Rebuttable – Reasoning As A Service

NYC Surrogate’s Courts Backlogs

– Poor near-term prognosis

Since the COVID pandemic, many courts in the country have experienced worsening case backlogs. (See, eg, here.) New York Surrogate’s Courts are no exceptions, causing prolonged delays in probate and administration proceedings[1]. In an ongoing administration case of mine, the family of the deceased has been waiting for almost 1 year and the Court still has not decided on the petition. This is causing deepening agonies for the family members, who have just lost their beloved one but have to endure the uncertainties in administering the estate.

The near-term prospect for improving case backlogs in NY’s Surrogate’s Courts, particularly in NYC, does not seem bright at this point. The chart below shows the annual numbers of probate and administration filings, dispositions, and their accumulated differences from 2010 to 2022 in the NYC Surrogate’s Courts[2].

Based on the chart, NYC Surrogate’s Courts did successfully improve the probate and administration backlogs (disposing of more cases than filed) from 2014 thru 2019. The pandemic, however, threw a wrench to the campaign, and the efforts faltered. The case backlogs are now back to the level around 2014. It will likely take many more years to clear the backlogs.

Such a poor near-term prognosis of the case backlogs in NYC Surrogate’s Courts may prompt more people to consider alternative approaches for avoiding probate, such as living will, joint tenancy, designated beneficiary, or even LLC and other corporate entities. Each approach, however, has its own pros and cons that may require further evaluations and planning.

[1] When a person passes leaving a will, the heirs initiate a “probate” proceeding in the Surrogate’s Court to obtain the authority to access and distribute the deceased person’s estate. If the deceased did not leave a will, an “administration” proceeding is used.

[2] Based on the Annual Reports of the Chief Administrator of the NYS Courts, accessible here.

Inheritance of Real Estate in NY, Part 2 – Practical Implications (Estate Sale)

In my previous posting, I introduced the “immediate vesting” rule that the ownership of real estate transfers automatically and immediately to the beneficiaries[1] when the original owner passes away. After reading the posting, a real estate broker friend of mine asked me, “What about estate sales[2]?”

To paraphrase my friend, the question is:

“If the ownership of the home of a deceased person has been transferred to the beneficiaries, how come the estate has the authority to sell the home in an estate sale?”

This question relates to the practical implications of the immediate vesting rule, specifically with respect to the administration of the estate.[3] Therefore, I thought it a good opportunity to follow up with my previous posting and address my friend’s question regarding estate sales.

Who has authority to sell in estate sales?

In the first level of thinking, under the immediate vesting rule, since the ownership transfers immediately to the beneficiaries after the original owner passes away, the beneficiaries become the new owners and therefore have the authority to sell the home. As a result, for many estate sales, it is (or should be) the beneficiaries that are listing the property for sale, not the estate.

However, the estate (via the executor or administrator) may also have the authority to sell the home, notwithstanding the ownership by the beneficiaries, under certain circumstances, such as to pay the estate administrative expenses and/or debts, or to make distributions to the beneficiaries.[4] As one court opined, “While it is true that title to an estate’s real property vests in beneficiaries at the moment of a testator’s death, their title is qualified and subject to the executor’s power to sell the property to satisfy the debts and obligations of the estate.”[5]

Therefore, practically speaking, both the beneficiaries and the fiduciary (i.e., the executor or administrator) may have the power to sell the home in an estate sale.[6] Moreover, this means that beneficiaries may not be able to sell the home until after the estate administration has been settled and the fiduciary has consented to the sale.[7]

It is noted that many estate sales in NYC involve a cooperative apartment, which is not a real property (but is, rather, shares of the cooperative corporation and thus a personal property). Therefore, the estate (via the fiduciary) has the sole power to conduct the estate sale before the estate is settled and the shares of the coop apartment is distributed to the beneficiaries.

Thus, the simple answer to my friend’s question is: Either the beneficiaries or the estate (via the fiduciary) may conduct an estate sale, although the beneficiaries legally may need the consent of the fiduciary to sell.

Dual powers – A struggle by courts to adapt to practical needs

NY’s current legal framework for the inheritance of real estate results in dual powers over the disposition of real property in an estate. – One held by the beneficiaries arising from the immediate vesting rule, and the other held by the fiduciary arising from the statutory and common law authorities to administer the estate. The separation line between these dual powers, however, may not be clear, leaving the courts to struggle to draw the line.

For example, the courts have cited EPTL[8] 11-1.1(b)(5) as giving the fiduciary broad authority to sell real property without a court order.[9] EPTL 11-1.1(b)(5) provides (in relevant part):

“[E]every fiduciary is authorized: […] [w]ith respect to any property [..] owned by an estate […] [t]o sell the same […]” (emphasis added)
EPTL 11-1.1(b)(5)

Because of the immediate vesting rule, however, real property of the estate is no longer “owned” by the estate immediately after the death of the original owner. And therefore, based on its literal language, the specific EPTL provision should not apply to real property of an estate, and does not support the courts’ interpretation giving broad authority to the fiduciary to sell real property without a court order. The courts have struggled to interpret the statute to reconcile between the immediate vesting rule and the practical needs for the fiduciary to administer the estate efficiently, with minimal court intervention. As one court pointed out, “where property is subject of formal title, the executor is unavoidably going to have to be involved in formal transfer of title to the beneficiary.”[10] Considering such practical needs, the courts have interpreted the statute to allow the fiduciary broad authority “to enable them to deal with the property to the extent that they, as fiduciaries, must do”[11], even if the literal language of the statute does no clearly support such an interpretation.

Such a system of dual powers may increase the risks of disputes, uncertainties, and confusions. For example, the beneficiaries may rent out the home as the new owner, before the settlement of the estate, and only to learn subsequently that the fiduciary plans to sell the home to pay the estate expenses and debts. Given such risks, the optimal strategy for beneficiaries is to confirm with the fiduciary before planning an estate sale, or otherwise dispose of the home.

[1] The term “beneficiaries” will mean both the “devisees” under a will and the “distributes” when there is no will. Additionally, the plural form (beneficiaries) will mean both the plural and/or singular form.

[2] Here, “estate sale” means the sale of a person’s home (primarily real property and, sometimes, fixtures) when the person passes away, as opposed to the sale of all the contents of the home.

[3] Other implications may relate to the estate planning, or the responses of the beneficiaries / heirs to the ownership of the real estate.

[4] Surrogate’s Court Procedure Act, §1902: “The real property may be disposed of for any or all of the following purposes: (1) For the payment of the expenses of administration. (2) For the payment of funeral expenses. (3) For the payment of the debts of the decedent, including judgment or other liens, excepting mortgage liens, existing thereon at the time of his death. (4) For the payment of any transfer, estate or other death tax. (5) For the payment of any debt or legacy charged thereupon. (6) For the payment and distribution of their respective shares to the persons entitled thereto. (7) For any other purpose the court deems necessary.”

[5] 72634552 Corp. v. Okon, 2018 NY Slip Op 51991(U) (Sur. Ct. Kings. County 2018).

[6] Estate of Mendelson, NYLJ July 19, 2017, at 27, col. 3, fn. 4 (Sur. Ct., NY County 2017) (“B)eneficial entitlement passes automatically to specific beneficiaries or specific devisees, with only a `qualified legal title’ passing to the fiduciaries […].”)

[7] 72634552 Corp. v. Okon, supra. (“Accordingly, ‘title does not fully vest in the legatee until a fiduciary gives an assent to its release.’”, citing Estate of Coe Kerr, Jr., NYLJ Mar. 16, 1983, at 6, col. 3 (Sur. Ct. NY County 1983))

[8] NY Estates, Powers, and Trusts Law.

[9] See, e.g., In Matter of Freund, 162 Misc.2d 965 (Sur. Ct. Schoharie County 1994). (“an executor clearly has broad authority and power pursuant to EPTL 11-1.1 (b) (5) to sell real property”.)

[10] Estate of Mendelson, supra.

[11] Estate of Mendelson, supra.

Inheritance of Real Estate in NY

In NY (and many other states), the ownership of real estate is transferred automatically and immediately when the original owner passes away, either according to the will (if the late owner left one), or according to the law. That means, no probate or administration[1] will be required!!

Many people are surprised to learn about this rule. – As owners of real estate, they may have spent efforts and resources to establish plans to avoid the dreadful probate, by, for example, setting up living trusts or joint tenancies. On the flip side of the coin, they may find themselves the new owners of real properties without much advance notice. (Or, they may never find out that they are the owners of real properties.)

In this article, I will delve into the legal framework of this rule, including its root tracing back to the British common law. In later article(s), I will explore the practical ramifications of the rule.

Real properties as primary household assets

For many households, particularly low- to middle-income groups, their homes are often the largest assets of their household wealth. For example, according to here, as of 2019, for households having annual income ≤ $192k, housing comprised more than 85% of the household wealth.[2] Therefore, for these households, how real estate is inherited can result in substantial practical impacts, both in terms of the estate planning for owners of real estate, and in terms of the responses required, if any, of the new owner(s) of the inherited real estate.

The rule – Title to real estate vests immediately in heirs and devisees upon death of owner

In NY, the courts have long held that “[t]he title to real estate, upon the death of the owner, vests immediately in his heirs and devisees”.[3] This means that the moment when the owner of a house passes away, the legal ownership of the house automatically & immediately transfers to whomever entitled to inherit the house. If the deceased owner left a will, the “devisee(s)” of the house provided under the will becomes the new owner(s).[4] And, if the deceased owner did not leave a will, then the “distributee(s)” of the estate provided under the NY law[5] take the house[6]. Legally, no further actions on the part of the new owner(s) are required to transfer the ownership of the house.

For example, John passed away owning a residential house and a Picasso painting, both located in NY, and John was survived by his wife Jane and no children. If john passed without a will (“intestate”), then under the NY law, the house will be owned immediately by Jane at the moment when John passed. Jane can sell, rent, mortgage, or renovate the house right away, without any court proceeding. In contrast, Jane will need to start a court administration proceeding for her to officially inherit the Picasso painting.

On the other hand, let’s say John passed away owning the residential house, the Picasso painting, and a commercial property in NY. Additionally, John passed leaving a will (“testate”) gifting the commercial property specifically to a local nonprofit organization for use as its operational base, and everything else to Jane. Then, at the time when John passed, the nonprofit organization became the new owner of the commercial property, and Jane became the new owner of the house, without the requirement for the nonprofit or Jane to take any further actions. Jane will still need to start a court proceeding to probate the will in order to inherit the Picasso painting.

Uniform Probate Code

NY is not the only state that has adopted the rule of immediate vesting of the title of real estate. At the minimum[7], the Uniform Probate Code[8] also provides for the same rule. Specifically, §3-101 of the UPC provides:

“Upon the death of a person, the person’s real and personal property devolves to the persons to whom it is devised by the person’s last will […], or in the absence of testamentary disposition, to the person’s heirs […]” (emphasis added)
UPC (2019), §3-101[9]

As of this date, 18 states have adopted UPC, not including NY.[10] Therefore, these 18 states should have the same rule as NY regarding immediate vesting of the ownership of real estate upon death of the owner. As discussed in the next section on the root of the rule, it’s probably safe to further conclude that the rule should be common across the country.

The root – British common law under feudal economy

According to one author[11], the root of this immediate vesting rule can be traced back to the early English law under the feudal system. At the time, real properties (lands in particular) were the primary assets of an estate, and were inherited directly by the eldest son. (“[U]nder English law, […] land was the bulwark of the economy and the feudal system required it to be passed on to the eldest son”.) The surviving spouse and other children and relatives were entitled to inherit only the personal properties (with exceptions not detailed here).

In America, this dichotomy between real property and personal property persisted, manifesting itself in the immediate vesting rule for real property and in the need for a probate or administration proceeding to transfer the title of personal property.[12][13] Regardless of its historical root, in the modern municipal real estate system, such an immediate vesting rule does provide the benefits of continued ownership of real properties, allowing municipalities to assign responsibilities for the payment of property taxes and fees to the new owner(s) without prolonged disruptions.

Practical implications

For real estate owners, this immediate vesting rule may complicate the cost-benefit analysis of their estate plans. For example, for a person whose primary assets are real properties, it may not be cost- or tax-efficient to adopt measures to avoid probate, such as living trusts or joint tenancies, since real properties do not require probate. For those who inherited real estate, uncertainties often arise as to the responses required to complete the inheritance process, such as whether and how to officially clear the titles of the inherited real estate. Also, if the deceased owner of real properties did not leave a will, there may be uncertainties about who the rightful heir(s) (and thus the new owner(s) of the real properties) are, resulting in errors, unexpected delays, or even frauds.

I will explore these practical implications in later posting(s).

[1] The court proceeding for the distribution of a decedent’s estate is termed “probate”, if there is a will, or “administration”, if there is no will. In this article, the two terms are used interchangeably, unless specifically noted otherwise.

[2] The numbers are based on my visual measurements of the bar chart in the article. The texts of the article observed a little differently: “In 2019, housing wealth represented, on average, nearly 75 percent of the total assets of the lowest-income households. For households in the middle of the income distribution, housing wealth represented between 50 and 65 percent of total assets, but for the highest income households that percentage was only 34.”

[3] Kingsland v. Murray, 133 N.Y. 170, 44 N.Y. St. Rptr. 515, 30 N.E. 845 (N.Y. 1892); see also, Town of Niskayuna v. Joll, 2020 N.Y. Slip Op. 32408 (N.Y. Sup. Ct. 2020).

[4] E.g., Waxson Realty Corp. v. Rothschild, 255 N.Y. 332, 174 N.E. 700 (N.Y. 1931). (“Upon the death of […] the testatrix, the title to the land in question […] vested in the devisees named in her will or, if not legally devised, in her heirs at law.”)

[5] The “distributes” are family members, prioritized according to their relationships to the deceased, with the spouse and child(ren) having the highest priority. NY Estates, Powers, & Trusts Law, §4-1.1.

[6] E.g., Kraker v. Roll, 100 A.D.2d 424, 474 N.Y.S.2d 527 (N.Y. App. Div. 1984). (When [a person dies] intestate […], title to [real property] automatically vested in his distributes […] as tenants in common”.); also see, Waxson Realty Corp. v. Rothschild, supra.

[7] I did not conduct a survey of the laws of all 50 states, nor have I found any sources with such information.

[8] Initially promulgated in 1969 by the National Conference of Commissioners Uniform State Laws, and approved by the House Delegates of the American Bar Association. See, e.g., Goldsworthy, Body F. (1969), “Uniform Probate Code – Abolishing the Distinction between Real and Personal Property in Estate Administration,” North Dakota Law Review: Vol. 46: No. 3, Article 3. Available at: https://commons.und.edu/ndlr/vol46/iss3/3. (“Goldsworthy”.)

[9] Accessible at: https://www.uniformlaws.org/viewdocument/final-act-104.

[10] AK, AZ, CO, HI, ID, MA, ME, MI, MN, MT, ND, NE, NJ, NM, PA, SC, SD, & UT. See https://www.uniformlaws.org/committees/community-home?CommunityKey=35a4e3e3-de91-4527-aeec-26b1fc41b1c3.

[11] Goldsworthy, supra at Footnote 8.

[12] “In this country, by tradition, title to personal property of the decedent passed to his personal representative and thence to his next of kin or legatees. Title to land, however, belonging to a decedent devolved directly upon the heir or devisee.” Goldsworthy, supra, p.313.

[13] The Uniform Probate Code removed the dichotomy between real and personal property, providing for the immediate vesting for both real & personal properties. (“Upon the death of a person, the person’s real and personal property devolves to the persons […]” UPC, §3-101.) Many other states have also followed suit, but not NY.

To Note Or Not To Note – Promissory Note in Commercial Lending

[Note: This article was originally posted on July 9, 2021.]

“Undesirable” consequence of “confusion & doubt”

In 1976, a UK lawyer questioned the wisdom of the common practice in US to memorize a commercial lending transaction with both a loan agreement and a promissory note:[1]

“[M]any English lawyers regard them [American-style promissory notes] as undesirable. I think most English lawyers would advise strongly against the practice of setting out the obligations as between borrower and lender in two contemporaneous documents expressed in different terms. The opportunities for confusion and doubt and legal difficulty involved in such a practice are something which lawyers are – or ought to be – brought up to avoid.”

Given such an “undesirable” consequence of “confusion & doubt” by using a promissory note and a loan agreement “contemporaneously”, the question is whether it makes sense to continue this practice. To answer the question, it may be useful to find out why US adopted this practice in the first place.

Historical developments – divorce from UK practice

As the UK lawyer noted, because of the “undesirable” consequence associated with the use of “contemporaneous” documents in a transaction, in whole or in part[2], it appears UK bankers have historically avoided using promissory notes in commercial lending, relying instead on bills of exchange primarily.[3] In US, however, as the banking industry began to develop after the revolutionary war, the influence of UK banking practice began to wane, and promissory notes eventually replaced bills of exchange in commercial lending by the 100th birthday of the new nation. (See, eg, Summers, in Footnote 3. “[T]he bill of exchange, so prominent from Colonial times, slowly disappeared and was replaced by the promissory note as the most common credit instrument, a transition largely completed by the end of the Civil War”.)

So, why did US bankers & lawyers ignore the wisdom of their UK counterparts and preferred promissory notes over bills of exchange, in spite of the potential “confusion and doubt” (and any other potential disadvantages) arising from the use of two “contemporaneous” documents?

To answer the question, one NY lawyer proposed a few explanations, again in 1976.[4] First, UK imposed a stamp duty on promissory notes in 1782, which remained effective for almost 200 years. In US, on the other hand, stamp taxes for promissory notes were enacted as wartime emergency measures and repealed relatively quickly.[5] Second, as US became more mobile and less structured, borrowers could relocate to another state easily. US bankers might have preferred a simple piece of paper, without the need to produce the full bank records, to sue borrowers across state lines. Third, prior to the enactment of the Federal Reserve Act in 1913, there was uncertainty whether national banks in US had the corporate power to accept bills of exchange drawn on themselves. And fourth, habit. That is, the participants in US commercial lending – bankers, borrowers, bank regulators, judges, juries, etc – had been accustomed to promissory notes and found no compelling reasons to change.[6]

From the above historical analysis, it’s fair to conclude that the adoption of promissory notes in commercial lending in US served primarily as a substitute of the bills of exchange used in UK. However, in a typical promissory note, the obligor for payment (the borrower) is also a party to the loan agreement. The obligor for payment in a typical bill of exchange, on the other hand, is not the borrower, and therefore not a party to the loan agreement.[7] Therefore, replacing the bill of change by the promissory note results in the “undesirable” consequence of using “contemporaneous documents” in a transaction.

The next question then is whether, in the current environments, such an “undesirable” consequence (and any other additional disadvantages) may outweigh the benefits, if any, that promissory notes can provide, and thus whether it makes sense to continue to use promissory notes in conjunction with a loan agreement.

Modern analysis of pros & cons – noteless syndicated loans

Many commentators have analyzed the advantages & disadvantages of promissory notes under the modern-day legal frameworks for commercial lending in US. (See, eg, here, here, & Bellucci and McCluskey, The LSTA’s Complete Credit Agreement Guide (2nd ed. 2017), pp.200-203.) So, I will only briefly summarize the main points here.

In terms of the advantages of a promissory note, the main one is to “evidence” the associated loan. By my interpretation, this means the ability to show the world (ie, the borrower, regulators, courts, juries, third parties, …) the existence of the loan in a short, simple, and easy-to-understand document, in contrast with the lengthier and more complicated loan agreement. Additional notable advantages include negotiability[8], expedited court proceedings (mainly in NY[9] and some Latin America countries[10]), and the ability to pledge the note to the Federal Reserve at its discount window[11].

On the other hand, the disadvantages of a promissory note include difficulties in safekeeping and locating the note, the need to amend and re-issue the promissory note when the loan agreement is amended or when the loan principal amount changes under the existing loan agreement, the potential for inconsistencies between the promissory note and the loan agreement (as the UK lawyer noted), the additional work required to ensure consistency between the documents, and, particularly for syndicated loans, the logistic burdens created when a lender assigns all or part of its commitment (requiring collection of old notes to issue new notes).

It has been argued, however, that except for the “evidence” advantage, most of the other advantages offered by a promissory note are either not available (negotiability[12]) or can be accomplished by a loan agreement (expedited proceeding & pledge at Federal Reserve[13]) in most instances. This is particularly so for syndicated loans, which involve mostly sophisticated parties in complicated transactions, and the combined disadvantages of the promissory note outweigh its weakened advantages. As a result, in recent years, most syndicated loans have been “noteless”, making promissory notes optional by the request of individual lenders, and relying primarily on the loan agreements to memorize the transactions.[14]

Appropriate use of promissory notes – careful evaluation and practical expectation

Despite the “noteless” trend in syndicated loan transactions, not all commercial lending transactions need to forsake the promissory note. It may still be beneficial to have a short, simple, and easy-to-understand document to “evidence” the existence of the loan. Care & caution must be exercised, however, to reduce, minimize, or avoid the potential disadvantages embodied in the use of two “contemporaneous” documents in a single transaction.

First of all, the reality is a short and simple document, as desirable as it may be, cannot be expected to properly memorize a complicated transaction. This deficiency may be reflected on the availability of the NY expedited proceeding afforded to a promissory note. Under NY laws, the expedited proceeding may not be available to the lender if the promissory note and the loan agreement have become so “intertwined” at the time of breach.[15] Consider the case in Bonds Financial v. Kestrel Technologies[16]. There, the loan agreement of a resolving credit included events of default other than the failure to make payments. The borrower defaulted on a non-monetary term under the revolving loan agreement, which accelerated payment under the promissory note, and the lender instituted an expedited proceeding based on the promissory note. The court held that the expedited proceeding was not available pursuant to the promissory note, because it was necessary to reference an external document, the loan agreement, to determine whether an event of default had occurred.

Therefore, when structuring a loan transaction, the parties should carefully evaluate the interactions between the promissory note and the loan agreement (and other loan documents such as the mortgage[17]) and the potential of reduced or lost benefits from the promissory note, weigh the advantages and disadvantages afforded by using the note, and consider the option of a “noteless” loan transaction. This is particularly so when the promissory note references the loan agreement, which adds to the “intertwine-ness” between the documents (thus reducing the availability of the NY expedited proceeding) and also erodes the negotiability of the note.

In the minimum, a control clause should be included in both the promissory note and the loan agreement and specify which document should control in the event of inconsistencies.

[1] Richard G.A. Youard, Promissory Notes in International Loan Transactions: An English View, 4 INT’l Bus. LAW. 259 (1976).

[2] One author suggested that the UK stamp duty imposed on promissory notes in 1782 might have been another reason for the UK practice against promissory notes. Bruce W. Nichols, Some Observations on the American Approach to the Use of Notes in International Lending, 4 INT’l Bus. LAW. 239 (1976).

[3] See, e.g., Youard, supra; Nichols, id. (“English banks […] seem chiefly to have supplied credit by discounting bills of exchange held by customers, not the notes of such customers.”; Bruce J. Summers, Loan Commitments to Business in United States Banking History, Economic Review, vol. 61, September/October 1975, pp.15-23.

[4] Nichols, supra in Footnote 2.

[5] Florida currently imposes stamp taxes on promissory notes.

[6] The NY lawyer also suggested “transferability” of promissory notes (as opposed to loan agreements) as another reason for their continued use, particularly the ability to pledge promissory notes at the Federal Reserve. This reason, however, is now out of date, as most loan agreements are now transferrable, and the Federal Reserve currently accepts loan agreements as collateral. The latter subject will be discussed later in this article.

[7] In a typical bill of exchange associated with a trade, the seller (beneficiary) borrows from the seller bank (which may or may not be the drawee), which is documented by the loan agreement, while the buyer (drawer) orders the buyer bank to pay the seller (beneficiary), which is documented by the bill of exchange.

[8] Under UCC Article 3, an assignee of a “negotiable” instrument who qualifies as a “holder in due course” takes the instrument free and clear of most claims and defenses afforded to the maker of the instrument against the original holder. NY UCC 3-302 & 3-305. See also Footnote 12.

[9] NY CPLR 3213, titled “Motion for Summary Judgment in lieu of Complaint”, provides an expedited proceeding for enforcing an “instrument for the payment of money only”.

[10] See, eg, The LSTA’s Complete Credit Agreement Guide, supra at 201-202.

[11] The LSTA’s Complete Credit Agreement Guide, supra at 202.

[12] Under UCC Article 3, a “negotiable” instrument must include an unconditional promise or order to pay and all essential terms. NY UCC 3-104(1)(b). Most modern day promissory notes refer to the associated loan agreements and thus do not satisfy these requirements. See, eg, https://www.lewisrice.com/publications/noteworthy-should-lenders-use-promissory-notes.

[13] The Federal Reserve began to accept noteless loans as collateral in late 1990s. The LSTA’s Complete Credit Agreement Guide, supra at 202.

[14] The LSTA’s Complete Credit Agreement Guide, supra at 202-203. “[W]ith few exceptions [syndicated loan] lenders today no longer generally request promissory notes of the borrower”.

[15] Mlcoch v Smith, 173 AD2d 443, 444 (NY App Div. 2nd Dept. 1991). (“[T]he general rule is that the breach of a related contract cannot defeat a motion for summary judgment on an instrument for money only unless it can be shown that the contract and the instrument are “intertwined” and that the defenses alleged to exist create material issues of triable fact”.

[16] Bonds Financial, Inc. v. Kestrel Technologies, LLC, 48 AD 3d 230 (NY App Div. 1st Dept. 2008)

[17] In some states, a mortgage (or deed or deed of trust) must recite the amount of debt secured by the mortgage. If the mortgage references a promissory note, and the debt principal amount changes, a new note may need to be issued, and the mortgage will need to make sure to reference the correct note. See, https://www.linkedin.com/pulse/do-lenders-really-need-promissory-notes-anthony-cianciotti.

Trademark Disclosure and Fraud, Part II – Legal Framework

Disclosure by a trademark applicant

In Part I of this 2-part series, I pointed out that the Trademark Law (Lanham Act) requires a trademark (including service mark) registration applicant to provide the following specific info to USPTO (US Patent & Trademark Office) in the registration application[1]:

Applicant’s domicile & citizenship;
The date of applicant’s first use of the mark;
The date of the applicant’s first use of the mark in commerce;
The goods / services in connection with which the mark is used;
A drawing of the mark;
One or more specimens of the mark as used.

Additionally, the Lanham Act also requires the applicant to submit a verified statement, certifying, among others, that he/she is entitled to use the mark, that he/she has a bona fide intention to use the mark, that (to his/her best knowledge and belief) the facts recited in the application are accurate, and that (to his/her best knowledge and belief) no other person has the right to use the mark without causing confusion or mistake, or to deceive.[2] In the USPTO trademark application form, the pre-prepared texts of the verified statement specifically warns that “willful false statements and the like are punishable by fine or imprisonment, or both, under 18 U.S.C. § 1001, and that such willful false statements and the like may jeopardize the validity of the application or submission or any registration resulting therefrom”[3].

The required verified statement makes it plenty clear that submitting “willful false statements” is prohibited by the Lanham Act (besides constituting a federal criminal offense under 18 USC 1001). Many questions, however, remain. – What actions constitute a “willful false statement”? What if the applicant makes a mistake, or omits to submit certain info. Does the applicant have an affirmative duty to provide certain info, even if not specifically required to register a mark? What may be the punishments?

Statutory prohibitions – Lanham Act

The Lanham Act sets forth the specific statutory language that defines prohibited violations of the disclosure requirements with respect to a USPTO trademark application, and the respective punishments. Specifically, it prescribes 3 types of punishments: Cancellation of registration; denial of incontestability; and civil action liabilities. Below is the language adopted in the Lanham Act prescribing such prohibitions.

Cancellation of registration (15 USC 1064(3)): “A petition to cancel a registration of a mark […] may […] be filed […] [a]t any time if […] its registration was obtained fraudulently”. (Emphasis added.)
Denial of incontestability (15 USC 1115(b)(1)): “To the extent that the right to use the registered mark has become incontestable […], the registration shall be [incontestable,] subject to the [defense or defects] [t]hat the registration or the incontestable right to use the mark was obtained fraudulently”. (Emphasis added.)
Civil damages (15 USC 1120): “Any person who shall procure registration […] of a mark by a false or fraudulent declaration or representation […] or by any false means, shall be liable in a civil action […] for any damages sustained thereof”. (Emphasis added.)

Under the Lanham Act, therefore, a trademark registration “obtained” or “procured” “falsely” or “fraudulently” may be subject to punishments[4]. The law, however, does not define these terms. It is then up to the USPTO or courts to define them, and thus to define the scope of trademark disclosure required of a trademark applicant before USPTO.

Scope of prohibition – “Fraudulently”

It is beyond the scope of this writing to extensively discuss the court and USPTO cases addressing the definition of the term “fraudulently”[5]. I will only summarize the following 2 holdings.

No affirmative duty to disclose. In the 1961 case, Bart Schwartz v. FTC[6], the Court of Customs & Patent Appeals[7] held that a trademark applicant has no affirmative duty to disclose unrequired info to USPTO, and that “[t]he mere withholding of information” does not constitute a fraudulent act punishable under the Lanham Act. Rather, the Court determined that the Lanham Act only requires that an applicant “will not make knowingly inaccurate or knowingly misleading statements”. (Emphasis original.) There, the Court held that the mere withholding of the meaning of the mark (FIOCCO) in a foreign language (Italian) was not a fraudulent withholding of info, without more.
Willful intent to deceive required. Addressing the question of whether a trademark registration was obtained fraudulently, the Court of Appeals for the Federal Circuit pronounced in 2009 in the seminal case, In re Bose[8], that “a trademark is obtained fraudulently under the Lanham Act only if the applicant or registrant knowingly makes a false, material representation with the intent to deceive” the USPTO. (Emphasis added.) Particularly, the Court held that “the standard for finding intent to deceive is stricter than the standard for negligence or gross negligence”, and that “[t]here is no fraud if a false misrepresentation is occasioned by an honest misunderstanding or inadvertence without a willful intent to deceive”. In the case, the counsel of the registrant (Bose) represented to USPTO that the mark (WAVE) was in use in commerce for audio tape recorders and players, even though Bose had stopped manufacturing and selling audio tape recorders and players prior to the time of the counsel’s representation. The Bose counsel testified that Bose had continued to repair previously sold recorders & players and that in his belief such repairing activities constituted valid use of the trademark in commerce. The Court held that the Bose counsel’s statement was false but not fraudulent, because it was “not uttered with the intent to mislead” the USPTO. As a result, the WAVE mark avoided the fate of cancellation and remains registered.

In summary, a trademark owner does not have an affirmative duty to disclose unrequired information to USPTO and may be held to have obtained / procured a trademark registration “fraudulently” only if he/she has the intent to deceive the USPTO.

Of course, we are now left wondering what constitutes an “intent to deceive”. But that will wait for another day and another write-up!

Scope of prohibition – “Falsely”

As discussed previously, pursuant to the Lanham Act (15 USC 1120), if a trademark registration is obtained “falsely” (as a separate cause of action from “fraudulently”), the trademark owner may be liable to other persons in a civil lawsuit. (See Footnote 4.)

Therefore, even an honest mistake, a misunderstanding, or a careless omission in communications with USPTO may subject a trademark registrant to civil liabilities, even if it is not considered “fraudulent”. Such undesirable civil liabilities have prompted the courts to hold that “[a]n applicant for registration of a trademark is required to exercise uncompromising candor in his communications with the United States Patent and Trademark Office, lest any registration he obtains will be invalid and/or unenforceable. He must not only refrain from making false representations to the United States Patent and Trademark Office, but must make full disclosure of all facts to his knowledge which might bear in any way on the Office’s decision to grant the registration sought.”[9] (Emphasis added.)

Conclusion – Uncompromising candor

In Daesang Corp. v. Rhee Bros[10], the trademark owner did not inform the USPTO that the English translation of the registered mark, “Soon Chang”, was the name of a Korean province famous for producing the goods (Korean hot bean paste) associated with the mark. Did the non-disclosure of the association constitute a fraud on USPTO? Did the registrant have an affirmative duty to disclose the association? What knowledge must the registrant have possessed about the association for the non-disclosure to constitute intent to deceive? What knowledge must the registrant have possessed about the application requirements?

A trademark applicant or registrant pondering over these questions is best to heed the advise of the court to “exercise uncompromising candor” and “make full disclosure of all facts to his knowledge which might bear in any way on the Office’s decision to grant the registration sought.”

[1] 15 USC 1052(a)(1) & (2).

[2] 15 USC 1051(a)(3). The verified statement described in this paragraph is for an in-use application (under 1051(a)), which is slightly different from that for an intent-to-use application (under 1051(b)).

[3] Pursuant to the US criminal code under 18 USC 1001(a), it is a federal criminal offense to provide a “willful false statement” to any US government branch or agency, including USPTO. (“[W]hoever, in any matter [before the Federal government], knowingly and willfully — (1) falsifies, conceals, or covers up by any trick, scheme, or device a material fact; (2) makes any materially false, fictitious, or fraudulent statement or representation; or (3) makes or uses any false writing or document knowing the same to contain any materially false, fictitious, or fraudulent statement or entry; shall be fined under this title, imprisoned not more than 5 years or […].”) (Emphasis added.)

[4] The phrase “false or fraudulent” has been interpreted by some courts to provide for 2 separate causes of action. See, eg, Citibank N.A. v. Citibanc Group, 215 USPQ 884 (ND Ala 1982) (“’[F]alse’ and ‘fraudulent’ as used in 15 USC §1120 are not synonymous, and that damages are recoverable thereunder where the registration is procured either by a declaration which was incorrect or by a declaration which was a willful attempt to mislead and injury has resulted as a consequence thereof.”), aff’d 724 F.2d 1540 (11th Cir 1984); In re Bose Corporation, 580 F.3d 1240 (Fed Cir 2009) (“the latter involv[es] an intent to deceive, whereas the former may be occasioned by a misunderstanding, an inadvertence, a mere negligent omission, or the like.”)

[5] For more in-depth discussions, see, eg, here.

[6] Bart Schwartz v. FTC, 289 F.2d 665 (CCPA 1961).

[7] The court of Customs & Patent Appeals was the predecessor the Court of Appeals for the Federal Circuit, which was established in 1982 and has nationwide jurisdiction over trademark cases, among others.

[8] In re Bose Corporation, 580 F.3d 1240 (Fed Cir 2009).

[9] T.A.D. Avanti, Inc. v. Phone-Mate, Inc., 199 USPQ. 648 (CD Cal 1978).

[10] Daesang Corp. v. Rhee Bros., 77 USPQ.2d 1753 (D Md 2005).

Trademark Disclosure and Fraud, Part I – Impact and Implications of Surging Chinese Trademark Applications

This Part I of a 2-part series explores the recent exponential growth of the number of trademark applications at USPTO (US Patent & Trademark Office) that originated from China, and its impact and implications with respect to the disclosure by trademark applicants and registrants to USPTO. In Part II, I will review the legal standards and liabilities for trademark disclosure and the importance of “uncompromising candor” in all communications with USPTO.

Incentives for fraud – Attractive benefits of a federal trademark registration

In US, trademarks (including service marks) are protected under both federal and state laws. These protections are predicated on actual use. That is, once a mark is in actual use as an indicator of the source of goods / services, the mark can be protected without having to register the rights with the governments. Federal registration of a trademark, nonetheless, provides several benefits to the trademark owner (see, eg, here.), such as:

Presumption of validity and ownership of the trademark;
Nationwide priority in the trademark;
Public notice of the claim of ownership of the trademark;
Listing in USPTO’s online database;
Right to use the federal registration symbol “®”;
Use of US registration as a basis to obtain foreign registrations;
Ability to stop import of goods at the border;
Ability to bring a lawsuit in federal courts;
Ability to demand statutory damages;
Etc.

In the age of e-commerce, the benefits of a federal trademark registration can be even more attractive. A registered trademark owner can request an e-commerce platform, such as amazon.com, to take down listings that the owner believes to be infringing on the trademark, by presenting the trademark registration as proof of senior rights to use the trademark. To avoid their own liability, e-commerce platforms generally comply with the takedown request relatively quickly, hampering the alleged infringer’s ability to profit from the e-commerce platforms, which have become a critical sale channel for nearly all retail businesses.

Such benefits vested in federal trademark registrations, however, also can serve as a perverse incentive for bad actors to abuse the system, particularly when coupled with the relative ease at present to register a trademark in US. As the rest of this article discusses, in recent years, the number of trademark applications submitted by applicants located in China has risen phenomenally. Unfortunately, the number of fraudulent Chinese applications has also increased proportionally. These growing fraudulent applications pose a serious threat to the integrity of the federal trademark registration system and commercial activities in US. They have also prompted USPTO to scrutinize more carefully all trademark registrations and applications for potential fraud, affecting all trademark owners interested in registering their trademarks.

Vulnerability to abuse – Relatively simple application process

Compared with patents, registration of a trademark at USPTO appears relatively simple and straightforward. The registration application process is prescribed under the Lanham Act. (15 USC 1051 et seq.) Particularly, §1 of the Lanham Act requires a trademark registration applicant to provide the following key info (15 USC 1051(a)(1) & (2)):

Applicant’s domicile & citizenship;
The date of applicant’s first use of the mark;
The date of the applicant’s first use of the mark in commerce;
The goods / services in connection with which the mark is used;
A drawing of the mark;
One or more specimens of the mark as used.

There are a few other info that may also be required, if applicable, such as foreign translation of the trademark wording, special meaning of the trademark in the industry, geographical meaning, use by a licensee, etc. For many applications, however, the key info above is all that is required to register a trademark. Moreover, except for the “one or more specimens”, USPTO generally does not verify the authenticity of the info submitted by the applicant. Even for the specimen(s), although USPTO does examine them for any obvious deficiencies, it does not affirmatively verify their authenticity. Therefore, the trademark registration process adopts a largely honor system, relying primarily on the participants’ voluntary disclosure and the threat of penalty for false or fraudulent disclosure. Given the attractive benefits vested on a federal trademark registration, however, such an honor system may be vulnerable to abuses.

Increasing fraudulent applications and heightened alert at USPTO

In 2019, Ms. Mary Denison, then Commissioner for Trademarks at USPTO, presented a statement to the Congress titled “Counterfeits and Cluttering: Emerging Threats to the Integrity of the Trademark System and the Impact on American Consumers and Businesses.” (See here.) In the statement, Ms. Denison testified that trademark “filings from China have increased exponentially since 2014, jumping from approximately 5,161 applications in fiscal year 2014 to approximately 54,064 in fiscal year 2018. This dramatic rise in applications coincides with the rise in inaccurate and fraudulent claims of use”. In a report dated January 2021, USPTO further extended the timeframe to 2019, which continued to show exponential growth of Chinese applications. (See here and the Figure below.)

Furthermore, in a recent paper, Profs Barton Beebe & Jeanne Fromer examined a sub-set of 345 trademark applications randomly sampled from the set of use-based applications in Class 25 (Clothing) that originated from China and were filed to USPTO in 2017. Based on their analysis, they concluded that more than 2/3 (66.9%) of the applications examined included “fraudulent specimens”. (See here.)

Alarmed and alerted by this exponential rise in the number of potentially false, inaccurate, or fraudulent trademark applications, and the consequential harm to the trademark registration system and commerce, USPTO has implemented several measures to arrest this rising tide, including (derived from 2019 Denison Statement):

Requiring foreign-domiciled applicants to be represented by US counsel (effective 8/31/2019);
Auditing post-registration maintenance filings (initiated in 2012; made permanent in 2017);
Updating examination guidance and issuing refusals based on lack of evidence of use in commerce (2019); and
Piloting programs to allow third parties to provide evidence in examination and expedite inter partes non-use challenges (2018).

Furthermore, Congress has introduced bipartisan bills that would make it easier for the public or USPTO to expunge or re-examine a trademark registration that has not been in-use or has been abandoned. (See, eg, here.)

Trademark owners required to exercise “uncompromising candor”

All these agency and legislative actions and changes mean that all communications between trademark owners and USPTO will likely be scrutinized more closely than before, not only by USPTO but also by courts, competitors, opponents, and even the general public. Even before these changes, the courts have consistently required a trademark registration applicant to exercise “uncompromising candor” in communications with USPTO. With the new measures and changes, this “uncompromising candor” will likely be subject to scrutiny under an even stronger magnifying glass. All trademark owners should carefully review all their past and future disclosures to USPTO to make sure they have satisfied the “uncompromising candor” requirements.

In Part II, I will discuss the legal framework governing trademark disclosure and liabilities for violations.

US Sanctions Against China – Information for Risk Assessments

During the past 2 years, the US government has intensified its economic sanctions against China. These sanctions have been enacted & imposed by several government branches and executive departments, including Congress, President, Commerce, Treasury, Defense, & Justice, and were based primarily on the following federal statutes:

International Emergency Powers Act of 1977
National Emergencies Act of 1976
Export Administration Act of 1979
Export Control Reform Act of 2018
Global Magnitsky Human Rights Accountability Act of 2012
United States-Hong Kong Policy Act of 1992
Hong Kong Human Rights and Democracy Act of 2019
Hong Kong Autonomy Act of 2020
Section 1237 of the National Defense Authorization Act for Fiscal Year 1999
Defense Production Act of 1950
Holding Foreign Companies Accountable Act of 2020
Section 307 of the Tariff Act of 1930

It has been questioned whether prior economic sanctions were effective against smaller authoritarian regimes such as Iraq, Iran, or N Korea. (See, eg, here & here.) The effectiveness of these sanctions against China, the second largest economy in the world, can be even more uncertain, particularly considering the potential counter measures by China. (See, eg, here & here.)

Moreover, sanctions may be subject to changes in politics and enforcement variations. For example, on 5/16/2019, the Commerce Department added Huawei and its subsidiaries to the export blacklist, but a few days later granted a temporary general license to the sanctioned entities for more than a year, until 8/17/20, when the temporary general license was replaced by more limited but permanent authorizations. Additionally, many of the sanctions imposed by the Trump administration are expected to be modified by the upcoming Biden administration.

Regardless of their level of effectiveness, these sanctions do minimally provide certain information contents – those actions & actors that have been determined by the US government (Congress, President, & executive agencies) to “constitute an unusual and extraordinary threat […] to the national security, foreign policy, or economy of the United States”. (§1701(a) of the International Emergency Powers Act.) Such information may be valuable in risk assessments, for example with respect to business transactions, even if not for compliance purposes.

Below is an incomplete list of some of the sanctions against China imposed by US in the past 2 years, grouped into 6 categories: Technology (Huawei), Xinjiang, Hong Kong, Defense, Technology, & Investment. The citations of the sanction statutes, orders, & rules (in Pub L or Federal Register), if available, are included, so one can readily find more info, such as the identities of the sanctioned entities.

Category	Date	Government Branch / Agency	Description	Source
Technology (Huawei)	5/15/19	President	Prohibited purchase & use of telecommunication equipment made by companies posing national security risk	84 FR 22689
	5/16/19	Commerce	Added Huawei & 68 affiliates to export blacklist	84 FR 22961
	8/19/19	Commerce	Added 46 Huawei affiliates to export blacklist	84 FR 43493
	5/15/20	Commerce	Required foreign semiconductor makers to obtain license to ship Huawei-designed semiconductors produced using US technology to Huawei	85 FR 29849
	8/17/20	Commerce	Added 38 companies to export blacklist	85 FR 51596
Xinjiang	10/8/19	Commerce	Added 28 companies, government entities & security bureaus to export blacklist	84 FR 54002
	6/17/20	Congress	Enacted Uyghur Human Rights Policy Act	Pub L 116-145
	7/9/20	Treasury	Added 4 individuals & 1 entity to OFAC sanction list	85 FR 42981
	7/22/20	Commerce	Added 11 companies to export blacklist	85 FR 44159
	7/31/20	Treasury	Added 2 individuals & 1 entity to OFAC sanction list	85 FR 47838
	1/13/21	Homeland Security	Prohibited entry of cotton & tomatoes from Xinjiang
Hong Kong	11/27/19	Congress	Enacted Hong Kong Human Rights and Democracy Act	Pub L 116-76
	7/14/20	Congress	Enacted Hong Kong Autonomy Act	Pub L 116-149
	7/14/20	President	Revoked HK special status	85 FR 43413
	8/7/20	Treasury	Added 10 HK officials to OFAC sanction list	85 FR 55073
	12/8/20	Treasury	Added 14 high-level Chinese officials to OFAC sanction list
Defense	6/12/20	Defense	Added 20 companies to list of “Communist Chinese military companies”
	8/27/20	Commerce	Added 24 state-owned companies to export blacklist	85 FR 52898
	8/28/20	Defense	Added 11 companies to list of “Communist Chinese military companies”
	12/3/20	Defense	Added 4 companies to list of “Communist Chinese military companies”
	12/18/20	Commerce	Added 59 individuals & companies to export blacklist	85 FR 83416
Technology	8/6/20	President	Prohibited transactions with TikTok & WeChat	85 FR 48637; 85 FR 48641
	9/24/20	Commerce	Identified prohibited transactions with TikTok	85 FR 60061
	1/5/21	President	Prohibited transactions with persons developing or controlling Alipay, CamScanner, QQ Wallet, SHAREit, Tencent QQ, VMate, WeChat Pay, and WPS Office	86 FR 1249
Investments	11/12/20	President	Prohibited purchase of securities of “Communist Chinese military companies”	85 FR 73185
	12/18/20	Congress	Enacted Holding Foreign Companies Accountable Act	Pub L 116-222

Hong Kong Sanctions Create Fissures Between US & Chinese Financial Systems – A Quagmire for Foreign Banks in US

[Update: The President said he had signed the Hong Kong Autonomy Act into law.]

Will the fissures turn into a gorge?

The question is whether the fissures may coalesce into a deep gorge dividing the financial systems of the 2 largest economies of the world.

Quagmire for financial institutions

Less than 2 weeks ago, on 7/2/2020, the US Congress unanimously passed the Hong Kong Autonomy Act (HKAA), which was the Congress’ response to the HK National Security Law (HKNSL) that the Chinese government enacted a few days prior on 6/30/2020 (see my previous post). The legislation should become a law soon, likely by midnight today.[1]

The HKAA generally will ban financial institutions (FIs)[2] from engaging in certain transactions with those foreign FIs (primarily Chinese FIs, but can be any non-US FIs) that have done “significant” businesses with certain sanctioned persons who have “materially” contributed to the erosion of autonomy in HK. (For more info about the definitions of the terms under HKAA, please see here.) To comply with such sanctions, however, a FI may run afoul of Article 29 of the HKNSL, which makes it a crime for any person (anyone in the world) to “conspire” with a foreign country to impose such sanctions. (See, also, here.) Hence, a FI can be penalized in US if it does not comply with US sanctions[3], but face the quagmire of being prosecuted in HK/China if it so complies.[4]

Picking side, US or China, but not both – a Hobson’s choice

For FIs currently having exposures in both US & HK/China, this quagmire may force them to decide whether to conduct business in either US or HK/China, but not both. For example, consider a Taiwanese bank (or a German, British, French, Canadian, Japanese, S Korean, Indonesian, Brazilian or any foreign bank) that conducts banking in both US and HK/China. If its HK/China operations are identified as having conducted significant transactions with sanctioned persons under HKAA, its US operations may be prohibited from engaging in transactions with its HK/China operations, or even with the bank headquarter. But, by complying with the US prohibitions, the US operations of the Taiwanese bank may be found to have violated Article 29 of the HKNSL, and hence the bank’s HK/China operations may be prosecuted, because both the US operations and the HK/China operations belong to the same bank. Under such circumstances, the Taiwanese bank may have no choice but to pick where it wants to do business in, either US, or HK/China, but not both.[5] That may be a Hobson’s choice that is not a choice at all.

An outlier black swan

In a US election year, and amidst the fallout from the COVID-19 pandemic, tensions between US and China have escalated. Financial sanctions such as the HKAA & national security laws such as the HKNSL are but a part of the complicated web of conflicts and brinkmanship involved in this new cold war. However, the Hobson’s choice facing down global financial institutions and the potentially unfathomable impact on the global financial systems may tamper the practical effects of these laws and orders.

For example, after the HKAA becomes law, the President has up to 120 days to identify the foreign financial institutions to be subject to sanctions, and up to 1 year to implement the sanctions. That means in the short run, no sanctions under HKAA will likely be enforced before the US election. After the US election, the political tensions may ease, allowing fine-tuning of the laws & regulations and their implementations, which may reduce the risks involved.

On the other hand, the severe erosion of HK autonomy and civil liberties under the HKNSL are frighteningly real for the people of HK. The prospect of great disruptions to the current financial systems arising from the US-China tensions, even if a low-probability outlier at this point, can also be real. It can be a black swan testing humanity’s ingenuity!

[1] The legislation has been sent to the President, who is required to sign the legislation within 10 days (except Sundays) or return it to the Congress. (“If any Bill shall not be returned by the President within ten Days (Sundays excepted) after it shall have been presented to him, the Same shall be a Law”, US Constitution, Article I, Section 8, Clause 2). If the president takes no action by the 10-days deadline, the legislation automatically becomes a law. On the other hand, if the President returns it, the Congress should have the 2/3 votes required to override the veto, required under the same Section of the Constitution.

[2] “Financial Institution” under HKAA has the same definition as in FDIC (31 USC 5312(a)(2)), which includes a broad spectrum of institutions, including insured banks, commercial banks or trust companies, securities brokers & dealers, foreign bank branches or agencies, etc.

[3] Violations of HKAA can carry civil penalties of the greater of $250k or twice the amount of transaction. Criminal penalties include fines up to $1m, or imprisonment for up to 20 years for a natural person, in addition to the fine. (50 USC 1705)

[4] Penalties under HKSNA generally implicate imprisonment of various terms, up to 10 years, and/or fines.

[5] It’s not clear whether compliance of sanctions by US subsidiaries of the Taiwanese bank (not branches or agencies) may subject the HK/China operations or the parent bank to prosecutions under HKNSA. However, because the US subsidiaries may be subject to the prosecution, meaning its personnel may be at risk if they enter the “influence zone” of HK/China, it will be difficult for the Taiwanese bank to communicate with and maintain control of the US subsidiaries, even if its HK/China operations and headquarter are not implicated.

Hong Kong’s National Security Law – Implications in Business Risk Assessments

On June 30, 2020, the Chinese government enacted Hong Kong’s National Security Law (Chinese | English), which was not officially published until the same time when it became effective, at 11 pm local time, foreclosing any meaningful public input (at least from the HK public) to the new law. Within hours after the publication of the law, several commentators have made an effort to dissect and analyze the new law, such as the note by Professor Donald Clarke, and the videoconferencing sessions organized by Hong Kong Democracy Council. More analyses should become available as the international communities scrutinize and analyze the new law in greater scope and depth.

At a quick glance, the new law imposes several measures that severely restrict or eradicate the autonomy and civil rights previously vested in HK. Without going into great details, and not meant to be complete, I have summarized these measures below.

Measures	Descriptions	Article #
Mainland Control	The Chinese government (National People’s Congress) has the sole “power of interpretation” of the law.	65
	The law “prevails” over any HK laws.	62
	The law creates a “Committee for Safeguarding National Security” (CSNS) to oversee implementation of the law. CSNS “shall be under the supervision of and accountable to the” Chinese government.	12
	The head of the secretariat of CSNS, who supposedly will be in charge of the real work at CSNS, must be appointed by the Chinese government.	13
	The Chinese government will designate a “National Security Adviser” to “provide advise” to CSNS.	15
	The law creates a “National Security Department” (NSD) within the HK police force to investigate violations against the law. The head of the NSD must be appointed with approval by the Chinese government.	16
	NSD can be staffed by “professionals and technical personnel” from outside of HK (ie, China).	16
	The law creates a “Specialized Prosecution Division” in the Department of Justice to prosecute violations. The head of the division must be appointed with approval by the Chinese government.	18
	The law creates an “Office for Safeguarding National Security” (OSNS), a Chinese government body staffed directly by Chinese government, tasked, among others, with “collecting and analyzing intelligence and information” in HK. OSNS is funded directly by the Chinese government.	48, 49, 51
	OSNS has the power to exercise jurisdiction over any case involving national security, usurping the HK jurisdiction, and send the case to China for prosecution and sentencing according to Chinese laws.	55, 57
	OSNS is not subject to the jurisdiction of HK.	60
Vague & Broad Crimes	The law criminalizes the acts categorized under “Secession”, “Subversion”, “Terrorist Activities”, & “Collusion with a Foreign Country or with External Elements”, which are vaguely and broadly defined.	20-30
Extraterritorial Application	The law applies to offences committed by any “person who is not a permanent resident” of HK.	38
Secrecy	The work of CSNS will be kept secret and not disclosed to the public.	14
No Judicial Review	Decisions made by CSNS “shall not be amenable to judicial review”.	14
Trial without Jury	A case can be tried “without a jury by a panel of three judges”, on broadly stated grounds.	46
Unaccountable Broad Powers	Any person, be it an institution, organization, or individual must “comply with measures taken by” OSNS. Further, OSNS is not subject to HK jurisdiction or law enforcement.	57, 60

Inevitably, the new law will have significant international ramifications, not limited to HK only, evidenced by the sanction legislation passed promptly by US Congress in response to the new law. Notably, the new law is applicable to ANY person on the earth, a/k/a extraterritorial application. (Article 38. See the table above.) That means, for example, a foreigner non-HK resident may be found to have violated the new law by posting on twitter the words, “Fight for Freedom! Stand with Hong Kong!” In such cases, the person may be prosecuted under the new law if he/she is present in HK or China. Or, in a worst-case scenario, if the person resides in a country having an extradition treaty with China, he/she may face the specter of having to defend an extradition request from China.

What is more, the law creates the Office for Safeguarding Nation Security (“OSNS”), which is an agency of the Chinese government, but stationed within HK. This agency has tremendous powers, including “collecting and analyzing intelligence and information concerning national security” (Article 49(3)) and “handling cases concerning offence endangering national security” (Article 49(4)). It can take over jurisdiction from local HK government (Article 55) and send the case to China for prosecution and sentencing according to Chinese laws (Articles 56 & 57). Moreover, any person, be it an institution, organization, or individual must “comply with measures taken by” OSNS (Article 57). And yet, despite the tremendous powers OSNS wields, it is not subject to HK jurisdiction or law enforcement (Article 60). According to Professor Clarke, OSNS is not subject to Chinese law either. No wonder Professor Clarke lamented that the OSNS was “untouchable” and “Gestapol-level stuff”!

Considering its vague and broad scope, the extraterritorial application, the creation of such an unaccountable yet powerful agency as OSNS, and other authoritarian aspects of the new law, the business risks for international communities doing business with HK and China have increased substantially. It is unclear at this point how the new law will be enforced. Also, potential economic gains from the China markets and trades will likely remain an important factor in business risk assessments, which is itself a complicated undertaking. If we have learned anything about global risk assessments from recent events, however, it is that underestimating the risks in the early stage may prove to be unforgiving!

Black Lives Matter!

All human lives matter!

Civil liberties matter!

Political rights matter!

Democracy matters!

Four score and seven years ago our fathers brought forth on this continent, a new nation, conceived in Liberty, and dedicated to the proposition that all men are created equal.
Abraham Lincoln

It is still a long way to go before the words “all men” uttered by President Lincoln more than 150 years ago can truly mean “all humans”!!!