorization? The authorization would have to include a description of the information to be used or disclosed with sufficient specificity to allow the covered entity to know to which information the authorization references. For example, the authorization could include a description of "laboratory results from July 1998" or "all laboratory results" or "results of MRI performed in July 1998." The authorization must:

• identify sufficiently the covered entity or covered entities authorized to use or disclose the protected health information.
• identify the person or persons authorized to use or receive the protected health information with sufficient specificity to reasonably permit a covered entity responding to the authorization to identify the authorized user or recipient.
• state a specific expiration date.
• include a signature or other authentication (e.g., electronic signature) and the date of the signature.
• identify the authority or relationship of any individual signing the authorization if other than the patient.
• include a statement that the individual understands that he or she may revoke an authorization except to the extent that action has been taken in reliance on the authorization.
• clearly state that the individual understands that when the information is disclosed to anyone except a covered entity, it would no longer be protected this regulation.

If the covered plan or provider initiates the authorization by asking individuals to authorize disclosure, the authorization must include all of the items required above and must also:

• identify the purposes for which the information is sought as well as the proposed uses and disclosures of that information;
• request only the protected health information necessary to accomplish the purpose specified in the authorization;
• advise that the individual may inspect or copy the information to be used or disclosed, that the patient may refuse to sign the authorization, and that treatment and payment cannot be conditioned on the patient.s authorization;
• state, (if applicable), that the disclosure would result in commercial gain to the covered entity.

The regulations include a model authorization form, attached as Appendix A. The model is a unitary model, which includes all of the requirements for authorizations initiated either by the patient or by the health plan or provider. The model authorization form or a document written in plain language that includes the required elements would meet the requirements of the proposed rule and would have to be accepted by the covered entity. There would be no "authorization" within the meaning of the rules proposed below if the submitted document has any of the following defects:

• the date has expired;
• on its face it substantially fails to conform to any of the requirements because it lacks an element;
• it has not been filled out completely. Covered entities may not rely on a blank or incomplete authorization;
• the authorization is known to have been revoked; or
• the information on the form is known by the person holding the records to be materially false.

8. Minimum disclosures With certain exceptions, permitted uses and disclosures of protected health information would be restricted to the minimum amount of information necessary to accomplish the purpose for which the information is used or disclosed. In addition, access to protected health information must be limited only to those people who need access to the information to accomplish the use or disclosure. Health plans would be required to limit requests to the information to achieve the purpose of the request. For example, a health plan seeking protected health information from a provider or other health plan to process a payment should not request the entire health record unless it is actually necessary. Except where the individual has specifically authorized use or disclosure of the full medical record, the provider could not disclose the entire record unless the request included an explanation of why the purpose of the disclosure could not reasonably be accomplished without the entire medical record. 9. Business Partners The proposed regulations define a "business partner" as a person or entity to whom the covered health plan or provider discloses protected health information so that the business partner can carry out, assist with the performance of, or perform on behalf of, a function or activity for the covered plan or provider. This would include billing agents, auditors, third-party administrators, attorneys, private accreditation organizations, clearinghouses, accountants, data warehouses, consultants and many other actors. For example, if a covered entity seeks accreditation from a private accreditation organization and provides such organization with protected health information as part of the accreditation process, the private accreditation organization would be a business partner of the covered entity. This would be true even if a third party, such as an employer or a public agency, required accreditation as a condition of doing business with it. Covered plans and providers could not permit the business partner to make uses or disclosures that the covered entity could not make. Covered health plans and providers are prohibited from disclosing protected health information to a business partner unless they have entered into a written contract with the business partner that:

• prohibits the business partner from further using or disclosing the protected health information for any purpose other than the purpose stated in the contract.
• prohibits the business partner from further using or disclosing the protected health information in a manner that would violate the regulations if it were done by the covered entity.
• requires the business partner to maintain safeguards as necessary to ensure that the protected health information is not used or disclosed except as provided by the contract.
• requires the business partner to report to the covered plan or provider any use or disclosure of the protected health information of which the business partner becomes aware that is not provided for in the contract.
• requires the business partner to ensure that any subcontractors or agents to whom it provides protected health information received from the covered plan or provider will agree to the same restrictions and conditions that apply to the business partner with respect to such information.
• establishes how the covered plan or provider will provide access to protected health information upon request of the patient, when the business partner has made any material alteration in the information.
• requires the business partner to make available its internal practices, books and records relating to the use and disclosure of protected health information received from the covered plan or provider to HHS or its agents for the purposes of enforcing the provisions of this rule.
• establishes how the covered plan or provider would provide access to protected health information upon request of the patient, in circumstances where the business partner will hold the protected health information and the covered entity will not.
• requires the business partner to incorporate any amendments or corrections to protected health information when notified by the covered plan or provider that the information is inaccurate or incomplete.
• at termination of the contract, requires the business partner to return or destroy all protected health information received from the covered plan or provider that the business partner still maintains in any form, and prohibits the business partner from retaining such protected health information in any form.
• states that individuals who are the subject of the protected health information disclosed are intended to be third party beneficiaries of the contract.
• authorizes the covered plan or provider to terminate the contract, if the plan or provider determines that the business partner has repeatedly violated a term of the contract required by the regulations.

A business partner generally could create a database of de-identified health information drawn from the protected health information of more than one covered plan or provider with which it does business, and could use and disclose information and analyses from the database, as long as there is no attempt to re-identify the data. Covered plans and providers will be accountable for the uses and disclosures of protected health information by their business partners. A covered plan or provider that knows or reasonably should know of a material breach by a business partner and fails to take reasonable steps to cure the breach or terminate the contract will be in violation of the regulations. 10. Patient Rights The proposed regulations create several basic individual rights, including the right to obtain access to protected health information about them, the right to request amendment and correction of protected health information, the right to request restrictions on the use or disclosure of protected information, the right to an accounting of how their protected health information has been disclosed; and the right to a notice of information practices. A. Right to Review and Copy Records Covered health plans and providers must allow individuals to inspect and obtain a copy of protected health information about them. Individuals also have a right to inspect and obtained protected health information about them maintained by a business partner of a covered plan or provider when such information is not a duplicate of the information held by the plan or provider. This right would last for as long as the plan, provider, or business partner maintains the protected health information. Plans and providers may, but are not required to, deny inspection and copying under very limited circumstances, as follows:

• a licensed health care professional has determined that, in the exercise of reasonable professional judgment, the inspection and copying requested is reasonably likely to endanger the life or physical safety of the individual or another person. (This does not include the potential for causing emotional or psychological harm.)
• the information requested is about another person (other than a health care provider) and a licensed health care professional has determined that inspection or copying is reasonably likely to cause substantial harm to that other person.
• the requested information was obtained under a promise of confidentiality from someone other than a health care provider and such access would be likely to reveal the source of the information.
• the information was generated in the course of a clinical trial that is still in progress, and the subject-patient had agreed to the denial of access in conjunction with the subject.s consent to participate in the trial.
• the information is compiled in reasonable anticipation of, or for use in, a legal proceeding.

Upon denying an individual.s request for inspection and copying in whole or in part, the covered plan or provider must provide the individual with a written statement in plain language explaining the reason for the denial. The statement would need to include the name and number of the contact person or office within the entity who is responsible for receiving complaints. In addition, the statement would need to include information regarding the submission of a complaint with the Department of Health and Human Services. The covered plan or provider still must make any other protected health information requested available to the individual to the extent possible consistent with the denial. The plan or provider could redact or otherwise exclude only the information that falls within one or more of the denial criteria described above and would be required to permit inspection and copying of all remaining information. Covered plans and providers must take action upon the request as soon as possible but not later than 30 days following receipt of the request. The individual must be notified of the decision to provide access and of any steps necessary to fulfill the request. The requested information should be provided in the form or format requested if it is readily producible in such form or format. Finally, if the covered plan or provider accepts an individual.s request, it would be required to facilitate the process of inspection and copying. Covered plans and providers may charge a reasonable, cost-based fee for copying health information. B. Request for Corrections Individuals have the right to request amendment or correction of protected health information that is inaccurate or incomplete. A covered plan or provider must accommodate requests with respect to any information that the covered plan or provider determines to be erroneous or incomplete, that was created by the plan or provider, and that would be available for inspection and copying. A covered plan or provider may deny a request for amendment or correction if, after a reasonable review, the plan or provider determines that it did not create the information at issue, the information would not be available for inspection and copying, the information is accurate and complete, or if it is erroneous or incomplete, it would not adversely affect the individual. The individual must be provided with a written statement in plain language of the reason for the denial and permit the individual to file a written statement of disagreement with the decision to deny the request. If the health plan or provider created the erroneous information, it must accommodate a request for amendment or correction. In addition, to ensure that protected health information remains as accurate as possible as it travels through the health care system, the following is required:

• The covered health plan or provider must notify any relevant persons, organizations, or other entities of the change or addition.
• Other covered plans or providers that receive such a notification are required to incorporate the necessary amendment or correction.
• Covered plans or providers must require their business partners who receive such notifications to incorporate any necessary amendments or corrections.
• Covered plans and providers are required to accommodate requests for amendment or correction for as long as they maintain the protected health information. Action on a request for amendment or correction must be taken not later than 60 days following the request.

C. Request for Limitations Individuals have the right to request that a covered plan or provider restrict the protected health information that results from that encounter (with the exception of encounters for emergency treatment) from further use or disclosure for treatment, payment, and health care operations. Covered entities would not be required to agree to restrictions requested by individuals. The rule would only enforce a restriction that has been agreed to by the covered entity and the individual. Covered entities who do not wish to, or due to contractual obligations cannot, restrict further use or disclosure would not be obligated to treat an individual making a request under this provision. For example, some health care providers could feel that it is medically inappropriate to honor patient requests under this provision. Covered health plans and providers would not be responsible for ensuring that agreed-upon restrictions are honored when the protected health information leaves the control of the covered entity or its business partners. D. Accounting of Uses and Disclosures Upon request, covered health plans and providers must provide individuals with an accounting of all instances where protected health information about them is disclosed for purposes other than treatment, payment, and health care operations. This obligation will last for as long as the plan or provider maintains the protected health information. The proposed regulations do not specify a particular form or format for the accounting. The plan or provider could elect to maintain a systematic log of disclosures or it could elect to rely upon detailed record keeping that would permit it to readily reconstruct the history when it receives a request from an individual. The accounting must include all disclosures for purposes other than treatment, payment, and health care operations, subject to certain exceptions for disclosures to law enforcement and oversight agencies. This would also include disclosures that are authorized by the individual. The accounting must include the date of each disclosure; the name and address of the organization or person who received the protected health information; and a brief description of the information disclosed. For all disclosures that are authorized by the individual, the plan or provider must maintain a copy of the authorization form and make it available to the individual with the accounting. Disclosures to a health oversight or law enforcement agency would be excluded from the accounting if the oversight or law enforcement agency provides a written request stating that the exclusion is necessary for a specified time period because access by the individual during that time period would be reasonably likely to impede the agency.s activities. The written request must specifically state how long the information should be excluded. At the expiration of that period, the covered entity would be required to include the information in an accounting for the individual. The accounting of disclosures, including copies of signed authorization forms, must be made available to the individual as quickly as the circumstances require, but not later than 30 days following receipt of the request. E. Notices Patients must be given written notice of the information practices of covered health plans and providers. The notice would inform individuals about what is done with their protected health information and about any rights they may have with respect to that information. Covered plans and providers are prohibited from using or disclosing protected health information in any way other than as disclosed in their notice to patients. Covered plans and providers could change their policies and procedures at any time. Before implementing a change, however, the covered plan or provider must revise its notice accordingly. The notice must include several basic statements to inform the individual of their rights and interests with respect to protected health information. The notice must:

• inform individuals that the covered plan or provider will not use or disclose their protected health information for purposes not listed in the notice without the individual's authorization;
• inform individuals that such authorizations can be revoked;
• inform individuals that they have the right to request that the covered plan or provider restrict certain uses and disclosures of protected health information about them, and that the plan or provider is not required to agree to such a request.
• inform individuals about their right of access to protected health information for inspection and copying and to an accounting of disclosures.
• inform individuals about their right to request an amendment or correction of protected health information, including a brief description of the procedures for submitting requests to the covered plan or provider.
• include a statement that there are legal requirements that require the covered plan or provider to protect the privacy of its information, provide a notice of information practices, and abide by the terms of that notice.
• include a statement that the plan or provider may revise its policies and procedures with respect to uses or disclosures of protected health information at any time and that such a revision could result in additional uses or disclosures without the individual.s authorization.
• inform the individual how a revised notice would be made available when material revisions in policies and procedures are made, such as posting a notice.
• inform individuals that they have the right to complain to the covered entity and to the Secretary if they believe that their privacy rights have been violated.
• identify a contact person or office within the covered plan or provider to receive complaints, and to help the individual obtain further information on any of the issues identified in the notice. A specific person would not need to be named in the notice.

All covered plans and providers would be required make their notice available to any individual upon request, regardless of whether the requestor is already a patient or enrollee. Health plans must distribute the notice by the effective date of the final rule, at enrollment, within 60 days of a material change to the plan's information practices, and at least once every three years. Covered health care providers must provide a copy of the notice to every individual served at the time of first service delivery. In addition, they must post the notice in a clear and prominent location where it is reasonable to expect individuals seeking service from the provider to be able to read the notice, and copies must be available on-site for individuals to take with them. Covered health care providers are required to provide a copy of the notice to individuals they are currently serving at their first instances of service delivery within a year of the effective date of the final rule. Some health care providers, such as clinical laboratories, pathologists and mail order pharmacies, do not have face-to-face contact with individuals during service delivery. Such providers would be required to provide the required notice in a reasonable period of time following first service delivery, through mail, electronic notice (i.e. e-mail), or other appropriate medium. For example, a web-based pharmacy could meet this distribution requirement by providing a prominent and conspicuous link to its notice on its home page and by requiring review of that notice before processing an order. 11. Administrative Obligations Covered health plans and providers are required to designate a privacy official, develop a privacy training program for employees, implement safeguards to protect health information from intentional or accidental misuse, provide some means for individuals to lodge complaints about the covered entity.s information practices, and develop a system of sanctions for employees and business partners who violate the entity.s policies or procedures. Covered plans and providers also must maintain documentation of their policies and procedures for complying with these requirements. Privacy Official. An employee or other person must be designated to serve as the official responsible for the development of policies and procedures for the use and disclosure of protected health information. Covered plans and providers must also designate a contact person or office to receive complaints and provide information about the matters covered by the entity.s notice. The privacy official could also be designated as this contact person. Training. Covered plans and providers are required to train all members of the workforce (e.g., all employees, volunteers, trainees, and other persons under the direct control of a person working on behalf of the covered entity on an unpaid basis who are not business partners) who are likely to have contact with protected health information. Initial training must be provided by the date on which the proposed regulations become applicable. Upon completion of the training, the person would be required to sign a statement certifying that he or she received the privacy training and will honor all of the entity.s privacy policies and procedures. At least once every three years after the initial training, covered entities would be required to have each member of the workforce sign a new statement certifying that he or she will honor all of the entity.s privacy policies and procedures. Safeguards. Administrative, technical, and physical safeguards must be put in place to protect against any reasonably anticipated threats or hazards to the privacy of the information, and unauthorized uses or disclosures of the information. These requirements will be parallel and consistent with the security standards proposed for certain electronic information in the Notice of Proposed Rulemaking entitled the Security and Electronic Signature Standards (HCFA-0049-P), which can be found at 63 FR 43241. Internal complaint process. Covered plans and providers must have some mechanism for receiving complaints from individuals regarding the covered plan.s or provider.s compliance with the requirements of this proposed rule. The covered plan or provider would be required to accept complaints about any aspect of their practices regarding protected health information. Sanctions. All members of the workforce who have regular contact with protected health information should be subject to sanctions, as would the covered plan or provider.s business partners.

Advisory Opinion Blesses ASC Joint Venture By Alex Buchanan Physician joint ventures are tricky, but a recent Office of Inspector General (OIG) advisory opinion sheds some light on acceptable structures. The OIG has long been concerned about the potential for abuse posed by healthcare joint ventures in which investors are the sources of referrals or suppliers of items or services to the joint venture. The anti-kickback statute makes it a criminal offense knowingly or willfully to offer, pay, solicit or receive any remuneration to induce referrals of services or items reimbursed by federal or state healthcare programs. The statute has been construed broadly to find a violation even if only one of the purposes of the venture is to induce referrals. Against this backdrop, the OIG issued its Advisory Opinion 98-12 concerning a proposed investment by physician investors in a certified ambulatory surgery center (ASC). As noted in the opinion, the investment did not meet any of the safe harbors to the anti-kickback statute. These include the safe harbors for investments in large publicly traded entities and for investments in small entities in which no more than 40% of the investors are referral sources and the entity derives no more than 40% of its income from such investors. It also should be noted the investment does not meet the proposed safe harbor for investments in an ASC when all the physician/investors are surgeons who actively treat patients at the ASC. As noted in the opinion, the proposed surgery center investment was the antithesis of the small entity investment exception. The physician/ investors proposed to make a substantial contribution to the new entity (but not based on any expected volume of referrals) and expected to be a major source of the referrals to the entity. Furthermore, the proposal did not fall within the proposed ASC safe harbors because investors included several anesthesiologists as well as surgeons. In approving the proposed joint venture, the OIG noted four critical factors:

• All physician/investors would be making substantial investments in the ASC and incurring financial exposure for the lease.
• Each physician/investor would represent that he currently derives and anticipates continuing to derive at least 40% (and, in no case, less than 33.33%) of his medical practice income from the procedures he performs at the center. Further, a majority of the doctor's surgical procedures would be performed at the ASC.
• The investor/physicians estimated revenues for Medicare procedures at the ASC would amount to 5% or less of the center's total revenues.
• Any return to the physician/ investors would be proportionate to their capital investments and not based on referrals.

The OIG was careful to limit the scope of its opinion. It made clear no protection exists for investments by primary care physicians or other physicians who perform little or no services at the ASC. If a physician/investor's total medical practice income generated from performing medical procedures at the ASC were to drop below 33.3% of his total medical income, the opinion explicitly states the opinion would be without force and effect. The Advisory Opinion indicates the OIG is willing to permit physician/investor ownership where it appears there are legitimate business reasons for the ownership outside of inducing referrals and there is minimal risk the return on investment would be a disguised payment for referrals. In particular, the opinion indicates it is advisable to proceed with physician invest-ments only where the physicians devote a substantial portion of their time to the ASC.s activities and derive at least one-third of their total medical practice income from treating patients at the center. Although the OIG specifically states no outside parties may rely on advisory opinions, it is still helpful in providing guidance as to what types of investments the OIG is willing to accept. For the first time, practition-ers have direct guidance on a permit-ted physician investment where the investment is substantial and the investors are the major source of referrals to the joint venture. Alex Buchanan is a member of the firm and practices in the area of corporate law.

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General Principles of Asset Protection By K. Gabriel Heiser It is no secret there is a litigation explosion in the United States. As a result, more and more healthcare providers and executives are seeking ways to protect their hard-earned assets from lawsuits, frivolous claims, creditors and predators. Asset protection is a complex field covering many technical areas, including the laws of bankruptcy, tax, criminal, international and trusts. As such, this article is meant merely to cover some of the most basic concepts in a general way and should not be considered or relied upon as legal advice. You may think you can transfer your assets at any time to your spouse, child or a trust for the benefit of such individuals to protect assets from creditors_ claims. However, you must observe the maxim, "transfers when waters are calm are okay, while transfers when waters are choppy are too late." So, if a lawsuit already has been filed against you, it is too late. The transfer, in such a case, would be deemed fraudulent and the court will have the power to set it aside in favor of the creditor. Fraudulent transfer laws originated in England with the 1571 Statute of Elizabeth. It states, "If a transfer is made with actual intent to hinder, delay, or defraud any creditor of the debtor, it is fraudulent as to a creditor whose claim arose before or after the transfer date." This is addressed in the Uniform Fraudulent Conveyances Act which most states have adopted. In addition, if the transfer is one which renders you unable to meet your expected debts or obligations, it is deemed fraudulent regardless of your intent. However, not all creditors can take advantage of this fraudulent transfer rule. A creditor's claim must be in existence at the time of transfer. Thus, transfers can serve as insurance against a possible future creditor, e.g., a physician transferring assets to his or her spouse to protect against lawsuits for malpractice not yet committed. Specific Asset Protection Techniques Under some circumstances, assets can be protected without having to give up all ownership interests. For example, assets may be placed in a joint tenancy, tenancy-by-the-entirety or be owned through a limited partnership or placed in a retirement plan. These techniques have shortcomings, however. Holding real estate or other assets as joint tenants with right of survivorship still would allow a creditor to force partition and sale of the debtor's interest. The only benefit would be if the debtor dies before the creditor perfects his claim. Then it is too late for the creditor to enforce his claim against the debtor's interest. Holding assets as tenants-by-the-entireties is only available for spouses. In Tennessee, the creditor of one spouse can't touch real estate held as tenants-by-the-entireties unless the marriage dissolves or the debtor's spouse predeceases the debtor. However, joint debts of the spouses are not protected. Moreover, with respect to assets held as tenants-by-the-entireties other than real estate, the courts are divided as to whether a creditor of one spouse could seize all or a portion of the asset in satisfaction of the creditor's claim. Thus, tenancy-by-the entireties may not be a good long-term solution. Limited partnerships, if properly drafted, can offer some protection for assets owned by the partnership. For example, if the debt is unrelated to the partnership's activities, the creditor will only be entitled to the income allocated to the debtor's partnership interest, if the general partner decides to distribute the income. Further, the creditor will not gain any interest in the asset itself or any other rights in the partnership. However, if the lawsuit is related to the activities of the partnership, then creditors can reach all partnership assets and all assets of the general partners. In such instances, limited partners risk the loss of their investments in the partnership. Retirement plans may also offer significant asset protection. The U.S. Supreme Court has ruled ERISA-qualified plans are protected against creditors. Regular IRAs have no federal protection, but are protected in some states by statute. However, there is still some question whether Roth IRAs are similarly protected. The Problem with U.S.-Based Trusts Revocable or living trusts offer no asset protection to the creator of a trust since the creator still has control over the assets and can be required to use them to pay legitimate debts. In most states, irrevocable trusts are not much better if the creator retains an interest as a beneficiary since that interest can still be reached. In addition, in almost every state, the trust is subject to a legal doctrine known as the Rule Against Perpetuities. This may limit the creator's ability to protect the assets for unlimited future generations or to take advantage of generation-skipping transfer tax exceptions. Additionally, the trust's investments are limited by Securities and Exchange Commission (SEC) regulations, so certain foreign investments are not accessible to the domestic trust. Domestic trust assets are easy for lawyers to discover and attack as fraudulent. The burden of proof is typically fairly easy to meet, and the transfer need only have been fraudulent as to any creditor, even one not part of the lawsuit. Once the transfer is proven fraudulent, the entire amount of property in the trust is set aside and available for all current creditors. There is not great expense or risk to attacking domestic trusts. Usually, it is done on a contingency fee by the creditor's attorney. Finally, there are long statutes of limitations to attack a fraudulent domestic transfer; six years or more is typical. Foreign Trusts Advantages Because of the numerous shortcomings of domestic trusts just discussed, more and more wealthy individuals (and their advisors) are looking offshore. There are now a small number of foreign countries that offer superior asset protection for the following reasons:

• Their very foreignness -Location, currency, language, customs, court systems, etc., all must be learned and dealt with by the creditor.
• Distance from U.S.
• Must hire a local attorney -Most countries do not allow contingency fees. Further, most attorneys will be conflicted out and, therefore, unavailable to the creditor because of current work with one or more of the country's large trust companies.
• Bond -In most cases, forfeitable bond must be posted to institute a lawsuit if the plaintiff loses.
• Legal fees -The defendant's legal fees may have to be paid by a losing plaintiff
• No Rule Against Perpetuities -A true dynasty trust may be set up for unlimited future generations which also allows taking full advantage of the $1 million generation-skipping transfer tax exemption.
• Grantor -The grantor may be a discretionary beneficiary and the trust will still be protected against creditor attack.
• Global investment opportunities are not limited to SEC-approved securities -Note, however, the assets need not be relocated to the foreign country. The grantor's local trusted advisor may safely continue to manage the assets unless and until a threat of a lawsuit is perceived.
• Difficult to discover -It should be pointed out, however, that secrecy is not the important key to the soundness of this plan.
• Difficult to attack -There is a higher burden of proof required to prove the transaction was fraudulent, e.g., beyond a reasonable doubt (the standard of evidence required in the Cook Islands) versus a preponderance of the evidence (the standard required in most states.) The transfer must have been fraudulent as to the particular creditor who is the plaintiff. Finally, if a transfer is found to be fraudulent as to a particular creditor, only such assets will be set aside as are necessary to satisfy that creditor's claim, forcing each creditor to litigate separately.
• Judgments obtained in the U.S. are not recognized by the foreign entity, i.e., no comity -A new lawsuit must be begun on foreign soil, retrying the claim. Witnesses, exhibits and all other evidence must be transported to the foreign country at great expense to the creditor.
• Short statutes of limitations -These may range from zero to two years from the date the property is titled in the name of the trust if the grantor was solvent at such time and if an obligation or liability existed on the date of transfer and the transferor had actual notice of it. After the period has run, no creditors may attack the trust on fraudulent transfer grounds.

A transfer to a trust that took place before a cause of action accrued is not deemed to be fraudulent and therefore cannot be attacked. The bottom line is that when faced with all of the above hurdles, the debtor usually will be able to negotiate an early, cheap settlement with the creditor or prevent the filing of the lawsuit in the first place. Finally, the test is not, "Have you absolutely protected your assets from creditors?" but rather "Are you in a better position after creating your asset protection plan than you were before you started?" Gabriel Heiser is an associate of the firm and practices in the area of trust and estate law.

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New Liability Concern for Providers By Jane Hyatt Thorpe Check Medicare Status of Contractors Hospitals and physicians now face yet another concern when entering into contracts for supplies and services indirectly covered by Medicare. By failing to check whether the other party has ever been sanctioned or excluded from Medicare, they could face severe penalties, including fines of up to $10,000 per item or service, treble damages, denial of reimbursement and exclusion from Medicare. Exclusion of Indirect Providers The Health Care Financing Administration (HCFA) and the Office of the Inspector General (OIG) recently began cracking down on indirect providers who have defrauded or abused Medicare. As of Oct. 2, the OIG expanded its authority to exclude these indirect providers from Medicare. Indirect providers include suppliers of drugs, medical devices and other reimbursable items as well as some service providers. They are referred to as indirect providers as they do not submit claims directly to Medicare. Rather, they supply products or services to hospitals and physicians who then submit claims (which often include the cost of the supplies or services) directly to Medicare for reimbursement. Effect On Hospitals and Physicians The exclusion of indirect providers may have a significant effect on hospitals, physicians and other providers who submit bills directly to Medicare. Under the Balanced Budget Act, it is illegal to submit claims to Medicare for products or services provided by sanctioned or excluded suppliers or service providers. However, only those hospitals and physicians who know or should know a supplier or service provider has been excluded will be subject to the civil monetary penalties. The OIG's interpretation of "know or should know" mandates all hospitals and physicians keep themselves apprised of all exclusions. According to the OIG, this duty is part of the ongoing responsibility physicians and hospitals have to refrain from contracting with excluded entities. To assure hospitals and physicians do not unknowingly bill Medicare for products or services furnished by an excluded indirect provider, the OIG will inform the public of any exclusions quickly over the Internet at the OIG's web site. (See "Precautions" box.) Thus, the OIG is advising hospitals and physicians to check the site regularly to avoid any contracts or arrangements with excluded suppliers or service providers. Enrollment Disclosure HCFA is using the Medicare General Enrollment Form 855 to prompt hospitals and physicians to make inquiries of all their suppliers and service providers. This form requires hospitals and physicians to disclose specific information regarding all medical suppliers and service providers who are paid more than $10,000 per year by the enrolling hospital or physician. All hospitals and physicians must provide this information so HCFA may ensure they are not contracting with excluded entities. This may be burdensome for some facilities and corporate offices which negotiate a number of national contracts for all their facilities. Jane Hyatt Thorpe is an associate of the firm and practices in the area of health law.

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OIG Sets Provider Self-Disclosure Protocol By Michelle B. Marsh What do you do if, during your compliance activities, you discover an overpayment that needs to be disclosed to the government? The Office of Inspector General (OIG) of the Department of Health and Human Services released its answer to this question in its October 21 Provider Self-Disclosure Protocol. However, healthcare providers should be aware of the pitfalls. The voluntary protocol may be used by any provider, unlike OIG's Operation Restore Trust voluntary pilot program, and is intended to provide a viable opportunity for self-disclosure. The complete protocol can be found on the OIG's website. It describes all the information the OIG expects to be included in a meaningful self-disclosure, including:

• A description of the nature and extent of the improper practice.
• The provider's discovery and response.
• An estimate of the monetary impact of the disclosed matter.

The OIG will not provide any guarantees about the benefits of disclosure to the provider. The OIG requests very detailed information to be included in these descriptions, including identification of corporate officials, employees or agents who either knew of, encouraged or participated in the practice or should have known of, but failed to detect the practice. The OIG also provides specific guidelines on how the monetary assessment should be conducted. The Pitfalls Although the OIG's guidance in this arena is useful, there are some major pitfalls. First, the provider must determine to which government entity it is appropriate to disclose the matter. Some overpayments may still be more appropriately handled by the carrier or intermediary. The OIG also indicates that, when it believes it is necessary, it will refer matters disclosed to it to the Department of Justice. Therefore, providers are cautioned it may be necessary to disclose simultaneously to several agencies. Since it is important to choose the forum and timing of disclosures carefully, providers are urged to seek legal counsel before making a disclosure. The OIG's protocol is one indicator of how seriously the government takes providers_ responsibility for self-monitoring compliance issues. When you find you have an issue requiring disclosure, recognize the OIG's protocol is a useful tool, but not a cure-all for disclosure questions. Some overpayments may still be more appropriately handled by the Medicare carrier or intermediary. The OIG also indicates that, when it believes it is necessary, disclosed matters will be referred to it to the Department of Justice. Therefore, providers are cautioned it may be necessary to disclose simultaneously to several agencies. Since it is important to choose the forum and timing of disclosures carefully, providers are urged to seek legal counsel before making a disclosure. The OIG's protocol is one indicator of how seriously the government takes providers_ responsibility for self-monitoring compliance issues. When you find you have an issue requiring disclosure, recognize the OIG's protocol is a useful tool, but not a cure-all for disclosure questions. Michele B. Marsh is an associate of the firm and practices in the area of health law.

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PRECAUTIONS AGAINST LIABILITY By Michelle B. Marsh To help avoid contracts or arrangements with excluded providers, the Office of Inspector General (OIG) advises hospitals and physicians to check its website regularly at http://oig.hhs.gov/ for excluded suppliers or service providers. The General Services Administration's website also contains list of excluded providers and can be found at http://www.arnet.gov/epls. In addition, hospitals and physicians may want to include the following warranty in their agreements with contractors: "Contractor has never been suspended, excluded, barred or sanctioned by Medicare or any other state or federal healthcare program, nor has Contractor ever been convicted of a criminal offense related to healthcare. Contractor shall notify [HOSPITAL or PHYSICIAN] immediately if any such action is proposed or taken against Contractor, or if Contractor becomes the subject of an investigation that could lead to such action."

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Provider-Based Status: Proposed Rules Require Advance Determination By Patsy O. Powers The Health Care Financing Administration (HCFA) proposed rules on Sept. 8 for the payment of hospital outpatient services on a prospective payment system (the Proposed Rules). The Proposed Rules, when adopted, will implement a number of provisions contained in the Balanced Budget Act. These generally eliminate cost-based reimbursement for hospital outpatient services. The Proposed Rules are of special concern to hospitals because they contain new criteria for determining whether the hospital's outpatient departments and off-campus facilities qualify as provider-based. HCFA has indicated the provider-based rules will go into effect within 30 days following adoption and publication of the final rules. This is in contrast to other portions of the Proposed Rules that have been delayed until after Jan. 1, 2000, due to concerns about year 2000 problems. Hospitals should not wait until the 30-day period following publication of the final rules to make sure their provider-based facilities meet the new criteria. Definition The Proposed Rules define a provider-based entity as "a provider of healthcare services_ either created by, or acquired by, a main provider for the purpose of furnishing healthcare services under the name, ownership and administrative and financial control of the main provider." The Proposed Rules state HCFA must make this provider-based determination in advance before the entity begins billing for services as provider-based or before it includes any allowable costs of those services on its cost reports. Criteria for such a determination include:

• Licensure -The provider-based entity and the main provider are operated under the same license, except in areas where state law requires a separate license for the provider-based entity.
• Common Ownership and Control -The provider-based entity and main provider must have the same owner and be governed by the same board of directors and bylaws. Facilities owned and operated in joint ventures with other parties cannot be considered provider-based unless the main provider is owned and operated by the same joint venture.
• Common Administration and Supervision -This includes a day-to-day reporting relationship and common financial services (billing, payroll, salary structures).
• Integrated Clinical Services -This may be evidenced by common privileges, monitoring and oversight, medical records and full access to all services of the main provider.
• Financial Integration -Evidence includes shared income and expenses between the main provider and the provider-based entity. Additionally, the costs of the provider-based entity are reported in a cost center of the main provider and the financial status of the provider-based entity is incorporated and readily identified in the main provider's trial balance.
• Public Awareness -The provider-based entity is held out to the public and other payers as part of the main provider.
• Location in the Immediate Vicinity -The parties should be on the same campus unless the provider-based entity and the main provider can furnish data to demonstrate they serve the same patient population. Provider-based entities are not considered to be in the immediate vicinity if they are located in a different state from the main provider.

If a hospital treats a facility or organization as provider-based before obtaining determination of provider-based status, the Proposed Rules indicate HCFA may investigate and reconsider all payments to that main provider to determine whether the designation was appropriate. If HCFA finds the entity was not provider-based, it will seek to recover all payments in excess of those payments that should have been made in the absence of the provider-based status. The good news, however, is recovery will not be made for services billed prior to the effective date of the rules that finally are adopted as long as the main provider made a good-faith effort to operate the entity as provider-based. The proposed rules can be found at 63 FR 47552. They are also available on the Internet at http://www.gpoaccess.gov/fr/index.html. Patsy Powers is an associate of the firm and practices in the area of health law.

The Securities and Exchange Commission recently adopted comprehensive revisions to its rules applicable to takeover and business combination transactions (including mergers, acquisitions and tender offers). The new rules are intended to:

• Facilitate communications with security holders and the markets in the context of business combinations or proxy solicitations
• Minimize selective disclosure issues
• Level the playing field for cash and stock tender offers
• Update the tender offer rules to clarify regulatory requirements
• Reduce compliance burdens consistent with investor protection

These rules, which are contained in the SEC's new "Regulation M-A," will become effective on January 24, 2000.¹

This summary highlights and briefly explains the most significant provisions of Regulation M-A. You are encouraged to contact a Waller Lansden attorney in our Securities/M&A Working Group to discuss any aspect of Regulation M-A and its potential effect on your business or prospective transactions.

Introduction

Under the existing legal framework, the SEC imposes restrictions on communications of transaction-related information to security holders and the markets immediately following the announcement of a business combination transaction. The SEC has also long noted the regulatory disadvantages of stock tender offers as compared to cash tender offers. In addition, the SEC has recognized that multiple, conflicting disclosure schemes are often applied to the same transaction (e.g., proxy and tender offer rules), resulting in severe regulatory burdens and accompanying legal exposure to M&A transaction participants.

In addition to these structural problems with the existing regulatory scheme, the SEC has acknowledged that:

• There have been an increasing number of transactions where securities (rather than cash) are offered as consideration
• Hostile transactions involving proxy or consent solicitations have become more commonplace
• Significant technological advances have made rapid, frequent and direct communications with security holders both feasible and efficient

These trends, when coupled with the shortcomings of the existing legal framework, provided the impetus to the SEC to adopt Regulation M-A.

Enhancing Communications Before Filing of Disclosure Documents

In what we believe to be the most significant revision of the rules, the SEC has eliminated current restrictions on oral and written communications with security holders before the filing of a registration statement, proxy statement or tender offer statement. The SEC has adopted a "free communication exemption" permitting communication:

• Before filing and public dissemination of registration statements relating to stock mergers and stock tender offers
• Before filing and public dissemination of a proxy statement (for any solicitation, not just those relating to a business combination)
• Regarding a proposed tender offer without triggering "commencement" of the offer

The SEC has established certain requirements that must be met before a party can utilize this free communication exemption. First, all written communications regarding business combination transactions must be filed with the SEC on the date of first use.² Oral communications, however, need not be filed. Second, all written communication must contain a prominent legend advising investors to read the registration, proxy or tender offer statement. Finally, parties must still continue to comply with the applicable rules requiring delivery of the appropriate disclosure documents prior to the time security holders receive a proxy card soliciting a vote or a transmittal letter soliciting a tender. There are no eligibility requirements regarding size and seasoning of the issuer that would restrict the availability of the free communication exemption. In addition, the SEC clarified that an immaterial or unintentional delay or failure to file would not result in the loss of the free communication exemption, so long as a good faith, reasonable attempt was made to file immediately upon discovery of such omission.

The SEC believes that the new regulatory scheme will enhance communication with security holders and the market while reducing the amount of selective disclosure of information, because Regulation M-A requires companies to file publicly all written communications relating to a transaction. When combined with new information delivery technologies such as websites and e-mail, Regulation M-A should enhance the flow and quality of information, ensure a more even distribution to sophisticated financial analysts and the general public alike and promote informed investing and voting decisions.

The SEC added one significant protection for investors in newly-adopted Rule 14e-8, which prohibits bidders from announcing an offer (i) without an intent to commence or consummate an offer within a reasonable time, (ii) with the intent to manipulate the price of the bidder or target's securities or (iii) without a "reasonable belief" that the bidder has the means to purchase the securities sought. The "reasonable belief" test is meant to constitute an objective test, and in its commentary on the new rule the SEC observed that in most cases a commitment letter or other evidence of available funds (e.g., a credit facility or cash on hand) would satisfy the reasonable belief requirement.

The SEC has also substantially narrowed the availability of confidential treatment for filed merger proxy statements. Under current rules, merger proxy materials can be filed on a confidential basis and not made public until all of the comments of the SEC staff have been resolved. Regulation M-A retains confidential treatment only if the parties to the transaction limit their communications with the marketplace to those permissible under Rule 135. In essence, parties will now have to choose between the free communication exemption under the new rules and confidential treatment of a merger proxy filing.

The SEC ultimately did not adopt the "test the waters" approach that it had suggested in its proposed rule.³ The "test the waters" approach would have permitted both written and oral proxy solicitations prior to the filing of a proxy statement. Given concerns about unregulated and secret solicitations, the SEC will rely instead on the free communication exemption and the new requirement to file written materials upon first use.

Leveling the Playing Field for Cash and Stock Tender Offers

New Regulation M-A permits issuer and third-party exchange offers to commence upon the filing of a registration statement. Currently, registered exchange offers cannot commence until the related registration statement becomes effective. Cash tender offers, however, can commence as soon as a bidder files and disseminates a tender offer statement. This disparate regulatory treatment gave cash tenders a distinct timing advantage over exchange offers.

Early commencement under the new scheme, however, is not mandatory. The bidder may elect early commencement under Regulation M-A or elect to commence the offer upon the SEC's declaration of the effectiveness of the registration statement. To commence an early offer, the bidder must:

• File a registration statement relating to the securities offered, including a preliminary prospectus with all information (including pricing) necessary for investors to make an informed investment decision
• Disseminate the preliminary prospectus to all security holders
• File a tender offer statement on new Schedule TO with the SEC

With respect to mechanics, Regulation M-A will permit security holders to withdraw the tendered securities at any time prior to purchase by the bidder. In addition, the SEC has retained the requirement that no securities may be purchased until the SEC declares the registration statement effective and the 20 business day tender period has expired.

The new rules also provide that bidders sending a preliminary prospectus must disseminate a supplement to security holders if there are any material changes (resulting from SEC staff review or otherwise) in the information previously disclosed. The SEC also requires the bidder to extend the offer for a specified minimum period of time after it circulates a supplement, in order to permit security holders to react to such information and withdraw previously tendered securities, if so desired. SEC revised Rule 14d-4 to specify the mandated extension periods:

• Five business days for a prospectus supplement containing a material change other than price or share levels
• Ten business days for a prospectus supplement containing a change in price, the number of shares sought, the dealer's soliciting fee or other similarly significant change
• Ten business days for a prospectus supplement included as a part of a post-effective amendment
• Twenty business days for a revised prospectus when the initial prospectus was materially deficient (e.g., filing of a "shell" document intended solely to trigger commencement and staff review)

Finally, the new rules do not require bidders utilizing the early commencement offer strategy to deliver a final prospectus, so long as the bidder mails the preliminary prospectus and all supplements with material changes to security holders. The bidder, however, still must file a final prospectus with the SEC.

Harmonizing Disclosure for Tender Offers and Mergers

Currently, there are different disclosure schedules for issuer tender offers, third-party tender offers and going-private transactions. Because a given transaction may be covered by more than one of these regulatory schemes, a company may be required to file several different disclosure documents for the same transaction. Regulation M-A eliminates the need for these essentially duplicative filings by combining the rules governing these types of transactions into one location. The new rules are found in new subpart 1000 of Regulation S-K (also called Regulation M-A), and new Schedule TO replaces Schedule 13E-4 (issuer tenders), Schedule 14D-1 (third-party tenders) and Schedule 13E-3 (going-private transactions).

Under Regulation M-A, the SEC will also now require a plain English term sheet summarizing the material elements of a transaction to preface all issuer and third-party cash tender offer statements, cash merger proxy statements, and going-private disclosure documents. Regulation M-A mandates that the plain English term sheet present information in "bullet-point format and may include cross-references to more detailed information found elsewhere in the disclosure documents." Certain questions⁴ the SEC would like addressed include:

• Who is offering to buy my securities?
• How much is the bidder offering to pay and what is the consideration?
• How long do I have to decide whether to tender in the offer?
• Can the offer be extended? Under what circumstances?
• If the offer is negotiated, what does my board of directors think about the offer?
• Will the tender offer be followed by a merger if all the company's shares are not tendered in the offer?

Prospectuses delivered in connection with stock mergers and registered exchange offers are already subject to the plain English rules. Through Regulation M-A, the SEC is extending plain English to the cash tender offer, each merger and going private transaction context.

Regulation M-A will also require any bidder to disclose pro forma financial information for the bidder and the target on a combined basis in cash tender offers with a stock or debt back-end merger. This disclosure is only required in negotiated (not hostile) transactions and in transactions in which the target would constitute 20% or more of the bidder's total assets. Finally, if required, such disclosure must include both historical and pro forma combined financial statements. This final requirement may prove problematic for bidders, as pro forma financial statements often prove burdensome and time consuming to prepare.

The SEC has also modified the disclosure requirements in Item 14 of Schedule 14A to simplify the information required in proxy statements and information statements related to extraordinary transactions. For example, Regulation M-A clarifies that financial statements about the bidder in a cash merger are only needed if material to the voting security holders_ analysis of the deal. In addition, Regulation M-A reduces the coverage of financial statements required of the acquiror under Item 14 from three years to two years. Finally, Regulation M-A eliminates the need to provide information about the target in a cash merger when the bidder's security holders are not voting on the transaction.

Item 10 of new Schedule TO also clarifies the financial information requirements for bidders in cash tender offers. The SEC has determined that financial statements of the bidder are not material when the bidder only offers cash, there are no financing contingencies to consummation and the bidder is a 1934 Act-reporting company that files reports electronically on EDGAR, or the offer is for all outstanding securities of the target.

Revised Tender Offer Mechanics

The SEC has adopted a new Exchange Act Rule 14d-11 which permits a "subsequent offering period" after completion of a tender offer during which shareholders can tender their shares, with no withdrawal rights. The SEC's stated purpose of this rule is to assist bidders in reaching state law minimum ownership thresholds necessary to complete a subsequent short-form merger and to afford security holders who remain after they offer one last opportunity to tender into an offer that is otherwise complete. Mechanically, Rule 14d-11 requires a bidder to accept and pay for all securities tendered in the initial offering period, at which point the results must be announced. If the bidder elects, the subsequent offering period may extend from three to 20 days.

For bidders, a difficult question involves when to announce the utilization of a subsequent offering period under the new rules. In the commentary to Regulation M-A, the SEC indicated that a bidder's election to utilize a subsequent offering period would be a material change in the terms of the initial offer and must be disclosed at least five business days prior to the expiration of the initial offering period. In the typical tender offer transaction, target security holders often wait until the last few days of the initial offering period to accept an offer. This may complicate the bidder's decision whether to extend the offering. In fact, the announcement of the subsequent offering period may minimize the incentive for target security holders to tender within the initial offering period.

Finally, the SEC has revised Rule 10b-13, which prohibits purchases by a bidder outside an offer. Regulation M-A redesignates Rule 10b-13 as Rule 14e-5 and clarifies that the proscription on purchases of securities outside of a tender or exchange offer commences only upon the first public announcement of a tender offer and continues until the tender offer expires. For example, the acquiror in negotiations involving a prospective tender offer will be free to structure transactions with insiders or controlling shareholders of the target prior to the announcement of the offer (e.g., options or similar lock-up agreements).

How to Contact Us

If you have any questions regarding Regulation M-A, please call Marlee Mitchell, Hunter Rost or Robert Harris at 615/244-6380.

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¹ Regulation of Takeovers and Security Holder Communications, Release No. 33-7760, 34-42055, IC-24107, November 10, 1999 (hereinafter, "Regulation M-A").
² The SEC considers telephone scripts utilized in conference calls and overhead slides used in analyst presentations, for example, to constitute "written" materials that would need to be filed upon first use. SEC also stated in footnote 37 to Regulation M-A that: "[w]ritten communications include all information disseminated otherwise than orally, including electronic communications and other future applications of changing technology. Videos and CD-ROMs, for example, should be filed on EDGAR by means of a transcript." (emphasis added)
³ The SEC published its proposed rules on December 4, 1998, in The Regulation of Security Offerings, Release No. 33-7606A; 34-40632A.
⁴ A more complete list of example questions can be found in Section II.F.2.a. of Regulation M-A.

The Securities and Exchange Commission recently proposed comprehensive revisions to its rules applicable to full and fair disclosure of information and insider trading liability. The new proposed rules are intended to enhance investor confidence in the fairness and integrity of the securities markets by:

• Providing all investors with equal access to the material information an issuer discloses; and
• Clarifying two unsettled issues under current insider trading law.

The public comment period for these proposed rules, which are contained in the SEC's new Regulation FD and Rules 10b5-1 and 10b5-2, runs until March 29, 2000.

This summary highlights and briefly explains the most significant provisions of Regulation FD and Rules 10b5-1 and 10b5-2. You are encouraged to contact a Waller Lansden attorney in our Securities Working Group to discuss any aspect of Regulation FD and Rules 10b5-1 and 10b5-2 and their potential effect on your business or prospective transactions.

Selective Disclosure: Regulation FD

Background

The federal securities laws promote full and fair disclosure of information by issuers of securities to the investing public. Although the SEC encourages prompt disclosure of material information, it does not require issuers to publicly disclose every important corporate development when it occurs. The SEC allows issuers to retain some control over the timing and forum for many important disclosures. This freedom has sometimes led issuers to selectively disclose information to a small group of investors or analysts before making full disclosure to the general investing public. The SEC believes that this selective disclosure poses a serious threat to the fairness and integrity of the securities markets.

One reason that issuers engage in selective disclosure of material nonpublic information may be the uncertainty in current law about when selective disclosures are prohibited. Historically, liability for selective disclosure has been regulated primarily under the principles of insider trading. The lack of a clearly-defined legal framework in the area of selective disclosure has provided the impetus for the SEC to propose Regulation FD.

Description of Proposed Regulation FD

Regulation FD, like current law, would not require issuers to make public disclosure of all material developments when they occur. Instead, it provides that when an issuer discloses material nonpublic information, it must disclose the information generally to the investing public and not to a select few. If an issuer makes an I disclosure of material nonpublic information, it must make such disclosure in a public manner. If an issuer makes an unintentional selective disclosure of material nonpublic information, it must promptly make public disclosure of the information after learning of the selective disclosure.

Under Regulation FD, a selective disclosure is "intentional" if the individual knew prior to the disclosure, or was reckless in not knowing, that the information was material and nonpublic. If an individual makes an unintentional selective disclosure of material nonpublic information, the issuer must make public disclosure "promptly," which is as soon as is reasonably practicable but no later than 24 hours after a senior official knows, or is reckless in not knowing, of the unintentional disclosure. Thus, if an employee disclosed material information inadvertently or mistakenly believed that the information was already public, the issuer will not be in violation of Regulation FD if it makes public disclosure of such information within a day of learning of the improper disclosure.

Regulation FD applies to all issuers whose securities are registered pursuant to Section 12 of the Exchange Act or that are required to file reports under Section 15(d) of the Exchange Act, including closed-end investment companies but not other investment companies. It does not apply during an issuer's initial public offering before the registration statement becomes effective but does apply to reporting issuers with pending registration statements for securities offerings. Thus, if a reporting issuer makes oral selective disclosure of material information during a roadshow for a follow-on offering, the issuer would have to make public disclosure of the information.

Regulation FD applies to selective disclosure made by an issuer or an officer, director, employee or agent acting within the scope of his or her authority. The issuer would not automatically be liable if its employee or agent discloses material nonpublic information for his or her own benefit, such as trading or providing an improper tip in violation of Rule 10b-5. Additionally, the issuer would not be liable if an employee or agent discloses information to a person who owes a duty of trust or confidence to the issuer, such as an attorney or accountant, or to a person who has expressly agreed to treat the information as confidential. Thus, issuers and their employees or agents may share material nonpublic information with outsiders if those outsiders agree to keep the information confidential prior to public disclosure.

The following methods of disclosing material nonpublic information would satisfy the "public disclosure" requirements of Regulation FD:

• Filing a Form 8-K with the SEC (or a Form 6-K if a foreign private issuer);
• Publishing a press release through a widely circulated news or wire service; or
• Publicizing information through any other method of disclosure that is reasonably designed to provide broad public access to the information without exclusion of any members of the public, such as an announcement at a press conference to which the public is granted access.

The SEC does not consider posting information on the issuer's website to be a sufficient means of public disclosure.

Proposed Regulation FD is not an antifraud rule, and an issuer's failure to make public disclosure in accordance with Regulation FD will not result in private liability. It may, however, result in an SEC enforcement action against the issuer or the individual(s) responsible for the violation.

Effects of Proposed Regulation FD on Current Practice

As previously discussed, proposed Regulation FD could require a reporting issuer that has filed a registration statement to make public disclosure of material information disclosed during a roadshow. The SEC recognizes that such public disclosure could be considered an "offer" under Section 5 of the Securities Act and, if made by writing or broadcast, could also be considered a "prospectus" under Section 2(a)(10) of the Securities Act. Consequently, the public disclosure required by Regulation FD might result in the violation by the issuer of Sections 5(c) or 5(b)(1) of the Securities Act requiring that offers of securities be made only by means of a written prospectus that complies with Section 10(a) of the Securities Act. To remedy the conflict with Section 5(b)(1) of the Securities Act, the SEC is also proposing new Rule 181 which would provide that any public disclosure made in accordance with Regulation FD would not need to satisfy the requirements of Section 10 of the Securities Act for a prospectus.

It is important to note, however, that the SEC is not proposing an exemption to Section 5(c) of the Securities Act for disclosure required by Regulation FD, which the SEC acknowledges may create problems in some situations. If an issuer that is planning an offering, but who has not yet filed a registration statement, makes an inadvertent selective disclosure of material nonpublic information, it will be required to make public disclosure under Regulation FD. This disclosure could constitute an "offer" of securities in violation of Section 5(c) and result in liability under Section 12(a)(1) if the issuer proceeds with the offering. The SEC is reluctant to propose an exemption from Section 5(c), although it is soliciting comment on the issue, citing its concerns for abuse of such an exemption and the need for continued prohibition on offers and publicity in the pre-filing period. Thus, reporting issuers planning a registered offering of securities will need to adopt extra precautions to ensure that selective disclosures do not take place (e.g., to analysts or third parties not in a position of confidence or trust) during the period preceding the filing of the registration statement. Material disclosures made to underwriters or potential underwriters in the pre-filing period presumably would not be subject to public disclosure under proposed Regulation FD, because the underwriters would be acting in a position of confidence and trust to the issuer. The same would apply to analysts employed by the participating investment banking firms who are brought "over the wall" to participate in meetings between the issuer and the underwriters.

In the proposing release, the SEC states that the Regulation FD requirements would be in addition to the filing and legending requirements of new Regulation M-A, which became effective January 24, 2000. In Regulation M-A, the SEC adopted non-exclusive exemptions under the Securities Act, proxy rules and tender offer rules that permit communications with respect to business combinations prior to the filing of definitive disclosure documents if the conditions of the rules are satisfied. Oral communications are not required to be filed under Regulation M-A, but must be filed under proposed Regulation FD. The SEC has stated that early discussions among parties to a business combination that are protected by a confidentiality agreement among the parties and are kept confidential generally would not be subject to the disclosure requirements of Regulation FD. To the extent some business combination transactions currently proceed without a confidentiality agreement, this may cause a change in the current practice.

Insider Trading: Rules 10b5-1 and 10b5-2

Background

Insider trading law is based on the antifraud provisions of the federal securities laws, particularly Section 10(b) of the Exchange Act and Rule 10b-5, and generally provides that it is illegal to trade a security on the basis of material nonpublic information about the security or issuer in breach of a duty of trust or confidence that is owed to the issuer, its shareholders or any other person who is the source of the material nonpublic information. Insider trading has not been expressly defined by Congress or the SEC but has been interpreted and developed by the courts.

One unresolved question under current insider trading law is when trading "on the basis of" material nonpublic information occurs. It is unclear if a person would be liable for trading while merely in "knowing possession" of material nonpublic information or if it must be shown that the person specifically "used" such information for trading. Several recent federal court of appeals cases have provided conflicting answers to this issue.

Another unsettled issue under current insider trading law relates to the "misappropriation theory" of insider trading. Under the "misappropriation theory," a person commits fraud in violation of federal securities laws by misusing material nonpublic information in breach of a duty of loyalty or confidence to the person communicating the information. This violation may occur whether the recipient of the information tips another person or actually trades on the information in breach of a duty of loyalty or confidence. It is unclear under current law, however, what non-business relationships may give rise to the duty of trust or confidence requisite for liability under the misappropriation theory. Several recent cases have addressed this issue, but their holdings may lead to inconsistent results.

Description of Proposed Rule 10b5-1

Proposed Rule 10b5-1 provides that a securities trade is "on the basis of" material nonpublic information if the trader was aware of the information when he or she made the trade. Thus, it need not be demonstrated that the person actually used the material nonpublic information in deciding to trade.

Rule 10b5-1 enumerates four specific defenses against liability. A person will not be in violation of the Rule if the person can demonstrate that, before becoming aware of the material nonpublic information, the person:

• Entered into a contract to execute a trade specifying the set amount, price and date at which the person ultimately traded;
• Provided instructions to another person to execute a trade for the instructing person's account specifying the set amount, price and date at which the trade was ultimately executed;
• Adopted a written plan specifying the set amount, price and date at which the person ultimately traded; or
• Adopted a written plan designed to track a market index, market segment or group of securities and the amount, price and date at which the person ultimately traded were a result of following the plan.

These enumerated defenses are only available if the contract, plan or instruction to trade was entered into in good faith and not as part of a scheme to avoid the prohibitions of the Rule. If a person changes an existing contract, plan or instruction to trade after becoming aware of material nonpublic information, the person will not be able to assert these defenses.

An additional defense exists solely for entities other than natural persons that trade. Such an entity will not be in violation of the Rule if it can demonstrate that the person making the decision on behalf of the entity was not aware of the material nonpublic information and the entity had implemented reasonable policies and procedures to ensure that persons making investment decisions would not violate insider trading laws.

In enforcement actions, the SEC has long advocated the "possession equals use" position now articulated by proposed Rule 10b5-1, but has met with mixed support from the courts. We expect this proposed rule to draw extensive comments from issuers and the securities bar.

Description of Proposed Rule 10b5-2

Proposed Rule 10b5-2 defines non-exclusive circumstances in which a person has a duty of trust or confidence for purposes of the "misappropriation theory" of insider trading. Rule 10b5-2 does not modify any other aspect of insider trading law, which is otherwise defined by case law interpreting Rule 10b-5.

Rule 10b5-2 provides the following non-exclusive list of circumstances in which a duty of trust or confidence exists:

• Where a person agrees to maintain information in confidence;
• Where two people have a history, pattern or practice of sharing confidences such that the person sharing the material nonpublic information has a reasonable expectation that the recipient would maintain its confidentiality; or
• Where a person receives material nonpublic information from the person's spouse, parent, child or sibling, unless the recipient can establish that the spouse, parent, child or sibling had no reasonable expectation that the person would keep the information confidential because the parties had neither a history, pattern or practice of sharing confidences nor an agreement or understanding to maintain the confidentiality of the information.

How to Contact Us

If you have any questions regarding proposed Regulation FD or proposed Rules 10b5-1 and 10b5-2, or if you have any comments on the substance or effects of proposed Regulation FD or proposed Rules 10b5-1 and 10b5-2 and would like us to consolidate and convey your comments to the SEC during this public comment period, please call Marlee Mitchell, Hunter Rost, Chris Howard or David Wilson at 615/244-6380.

The SEC recently announced its adoption of new Rule 155, which provides integration safe harbors for registered offerings following abandoned private offerings and private offerings following abandoned registered offerings. The staff believes the new rule will reduce the capital raising costs of small businesses and provide more flexibility in the securities offering process.

Originally proposed as part of the SEC's comprehensive "aircraft carrier" overhaul of the securities laws, the new rule seeks to address various SEC interpretations over the last 65 years as to when two securities offerings by the same issuer ought to be "integrated" and treated as a single securities offering. There are two common scenarios under which a private offering and a public offering by one issuer could be integrated, resulting in a combined offering that could result in securities law violations.

Public Offering Following Abandoned Private Offering

The first scenario is where a company abandons a private offering to commence a public offering. The company may have begun a successful, and perhaps oversubscribed, private placement and then decided that it wants to conduct a broader distribution of its securities. Because a registration statement must be filed before offers are made in a public offering, under the doctrine of integration, the SEC may view the solicitation efforts for the private placement as illegal pre-filing offers, or "gun jumping," in the public offering. Until now, an issuer of securities has had three alternatives to avoid integration of the two offerings: (1) wait six months before making a public offering, invoking the Regulation D safe harbor from integration; (2) rely on SEC Rule 152, although this rule is subject to varying interpretations; or (3) satisfy the five-factor integration test. Each of these alternatives is described in more detail below.

Private Offering Following Abandoned Public Offering

The second scenario is where a company abandons a public offering and subsequently begins a private offering. In 2000, for example, many companies filed registration statements and conducted roadshows but were ultimately unable to complete their offerings because of adverse public market conditions. Were such a company to then convert to a private offering of the same securities, it may encounter difficulty establishing a private placement exemption.

The SEC has long viewed the filing of a registration statement as a general solicitation, which is prohibited in a Section 4(2) or 4(6) offering.

Prior to Rule 155, the company had five alternatives to avoid integration: (1) start the private offering after the Regulation D six-month waiting period; (2) comply with the concurrent offering exception articulated by the SEC in a series of no-action letters beginning with its 1990 letter to Black Box Incorporated by making a subsequent private offering only to qualified institutional buyers (QIBs) or to two or three large institutional accredited investors; (3) satisfy the five-factor integration test; (4) continue with a directed public offering to a limited number of offerees; (5) or continue with an offshore offering under Regulation S.

New Rule 155

Recognizing that the existing alternatives to avoiding integration may not be available or satisfactory to many issuers, the SEC has adopted two new safe harbors in Rule 155.

Rule 155(b) offers a safe harbor from integration for a registered offering following an abandoned private offering if four requirements are met: (1) no securities have been sold in the private offering; (2) the private offering is actively terminated before the issuer files the registration statement; (3) the registered offering prospectus contains disclosures about the private offering (including the amount sought to be raised), the type of securities offered privately and the general purpose of the abandoned offering, the date the private offering was abandoned, and a statement that all offers to buy were rejected; and (4) the issuer must wait 30 days after the termination of all private offering activity to file a registration statement if the private offering was made to persons other than "accredited" investors or "sophisticated" investors as defined under other SEC rules.

The SEC adopted new Rule 155(b) to, in effect, amend existing Rule 152, which was adopted in 1935 and which the SEC has interpreted through Black Box and other no-action letters to provide a safe harbor for issuers conducting a public offering after a "completed" private offering. Like Rule 152, new Rule 155 applies to offerings under Sections 4(2) and 4(6) of the Securities Act of 1933. The safe harbors do not apply to public offerings following abandoned Regulation D Rule 505 offerings.

Rule 155(c) provides a safe harbor from integration for a private offering following an abandoned registered offering if five requirements are met: (1) no securities were sold in the public offering (whether or not the registration statement was declared effective); (2) the registration statement was withdrawn; (3) the private offering commences at least 30 days after the effective date of the withdrawal of the registration statement; (4) the issuer notifies each private offeree that the offering is not registered, the securities offered are "restricted securities" under Rule 144(a)(3), purchasers do not have the protection of Section 11 under the Securities Act of 1933 and that the registration statement was withdrawn and specifying the effective date of the withdrawal; and (5) any private offering materials must disclose any changes in the issuer's affairs occurring after the filing of the registration statement which are material to the investment decision in the private offering.

In order to encourage reliance on the new Rule 155(c) registered-to-private-offering safe harbor, the SEC has amended two related rules. First, the SEC has expanded Rule 429 and moved its fee offset provisions to Rule 457 to allow a registered offering filing fee to be used as an offset for future filings for five years. Rule 477 has also been revised to provide automatic effectiveness for any application to withdraw a registration statement before it is declared effective unless the SEC objects within fifteen days after the filing of the withdrawal application.

Alternatives to Rule 155 Remain Available

In adopting Rule 155, the SEC has stated that the new rule is intended to create non-exclusive safe harbors, and does not replace existing alternatives for structuring offerings to avoid integration.

For example, Black Box and related no-action letters provide that "concurrent" private and public offerings are allowed if the private offering is limited to QIBs and no more than two or three large institutional accredited investors.

Another alternative still available for issuing companies wishing to avoid integration is the five-factor test¹ known as the integration doctrine. While this test provides some guidance to companies in deciding whether their offerings will be integrated, the integration doctrine requires a review of all facts and circumstances of an offering, often leaving it unclear to an issuing company how factors should be weighted and applied. Moreover, the integration doctrine as applied by the SEC and courts gives no guidance about how many factors must be satisfied for integration. Because one of the factors looks at whether the same securities are being offered, the test is often of little practical use unless the issuer decides to offer a different security in the subsequent offering.

The Regulation D integration safe harbor, adopted in 1982, provides issuing companies with a clear, bright-line test, but the six-month waiting period between offerings often does not provide a realistic alternative to many companies seeking to commence a new offering.

Issuers may still conduct offshore offerings to non-US persons under Regulation S concurrent with an otherwise exempt domestic offering.

We believe Rule 155 provides workable alternatives to the confusion surrounding integration of public and private offerings, particularly where an issuer can wait 30 days to conduct the subsequent offering. In the case of an abandoned private offering that was limited to persons who were (or who the issuer reasonably believes were) accredited or sophisticated investors, Rule 155 permits a registration statement to be filed immediately. Otherwise, if an issuer needs to conduct a subsequent offering in less than 30 days following an abandoned offering, the traditional integration analysis still applies. The new rule takes effect March 7, 2001.

We welcome any questions you may have regarding new Rule 155 or any other securities law compliance issues. Please call Marlee Mitchell, Hunter Rost or any other member of our Securities Working Group with any questions or comments.

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¹ The following factors will be considered in determining whether two offerings will be integrated: (1) whether they are a part of a single plan of financing; (2) whether the same class of securities is being offered; (3) whether the offerings are made at or about the same time; (4) whether the offerings are made for the same type of consideration; (5) whether the offerings are made for the same general purpose.

A patient with a bad habit of groping at the nurses. A doctor with staff privileges who tells dirty jokes in the presence of hospital employees. A lab technician who won't take no for an answer from a co-worker he has repeatedly asked out. These are just a few examples of workplace conduct that can create legal headaches for hospitals and medical professionals who serve double duty as employers. With the explosion of sexual harassment lawsuits filed in recent years and the resulting media coverage, everyone knows that sexual harassment is wrong. What many employers do not know, however, is how best to prevent workplace harassment and how to reduce one's exposure to the substantial liability that can result in a harassment lawsuit.

1. Why Employers Should Care

From a common sense standpoint, it is easy to recognize that employees should be afforded the opportunity to work in a workplace free of harassment from their bosses, co-workers, and anyone else with whom they come into contact in their daily duties. Not only is harassment unpleasant for the employee, it is counter-productive to the employer because it reduces workplace morale and interferes with the employer's operation. From a financial standpoint, workplace harassment can be particularly troublesome to employers because of the substantial money that can be recovered by employees who prevail in court.

Federal and state law prohibit several types of discrimination and harassment in the workplace. While sexual harassment may receive the most press, it is important to note that discrimination and harassment on the basis of race, disability, age (forty and older), color, national origin, and religion are also prohibited. All but the smallest of employers are required to comply with the anti-discrimination laws, which include Title VII of the Civil Rights Act of 1964 (covering employers with fifteen or more employees), the Americans With Disabilities Act (fifteen or more employees), the Age Discrimination in Employment Act (twenty or more employees), and, here in Tennessee, the Tennessee Human Rights Act (eight or more employees within Tennessee).

Legal liability for workplace harassment can be substantial, and can include payment to the employee for back wages, lost benefits, emotional distress, and attorney fees. The median jury verdict for plaintiffs who won employment lawsuits in 1998 was $137,000.00, with ten percent of those verdicts over $10 million dollars each. Depending on the type and extent of the discrimination or harassment, the employer can even be assessed punitive damages or ordered to pay double damages.

2. Who To Watch Out For

There are three types of harassers that can expose an employer to liability for workplace harassment of employees: 1) supervisors, 2) co-workers, and 3) everyone else. In other words, just about anyone an employee comes into contact with in the course of their employment can put an employer in legal jeopardy, including independent contractors. In the hospital context, this can include physicians, patients, and other visitors, even if they are not employed by the hospital.

3. What Is Harassment?

Fortunately for employers, not all harassing conduct results in liability. In order to make a case, harassment must meet at least three criteria. First, it must be because of the employee's gender, race, disability, or other protected category. Second, the harassment must be sufficiently severe or pervasive. More severe conduct can result in liability even if it happens once or a few times, such as a sexual assault. Less severe conduct results in liability when it occurs more frequently, such as repeated crude jokes or sexist remarks. Third, the conduct complained of must be offensive, both to the employee experiencing it and from the standpoint of a reasonable person. Therefore, if the employee welcomed the conduct or if a reasonable person would find it inoffensive, an employer will not be found liable.

4. "Non-traditional" Harassment

Most sexual harassment lawsuits allege harassment by a man against a woman. Likewise, racial harassment suits typically allege harassment by a Caucasian against a racial minority. Also illegal, however, is sexual harassment against a person of the same gender as the harasser, even if the harassment is not homosexual in nature, and "reverse" harassment, such as harassment by a minority employee against a Caucasian. There are many variations of this theme - including a female harassing a male and a racial minority harassing another person of the same race - so it is important for employers to avoid assuming that they need only watch out for harassment by white males.

5. An Ounce of Prevention ...

In the area of harassment law, an ounce of prevention truly is worth a pound of cure. In fact, in many cases, the mere implementation of an anti-harassment policy can make the difference in determining whether an employer will be liable or not for a harasser's conduct. Some words of caution, however, with respect to harassment by supervisors. If a supervisor has harassed a subordinate employee, and has in connection with the harassment done something to adversely impact that subordinate's employment, such as transferring or firing him or her, the employer can be held liable regardless of the employer's efforts at preventing or correcting the harassment. It will also be liable even if it knew nothing about the harassment until the employee complained. If, on the other hand, the employee's job has not been affected, liability will depend on whether the employer has done anything to prevent or correct the harassment (such as the adoption and effective implementation of an anti-harassment policy), and whether the employee tried to do anything to stop the harassment (such as complaining pursuant to the policy).

Although employers are held to a very high standard for the harassing conduct of their supervisors, a somewhat lesser standard applies for harassment by co-workers and third-parties. In those cases, an employer will be held liable only if it was negligent in preventing the harassing conduct. In other words, the employer knew or should have known of the harassment, but failed to stop it.

6. Taking Action

While the adoption and implementation of an anti-harassment policy will not always insulate an employer from liability on a harassment claim, employers who conduct business without such a policy do so at their own peril. To reduce the risk of harassment occurring in the workplace, and increase the odds of avoiding liability in the event harassment does occur, employers should consider seriously the following:

• Adopt a formal written policy prohibiting harassment on the basis of gender, race, disability, age, color, national origin, and religion, and prohibiting any retaliation against employees who make complaints pursuant to the policy. The policy should explain what constitutes prohibited harassment and retaliation, provide for a complaint procedure and confidentiality of complaints, and list potential disciplinary measures for policy violations. A copy of the policy should be distributed to each employee, with the employee signing a written acknowledgement that they have received the policy.
• Because an employee will have no one to turn to if their harasser is the same person to whom they are supposed to complain of a policy violation, designate several people to receive complaints.
• Inform employees, patients, suppliers, and anyone else with whom employees interact of the policy.
• Treat every complaint seriously, even if you doubt its validity. Investigate all claims and discipline those employees whose behavior violates the policy.
• For hospital employers and other entities with independent contractors (such as physicians), the employer is still responsible to its employees for harassment committed by those contractors. Taking action may include acting pursuant to the hospital's bylaws and seeking revocation of the harasser's hospital credentials. In the case of other independent contractors, tell their employer of the allegations and, where necessary, ask that they not be permitted to return to the hospital.

While these measures will not guarantee a harassment-free workplace nor ensure freedom from all lawsuits, they should at least reduce workplace harassment and aid in the employer's defense in court. More importantly, not taking action to prevent or correct harassing behavior, especially behavior the employer knew of or should have know of, is a sure way to invite liability for workplace harassment that does occur. The latter can be prove to be a costly gamble.

The Fruit Growers News Reprinted with permission The next time a restaurant customer files for bankruptcy without paying all of your fruit and produce invoices, take heart - a recent court opinion may make it possible for you to collect your debt in full. In an important decision for the fruit and produce industry, the United States Court of Appeals for the Third Circuit has found that restaurants can be held liable under the trust requirements of PACA, the Perishable Agricultural Commodities Act. The decision is the first by a higher court to address whether PACA applies to restaurants, and has a significant impact on the ability of growers and sellers to recover payments from financially-troubled eateries. The decision was issued March 1. The Court of Appeals_ ruling came in the case of Magic Restaurants, Inc., a restaurant chain which filed for bankruptcy in Delaware. Magic was the operator of upscale fast-food restaurants, and owed approximately $100,000 to a supplier of fruits and vegetables at the time of bankruptcy. After the bankruptcy filing, the supplier asked the court to order immediate payment of its invoices under PACA, and the Court of Appeals found in its favor, deciding that PACA does apply to restaurants like Magic. The result of the decision is that suppliers of fresh fruit and vegetables to struggling restaurants may be entitled to immediate payment of all of invoices in full, rather than having to wait years to be paid pennies on the dollar along with other creditors. The application of PACA to restaurants is an issue which has been aggressively litigated in the past few years, and the Court of Appeals_ ruling comes on the heels of several lower court cases which have reached inconsistent results. Although PACA has been in existence since 1930, its trust provisions came into being in 1984, and are still relatively new. The trust provisions provide that all perishable agricultural commodities received by a "commission merchant, dealer, or broker" in all transactions, all inventories of food or other products derived from them, and any receivables or proceeds from the sale of these products, must be held in trust by the buyer for the benefit of all unpaid suppliers. PACA requires buyers to maintain sufficient trust assets to pay the claims of all suppliers in full, and the effect of the trust is to provide unpaid suppliers with an ownership right in the goods and proceeds until they have been paid. PACA is intended to put produce suppliers ahead of banks which have loaned money and received a lien on the buyer's assets. Without the trust, those lenders would be able to sell the produce to recover for their own loans, without ever paying the suppliers. For a fruit and produce supplier to claim the benefit of the PACA trust, the supplier needs to provide written notice of its intent to preserve its PACA trust rights within a specified time period, generally 30 days after payment becomes due. PACA sets out particular language which must be included in the notice. As an alternative, the supplier can include a specified legend on its invoices, which will preserve the trust. In the Magic case, the Court of Appeals found that Magic was required to comply with the PACA trust because it was a "dealer" under the statute. Restaurants which annually purchase more than $230,000 of fresh fruit and produce, in "wholesale or jobbing" quantities totaling one ton or more in weight, fit within the definition and are subject to the trust. This decision by the Court of Appeals is significant, because it reverses a longstanding interpretation of the statute by the U.S. Department of Agriculture that PACA does not apply to restaurants. Strikingly, the Court of Appeals noted in its opinion that the result of its decision may be that restaurants like Magic, which have failed to obtain dealer's licenses from the USDA, have potentially been in violation of PACA for as much as the entire 70 years of the statute's existence. While the Court found this result troubling, it nevertheless concluded that the plain language of PACA requires that growers and suppliers be protected in dealings with financially-struggling restaurants. The decision could affect many of the business bankruptcies filed in the United States, because it governs litigation in Delaware, a favorite site for bankruptcy filings. The decision may also have a ripple effect on courts across the country, as it is the first issued by a Court of Appeals and will be viewed as highly persuasive. Further, the decision opens the door for the potential application of PACA to other institutional buyers of fruit and produce that may not have traditionally been considered dealers under PACA. In addition to providing a fruit and produce supplier with a powerful PACA trust claim against the buyer, the decision has an important incidental effect. Courts have often held that senior managers or owners who are "controlling persons" of the company buying produce can be held individually liable if the company fails to preserve sufficient assets to pay PACA trust claims. Thus, where a restaurant fails to maintain sufficient PACA assets to repay its suppliers, the suppliers may now be able to pursue claims against the individuals running the restaurant. These claims would not exist outside of PACA, and may well prove a compelling incentive for senior managers to ensure that restaurants pay their suppliers quickly. In light of this new Court of Appeals decision, fruit and produce growers and suppliers are well-advised to send PACA notices, if they do not already, to any restaurant customers (or other institutional buyers, for that matter) who may be covered under the act. As the Court of Appeals_ ruling makes clear, enforcing your PACA trust rights can have a significant effect on how much you collect from a restaurant debtor.¹

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¹ The information contained in this article is provided for general information purposes, and should not be construed as legal advice. As always, the reader should consult a qualified attorney for specific legal guidance.

The Securities and Exchange Commission has adopted new rules applicable to issuer disclosure of information to securities markets and insider trading liability. The new rules relate to three issues:

• Selective disclosure by issuers of material nonpublic information;
• When insider trading liability arises in connection with a trader's "use" or "knowing possession" of material nonpublic information; and
• When the breach of duty of trust or confidence in a family or other non-business relationship gives rise to liability under the misappropriation theory of insider trading.

The SEC received nearly 6000 comment letters from the public relating to the rules, which it originally proposed in December 1999. The final rules, adopted on August 10, 2000, contain several key revisions to the rules as originally proposed. The new rules go into effect October 23, 2000.

This bulletin summarizes the principal provisions of Regulation FD and Rules 10b5-1 and 10b5-2 as adopted.

Regulation FD

New Regulation FD provides that when an issuer releases material nonpublic information to enumerated categories of persons, such as securities analysts, other securities market professionals and institutional investors, it must also disclose the information generally to the public. If an issuer makes an intentional selective disclosure of material nonpublic information, it must simultaneously make public disclosure of the information. If an issuer makes an unintentional selective disclosure of material nonpublic information, it must promptly make public disclosure of the information after learning of the selective disclosure.

Regulation FD does not alter the current legal analysis as to what information is "material" or "nonpublic." Existing case law as well as SEC Staff Accounting Bulletin No. 99 will continue to guide materiality judgments.

Under Regulation FD, a selective disclosure is "intentional" if the individual knew prior to the disclosure, or was reckless in not knowing, that the information was both material and nonpublic. If an individual makes an unintentional selective disclosure of material nonpublic information, the issuer must make public disclosure "promptly," which is as soon as is reasonably practicable but no later than 24 hours after a senior official of the issuer knows, or is reckless in not knowing, that the information disclosed was both material and nonpublic.

Regulation FD applies to all issuers whose securities are registered pursuant to Section 12 of the Exchange Act or that are required to file reports under Section 15(d) of the Exchange Act, including closed-end investment companies but not other investment companies. As revised, the rule will not apply to foreign governments or foreign private issuers.

The following methods of disclosing material nonpublic information would satisfy the "public disclosure" requirements of Regulation FD:

• Filing or furnishing the information to the SEC on a Form 8-K;
• Publishing a press release through a widely circulated news or wire service; or
• Publicizing information through any other method of disclosure, or a combination of methods, reasonably designed to provide broad distribution of the information, such as an announcement at a press conference to which the public is granted access, conference calls that interested members of the public may attend or listen to, or Internet webcasts.

In the adopting release, the SEC encourages issuers to make the required disclosure through a combination of methods, such as a press release followed by an open conference call or Internet webcast. The SEC does not consider posting information on the issuer's website, by itself, to be a sufficient means of public disclosure.

Several other key revisions to the proposed rules are noteworthy; the final rules:

• Apply only to an issuer's communications with market professionals and holders of the issuer's securities under circumstances in which it is reasonably foreseeable that a security holder will trade on the basis of the information. Regulation FD will not apply to issuer communications with the press, rating agencies, and ordinary course business communications with customers and suppliers.
• Apply only to communications by the issuer's senior management (directors and executive officers), its investor relations professionals, and others who regularly communicate with market professionals and security holders. In all cases, the person communicating the information must be acting on behalf of the issuer.
• Provide that violation will not disqualify a company from use of Form S-8 or short-form registration on Forms S-2 or S-3, or affect investors_ ability to resell under Rule 144.
• Provide that Regulation FD is a disclosure rule and that the failure to make a disclosure required solely by Regulation FD will not create a violation of Rule 10b-5. Where the regulation is violated, the SEC can bring an administrative proceeding seeking a cease and desist order, or a civil action seeking an injunction and/or civil penalties. The rule does not provide a basis for a private right of action on behalf of shareholders.

As proposed, Regulation FD would have applied to reporting issuers with pending registration statements for securities offerings. As noted in our previous bulletin outlining the proposed regulation, we expressed concern that the public disclosure required by Regulation FD might result in a violation by the issuer of Section 5 of the Securities Act requiring that offers of securities be made only by means of a written prospectus that complies with Section 10(a) of the Securities Act. After considering a number of comments expressing the same concern, the SEC determined that the Securities Act currently provides adequate protections against selective disclosures during the registration process . As adopted, Regulation FD does not apply to disclosures made in connection with most securities offerings registered under the Securities Act.

In the adopting release the SEC appears to have zeroed in on the management of earnings expectations, cautioning that "[w]hen an issuer official engages in a private discussion with an analyst who is seeking guidance about earnings estimates, he or she takes on a high degree of risk under Regulation FD." Selective guidance to securities analysts on earnings forecasts will likely provide the basis of a Regulation FD violation.

Insider Trading: Rules 10b5-1 and 10b5-2

The SEC also adopted, substantially as proposed, two new rules designed to address two unsettled aspects of insider trading law.

Rule 10b5-1

New Rule 10b5-1 provides that a securities trade is "on the basis of" material nonpublic information if the trader was aware of the information when he or she made the trade. Therefore, it need not be demonstrated that the person actually used the material nonpublic information in deciding to purchase or sell securities.

Rule 10b5-1 enumerates four affirmative defenses against liability. There is no violation of the rule if the person trading can demonstrate that, before becoming aware of the material nonpublic information, he or she:

• Entered into a contract to execute a trade specifying the set amount, price and date at which the person ultimately traded;
• Provided instructions to another person to execute a trade for the trader's account specifying the set amount, price and date at which the trade was ultimately executed;
• Adopted a written plan specifying the set amount, price and date at which the person ultimately traded; or
• Adopted a written plan designed to track a market index, market segment or group of securities and the amount, price and date at which the person ultimately traded were a result of following the plan.

These enumerated defenses are only available if the contract, plan or instruction to trade was entered into in good faith and not as part of a scheme to avoid the prohibitions of the rule. If there are changes made to an existing contract, plan or instruction to trade after the trader becomes aware of material nonpublic information, the trader will not be able to assert these defenses.

An alternative defense exists solely for entities that trade. An entity will not be in violation of the rule if it can demonstrate that the person making the decision on behalf of the entity was not aware of the material nonpublic information and the entity had implemented reasonable policies and procedures to ensure that persons making investment decisions would not violate insider trading laws.

Rule 10b5-2

New Rule 10b5-2 defines non-exclusive circumstances in which a person has a duty of trust or confidence for purposes of the "misappropriation theory" of insider trading. That theory, as upheld by the U.S. Supreme Court in United States v. O_Hagan, provides that a person commits a fraud in violation of Rule 10b-5 by misappropriating material nonpublic information for securities trading purposes, in breach of a duty of loyalty and confidence. Rule 10b5-2 broadens existing case law on this subject, but does not modify any other aspect of insider trading case law.

Rule 10b5-2 provides the following non-exclusive bases for determining whether a duty of trust or confidence exists:

• Where a person agrees to maintain information in confidence;
• Where two people have a history, pattern or practice of sharing confidences such that the recipient of the material nonpublic information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or
• Where a person receives material nonpublic information from his or her spouse, parent, child or sibling, unless the recipient can establish that the spouse, parent, child or sibling had no reasonable expectation that the recipient would keep the information confidential because the parties had neither a history, pattern or practice of sharing confidences nor an agreement or understanding to maintain the confidentiality of the information.

If you have any questions regarding Regulation FD or new Rules 10b5-1 and 10b5-2, please call us at (615) 244-6380.

In 1999, the Tennessee General Assembly made a tax policy decision that in Tennessee the "cost" of limited liability generally would be the imposition of the franchise2 and excise tax3 ("F&E tax").4 As true with all other general tax rules, there were various limited exceptions.5 At that time, there was a provision in Tennessee's limited liability company statute that permitted the members of limited liability companies ("LLCs") to elect unlimited liability.6 However, as originally enacted, The Tax Revision and Reform Act of 1999 ("TRRA") imposed the F&E tax on these entities. Creation of Exception for Unlimited Liability. The Technical Corrections Bill ("TCB"), which was passed and signed into law in the last week of June 2000, an exception from the imposition of the F&E tax was created for certain limited liability entities.7 The F&E tax will not apply to LLCs, limited partnerships ("LPs") and registered limited liability partnerships ("LLPs"), all of whose members or partners are fully liable for the debts, obligations and liabilities of the entity and who have filed appropriate documentation to that effect with the Tennessee Secretary of State ("SOS") on or before the first day of the taxable year.8 This exception, however, does not apply to an entity which is owned in whole or in part, directly or indirectly, by a for-profit corporation.9 The TCB provided that a partner or member will be "fully liable" even though one or more persons or individuals dealing with the entity have by contract agreed to limit their claims against one or more owners of the entity or against the entity.10 In this article, the phrase "unlimited liability" shall mean a person or persons who are "fully liable" for the debt, obligations and liabilities of the entity in accordance with the TCB. When "fully liable," a person can be liable for a debt or obligation that the person does not even know exists. The liability of a general partner is "joint and several." This means that each person assuming such liability is 100% liable for each and every debt, liability and obligation (contract, tort or other) of the electing entity, unless the liability is limited by contract with such obligee.11 The purpose of this article is to explore the specific requirements for the utilization of this exception and issues raised by the statutory language. Before analyzing the specifics, the threshold question for all owners considering making such an election is whether the tax savings are worth the liability exposure. This is a question that needs to be carefully considered. If the election is made, the rules controlling the governance of the entity are not changed. Each owner should consider how well he or she knows the other owners and what controls, if any, does each such owner have over the activities of the entity. This decision should not be taken lightly.12 The scope and dollar coverage of any liability insurance should also be analyzed.13 The advisors to such persons should carefully document that the risks of unlimited liability were discussed, as there will be some people who elect to assume such liability and a significant or even catastrophic liability will actually emerge.14 Indeed, a person considering electing unlimited liability is strongly urged to discuss the meaning and consequences of such an election with an attorney. Overview. In order to qualify for the exclusion from limited liability the following must be present: 1. The entity must be a LLC, a LP, or a LLP; 2. No direct or indirect owner of the entity can be a for-profit corporation; 3. An election containing specific information must be filed with the SOS; 4. The election and certain other documents must meet certain requirements and, except for a transition exception15 and a new owner exception#16, the election must be filed on or before the first day of the taxable year for which the election is to be effective; and 5. Once filed, the F&E tax exemption continues until the election is revoked, an ineligible entity becomes an owner, or one or more owners do not have unlimited liability. Form of Entity. The shareholders of a corporation, beneficiaries of a trust, or owners of entities other than LLCs, LPs and LLPs cannot cause themselves to have unlimited liability and the entity to make an appropriate election to escape the F&E tax. This exclusion only applies to LLCs, LPs and LLPs. Ownership Requirements. The TCB states that the exception "shall not apply to any limited liability company, limited partnership or limited liability partnership which is owned, in whole or in part, directly or indirectly, by a corporation other than a not-for-profit corporation."17 If a for-profit corporation ("C" corporation or "S" corporation) owns any interest in the electing entity, the entity will not qualify for the exclusion. This ownership does not need to be a direct ownership. For example, an estate, a trust, a partnership (general or limited) or an LLC can be an owner of an electing entity qualifying for this exception. However, if a corporation is a partner or member of that owner, the electing entity will not be exempt from F&E tax. This means that the electing entity and its tax return preparer must know the identity of the electing entity's owners and if such owners are entities, who are the ultimate owners of such owners.18 Election Requirements. Neither the Tennessee Department of Revenue ("TDR") nor the SOS has prepared forms for filing this election. The SOS is treating the filings as amendments to articles of organization, certificate of limited partnership or miscellaneous filings. The SOS is not reviewing any such filing to see if it complies with any provision of any statute. There is no required form, but the filing must contain specified information and there are other documentation requirements that must be met. These requirements differ depending on whether the electing entity is an LLC, a LP or a LLP. As discussed herein, there are required provisions in the electing entity's governing documents independent of what is filed at the SOS. LLC Election. The Tennessee LLC Act contains a provision that predates the TCB by five years which permits members of an LLC to elect unlimited liability.19 This provision was not amended by the TCB, but, as discussed below, the TCB added a section in the F&E tax law providing for members to elect unlimited liability.20 The two sections are similar, but not identical. The author recommends that the requirements of both sections for electing unlimited liability and, later if appropriate, for ceasing to have unlimited liability be met. The duplication of provisions will cause a great deal of confusion. LLC Act Provisions. Under the LLC Act provisions, the articles may provide that one or more members will be personally liable for all of the debts, obligations and liabilities of the LLC to the same extent as a general partner in a partnership provided that: 1. The member(s) having such liability be identified in the articles; 2. Each member so identified must sign the articles or an amendment to the articles containing this provision21; 3. Under this provision, there is no mandatory language to be contained in the articles nor is there any mandatory provisions for the operating agreement. Pursuant to the TCB22 the articles of organization of a LLC may provide that one or more specifically identified members are personally liable for all of the debts, obligations and liabilities of the LLC. In order to be effective: 1. Each member identified as being personally liable must sign the articles or an amendment to the articles to be liable.23 2. The amendment or articles may provide that the agreement to undertake personal liability is only effective if all members make and maintain such election. In such case the articles must affirmatively identify each member and state that such persons constitute all of the members of the LLC.24 3. Each identified member continues to be personally liable until:

a. The member withdraws from the LLC25; b. The articles are amended to strike such member's name as a member electing joint and several liability26; or c. If the articles provide that all members must elect unlimited liability for any member to have unlimited liability, an amendment striking one member will strike

 

all members.27

4. If a member elects to discontinue his unlimited liability, such document must be executed by the member desiring to cease being so liable and promptly delivered to any remaining members who are identified as having unlimited liability.

LLC Exemption From F&E Taxation. The exemption from taxation occurs if all members are liable for the debts, obligations and liabilities of the LLC to the same extent as a general partner of a partnership and the appropriate papers have been timely filed with the SOS. Limited Partnership Election. In order for a limited partnership to be exempt from the F&E tax, the certificate of limited partnership and the limited partnership agreement must contain certain provisions. The Certificate of Limited Partnership must provide that one or more specifically identified limited partners as named in the certificate will be personally liable for all of the debts, obligations and liabilities of the limited partnership to the same extent as a general partner. It should be noted that this taxing statute provides that if such statement is in the certificate of limited partnership and certain other requirements are met, each specifically identified limited partner shall be liable to the same extent as a general partner.28 In order to be effective to create unlimited liability for a limited partner the following requirements must be satisfied29: 1. The certificate of limited partnership or an amendment to the certificate must be executed by each identified limited partner that will have unlimited liability; 2. The signature of such limited partner must be notarized; 3. The certificate or amendment must contain in all capitalized letters the following statement: "THE EXECUTION AND FILING OF THIS DOCUMENT WILL CAUSE SUCH LIMITED PARTNER TO BE PERSONALLY LIABLE FOR THE DEBTS AND OBLIGATIONS OF THE LIMITED PARTNERSHP TO THE SAME EXTENT AS A GENERAL PARTNER. PLEASE CONSULT YOUR ATTORNEY." 4. The certificate or amendment may provide, but is not required to provide, that it is only effective if all limited partners make and maintain such an election.30 If the certificate or amendment so provides, the certificate31 must affirmatively identify each general and limited partner and state that such persons constitute all partners. Each limited partner has the absolute power to "unelect" unlimited liability.32 The document "unelecting" unlimited liability must be filed with the SOS and delivered to the general partner and each limited partner who has elected unlimited liability as shown on the certificate or amendment thereto.33 The "unelection" of unlimited liability may cause the unelecting limited partner to violate the agreement of limited partnership and be liable for damages or as otherwise provided therein, but, as stated above, the limited partner has the power to unelect. If a person withdraws as a limited partner, that withdrawal must be recorded with the certificate of limited partnership at the SOS to cease being liable for future debts, obligations and liabilities.34 An electing limited partnership must have a written limited partnership agreement that sets forth in reasonable detail the following:35 36

1. The purpose of the LP37;

2. The identity of each general partner38;

3. The scope of authority within the LP of one or more of the general partners to incur debt or other obligations in the absence of limited partner approval39;

4. The fact that each limited partner electing to have joint and several liability will be liable for all the debts and obligations of the limited partnership however arising (contract, tort, or otherwise) or from the actions of the general partner(s) or other limited partners in furtherance of the LP's business or other activity40;

5. The fact that each limited partner may revoke the election to have joint and several unlimited liability and remain a limited partner41; and

6. The terms and conditions under which one or more general partners may be removed or the LP dissolved and terminated.42

Registered Limited Liability Partnerships. The requirements for exclusion from the F&E tax for LLPs are similar to those for LPs.43 Rather than the certificate of limited partnership or an amendment to such certificate containing certain provisions, those provisions must be found in the application of registered limited liability partnership. The substantive requirements for the application are the same as those for the LP. The formalities of execution are the same. The LLP partnership agreement must contain the same provisions as a limited partnership agreement in which the LP seeks exclusion from the F&E tax. Continuation of Unlimited Liability. Although the statute gives each partner or member the ability to elect out of unlimited liability, such partner or member will continue to be liable for the debts and obligations incurred while such person had elected unlimited liability. If the obligee or injured party reasonably relied upon the identity of the owners and their unlimited liability as set forth in the filings at the SOS, extensions of credit and other activities that occurred within 90 days from the filing of the papers to discontinue unlimited liability, such obligee will continue to have recourse against the owners who filed to cease being liable. For example, if a bank is making a loan and determines who has unlimited liability in the process of approving the loan, the fact that owners elect to discontinue unlimited liability immediately prior to the closing of the loan will not cause such "unelecting" owners to escape liability. Unless specifically notified of the "unelection" prior to the loan's closing, the bank will have reasonably relied upon the identified owners as backing a recourse loan. Under the LLC Act, once a member assumes personal unlimited liability, such member continues to have such liability until:

1.

The articles are amended to strike such member's name.

a. Such amendment must be signed by the chief manager or secretary and any remaining members who continue to be identified in the articles as having unlimited liability44; or

2. Such member withdraws from the LLC by filing an amendment stating that:

a.Such member has withdrawn from the LLC;

 

b. Such member will not be liable for any future debts, obligations and liabilities of the LLC45;

 

c. Such amendment shall be effective immediately except with respect to parties that have reasonably relied upon the articles naming such person as having unlimited liability.

3. An amendment to the articles unelecting unlimited liability or withdrawing from the LLC shall not be effective against such parties reasonably relying upon on such articles until the passage of ninety (90) days from the filing of the amendment to the articles.46

If an individual member or partner who has elected unlimited liability dies, what happens? If under the documents the estate is not a member or partner, it would appear that the decedent, by virtue of dying has withdrawn. However, the statute contains specific filings necessary to terminate the interest. Does the estate need to take actions on behalf of the decedent to withdraw in the manner provided in the statute to stop the future liability? It would seem prudent to do so. If the estate becomes a member or partner, is the estate considered to be a new member which must elect unlimited liability within thirty days or subject the entity to taxation, or is the election of the decedent binding on the estate on as an ongoing matter? Prudence would indicate that a new election should be made if taxation is to be avoided. As a fiduciary matter, will executors be comfortable in electing unlimited liability for an estate? Will fiduciaries seek the protection of a court order? As a practical matter, will the courts be able to react quickly enough if an order is requested? The true scope of the liability for debts and obligations incurred while a person elected unlimited liability will surprise many. If for example, a contract is entered into at a point in time in which one or more owners elected unlimited liability, and then after the election is revoked and action occurs pursuant to that contract giving rise to a liability, the "unelecting" owners are still liable. They were liable at the inception of the contract and they continue to be liable until the contract has ended, whether or not the obligee knows of the owner's election to cease having unlimited liability. This is the same rule that presently and previously applied to general partners.47 Unlimited Liability vs. F&E Taxes. The decision whether to undertake unlimited liability outside a general partnership is inherently factual and subjective.48 Only the parties to the transaction can make the decision. Each owner should strongly believe that the tax savings clearly outweigh the liability risk. A limited partner should consider whether the lack of control inherent in being a limited partner would indicate that another form of entity be used if the limited partner is to elect unlimited liability. For example, a board managed LLC in which the former limited partners have board seats (controlling or otherwise) and in which the former general partner is the chief manager, may be a more comfortable form of business is unlimited liability is elected. Real Estate. The F&E tax liability with respect to highly leveraged real property held for rental is rather high. Currently, there is not a reduction in the franchise tax base for secured debt. Therefore, a ten million dollar real estate project with a nine million dollar mortgage and one million dollars of equity carries a $25,000 franchise tax. Many feel that the liabilities are understood, can be adequately insured against, and adequate insurance is much less expensive than the F&E tax. If a project is likely to be sold in a few years and has a lot of appreciation, partners should think about electing the unlimited liability to avoid the six percent (6%) excise tax on the sale of the project.49 Before electing unlimited liability, however, an evaluation of the environmental liability risk is recommended. Securities Holdings. If an entity is only purchasing and selling listed securities and does not margin or hedge the securities, there appears to be very little risk is electing unlimited liability. An appropriate agreement limiting what the entity will do will be sufficient for many to make the election for unlimited liability. Split Views on the Election of Unlimited Liability. Assuming unlimited liability is an inherently personal decision. Peer group pressure should not be the controlling force. In the event that almost all or a very substantial portion of the owners of an LLC, LP or LLP desire to elect unlimited liability, those who do not wish to have such exposure should not have it forced upon them. As discussed above, a corporation cannot be a direct or indirect owner of an electing entity. However, another LLC can be a member. Those who do not wish to have personal unlimited liability can form an LLC which in turn holds the interests in the electing entity. This new LLC elects unlimited liability, but the individual owners of such LLC do not. That will mean that the new LLC is subject to the F&E tax, but the electing entity will not be subject to the F&E tax. This will involve some additional costs (other then the F&E tax on the new LLC), but the parties should be able to agree how to bear that cost in a manner that is equitable to everyone. Other Exceptions.50 The TCB added an exception for family owned LLCs and LPs that almost exclusively own securities and rental real estate generating passive investment income.51 In addition there is an exception for certain family owned residences and farms.52 Finally, there is an exception for certain venture capital funds.53 These exceptions do not require the election for unlimited liability. Conclusion. The ability to elect unlimited liability to avoid the F&E tax is a useful option for many. Under the right circumstances, it can generate substantial tax savings. The decision to assume unlimited liability is something that each owner must independently make. The potential personal exposure is great. The ability exists, through the creation of a separate LLC or certain other entities, for some owners to assume such liability and avoid the F&E tax, while others enjoy the protection of limited liability and are subject to the F&E tax. The procedure for electing unlimited liability is technical and must be carefully followed. Legal documents must be generated and for LPs and LLPs, the basic agreements of the entity will likely have to be amended. Whether this procedure will generate personal liability to owners of non-Tennessee LLCs, LPs and LLPs where the state of creation does not have the statutory provisions that allow such an election is unknown. © 2000 Waller Lansden Dortch & Davis, PLLC All rights reserved 1  J. Leigh Griffith, J.D. (Vanderbilt), LL.M. (NYU), C.P.A. (MS and TN). Mr. Griffith is the Reporter for the Tennessee Bar Association Task Force on Limited Liability Companies and is one of the principal draftsmen of the Tennessee LLC Act and the 1995 and 1999 Amendments. Mr. Griffith is a member in the Nashville law firm of Waller Lansden Dortch & Davis, a Professional Limited Liability Company. Mr. Griffith is licensed to practice law in the District of Columbia, New York and Tennessee, and is a licensed certified public accountant in Tennessee and Mississippi. He is one of the approximately 650 Fellows of the American College of Tax Counsel, a Charter Life Member of The American Tax Policy Institute, a member of the Council of the Tennessee Society of Certified Public Accountants, is active in the ABA Section of Taxation at a national level and is the Tennessee Reporter for State Limited Partnership Laws: Limited Liability Company Statutes, (P-H) (Michael A. Bamberger & Arthur J. Jacobson eds.). Mr. Griffith is listed in The Best Lawyers in America, Who's Who in American Law, Who's Who in Practicing Attorneys, Who's Who in Emerging Leaders of America and Who's Who in America. Mr. Griffith created the first LLC and the first professional LLC under the Tennessee LLC Act. Mr. Griffith was active behind the scenes in the 1999 tax legislative battles and involved in many parts of the 2000 technical corrections to such legislation. Mr. Griffith has extensively written and spoken on Tennessee's new Franchise and Excise tax laws. 2  The franchise tax is a tax on the value of assets used in Tennessee. The tax rate is 25 cents per $100. 3  The excise tax is a six percent (6%) privilege tax on net income. 4  See The Tax Revision and Reform Act of 1999. 5  Those exceptions are generally found in TCA § 67-4-2008 (excise tax) and § 67-4-2105(a) (franchise tax). 6  TCA § 48-217-101(f). 7  See Section 18 of Chapter 982 of the Public Acts of 2000. 8  For tax years beginning before January 2, 2000, the election can be made by September 15, 2000 and will relate back to the first day of the tax year. 9  TCA § 67-4-2008(a)(8). 10  TCA § 67-4-2008(a)(8). 11  Under Tennessee's Uniform Partnership Act, all general partners are liable, jointly and severally, for everything chargeable to the partnership. TCA § 61-1-114. A general partner, however, has a right to seek reimbursement from the other general partners in accordance with each general partner's proportionate ownership percentage. See TCA § 61-1-117. However, that does not change each such general partner's liability to third parties and may take separate lawsuits against the other general partners to collect. If one or more partners are unable to pay, that is the burden placed on the other general partners. 12  As discussed later herein, while an owner can "unelect" personal unlimited liability, the owner will remain liable with respect to contracts and other actions that were entered into prior to the withdrawal. Under certain circumstances, a person who "unelects" personal liability will continue to be liable for new obligations that are created within 90 days following the filing of the "unelection." 13  The author recommends that, to the extent possible, the insurance company be required to give each electing owner notices of premiums due or failure to pay premiums and any changes to the scope or limits of coverage. Each owner has a direct interest that the liability insurance remain in force. Consideration should be given as to whether the owners should be named insureds in the policy. 14  A person facing a large personal liability may consider the advice received when making such an election to be legal advice. An advisor who is not an attorney may find that the insurance carrier interpret such as legal advice and decline coverage. 15  TCA § 67-4-2008(a)(8). Entities formed before January 2, 2000, elect by September 15, 2000, for exemption from the F&E taxes. 16  TCA § 67-4-2008(a)(8). A new owner must file the appropriate papers within sixty (60) days of becoming an owner. 17  TCA § 67-4-2008(a)(8). A not-for-profit corporation should consider whether, under the circumstances, an election to undertake unlimited liability is consistent with its exempt purpose and whether such election may cause a prohibited enurement. 18  The author recommends that the governing instruments of the electing entity require the disclosure of all direct and indirect owners of the electing entity. The CPA who prepares the electing entity's tax returns may want to have proof of ultimate ownership in the CPA's files. 19  TCA § 48-217-101(f). This provision was added in 1995 to allow one or more members to elect unlimited liability in order to satisfy the then federal entity classification rules for determining whether an unincorporated entity was to be taxed as a partnership or an association taxable as a corporation. 20  TCA § 67-4-2008(d). 21  Unlike the TCB provisions dealing with LPs and LLPs, the signature of the party assuming unlimited liability does not require a notary. 22  TCA § 67-4-2008(d)(1). 23  TCA § 67-4-2008(d)(1)(A). 24  This is the same as the LLC Act. 25  This is not in the LLC Act, but is not inconsistent with the LLC Act. 26  This is consistent with the LLC Act. However, the LLC Act requires that the amendment by signed by the Chief Manager or Secretary and other remaining members who have unlimited liability to be effective. TCA § 48-217-101(f)(1)(B). 27  The addition of this provision will allow an election out of unlimited liability to be effective with the signature of the chief manager or secretary and the member election out as there would be no remaining members liable as the others automatically are deemed to have elected out. See "Continuation of Limited Liability" infra. 28  TCA § 67-4-2008(b)(1). The location of this provision imposing unlimited liability will confuse many practitioners. It will be easy to miss this wrinkle as most practitioners would anticipate finding this provision in the limited partnership portion of the Tennessee law as opposed to an excise tax provision. This provision on its face does not require the electing entity to be a Tennessee entity. The statute does require that actual unlimited liability exist for each owner. With respect to an entity formed under the laws of another state which does not provide for an election of unlimited liability, will a Tennessee election be effective. Indeed, generally amendments to the certificate of limited partnership, for example, must be filed in the state of organization to be effective. Will such an amendment be accepted and/or be honored in such other state? (At a minimum, the author recommends that the amendment to the articles or certificate be filed in the state or organization as well as with the SOS. The author, however, does not know it this will cause the amendment to be effective as a matter of the state of organization's law. Consideration should be given to changing to Tennessee the state of organization.) If unlimited liability is in fact no created, then it would appear that the F&E tax will apply to such entity to the extent it is doing business in Tennessee. 29  TCA § 67-4-2008(b)(1)(A). 30  The author strongly recommends that the certificate provides that it is only effective if all limited partners make and maintain such an election. If one partner does not elect or revokes his election, the tax benefit is lost and there is no reason for the other limited partners to continue to be liable for new debts and obligations of the limited partnership. 31  TCA § 67-4-2008(b)(1)(A) does not use the words "certificate or amendment" at this point, but it would appear from the context that an amendment to the amendment should be considered a part of the certificate. 32  TCA § 67-4-2008(b)(2). 33  TCA § 67-4-2008(b)(2). 34  The withdrawal as a limited partner must conform to the limited partnership act. The withdrawal may cause the limited partner to be liable to the LP if the limited partnership agreement so provides. 35  This footnote and the following seven footnotes should be taken out of the published piece. TCA § 67-4-2008(b)(1)(c). The author had significant input with respect to the manner of election and the items that had to be specifically covered in the limited partnership agreement. The footnotes following each of the partnership agreement items below are some of the author's rationale. It is unknown whether the TDR or the General Assembly shared the exact policy thoughts. 36  The author thought that specific items were necessary to be certain that each limited partner had a reasonable opportunity to understand that unlimited liability would exist, that the limited partner could withdraw from continued unlimited liability and retain his limited partnership interest. In addition, some of the items could be used, within the governance framework of a limited partnership, to somewhat restrict what the general partner(s) actually did. 37  By limiting the purpose of the limited partnership, actions taken outside the scope of that purpose by a general partner would be ultra vires. That would give the limited partners rights against the general partner and in some cases defenses against third parties, if the third parties have knowledge of the limitations for liabilities arising from actions that are outside the limited purposes of the partnership. It should be noted that if the partnership agreement has the phrase "or any other legal purpose", this provision will not limit the scope of the partnership's activities. A limitation on the purpose of a partnership will require the general partner(s) to act more carefully and may result in third parties requiring limited partner approval before certain transactions will be entered into. The author recommends that if the purpose of the limited partnership is to be limited by the partnership agreement, the same limited purpose be placed in the certificate of limited partnership so as to give third parties constructive notice. 38  Each general partner is already required to be identified in the certificate of limited partnership. TCA § 61-2-201(a)(4). The restatement here is to again make it clear as to who has the operating power as the liability will be the same as between those without operating power and those with operating power. 39  This is a variation of the first item. In this item, the ability of the general partner(s) to incur debt or certain other obligations can be limited even within the purposes of the limited partnership. For example, a persons willingness to have joint and several liability may be different if the general partner can incur debt of $50 thousand dollars versus $5 million dollars on which each limited partner has joint and several liability. 40  One more reminder to the limited partners that the personal liability assumption is real. 41  A reminder that unlimited liability is not a requirement to have a limited partnership interest and that one can withdraw from unlimited liability for future liabilities and retain the limited partnership interest. 42  This requires that the limited partners be told in the partnership agreement the circumstances under which a general partner can be removed and how the limited partnership may be dissolved and terminated. Indeed, if the limited partners are going to have unlimited liability, they may want relatively easy removal of the general partner and the ability to dissolve and terminate the limited partnership. 43  TCA § 67-4-2008(c). 44  TCA §48-217-101(f)(1)(B). 46  TCA §48-217-101(f)(3). The effectiveness of withdrawal to stop the liability for future events appears to have two provisions that apply to it. The interrelationship between (f)(2) and (f)(3) is unclear. Under these provisions, can an obligee reasonably rely on a withdrawn member's personal liability after 90 days from the filing of the withdrawal? May the time period be shorter than 90 days? 47  See TCA § 67-1-115. 48  Some general partnerships are converting to LLCs to avoid the "mutual agency" aspects of a general partnership and for some of the governance features of LLCs, even though unlimited liability is elected. 49  TCA § 67-4-2006(b)(1)(H) taxes the gain on an asset not already included in the taxpayer's net earnings or loss distributed by a taxpayer … when such asset is sold within twelve (12) months. 50  This is only a selected reference to certain exceptions which may overlap with the election for unlimited liability. The details on these other exceptions are beyond the scope of this article. 51  TCA § 67-4-2008(8)(A). The exception may apply to other real estate - for example, a ski condominium shared by several families. However, it is not clear at this time. The statute refers to "rents" and does not talk about the holding of real property. The exception is for certain entities the activity of which is the production of passive investment income. 52  TCA § 67-4-2008(a)(6). This provision was in the original TRRA, but was substantially amended by the TCB. 53  TCA § 67-4-2008(a)(5).

Legislative Enactments Franchise and Excise Tax. 2000 Tenn. Pub. Acts ch. 982, effective various dates, enacts "technical corrections" to 1999 legislation imposing the Franchise and Excise Taxes to flow-through entities such as limited liability companies, limited partnerships and limited liability partnerships. The primary focus is to provide exclusions for Real Estate Investment Trust and various family owned entities. 2000 Tenn. Pub. Acts ch. 973, effective June 23, 2000, permits a credit against the franchise and excise tax for "unbudgeted property taxes" which are the excess of (i) actual property taxes due on property included in the low income housing credit program over (ii) the average property taxes projected for all low income housing credit projects in the applicable county which were included in final applications after 1995 but before June 23, 2000. The credit is limited to five years. Sales and Use Tax. 2000 Tenn. Pub. Acts ch. 540, effective January 27, 2000, exempts from the sales and use tax spallation neutron source facilities funded solely by the United States Government, including any property that becomes a part of the facility and any services or materials provided to the facility in the facility's construction or maintenance. The exemption applies only if the facility is located at a national laboratory. 2000 Tenn. Pub. Acts ch. 631, effective April 5, 2000, enacts the "Streamlined Sales Tax System for the Twenty First Century Act" and requires the Commissioner of Revenue to discuss with taxing authorities of other states the need to create a neutral system for collecting sales and use taxes from both traditional and electronic commerce transactions. This enables the Tennessee Department of Revenue to participate in the Streamlined Sales Tax Project. The Commissioner is supposed to report to various political leaders by March 1, 2001, on the status of the multi-state discussions. Miscellaneous Tax. 2000 Tenn. Pub. Acts ch. 587, effective March 10, 2000, codified at Tenn. Code Ann. section 48-248-103(a), permits a professional limited liability company to organize as a single-member professional limited liability company. 2000 Tenn. Pub. Acts ch. 594, effective March 16, 2000, codified at Tenn. Code Ann. sections 4-5-315(b) and 4-5-317(a), extends the time from ten (10) to fifteen (15) days within which (i) a governmental agency may give notice of intention to review order of an administrative law judge on its own motion in a hearing under the Administrative Procedures Act and (ii) a party to a hearing may file a petition for reconsideration after the entry of an initial or final order. 2000 Tenn. Pub. Acts ch. 623, effective April 5, 2000, codified at Tenn. Code Ann. sections 48-21-111 and 48-21-112, permits a corporation to convert to a limited liability company according to the procedures and other requirements set forth in the statute by filing articles of conversation with the Secretary of State's office. The federal and state tax consequences of the conversion will be governed by applicable tax statutes. Estate and Gift Tax. 2000 Tenn. Pub. Acts ch. 600, effective March 21, 2000, allows reformation of inter-vivos or testamentary charitable remainder trusts to comply with federal income tax regulations regarding qualifying payments to non-charitable beneficiaries. The trust can be amended on the unanimous written consent of all living grantors and individual beneficiaries, charitable remainder beneficiaries named or provided for in the trust instrument and the trustee. The attorney general must concur with the reformation. In the event the required consents are withheld, the trustee or any beneficiary can petition any court of competent jurisdiction to reform the trust instrument to comply with the applicable federal income tax regulations. Ad Valorem Tax. 2000 Tenn. Pub. Acts ch. 649, effective April 10, 2000, permits the Comptroller of the Treasury to assess property taxes on telecommunication tower properties (including towers, site improvements, land, and supporting structures) against the owners of the telecommunication tower properties whether or not the properties are owned by a public utility company. 2000 Tenn. Pub. Acts ch. 649, effective April 10, 2000, codified at Tenn. Code Ann. section 67-5-1301(a)(2), updates the property tax statutes to delete telegraph companies and to add companies engaged in the business of cellular or wireless telecommunications and/or the ownership of telecommunication towers to the list of companies subject to tax by the Comptroller of the Treasury. The amendments enacted by Pub. Acts ch. 649 are effective April 10, 2000, but any taxpayer who is subject to the taxes above for the first time will be given sixty days after the receipt of a report form to file the ad valorem report. 2000 Tenn. Pub. Acts ch. 649, effective April 10, 2000, codified at Tenn. Code Ann. section 67-5-903(f) (GROUP 4), provides that property tax GROUP 4 will apply to towers that are not considered real property. Business Tax. 2000 Tenn. Pub. Acts ch. 920, effective July 1, 2000, codified at Tenn. Code Ann. section 67-4-702(a)(19)(D), extends the definition of "wholesale sale" to include sales of parts and services by franchised motor vehicle dealers to manufacturers, distributors of motor vehicles or other obligors under their respective extended service contracts. The definition of "wholesale sale" was also extended to include pre-delivery inspection charges paid to the franchised motor vehicle dealer by the manufacturer or distributor. Cases and Rulings Franchise and Excise Tax. In J.C. Penney National Bank v. Johnson, 19 S.W.3d 831, Tenn. App. LEXIS 826 (1999), the Court of Appeals reversed the decision of the trial court holding that taxpayer had substantial nexus with Tennessee under the commerce clause to impose the franchise and excise tax on its gross receipts earned from credit cards located within Tennessee, even though taxpayer (nor its affiliate agents) did not have physical presence in Tennessee. The Court extended the reasoning of Quill Corp. v. North Dakota by stating that where a taxpayer or its affiliates, which perform services on taxpayer's behalf, do not have physical presence in the state, the taxpayer does not have substantial nexus with the state under the commerce clause to impose the franchise and excise tax. The United States Supreme Court denied certiorari in October, 2000. In L.M. Berry & Co. v. Huddleston, 1999 Tenn. App. LEXIS 738 (1999), the Court of Appeals reversed the decision of the trial court holding that the taxpayer must include dividends received from two twenty percent owned subsidiaries as business earnings subject to apportionment under Tenn. Code Ann. section 67-4-804. In order for the dividends to constitute "business earnings" and become subject to apportionment by Tennessee, the companies must operate as a unit or be otherwise functionally integrated. Where companies had absolutely no interaction with each other but for some overlap in officers, the companies were functioning as separate economic units and, accordingly, dividends from the subsidiaries are not "business earnings" subject to apportionment by Tennessee. In Wachovia Bank of North Carolina, N.A. v. Johnson, 2000 Tenn. App. LEXIS 6 (2000), the Court of Appeals reversed the decision of the trial court holding that Tenn. Code Ann. section 67-4-805(a)(3) allows a taxpayer to include deductions related to transactions between members of unitary group in the calculation of net earnings when filing on a combined basis. Tenn. Code Ann. section 67-4-805(a)(3) excludes "dividends, distributions and receipts from transactions between members of the unitary group" from the calculation of net earnings of a unitary group filing a combined return. The Court stated that the term "distributions" includes expenses arising as a result of transactions between members of a unitary group that file a combined return. Based on this reading of the statute, the taxpayer must exclude both income and deductions arising from transactions between members of a unitary group that file a combined return. Sales and Use Tax. In Equifax Check Services, Inc. v. Johnson, 2000 Tenn. App. LEXIS 412 (2000), the Court of Appeals affirmed the decision of the trial court holding that check guarantee services do not constitute telecommunication services subject to sales and use tax under Tenn. Code Ann. section 67-6-102(22)(F)(iii) where true object of the contract was check guarantee services and not telecommunication services. In Nashville Clubhouse v. Johnson, 2000 Tenn. App. LEXIS 163 (2000), the Court of Appeals affirmed the decision of the trial court holding that taxpayer's provision of food and beverages to hotel guests for which the charges were not separately detailed on the hotel bill were not subject to sales and use tax. The Commissioner argued that the taxpayer's use of a resale certificate in purchasing the food and beverage was improper because the purchase was not a sale for resale as the items were not resold "as such" to the taxpayer's hotel guests as required by Comp. R. Regs. R. 1320-5-1.63(1). The Court of Appeals stated that taxpayer's sold the food and beverage "as such" because taxpayer transferred title to the items to the hotel guests for which consideration was provided as the hotel bill included the cost of the items with the room. In City of Chattanooga v. BellSouth Telecommunications, Inc., 2000 Tenn. App. LEXIS 32 (2000), the Court of Appeals affirmed the decision of the trial court holding that a city ordinance imposing a fee equal to a percent of a taxpayer's gross telecommunication revenues was invalid as an improper tax. Tenn. Code Ann. sections 67-4-401 and 406 prohibit cities from imposing taxes on telecommunication services. The fee would be valid if the City was acting under its police authority. In order to be a valid fee under the city's police authority, the Court stated that it must be based on the actual expense of enforcement and supervision of the taxpayer's use of the right of way. Since the fee bears no relation to the City's cost, the fee is a tax and is invalid. In American Airlines, Inc. v. Johnson, 2000 Tenn. App. LEXIS 539, the Court of Appeals affirmed the decision of the trial court denying summary judgement to the taxpayer with respect to a refund suit on use taxes paid on aviation fuel without provision for apportionment. The import-export exemption from the sales and use tax in Tenn. Code Ann. section 67-6-313(a) does not apply where taxpayer purchased aviation fuel outside of Tennessee and brought the aviation fuel into Tennessee for storage and use. Taxpayer's storage and fueling of jets in Tennessee constitute "use" of the aviation fuel within Tennessee under Tenn. Code Ann. section 67-6-217 and, therefore, the imposition of use tax was not limited to only that fuel actually "burned off" within Tennessee. Ad Valorem Tax. In International Flight Center v. City of Murfreesboro, 2000 Tenn. App. LEXIS 540 (2000), the Court of Appeals reversed the decision of the trial court holding that the taxpayer is entitled to use the estoppel defense. The City retroactively assessed property taxes against the taxpayer on a leasehold estate between the City and the taxpayer upon breach of the lease agreement by the taxpayer. The case was remanded to the trial court to determine whether City can retroactively assess property taxes on property owned by the City and leased to the taxpayer. In Seaton d/b/a KMS Enterprises v. Tennessee Board of Equalization, 2000 Tenn. App. LEXIS 425 (2000), the Court of Appeals reversed the decision of the trial court holding that the State Board of Equalization did not properly consider the effect of replacement reserves in applying the historical expense ratio for purposes of valuing property under the "income approach." The Court of Appeals stated that the trial court was in error to substitute its judgement when the decision of the State Board of Equalization was supported by substantial and material evidence and the State Board of Equalization was acting within the area of its knowledge, experience and expertise. In Pell v. City of Chattanooga, 2000 Tenn. App. LEXIS 302 (2000), the Court of Appeals affirmed the decision of the trial court holding that the notice provisions of Tenn. Code Ann. section 67-5-2415(e)(1) are constitutional and provide the taxpayer with adequate due process. In an action by the taxpayer to set aside a tax sale of his residence for delinquent property taxes, notice of a tax sale was sent by certified mail/return receipt requested, which was signed by the taxpayer's spouse. Tenn. Code Ann. section 67-5-2415(e)(1) provides personal notice can be evidenced by certified mail and returned receipt signed by taxpayer's spouse or other person deemed appropriate to receive summons or notice as provided in the Tennessee Rules of Civil Procedure. Tennessee Rules of Civil Procedure Rule 4.04 authorizes entry of default against a defendant where record contains a return receipt showing personal acceptance by persons authorized by statute, such as Tenn. Code Ann. section 67-5-2415(e)(1). In Westvaco Corp. v. Tennessee Assessment Appeals Commission, 1999 Tenn. App. LEXIS 789 (1999), the Court of Appeals reversed that portion of the trial court's decision that held the "residual method" is the only method allowed for valuing timberland under Tenn. Code Ann. section 67-5-601(a). The Court of Appeals affirmed that portion of the trial court's decision holding that method where appraiser used the prior year's appraisal and increased it by $50 to arrive at the current value was not supported by substantial and material evidence as required by Tenn. Code Ann. section 4-5-322(h). Privilege Tax. In Polk County, Tennessee v. Rogers d/b/a Ocoee River Rafts, 2000 Tenn. App. LEXIS 119 (2000), the Court of Appeals reversed the decision of the trial court holding that a privilege tax imposed under Chapter 2, Private Acts of 1981, on white water outfitters who conduct business on the Ocoee river was constitutional. The Court of Appeals reasoned that because Tenn. Code Ann. section 67-6-330(9) exempts white water activities from the imposition of a sales and use tax, then Polk County must demonstrate that a reasonable basis exists for the imposition of privilege tax to sustain a constitutional challenge. The record, however, contained no evidence that would justify treating customers and businesses in Polk County differently than customers and business in other Tennessee counties in violation of the Tennessee Constitution, which states the Legislature shall not have the ability to "pass any law for the benefit of individuals inconsistent with the general laws of the land." The case was remanded to the trial court to determine whether a reasonable basis exists. In Harold v. Johnson, 19 S.W.3d 241, 2000 Tenn. App. LEXIS 23 (2000), the Court of Appeals affirmed the decision of the trial court that imposed a privilege tax of 15% on the gross receipts from the sale of sealed liquor under Tenn. Code Ann. section 67-4-410. Tenn. Code Ann. section 67-4-410 defines "mixed drinks and/or set-ups for mixed drinks" as any sale of beverages containing alcoholic content, other than beer. The taxpayer's illegal sale of bottled liquor constituted the sale of "mixed drinks and/or set-ups for mixed drinks" and was, therefore, subject to the privilege tax under Tenn. Code Ann. section 67-4-410. Gift Tax. In Hull v. Johnson, 1999 Tenn. App. LEXIS 856 (1999), the Court of Appeals affirmed the decision of the trial court holding that the taxpayer was liable for gift tax on a transfer of money to the daughters of the deceased from a joint bank account owned by the taxpayer and the deceased as joint tenants with right of survivorship. The taxpayer disclaimed the amounts so that it would pass to the daughters of the deceased. The Court reasoned that since the taxpayer owned the bank account outright from its inception as joint tenants with right of survivorship and, therefore, never received the property from her deceased husband, the bank account was not eligible property subject to the right of disclaimer. Miscellaneous Tax. In Home Builders Association of Middle Tennessee v. Maury County, Tennessee, 2000 Tenn. App. LEXIS 600, the Court of Appeals affirmed the decision of the trial court holding that Private Act 118 that imposes a privilege tax on new development was constitutional as a tax and did not constitute a regulatory fee. Letter and Revenue Rulings Franchise and Excise Tax Letter Ruling No. 00-08, 2000 Tenn. Rev. Rul., March 30, 2000 This Ruling addresses the application of Franchise and Excise Taxes to a limited partnership that is solely in the business of owning securities for its own account and where the limited partnership's entire portfolio of investments is held outside of Tennessee. The Commissioner stated that the although the facts asserted by the taxpayer were that all the business of the partnership is performed in and directed and managed from a state other than Tennessee that is not the case. The Commissioner concluded that the stockbroker that provided the services was merely an out-of-state commission broker and that the actual business of the partnership was conducted in Tennessee. It is interesting to note that the Commissioner held that the provision of such services by a Tennessee stockbroker to an out-of-state limited partnership would not constitute doing business in Tennessee. Accordingly, the Commissioner concluded that the limited partnership was subject to the Franchise and Excise Tax. This Ruling has been rendered moot by 2000 Tenn. Pub. Acts ch. 982 which exempts such partnerships from Franchise and Excise Taxes commencing January 1, 2000. Letter Ruling No. 00-10, 2000 Tenn. Rev. Rul., April 12, 2000 This Ruling addresses the application of Tennessee's Franchise, Excise and Income Taxes to a limited partnership that owns stock in a Tennessee corporation. The corporation is incorporated under the laws of the State of Tennessee; will do business in Tennessee; and will pay Tennessee's Franchise and Excise Taxes. Based upon the provisions of the Franchise and Excise Taxes, the Commissioner concluded that the value of the stock would be included in the Franchise Tax base of the limited partnership but the partnership will be allowed a deduction from net worth to the extent of the value of its ownership interest in the corporation. The Commissioner further concluded that the effect of this deduction is dependent upon the size of the interest in the corporation as well as whether the Franchise Tax base is either the net worth or the book value of assets used in Tennessee. The Commissioner also concluded that the limited partnership would be subject to both the Tennessee Excise Tax as well as the Income Tax. However, the Income Tax paid would be credited against the Excise Tax pursuant to Tenn. Code Ann. section 67-4-2009(8). Finally, the Commissioner concluded that any distributions from the limited partnership to its partners would not be entirely subject to the Income Tax because such income would not be dividends or interest as such terms are defined under Tenn. Code Ann. section 67-2-102. Letter Ruling 00-11, 2000 Tenn. Rev. Rul., April 12, 2000 This Ruling addresses the effective date of the Tennessee Tax Reform and Revision Act to a limited partnership composed of two subsidiaries of an out-of-state corporation which conducted no business in the State of Tennessee. The Act provided that for limited partnerships in which one or more corporations subject to Franchise and Excise taxes under prior law, directly or indirectly own, in the aggregate, an 80% or more ownership interest at any time after June 30, Sections 3 and 4 of the Act shall apply to tax years ending on or after June 30, 1999; but for all other taxpayers, Sections 3 and 4 shall apply to tax years beginning on or after July 1, 1999. Although the limited partnership was owned by a corporation having, in the aggregate, over an 80% interest in the partnership, because such corporations were not subject to the Franchise and Excise Taxes, the earlier effective date would not apply to such partnership. Letter Ruling No. 00-22, 2000 Tenn. Rev. Rul., July 24, 2000 This Ruling addresses the application of the Tennessee Financial Institutions Tax Act to the activities of out of state subsidiary banks of a Tennessee Bank Holding Company. Specifically, the Ruling addresses whether such subsidiaries are "doing business" within Tennessee. The subsidiary banks made loans to Tennessee residents, some of which are secured by property located in Tennessee; solicited, investigated and service loans in Tennessee; have loan officers traveling to Tennessee to meet with customers and inspect collateral; and have loan officers who have the responsibility and authority to administer the subsidiary banks entire investment portfolio. Based upon the facts presented, the subsidiary banks were ruled to be "doing business" within the State of Tennessee for purposes of the Franchise and Excise Tax. Revenue Ruling No. 00-23, 2000 Tenn. Rev. Rul., July 27, 2000 This Ruling addresses which members of an affiliated group of corporations are "financial institutions" under the Tennessee Financial Institutions Tax Act. The group consisted of a bank holding company (Corporation A), its subsidiary bank (Corporation B), a sub-tier holding company(S1), its subsidiary which was also a sub-tier holding company (S2) and a Real Estate Investment Company (REIT) which was a wholly owned subsidiary of S2. The Commissioner first ruled that to be a member of a unitary group which is required to file a combined return, the entity must be a "financial institution" within the meaning of the Act. Because the sole source of income of S2 was dividends from the REIT, it was not a financial institution and would be required to file a separate Franchise and Excise Tax return. The REIT's sole source of income was participation interests in real estate loans secured by mortgages. Based solely upon the facts presented, the Commissioner ruled that the REIT was a financial institution and required to file a combined return with Corporation A, Corporation B and S1. Sales and Use Tax Letter Ruling No. 99-32, 1999 Tenn. Rev. Rul., December 7, 1999 This Ruling addressed the applicability of the Sales and Use Tax to various types of medical equipment. This Ruling addresses the application of Tennessee's Excise and Business Taxes to a foreign corporation. The foreign corporation has its domicile in a country which has an income tax treaty with the United States. The foreign corporation has no United States subsidiary, employees or facilities in Tennessee, but does sell products which are stored in a warehouse that is located in a Free Trade Zone in Tennessee. The Commissioner concluded that the foreign corporation was doing business in Tennessee and that absent some prohibition would be subject to both taxes. The Commissioner then analyzed the impact of both taxes under the Complete Auto Transit and Japan cases. Commissioner concluded that both taxes could be constitutionally imposed under the four-prong test of Complete Auto Transit. The Commissioner noted that Japan adds two additional tests: (1) there must be no substantial risk of double taxation; and (2) the tax must not prohibit the United States from speaking with one voice when regulating commerce with foreign nations. Because the Excise Tax is measured by net income, the Commissioner concluded that there was both a substantial risk of double taxation and a prohibition keeping the United States from speaking with one voice with regard to Income Tax measures. However, the Commissioner concluded with respect to the business tax that because it was a gross receipts tax, it did not result in a risk of double taxation nor did it prohibit the United States from speaking with one voice. Letter Ruling No. 99-33, 1999 Tenn. Rev. Rul., December 14, 1999 Under Tenn. Code Ann. section 67-6-102(24)(F)(vi), installing tangible personal property which remains tangible personal property after installation is a taxable service. In this Ruling, the Commissioner determined that "vent-a-hoods" remained personal property after installation. The hoods were installed with brackets and were specially designed to be used with a specific piece of kitchen equipment. The hood could be moved if the corresponding piece of equipment was moved. Whether personal property remains personal property after installation is determined by the law of fixtures. Under the law of fixtures, the determination is made by the intention of the parties and not necessarily by the mode of installation. The intent can be demonstrated both subjectively as well as objectively. Objective factors include the type of structure, the mode of attachment and the use and purpose of the property. Further, regardless of the subjective intent of the parties, personal property becomes a part of the realty if its removal would seriously damage the building to which it is affixed or if the character of the personalty would be destroyed upon removal. In this Ruling, no subjective intent was indicated. Accordingly, the fact that the equipment was installed with brackets and could be moved without destroying the hood or the building indicated that the equipment remained personalty. Letter Ruling No. 99-34, 1999 Tenn. Rev. Rul., December 14, 1999 This Ruling addresses the application of Tenn. Code Ann. section 67-6-225(b) in a leasing context. The statutory provision provides for a reduced rate of Sales or Use Tax on the "sales price" of an aircraft. Although a sale includes a Lease, the measure of the tax in connection with a sale is the "sales price" whereas the measure of the tax in connection with the Lease is the "gross proceeds." Because the statutory provision specifically uses the words "sales price," the Commissioner concluded that it had no application with respect to a Lease. Letter Ruling No. 99-35, 1999 Tenn. Rev. Rul., December 16, 1999 This Ruling concluded that a "chest drainage system" used in connection with surgery as well as a disposable one-piece, three-chamber setup" also used in connection with surgery were subject to the Sales and Use Tax. Letter Ruling No. 00-01, 2000 Tenn. Rev. Rul., January 11, 2000 This Ruling address the application of the Sales Tax to computer software which was licensed to a customer located in Tennessee who subsequently delivered or installed the software in branch offices outside of the State. The Taxpayer argued that Tenn. Code Ann. section 67-6-313 (a), which exempts from Sales and Use Tax property imported for export should apply to the software. The Commissioner relied upon the case of Jack Daniel Distillery v. Jackson, 740 S.W.2d 413 (Tenn. 1987) and concluded that the license and the subsequent transfer out-of state were separate events and that the original installation was subject to Sales Tax. Revenue Ruling No. 00-03, 2000 Tenn. Rev. Rul., January 14, 2000 This Ruling denies the exemption from use tax by a contractor in fulfilling the contractor's contract where the titleholder of the tangible personal property was not a church, private nonprofit college or university and the tangible personal property was not for church, private nonprofit college or university construction. Tenn. Code Ann. section 67-6-209(b). The facts of the Ruling are somewhat complex. A private nonprofit university ground leased some real property to a section 502(c)(3) foundation to construct a dormitory. The foundation contracted with the contractor and obtained financing for the construction pursuant to a bond issue. Title to the real property was to automatically vest in the university upon full payment of the bonds. The personal property was purchased using the foundation's exemption certificate. The Commissioner held that because the statute requires the "titleholder" to be the university, the exemption did not apply because title was in the foundation. Further, the Commissioner ruled that the foundation was not the agent of the university. Letter Ruling No. 00-05, 2000 Tenn. Rev. Rul., January 27, 2000 This Ruling holds that membership fees, meeting room fees and payments for personal fitness trainers in a fitness facility to be built and controlled by a municipality are exempt from the Amusements Tax. Tenn. Code Ann. section 67-6-330(a)(13) specifically exempts fitness facilities controlled by municipalities. The Sales Tax on rooms rented to "transients" does not encompass meeting rooms rented to local residents. Finally, fitness trainers are not within the list of taxable services under Tenn. Code Ann. section 67-6-102(24)(F). Revenue Ruling No. 00-06, 2000 Tenn. Rev. Rul., February 3, 2000 This Ruling addresses the application of the Sales and Use Tax to a Qualified Subchapter S Subsidiary ("QSSS") and to a disregarded LLC. The Commissioner noted that for Franchise and Excise Tax purposes, all entities shall be classified in accordance with the provisions of 26 U.S.C.A. § 7701. Because QSSS is disregarded pursuant to the provisions of Subchapter S and not Section 7701, a QSSS is not a disregarded entity for purposes of the Franchise and Excise Tax. On the other hand, Tenn. Code Ann. section 48-211-101 provides that for "purposes of all state and local Tennessee taxes, a …LLC shall be treated …as such classification is determined for Federal Income Tax purposes." If an LLC is a disregarded entity for any Federal Income Tax purpose, then for purposes of the Sales and Use Tax it will also be disregarded. Because a QSSS is disregarded for Federal Income Tax purposes, it is disregarded for Sales and Use Tax purposes. Letter Ruling No. 00-07, 2000 Tenn. Rev. Rul., February 18, 2000 This Ruling considered the application Tenn. Code Ann. section 67-6-510(a) to a trade-in of an automobile registered in another state. The statutory provision allows the Sales Tax to be computed on the difference between the value of the automobile traded in and the value of the new vehicle purchased. The Commissioner concluded that nothing in the provision made a distinction between vehicles registered in the State of Tennessee and those not registered in the State of Tennessee. The Commissioner then concluded that the Sales Tax would be due only on the value of the vehicle in excess of the trade-in value. Letter Ruling No. 00-09, 2000 Tenn. Rev. Rul., April 4, 2000 This Ruling addresses the application of Tenn. Comp. R. & Regs. 1320-5-1-1.13. That Rule holds that recording studios, television studios, and similar businesses are engaged in the business of performing services and are not subject to Sales Tax. Based upon that rule, the Commissioner concluded that a Tennessee corporation that owns a facility engaged in the production of video tapes for commercials, television programs, employee training tapes, and other purposes was not subject to the Sales Tax on such services. The Taxpayer was subject to the Tennessee Used Tax on the purchase of the video tapes used in its productions. Letter Ruling No. 00-14, 2000 Tenn. Rev. Rul., May 15, 2000 This Ruling addressed the application of the Sales and Use Tax to crates used to deliver milk cartons. The Commissioner addressed the application of both Tenn. Comp. R. & Regs. 1320-5-1-.11 and Tenn. Code Ann. section 67-6-102(24) involving an exemption for packaging material. The Commissioner concluded based upon the language of the statute as well as the Legislative history that only packaging material which is ultimately resold to the consumer is exempt from the Sales and Use Tax. Items used merely for transportation or shipment of goods would not be exempt. The Commissioner distinguished Coca Cola-Bottling Company of West Tennessee v. Celauro, 1993 WL 330303 (Tenn. 1993) where the Supreme Court held that pressurized tanks used to deliver coke product to restaurants for dispensing from fountains where exempt from Sales and Use Tax. The Commissioner concluded that because the tanks remained with the product until after the sale to the consumer, that such tanks came within the purview of the exemption. Letter Ruling 00-15, 2000 Tenn. Rev. Rul., June 30, 2000 This Ruling discussed the application of the single article limitation of the local option tax to the sales of computer software maintenance agreements. The Commissioner noted that the single article exemption applies only to the sale of articles of personal property. Tenn. Code Ann. section 67-6-701(a)(1). Charges for warranty or service contracts for the repair and maintenance of personal property, however, are taxable services, Tenn. Code Ann. section 67-6-102(24)(F)(ix). The Commissioner concluded that the Maintenance Agreements were Service Contracts. Because taxable services are not excluded from the single article exemption for the local option Sales Tax, the charges for the maintenance contracts were not subject to such limitation. Revenue Ruling No. 00-20, 2000 Tenn. Rev. Rul., July 11, 2000 This Ruling involves the application of the Sales and Use Tax to a contractor who purchases and installs windows in commercial buildings. In a three part Ruling, the Commissioner held that because the windows become a part of the realty, the contractor is required to pay Sales Tax upon the purchase of the windows; however, because the windows do become part of the realty, Sales and Use Tax are not applied to the installation charges for labor pursuant to Tenn. Comp. R. & Regs. 1320-5-1-.27(2); and because the windows are not to be resold by the contractor, the contractor may not use a resale certificate in accordance with Tenn. Comp. R. & Regs. 1320-5-1-.68(3). Letter Ruling No. 00-21, 2000 Tenn. Rev. Rul., July 13, 2000 This Ruling addresses the application of the Sales and Use Tax in ten separate situations involving the purchase, delivery and resale of sod and other agricultural products. The taxation of delivery charges is controlled by the Uniform Commercial Code. Delivery charges are subject to Sales Tax where the title to the property passes to the vendee at the destination point. If title passes at the loading point, delivery charges are not subject to Sales Tax. Agricultural products are exempt from the Sales and Use Tax if the vendor derives more than 50% of its revenues from products which the vendor produces. Installation charges for sod and shrubbery are not subject to Sales Tax because they become affixed to the realty but the contractor is subject to the Use Tax. Letter Ruling No. 00-24, 2000 Tenn. Rev. Rul., July 27, 2000 This Ruling addresses the application of the Sales and Use Tax in "mixed" transactions where part of the transaction is subject to tax and part of the transaction is exempt from tax. In general, the Commissioner ruled that when a mixture of services is performed for a customer and not all of those services are subject to Sales Tax, a separate billing must be made or all of the invoice is subject to tax. Multiple invoices are not required but the taxable and non-taxable elements must be separately detailed on the invoice. If a "package" price is charged for both taxable and non-taxable items, if both the taxable and non-taxable items are "essential," then entire package price is subject to tax. Where a customer provides the personal property to be used in direct mail services, the services are exempt from Sales and Use Tax. Business Tax Letter Ruling No. 00-19, 2000 Tenn. Rev. Rul., July 10, 2000 This Ruling holds that the purchase of accounts receivable at a discount and the subsequent servicing of such accounts is not one of the taxable services listed in Tenn. Code Ann. section 67-6-408(3)(c)(x). Attorney General Opinions Sales and Use Tax Opinion No. 00-098, 2000 Tenn. AG LEXIS 100, May 23, 2000 This Opinion considered the application of the Amusement Tax to events sponsored by a charitable firefighters association. The Nashville Firefighters_ Union Local 763, a qualified charitable organization, produced through FireCo, L.L.C. certain events. The contract specified that the event was "under the direction and control and with the approval of" the Firefighters Union. However, the primary responsibility for putting on a show fell clearly upon FireCo. The Amusement Tax specifically exempts events conducted by qualified charitable organizations if such organizations promote, produce and control the entire production or function. In determining whether a qualified charitable organization controls the entire production, the Attorney General relied upon the case of Gehl Corp. v. Johnson, 991 S.W.2d 246 (Tenn. Appeals App. 1998). That case stated that the qualified charitable organization would be deemed to control the event if the for-profit entity was its agent. After reviewing the contract in this situation, the Attorney General concluded that FireCo was not the Agent of the Union. Ad Valorem Tax Opinion No. 99-216, 1999 Tenn. AG LEXIS 182, October 27, 1999 The Attorney General considered whether the General Assembly could empower a municipality to provide for property tax relief to elderly homeowners, low-income homeowners, disabled homeowners and disabled veterans. The Attorney General concluded that Article II, Section 28 of the Tennessee Constitution required all property to be subject to taxation. Accordingly, the only relief the General Assembly could provide was to make reimbursements to taxpayers and also authorized payments to be made to reimburse such persons for taxes. Opinion No. 00-066, 2000 Tenn. AG LEXIS 67, April 25, 2000 This Opinion considered whether a proposed statutory provision, which was subsequently enacted into law, violates the Equal Protection Clauses of either the Constitution of the State of Tennessee or of the United States Constitution. The proposed legislation directs that the intangible property rights created by the tax credits under the low-income housing tax credit program, are not to be considered in calculating fair market value and that the voluntary restrictions limiting the tenants to persons of low-income should be recognized. The Attorney General first noted that the proper method of valuing low-income housing for property tax purposes was in litigation. The Attorney General also noted that courts in other states have reached different conclusions as to whether or not value should be assigned to the tax credits and whether or not the assessed value should reflect the restrictions imposed by the low-income housing program. The Attorney General then noted that under Article II, Section 28, "the value and definition of property in each class or sub-class [is] to be ascertained in such manner as the Legislature shall direct." The Attorney General then analyzed the proposed enactment under the existing Greenbelt Law. The constitutionality of the Greenbelt Law was approved by the Court of Appeals in Marion County v. the State Board of Equalization, 710 S.W.2d 521 (Tenn. Ct. of App. 1986 ). That Court reasoned that where the Legislature has issued an invitation to property owners to voluntarily restrict the use of their property that that restriction affects the property's value and should be respected. The Attorney General noted that a clear distinction must be drawn between a taxpayer's voluntary restriction of the use of his or her property at the invitation of the Legislature and a taxpayer's voluntary restriction of the use of his or her property without any governmental invitation. Where there is a governmental invitation, the Legislature may elect to recognize such restriction. Without such invitation, however, the Legislature may not recognize such restriction. The Attorney General then noted that the restriction of the low-income housing was at the invitation of the Government and that the Legislature had the power to respect such restriction. Opinion No. 00-106, 2000 Tenn. AG LEXIS 108, June 9, 2000 This Opinion addresses the issue of whether granting a property tax exemption to a non-profit wellness center, such as the YMCA, violates the equal protection clause of the Constitution of the State of Tennessee. The Attorney General concluded that Article XI, Section 8, the Equal Protection Clause, is construed in the same manner as the Fourteenth Amendment to the United States Constitution; that the reduced scrutiny or rational basis test is the applicable standard; and that there are several reasonable bases for the distinction between for-profit and not-for- profit wellness centers. Miscellaneous Opinion No. 00-097, 2000 Tenn. AG LEXIS 99, May 22, 2000 This Opinion considered whether a legislative enactment that authorizes a transfer of funds from the Tennessee Transportation Equity Trust Fund to the general fund would violate the revisions of 39 USC sections 47107 and 47133. The Attorney General concluded that the legislative enactment preceded such sections and would not preclude such a transfer but that the Federal Aviation Administration could withhold future grants if the funds were used for general purposes. Opinion No. 00-103, 2000 Tenn. AG LEXIS 105, June 1, 2000 This Opinion considered whether a proposed statute prohibiting the enactment of any new "adequate facilities tax" are increasing the rate of any such tax acted in any way to affect, limit or buy certain fees and permits relating to the development and building enacted by a city in Tennessee. The Attorney General stated that in Tennessee, "taxes are distinguished from fees by the objections for which they are imposed. If the imposition is primarily for the purpose of raising revenue, it is a tax; if [the] purpose is for the regulation of some activity under the police power of the governing authority, it is a fee." The Attorney General then reviewed certain specific fees and concluded that they were not taxes. Income Tax Opinion No. 99-217, 1999 Tenn. AG LEXIS 181, October 28, 1999 In this Opinion, the Attorney General held that the enactment of a general Personal Income Tax by the Legislature in Tennessee would be constitutional.

Important provisions of the final Stark II regulations were released on January 4, 2001. The regulations are subject to a 90-day public comment period ending on April 4, 2001, and do not actually go into effect until January 4, 2002, a year after being issued. HCFA refers to the newly released regulations as "Phase I." The regulations (1) clarify a number of definitions, including the addition of CPT codes for some designated health services; (2) address direct and indirect financial relationships; (3) expand the in-office ancillary services exception for physician groups; and (4) implement several new exceptions, including the fair market value compensation exception that was first proposed in 1998.

However, Phase I does not address other ownership or compensation exceptions such as the "whole hospital" exception or exceptions regarding entities paid on a composite basis., Providers will have to wait until Phase II to learn how those issues will be treated.

Discussed below are some of the major provisions of the new Stark II regulations.

Fair Market Value Compensation Exception. This broad exception, which protects compensation arrangements that are for fair market value and that meet other specified requirements, is expected to make most of the other compensation exceptions unnecessary. As adopted, the exception remains similar to the version proposed in 1998, but no longer requires cross-references to other agreements between the parties.

"Per Use" or "Per Click" Payments Allowed. The new regulations now interpret the phrase "volume or value" to allow payments based on a fee schedule or similar "per unit" payment method even when the physician receiving the payment generated the referral. This new interpretation applies to all exceptions that otherwise prohibit payments based on volume or value. The "per unit" payment must be fair market value and must not vary over the term of the agreement.

Shared Ancillary Services Arrangements. The new regulations throw a significant wrench into the common practice of different physician groups sharing ancillary centers (such as MRI or CT centers) on a part-time or "block-time" lease arrangement. In the past, each physician group has operated the leased center as its "centralized" location of ancillary services pursuant to the Stark in-office ancillary services exception. Under the new regulations, however, a centralized location must be owned or leased by the group on a full-time basis in order to meet the exception. A group with a centralized ancillary center may, however, still provide services to other providers (for example, purchased diagnostic tests). Two or more groups sharing an ancillary center on a part-time basis can still fall within the in-office ancillary services exception, but only if the ancillary services are provided in the same building as where at least one member of the group practice has his regular office practice (i.e., a practice unrelated to the provision of the ancillary services). (NOTE: The limitation on shared services arrangements may be an issue that warrants sending in protests and suggestions during the 90-day comment period.)

Supervision Requirements Loosened. In a surprisingly logical change, HCFA now says that the "supervision" requirement of the in-office ancillary services exception will be met as long as the ancillary service is supervised in accordance with the Medicare billing supervision requirements relevant to the particular service. In some cases, this may mean the supervising physician does not have to be present in the same office suite when the service is performed.

Independent Contractor Physicians. In contrast to the earlier proposed rules, the new regulations allow ancillary services to be supervised by an independent contractor physician who practices with the group. In addition, group practices can pay their independent contractor physicians productivity bonuses and a share of the overall profits of the group. The independent contractor's hours are not, however, considered when calculating whether group members have provided at least 75% of the group's services.

• Definition of Physician Group. The new rules provide considerably more flexibility in structuring group practices. For example, one or more physician-owned corporations may own the group practice, as long the physician owners become employees of the new group practice and the investing entities cease functioning as group practices. The group now may operate separate cost centers, provided that revenues from ancillary services are distributed appropriately. In addition, specialists in multi-specialty practices may create separate specialty "pools" with income generated from designated health services provided within the specialty, as long as there are at least 5 physicians in the specialty pool. Guidance is given on group governance and a number of other issues as well.
• Lithotripsy. Lithotripsy, when billed as a hospital service, is still deemed a designated health service. However, more flexibility is allowed now that the physician owners may be paid on a "per use" basis even if they generated the referrals, provided that the arrangement meets an appropriate exception.

Use of CPT Codes. To reduce confusion, the new regulations include a list of CPT and HCPCS codes to define which drugs, clinical lab tests, physical therapy services, and imaging services are deemed designated health services. If a procedure is not on the code list, it is not considered a designated health service. For example, cardiac cath is not on the list of covered imaging services and is not a designated health service.
Indirect Financial Relationships and Exceptions. The regulations attempt to provide more guidance on what constitutes an indirect ownership or compensation relationship. In addition, two new exceptions cover indirect compensation arrangements, including (1) arrangements where the provider of designated health services does not know about, or have reason to suspect, that the physician receives compensation that varies based on the volume or value of referrals to the provider of designated health services; and (2) arrangements where the indirect compensation itself is for fair market value, does not vary based on the volume or value of referrals or other business between the parties, and meets additional requirements.

Self-Referral Does Not Include Personally Performed Services. The definition of "referral" now specifically excludes services personally performed by the referring physician. However, the term still includes services performed by someone other than the physician, including "incident-to" services performed by the physician's employees.

Other New Exceptions. In addition to the exceptions noted above, the regulations add or revise several other exceptions. These include (1) a revised "de minimus" test (now called the "Non-Monetary Compensation" exception) which, among other things, eliminates the earlier limit of $50 per gift as long as the total amount per physician does not exceed $300 per year; (2) a new exception for certain payments by academic medical centers to members of faculty practice plans; (3) a new exception for incidental benefits to medical staff members when the benefits are used on the hospital's campus and certain other requirements are met; (4) a new exception for certain risk-sharing arrangements such as withholds, bonuses, and risk pools as long as such arrangements do not violate reimbursement requirements or fraud and abuse laws; and (5) an exception allowing hospitals to provide compliance training to physicians in the community.

Between now and the end of the 90-day comment period, providers may want to avoid making any drastic changes to their current arrangements, since HCFA may make further revisions based on those comments. Once the comment period is over, however, physicians and other providers should begin revising their current arrangements to comply with the new Stark II regulations, and new arrangements involving designated health services should be structured from the outset to comply with the new regulations.

The Health Group of Waller Lansden Dortch & Davis, PLLC, is preparing more detailed information on how Stark II affects certain segments of the healthcare industry, such as hospitals, surgery centers, solo and group physician practices, practice management companies, and networks. If you would like to receive this information, please feel free to contact any member of the Waller Lansden Health Group.

Copyright "State Environmental Audit Laws Advance Goal of a Cleaner Environment" by James Weaver, Bob Martineau, & Michael Stagg, published in Natural Resources & Environment, Volume 11, No. 4 (1997) Reproduced by permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. Almost every state legislature during the last few years has introduced legislation that would provide privilege, immunity, or both to corporate environmental audits. The United States Environmental Protection Agency (EPA), the United States Department of Justice (DOJ), and many environmental public interest groups have opposed this legislation. If the first priority of EPA and the environmental community is, as it should be, environmental protection-not enforcement for the sake of enforcement-then the opposition to audit laws is misplaced. If the opponents of audit legislation are interested in providing the maximum protection to the environment, and not merely increasing the number of enforcement actions filed or dollars collected, then they should support the enactment and implementation of state audit laws. This article provides an overview of federal and state efforts to create audit privilege and immunity and argues that the environment will fare better under these audit laws. At the very least, it is important that the state audit privilege and immunity laws be allowed to remain in effect long enough to determine if the potential benefits to the environment materialize. Only after several years of real-world experience can the merits of these state audit laws be evaluated. In the meantime, as demonstrated by initial evaluations of these programs, there is no evidence of increased risk to human health and the environment resulting from enactment of these laws. In fact, preliminary data show improved environmental compliance by industry, and therefore a cleaner environment, as a result of these statutes. History of Environmental Audit Policies and Legislation Federal pollution control statutes have proliferated over the last 25 years, and state and local governments also have become increasingly willing to pass statutes and ordinances and promulgate regulations, the goal of which is protection of the environment. The cumulative effect of these environmental laws is a set of significant restrictions on many sectors of American business. Public awareness of environmental problems, heightened by highly publicized events such as Love Canal and rivers burning in Ohio, has in many instances been the catalyst for environmental regulation; in other instances, federal or state efforts have led to the education of the public about environmental issues. As a result, the American citizenry today has a more sophisticated understanding of environmental problems and a higher expectation that those industries that produce pollutants incident to their business will comply with the applicable environmental laws and limit the creation, emission, and discharge of pollutants. In short, being in compliance with environmental requirements-and the resulting positive public image as a responsible corporate citizen-generally make good economic sense for business. This public awareness of environmental problems and resulting demand for preventive and corrective actions by business, in conjunction with environmental laws and regulations and businesses_ desire to protect the environment, has prompted many businesses to self-police through environmental auditing as a means both to comply with environmental laws and to enhance the public image of the business. EPA's Audit Policy The Environmental Protection Agency has issued a policy statement "encouraging regulated entities to voluntarily discover, and disclose and correct violations of environmental requirements" so that the goal of protecting human health and the environment is advanced. Final Policy Statement on Incentives for Self-Policing: Discovery, Disclosure, Correction and Prevention of Violations, 60 Fed. Reg. 66,706, 66,706 (1995) (Final Policy). EPA has long encouraged the use of environmental audits as a means to identify and correct environmental hazards and achieve and maintain compliance with environmental requirements. See Environmental Auditing Policy Statement, 51 Fed. Reg. 25,004 (1986). EPA's Final Policy provides four incentives to regulated entities to encourage discovery, disclosure, correction, and prevention of violations of federal environ-mental laws. First, EPA will not seek gravity-based penalties, those that are based on noneconomic benefits obtained by the violator and that reflect the seriousness of the violator's behavior, if nine conditions set forth in the Final Policy are met. Second, EPA will reduce gravity-based penalties by 75 percent for violations the company voluntarily discovers and expeditiously discloses and corrects. Third, EPA generally will not recommend criminal prosecution be initiated by DOJ against a regulated entity that audits and discovers a violation, but subsequently meets the requisite conditions. Finally, EPA will not routinely request audit reports. Final Policy, 60 Fed. Reg. at 66,707-8. Most members of the regulated community share EPA's goal of "protection of human health and the environment," id. at 66,706, and most also agree in principle that voluntary self-policing through the use of environ-mental audits or due diligence is an appropriate means to the end of environmental protection. However, the regulated community, although generally supportive of the concepts underlying EPA's Final Policy and the specific incentives it does provide, typically does not believe that the Final Policy provides adequate incentives to business to voluntarily discover, disclose, and correct environmental violations. In fact, the Final Policy contains some disincentives to performing audits. For example, meeting all of the conditions for obtaining mitigation of penalties is difficult. There are nine conditions; the requirements are stringent and once all nine conditions are met, the universe of violations eligible for penalty mitigation is small. Also, the Final Policy does not preclude regulatory agencies or third parties from obtaining audit reports, which may contain sensitive business information not otherwise required by law to be disclosed, and in fact, that the company would otherwise not disclose. Acquisition of these reports may result in dissemination of this sensitive business information to competitors or use of the information in enforcement actions and citizen suits. In addition, although gravity-based penalties may be waived, a penalty based on economic benefit is retained. Finally, some regulated entities, particularly those that operate facilities in many states, worry that the Final Policy may not be applied consistently from one EPA regional office to the next. The potential benefits to the environment that naturally flow from auditing will be limited under EPA's Final Policy because these disincentives will prevent the regulated community from embracing environmental auditing on a large scale. DOJ's Sentencing Guidelines In 1991, the Department of Justice issued guidelines to be used by federal prosecutors in exercising their prosecutorial discretion in situations where the violator has voluntarily audited and disclosed violations. United States Department of Justice, Factors in Decisions on Criminal Prosecutions for Environmental Violations in the Context of Significant Voluntary Compliance or Disclosure Efforts by the Violator (July 1, 1991), reprinted in 4 THE DEPARTMENT OF JUSTICE MANUAL ß 5-11.104A (1995-3 Supp.) and 21 Envtl. L. Rep. (Envtl. L. Inst.) 35,399 (July 1991) (DOJ Criminal Policy). According to the guidance document, it is DOJ's policy "to encourage self-auditing, self-policing and voluntary disclosure of environmental violations by the regulated community by indicating these activities are viewed as mitigating factors in the Department's exercise of criminal environmental enforcement discretion." The DOJ Criminal Policy sets forth three principal factors to be considered by a federal prosecutor in determining whether lenience is appropriate. The DOJ attorney should consider (1) whether the violator made a voluntary, timely, and complete disclosure; (2) the degree and timeliness of the cooperation; and (3) the existence and scope of any regularized, intensive, and comprehensive environmental compliance program, including management or compliance audits. The 1991 DOJ Criminal Policy also lists three additional factors that may be relevant: (1) the pervasiveness of noncompliance; (2) any internal disciplinary actions taken; and (3) subsequent compliance efforts. Finally, the prosecutor should consider any other relevant factors. Although the document is intended primarily to pro-vide guidance to federal prosecutors, it is also intended to provide the regulated community with an idea of how DOJ attorneys consider factors relating to voluntary self-policing, disclosure, and correction when making prosecutorial decisions. Federal Environmental Audit Legislation During the period from 1993 to 1996, several states enacted audit privilege and immunity laws. In 1995 and 1996, environmental audit legislation was also introduced and debated at the federal level. The regulated community believes federal legislation is necessary, notwithstanding state protections, because EPA has overlapping federal enforcement jurisdiction and citizens_ groups may file a federal suit based on information contained in audit reports. Bills were introduced in both the House and Senate early in the 104th Congress, with Joel Hefley (R-Colo.) spearheading the House legislation and Mark Hatfield (R-Ore.) and Hank Brown (R-Colo.) introducing legislation in the Senate. The two bills were patterned loosely after the statutes enacted by the sponsors_ home states, Colorado and Oregon, the first two state statutes to go into effect. The House and Senate bills introduced and amended in the 104th Congress, although different in some aspects, would have granted immunity to some types of violations voluntarily discovered, corrected, and disclosed to EPA by regulated entities. Both bills also provided audit reports with privileged status, preventing their use as evidence in court proceedings. Despite pleas from some House Democrats, the White House refused to back the principles contained in the federal legislation. The 104th Congress adjourned without enacting any environmental audit or privilege legislation, although some of the backers of the bills plan to continue their efforts to pass federal audit legislation during the 105th Congress. State Environmental Audit Legislation State environmental audit laws have been enacted in large part due to the business community's belief that EPA's Final Policy and the DOJ Criminal Policy do not provide adequate incentives or safeguards to a regulated entity that performs environmental audits. Underlying enactment of the state environmental laws are the premises that (1) corporations performing environmental audits, implementing internal compliance management programs, and disclosing and correcting any observed deficiencies advances the goal of protecting human health and the environment, and (2) more businesses will con-duct environmental audits and implement environmental compliance management systems if provided with real incentives to do so. Although the specific provisions of the state environmental audit laws vary from state to state, most laws contain one or both of two incentives: privilege provisions and immunity provisions. The state audit laws, almost without exception, contain language creating the legal protection of privilege for environmental audits. Typically, the data and results of environmental audits performed by businesses are protected from disclosure and may not be used in enforcement actions against the company for violations of environmental laws. The statutes often contain immunity provisions as well, which typically provide immunity-civil, criminal, or both-from enforcement action or prosecution for violations that are discovered as a result of the audits, voluntarily corrected by the business, and reported to the appropriate state regulatory agency. Many business interests believe that some combination of the audit report, the facts used to develop the audit report, and the materials containing those facts should be privileged from disclosure to federal and state regulatory agencies and certain third parties. In addition, the regulated community generally supports immunity from civil or criminal prosecution for violations of environmental laws that are discovered by a regulated entity through auditing, and subsequently disclosed and corrected. In response, many states, at the urging of the regulated community, have enacted environmental audit statutes that typically provide some combination of privilege for audit reports and the underlying evidence and immunity from enforcement or prosecution for violations discovered during an audit and subsequently corrected. During the last few years many state legislatures have spoken regarding the role of environmental audits in obtaining compliance with environmental laws and regulations. Oregon, in 1993, was the first state to enact legislation that protected environmental audits from disclosure. Four states followed Oregon's lead and passed legislation in 1994-Colorado, Illinois, Indiana, and Kentucky. In 1995, the year EPA issued its interim and final policies on environmental auditing, a flurry of activity also occurred at the state level as thirty-four states introduced environmental audit bills and nine state legislatures enacted environmental audit legislation: Arkansas, Idaho, Kansas, Minnesota, Mississippi, Texas, Utah, Virginia, and Wyoming. In addition, New Jersey enacted a "grace period law," under which regulated entities have ninety days in which to correct minor violations without being assessed a penalty. Efforts to enact state audit privilege legislation continued in 1996, with Michigan, New Hampshire, South Carolina, and South Dakota enacting legislation. At the end of 1996, nineteen states had enacted legislation providing incentives to regulated entities that discover, disclose, and correct violations. It is interesting to compare two of the most significant state audit statutes: Oregon's statute provided the framework for subsequent statutes enacted by other states; the Texas statute, enacted in 1995, creates some of the most expansive protections and has been the lightning rod for the most significant EPA criticisms. Oregon's environmental audit statute provides only an evidentiary privilege and no immunity. Only the environmental audit report itself is privileged, and the report must be disclosed even if otherwise subject to the privilege if efforts to correct any violations discovered "were not promptly initiated and pursued with reasonable diligence." OR. REV. STAT. ß 468.963 (Supp. 1996). The audit privilege applies in administrative and civil cases, and to a limited extent in criminal cases. The privilege attaches only to the "environmental audit report," although that term is defined broadly in the statute to encompass most information in almost any form developed or collected in the course of preparing the report. However no immunity is granted, and in criminal cases a judge may require disclosure of the report if the district attorney has a compelling need for it, the material contained in the report is not otherwise available, and the district attorney cannot obtain the information without unreasonable expenditures and delay. The Oregon statute is still in effect, although data regarding its effectiveness in encouraging the use of environmental audits have not yet been developed. The statute has not been challenged by EPA or citizens_ groups, and it does not appear that the privilege has yet been raised in court. In contrast to the rather limited protections provided by the Oregon statute, the Texas environmental audit law provides broad coverage. See TEX. PUBLIC HEALTH CODE ANN. ß 4447cc (West Supp. 1997). The Texas law applies to health and safety audits in addition to environmental audits. The statute also provides both an evidentiary privilege and penalty immunity, and the category of information encompassed by the audit privilege is broad. Under the Texas law, the audit report, information developed in preparation of the report, remedial implementation plans, and legal memoranda discussing the audit report are not discoverable and not admissible as evidence in administrative, civil, or criminal proceedings. The privilege arises automatically once the audit is conducted, and no participant in the audit may be forced to divulge information obtained as a result of audit activities, unless that person observed a violation firsthand. The Texas statute also provides limited immunity from punitive sanctions. Although the state may seek injunctions or issue administrative remediation orders for disclosed violations, it may not seek punitive sanctions from a regulated entity that audits, discovers violations, and discloses those violations to the state. To obtain the benefit of this incentive, however, the entity must give prior notice to the state agency that it intends to audit. The immunity is limited; it does not apply to knowing or intentional violations, or to reckless violations that result in substantial personal injury at the site or off-site harm to persons, property, or the environment. Both the privilege and immunity are lost if the disclosing entity does not take action to correct any discovered violation, diligently pursue the corrective actions, and achieve compliance with the laws violated within a reasonable time. Although incentives offered under the statute may apply to a wide variety of regulated entities and affect violations of Texas health, safety, or environmental laws, protections offered to regulated entities are nevertheless limited. To date, of the 18 states enacting environmental audit legislation (not including New Jersey's grace period law), 17 states extend a privilege to the audit report or information used to develop the report; only South Dakota does not. Thirteen states with legislation, a majority, provide some form of civil immunity; five do not (Arkansas, Illinois, Indiana, Mississippi, and Oregon). Finally, the states are almost evenly divided on the question whether criminal immunity should be provided - eight laws contain criminal immunity provisions and ten do not. The states without any criminal immunity provisions are Arkansas, Illinois, Indiana, Kentucky, Mississippi, Oregon, South Carolina, Utah, Virginia, and Wyoming. Opposition to State Law Privilege and Immunity Provisions Although state environmental audit legislation has the support of the business community and has been passed by many state legislatures, EPA and most of the environmental public interest groups are opposed to the creation of both privilege and immunity through the enactment of state statutes. In its explanation of the Final Policy, EPA cited six reasons for its firm opposition to the creation of a statutory evidentiary privilege for environmental audits. First, EPA contends that privilege invites secrecy, which hampers the public's ability to trust industry to self-police. Second, EPA argues that a privilege for environmental audit results is not needed, because EPA seldom uses audit reports as evidence, and the use of environmental audits has greatly increased during the last ten years without a privilege. Third, defendants in civil or criminal actions might claim evidence needed by the government to establish a violation or identify the responsible party is privileged, thus potentially shielding the bad actor. Fourth, EPA believes that a privilege for environmental audits would breed litigation, because the lack of any national standard defining the scope of privileged material in the context of environmental audits will lead parties to argue and litigate about the documents covered or not covered by the privilege. Fifth, EPA contends a privilege is unnecessary because civil penalties and criminal liability are reduced for companies that audit, disclose, and correct violations. Finally, EPA asserts that public interest groups and the law enforcement community are opposed to audit privileges. Final Policy, 60 Fed. Reg. at 66,710. Most of the environmental interest groups also have put forth various manifestations of these arguments in their opposition to environmental audit legislation. In addition to opposing privilege provisions, EPA and environmental groups also have expressed concerns regarding immunity provisions contained in state environmental audit laws. Immunity provisions in many state statutes protect companies from administrative, civil, and criminal penalties for violations of environmental laws and regulations found through auditing. EPA is concerned that these immunity provisions could prevent a state from obtaining criminal penalties in appropriate situations, and that the laws could immunize facilities committing violations that harm human health and the environment, facilities that repeatedly violate environmental laws, and businesses that have violations resulting in substantial economic gain. EPA fears state laws could limit a state's ability to use typical enforcement tools, such as pursuing injunctions and issuing emergency orders, and that the immunity provisions could adversely affect enforcement of delegated federal laws such as the Clean Air Act, Clean Water Act, and Safe Drinking Water Act. See Audit, Takings Laws Compromise Ability to Run Injection Control Program, EPA Tells State, 27 Env't Rep. 1203, 1203 (Sept. 27, 1996); Title V Program Gets Only Interim OK as EPA Voices Concerns About Audit Law, 27 Env't Rep. 506, 506-07 (June 28, 1996). The reasons proffered by EPA and many environmental groups in opposition to environmental audit laws deserve careful review. First, EPA contends that privilege breeds secrecy. However, audit privilege laws do not relieve a company from the filing of documents, reports, and data required to be filed by federal, state, or local statutes and regulations. For example, information required to be submitted by a permit condition, such as discharge monitoring reports under Clean Water Act NPDES permits, must still be filed with a regulatory agency despite an audit privilege law. Furthermore, third parties retain their access to public records. The only information covered by an audit privilege is typically the report itself, and sometimes some of the underlying information, depending on the language of a particular state statute. This information and report often would not be created in the absence of an environmental audit privilege, therefore regulatory agencies and the public are not being deprived of any information to which they would otherwise have access. Second, in the Final Policy EPA contends that an audit privilege is not needed because (1) EPA does not use audit reports as evidence, and (2) the use of environmental audits is increasing without a privilege. However, there is evidence to indicate that many businesses do not conduct environmental audits for fear that information discovered by the business and voluntarily divulged to regulatory agencies will be used against the business in an enforcement action. In a much publicized report issued in April 1995 by the accounting firm of Price Waterhouse, 369 companies responded to a survey submitted to 1,800 businesses, and 75 percent of the responding companies reported that they perform environmental audits. Price Waterhouse LLP, The Voluntary Environmental Audit Survey of U.S. Business, 1, 5 (Mar. 1995) (available from Robert J. Jonardi, Director of Environmental Services Group of Price Waterhouse LLP, Washington D.C.); see Companies Would Perform More Audits if Penalties Were Eliminated, Survey Says, 25 Env't Rep. 2447, 2447 (Apr. 14, 1995). Of that 75 percent, approximately two-thirds reported that they would conduct more environmental audits if there was a policy in effect under which they would not be penalized for violations the company discovered, reported, and corrected. Price Waterhouse LLP, at 6. As EPA asserts, the use of environmental audits is increasing; however, there is much potential for increased adoption of environmental auditing pro-grams, particularly by small and medium-sized businesses. The Price Waterhouse survey revealed that size of company and resources available appear to affect the likelihood that a company will have an environmental auditing program. The survey revealed that every company reporting sales of more than $1 billion conducted environmental audits, yet not half of the companies with sales less than $50 million maintain an auditing program. Id. The survey was released about the same time as EPA's Voluntary Environmental Self-Policing and Self-Disclosure Interim Policy Statement and well before the Final Policy, so the survey reflects corporate practices in place before EPA's incentives encouraging companies to perform environmental audits were announced. Although EPA hopes the incentives provided in the Final Policy are adequate, many in the regulated community doubt that EPA's incentives will prompt small to mid-sized companies to adopt an environmental audit program. Consequently, many states enacted, and others are considering, environmental audit laws to encourage these small and medium-sized businesses to perform environmental audits. See, e.g., Idaho Environmental Audit Law Implemented, 26 Env't Rep. 1302, 1302 (Dec. 1, 1995). The other reasons proffered by EPA and some environmentalists to explain their opposition to an audit privilege also require scrutiny. EPA argues that a business could claim privilege for information needed in developing an enforcement action or prosecution; this would presumably have the effect of shielding a bad actor. However, most state environmental audit privilege laws contain a proviso that an audit cannot be performed with the intent of preventing disclosure. Also, as mentioned above, privilege cannot be claimed for information already required to be submitted to a regulatory agency. EPA also opposes an audit privilege based on the absence of a national standard for the types of material covered by a privilege, asserting that this omission would breed litigation. This argument appears disingenuous, however, because EPA opposes federal audit legislation, which could be used to provide a national standard defining the type of material covered by an audit privilege. Moreover, given the litigation that typically stems from the enactment of a new federal environmental law or EPA's regulations implementing it, it is difficult to accept this argument. Finally, under the Administrative Procedure Act, it is unlikely that EPA could cite the potential for litigation as a rationale for not promulgating or issuing one of its own regulations, policies, or guidance documents. EPA also contends that the privilege is unnecessary because civil penalties and criminal liability are reduced for businesses that audit and correct violations. Implicit in this argument is the assumption that these two concerns - civil penalties and criminal liability - are the only two factors taken into account by a company considering environmental auditing. In fact, equally important to many businesses are factors such as the potential negative publicity surrounding violations and the possible loss of sensitive business information. Finally, EPA states without explanation that statutory audit privileges should not be established because they are opposed by the law enforcement community and public interest groups. Presumably the opposition is based on the theory that information discovered as the result of an audit is unavailable for use in court, although in its Final Policy, EPA admitted that it rarely uses audit reports as evidence, and there is no evidence state regulatory agencies rely on audit reports more often than does EPA. Upon close review, EPA's objections to statutory audit privileges do not support strict scrutiny. What these objections do indicate, however, is perhaps a misplaced emphasis by EPA and environmental groups on the means and not the end. There are no benefits to limiting enforcement tools without considering the ultimate goal of better human health and a cleaner environment due to the increased compliance resulting from environmental auditing and correction. With proper focus on a health and environment-based goal, EPA and environmental groups might view privilege and immunity provisions in environmental audit laws more favorably. Arguments in Support of Privilege and Immunity Provisions Despite EPA's opposition to privilege and immunity legislation, there are good arguments in favor of state laws that provide incentives to companies that conduct environmental audits and disclose and correct violations. First, although the state laws are so new that little empirical evidence exists on which to judge their efficacy, the practical effect of these laws likely will be to increase compliance with environmental requirements and thus decrease emissions and discharges resulting in pollution. As noted below, initial results suggest state laws containing privilege and immunity provisions result in greater numbers of regulated entities reporting and correcting violations than does EPA's Final Policy. State audit laws should be given a chance to work; final conclusions regarding their merits can be drawn only after more evidence accumulates. Small and mid-sized businesses-only a small percentage of which perform environmental audits absent statutory privilege and immunity laws-may provide the best basis for judging the effectiveness of the audit laws in encouraging auditing and thus increasing compliance. Second, because the resources of EPA and most state regulatory agencies are spread so thin, most violations discovered and reported by businesses as a result of voluntary environmental audits probably would not otherwise have been found, much less reported and corrected. Environmental regulators simply do not have the financial resources or personnel to perform the type of detailed inspections being performed by companies in their efforts to self-police, nor can the regulators inspect every permitted business with the frequency self-policing provides. Self-policing by regulated entities supplements limited state regulatory resources. In addition, regulatory agencies do not have the detailed knowledge of a facility that the operator of that facility has, so owner/operator inspections will almost without exception be more thorough than an inspection con-ducted by a regulatory agency. Because of the audit laws, more violations are being discovered and corrected. Companies performing environmental audits should not be penalized for discovery of violations that almost certainly would never have been found by a regulatory agency, particularly when those violations have been corrected, as required by state audit laws. Third, traditional enforcement tools remain available to regulatory bodies. EPA and state agencies still may conduct enforcement inspections, initiating civil or criminal enforcement actions and assessing penalties and fines where appropriate. Emergency orders and injunctive relief, if necessary, usually will not be precluded by application of audit law privilege or immunity because the privilege or immunity under the state audit laws is obtainable only if the conditions resulting in violation have been corrected, typically obviating the need for this type of relief. Fourth, providing regulated entities incentives to perform environmental audits and bring themselves into compliance is consistent with the trend in environ-mental regulation of supplementing, or in some instances replacing, the traditional command and control scheme with alternatives that promote voluntary compliance. For example, EPA is in the midst of Project XL, a program that encourages compliance and the resulting cleaner environment by offering industry more flexibility in meeting environmental requirements. The carrot often works better than the stick, and is particularly likely to do so in the case of businesses that have experienced an ever-growing number of mandatory environmental requirements over the last two decades. Finally, most businesses want to be good corporate citizens because at a minimum a positive corporate image is good for business. To cultivate a positive image, many business managers make decisions based at least in part on factors other than economic ones. For example, when a company makes corporate donations to charities, supports the arts by underwriting programs or exhibits, or funds voluntary environmental improvement projects, it is undoubtedly seeking the positive benefits that inure to its public image. Beyond such calculated methods of image development, however, business managers are human, and most strive to "do the right thing." Environmental audit laws, by adding the incentives of privilege and immunity and minimizing disincentives, encourage companies both to adopt strategies to develop a positive image and to do the right thing, by discovering, disclosing, and correcting violations. The Initial Evidence Supports Privilege and Immunity Provisions Some of the first analyses of the new state statutes indicate that environmental audit legislation containing privilege and immunity provisions is in fact encouraging the use of environmental audits and disclosure of violations, thus advancing the ultimate goal of a safer and cleaner environment. For example, the Texas Senate Natural Resources Committee released a report in September 1996 that stated promising preliminary results under the Texas environmental audit privilege law. TEXAS SENATE NATURAL RESOURCES COMMITTEE, INTERIM REPORT TO THE 75TH LEGISLATURE: EFFECTIVENESS OF THE ENVIRONMENTAL AUDIT LEGISLATION (1996) (Texas Report). In preparation of its report, the committee heard testimony from numerous state agencies with responsibility for environmental and health laws, most notably the Texas Natural Resource Conservation Commission (TNRCC). The Texas environmental audit legislation became effective May 23, 1995. In the Texas Report, the committee reported that by duly 31, 1996, the TNRCC had received 256 notices of intent to audit from electric utilities, airlines, automobile manufacturers, oil refineries, chemical plants, various manufacturers, federal agencies, and municipalities. These notices represent only companies that gave prior notice because they might later seek immunity from penalties, and the TNRCC suspects that other entities are auditing and will seek to invoke only the privilege protection. During the same period the TNRCC received the 256 notices to audit, it also received forty-two disclosures from regulated entities that had discovered violations. Types of violations discovered and reported were varied, but included emission limitations exceedances, paperwork violations, incorrect and falsified data, and incorrectly permitted or unpermitted units. The TNRCC noted that the disclosures and the information contained in them was public information, and that many of the disclosed violations would not have been discovered by the TNRCC in the course of ordinary inspections. Texas, like most states, does not have the resources to inspect and police all regulated entities within its borders; Texas has only 635 full-time enforcement employees and more than 200,000 regulated entities. State regulatory agencies are forced to rely to a certain extent on regulated entities to police themselves, and audit privilege and immunity laws provide incentives for regulated entities to do so. The TNRCC reported that the audit privilege and immunity law has not interfered with its enforcement authority or activities. Although it does not measure enforcement success by penalties collected, the TNRCC reported that immunity provisions had no effect on penalty amounts received during the first year the law was in effect; in fact, the amount collected in penalties during fiscal years 1995 and 1996 exceeded those collected in previous years. Despite this increase in penalty amounts collected, the TNRCC reported that the best measure of the success of the audit law is an increase in compliance, the ultimate goal of enforcement actions. In addition to increased compliance, the TNRCC reported that it derived two additional benefits from the audit law. First, the agency receives information it would not otherwise have received, which can be used in other enforcement and permitting actions. Second, regulated entities that discover and disclose violations are more prepared to address the violations rather than argue about responsibility for the violations, which focuses resources on remedying the violation and bringing the facility into compliance. In the Texas Report the committee made three recommendations to the Texas legislature: First, the legislature should direct the TNRCC to continue to attempt to (1) explain the Texas audit law to EPA, (2) assure EPA that its concerns regarding the law are unfounded, (3) encourage EPA to give the audit law time to work, and (4 ask EPA to stop criticizing the law because of the potential chilling effect on its use. Second, the legislature should direct the committee to continue to monitor the results obtained under application of the law because information is still inadequate to reach final conclusions regarding the efficacy of the law. Finally, the legislature should encourage state agencies to fully implement the law and encourage regulated entities to discover, report, and correct violations. Despite the short track record, the committee concluded that "initial results are very positive." Ironically, the results obtained by EPA during the first year of its Final Policy tend to support arguments in favor of state audit laws with provisions similar to those contained in Texas's law in at least two ways. First, EPA's numbers are not impressive standing alone and are even less so when compared to the results obtained in Texas during the first year its audit law was in effect. EPA, with numerous environmental programs applicable to hundreds of thousands of regulated entities in all fifty states, received disclosures of violations from only 105 companies during 1996. See Office of Enforcement and Compliance Assurance, U.S. Environmental Protection Agency, EPA AUDIT POLICY UPDATE, Jan. 1997, at 1. During its first year, Texas-one state-received 256 notices of intent to audit and forty-two disclosures. Second, of the first forty companies with which EPA settled, nineteen companies-approximately one-half-settled for violations at facilities in Texas. Id. An argument can be made that without the incentives contained in the Texas state law, the Texas companies would not have audited in the first place and EPA's first-year results would be even poorer. These first-year results of EPA and Texas emphasize the necessity of allowing the states time to develop track records with their audit laws so meaningful conclusions can be reached. The Future Although the preliminary results indicate environmental audit statutes work to further the goal of environ-mental compliance, EPA has not tempered its opposition to state audit laws containing privilege or immunity pro-visions. In fact, in 1997 EPA appears to be poised to overfile enforcement actions against some of the companies that have used the Texas law to assert privilege for documents or to receive immunity for disclosing and correcting violations. Industry sources in Texas claim that EPA is attempting to uncover evidence that regulated entities have used the Texas law to escape penalties for egregious violations, thus acquiring ammunition with which to attack state audit laws, asserting they compromise environmental protection. Other industry sources speculate that EPA is concerned that a comparison of its results with those of a state law with strong incentives, such as Texas's law, might force EPA to admit that privilege and immunity provisions do in fact provide stronger incentives to the regulated community to discover, disclose, and correct environmental violations than does the EPA Final Policy. In addition, in spring 1996, EPA considered withholding delegation of permit programs under the Clean Air Act to states with legislation that in EPA's opinion undermined the states_ ability to effectively enforce the permit programs. See Memorandum on the Effect of Audit Immunity/Privilege Laws on States_ Ability to Enforce Title V Requirements, from Steven A. Herman, Assistant Administrator, EPA Office of Enforcement and Compliance Assurance, and Mary Nichols, Assistant Administrator, EPA Office of Air and Radiation, to Jackson Fox, Regional Counsel, EPA Region X (Apr. 5, 1996). Although EPA retreated from this position, it is now following a policy under which states must use a two-year interim approval period to explain to EPA how delegated Clean Air Act programs maintain the authority mandated by the Clean Air Act in light of the state audit law. In fact, EPA is already approving state Title V programs on an interim basis, citing concerns that the state programs are inadequate given state audit laws. See, e.g., Clean Air Act Final Interim Approval of Operating Permits Program; the State of Texas, 61 Fed. Reg. 32,693, 32,696-97 (June 25, 1996); Clean Air Act Proposed Interim Approval and in the Alternative Disapproval of Operating Permits Program, State of Idaho, 61 Fed. Reg. 30,570, 30,571-73 (June 17,1996). The debate over audit privilege and immunity provisions in state laws has been going on for several years and is likely to continue as more states, and perhaps Congress, consider such legislation. EPA, by approving delegated programs such as Title V on an interim basis in states with audit laws already on the books, is buying itself and the states with audit laws some time to sort out the interplay between the state legislation and delegation of federal programs, and it is commended for doing so. However, environmental groups have already begun to petition EPA to revoke state delegated programs in states with the controversial legislation. In response, a coalition of state environmental commissioners asked EPA to allow state delegated programs to be implemented and a track record developed before EPA revokes existing delegations or withholds pending ones. The commissioners hope that real-world experiences can be developed and the delegated programs evaluated in light of the success of state audit laws. See Letter from Russell J. Harding, Michigan Department of Environmental Quality, to Carol Browner, Administrator, EPA (Nov. 18, 1996) (letter signed by fifteen state environmental commissioners). Most businesses would agree that these state commissioners have the right idea. The recommendation to wait and see may not be accepted by EPA, DOJ, or environmental groups if their primary measure of enforcement is the number of environmental actions or citizen suits. However, if the ultimate goal of these parties is enhanced protection of the environment, then in fairness to states with audit laws and businesses that are attempting to comply with the underlying environmental regulations, all interested parties should adopt the wait-and-see philosophy. EPA, DOJ, and environmental groups may be pleasantly surprised to learn that the environmental audit laws have in fact encouraged greater compliance by the business community with environmental laws and regulations, resulting in a cleaner and safer environment.