Posted on

Cyborgs: Natural Bodies, Unnatural Parts, and the Legal Person

By Alexis Dyschkant*

INTRODUCTION

The phrase “one’s person” has an important legal role because of the unique rights an individual has over her person and because of the prohibition on wrongfully contacting another’s person.  Isolating the boundary of a person is crucial for determining when (or if) someone has wrongfully contacted an individual.  Historically, “one’s person” has been limited to “one’s natural body” and some, but not all, artificial attachments to one’s natural body.  The cyborg, a creature composed of artificial and natural parts, challenges this conception of a “person” because it tests the distinction between the natural body and an artificial part.  Artificial objects, such as prosthetics, are so closely attached to bodies as to be considered a part of one’s person.  However, claiming that personhood extends to things attached to our natural bodies oversimplifies the complicated interrelation between natural objects and artificial objects in the cyborg.  If our person is no longer limited to our natural body, then we must understand personhood in a way that includes the cyborg.  I argue that the composition of a body does not determine the composition of a person.  One’s person consists to the extent of one’s agency.

ARTIFICIAL PARTS AND ONE’S PERSON: LEGAL BACKGROUND

One commits battery when she causes a “harmful or offensive contact with the person of the other.”[1]  Contact with a person has not been limited to contact with that person’s natural body.  For example, grabbing an object out of one’s hand is battery if the object is so closely connected to someone as to be considered a part of his body.[2]  In particular, objects which serve to substitute for a part of one’s natural body may be considered a part of one’s body, such as interference with a cane.[3]  Disability aids, such as prosthetics, wheelchairs, or hearing aids, are paradigm examples of artificial objects that are viewed as intimately attached to one’s body.  Interference with these objects is likely to be considered contact with a person.

The Restatement of Torts gives a guideline as to what is considered an “intimate connection”:There are some things such as clothing or a cane . . . which are so intimately connected with one’s body as to be universally regarded as part of the person.  On the other hand, there may be things which are attached to one’s body with a connection so slight that they are not so regarded. [4] At the heart of the discussion is the physical relationship between the artificial object and the natural body.  The artificial object needs to be attached to the natural body, and this attachment comes in degrees of intimacy.  At some point, the object is so closely attached we commonly refer to the object as part of one’s person.  Physical attachment to the body is the most significant factor in considering the role of an artificial object to one’s person.  For example, it is unlikely that touching a prosthetic limb that is completely detached from a body would constitute contact with a person.  Being attached to a physical body is paramount to determining whether an artificial object is considered a part of one’s person.

NEUROPROSTETHICS AND THE HIDDEN CYBORG

The problem with focusing on whether an artificial object is attached to a body is that the concept of “attachment” creates a conceptual barrier between “thing attached” and “thing attached to.”  Attachment can come in degrees, but it necessarily includes a relationship between two separate entities.  The image of the body, wholly organic and natural, and its artificial parts creates a dichotomy between the original, real body and its subsequent alterations.[5]  This image may accurately describe common representations of prosthetics and disability products, such as wheelchairs and canes, which can clearly be separated from one’s body.  But, while these kinds of artificial objects are common, it is a mistake to think that this is the norm.  The cyborg is more common than many believe.

A cyborg, simply put, is a creature that consists of both natural and artificial parts.[6]  Recent developments in science, called “Neuroprosthetics,” suggest that a science fiction conception of the cyborg is not entirely fiction.[7]  As the name suggests, Neuroprosthetics are artificial objects that are directly controlled by one’s nervous system—similar to how a natural arm is controlled.  Just in the last few months, we have seen the creation and private use of “Neuroprosthetic exoskeletons,” mechanical additions to a human body, such as a mechanical limb, which are integrated into one’s body.[8]  These exoskeletons respond directly to neuro-information in what has been called a “brain-computer interface.”[9]  Not only are these Neuroprosthetics not easily detached from one’s body like traditional prosthetics, but they challenge the inherent dichotomy between “thing attached” and “thing attached to.”  Neuroprosthetics become conceptually and biologically woven into the natural fabric of one’s body.  At one end, there is a clearly mechanical exoskeleton composed entirely of artificial parts and at the other end there is a natural, organic brain.  Somewhere between these two points, there is the woven interconnection between organic and artificial, but locating the “attachment” is difficult, and potentially, impossible.

But one need not look to modern technology to find cyborgs.  We are all cyborgs.  If the cyborg is as pervasive in society, then there is an even stronger motivation to distance personhood from biology.  The hidden cyborg is someone who has become so accustomed to her artificial parts that she fails to see herself as a cyborg at all.  The image of the natural human body as distinct from artificiality has become a thing of the past.  The most obvious examples of this are everyday objects like eyeglasses or cosmetics.  Tattoos are permanent additions to one’s body that can only be removed by removing organic material.  At the most extreme end of artificiality is the role of devices into which one can “off-load” his cognition, such as smartphones.  Some argue that our ability to save information contributed to the growth of our neuro-processing ability.[10]  Importantly, some of these artificial parts are not attached to a natural body.  Glasses merely rest on a body.  Tattoos are not “affixed” to one’s body, but literally woven into one’s skin.  Computing devices are entirely detached from our natural body.  This suggests that the role of artificial objects in one’s person extends beyond attachment.

CONCEPTIONS OF THE CYBORG’S PERSON

There are three possible responses to the existence of the cyborg.  One is to insist that one’s person is composed of a natural body and attached objects.  A second response, advanced by Gowri Ramachandran, is to reconceive of the body as a “social body.”[11]  I advance a third response which distances the “person” from the “body” and associates one’s person with one’s agency.

Salvaging the Natural Body-Artificial Part Distinction

One may insist that there remains an important difference between the natural body and the artificial object attached to the body.  Tattoos do not occur naturally; one must add a tattoo.  Similarly, one must attach a Neuroprosthetic to a natural body.  The fact that the location at which the exoskeleton is attached is difficult to locate does not mean that there is no point of attachment.  Moreover, consider the exoskeleton or the tattoo a paradigm example of the most intimate attachment.  However, this response blurs the role that “attachment” to one’s person is meant to play.  If the location of the attachment is lost and, thus the boundary between the artificial and the natural, then what distinguishes it from natural attachments such as donated organs other than the fact that it is artificial?  Moreover, even naturally occurring parts of one’s body can also become detached, such as temporary organ removal during surgery or a lost tooth that is going to be reattached.  The fact that functionally-equivalent artificial objects and natural objects can be attached and detached in similar ways suggests that a concept of “one’s person” should not depend on the natural-artificial distinction or the attached-detached distinction.[12]

The Social Body

Ramachandran offers a solution to the cyborg problem by introducing the “social body” which consists of those objects, possibly natural or artificial, which are important to our daily lives.[13]  One’s social body may include objects which blur the line between natural and artificial.  “Pacemakers, imaginary artificial organs of the future, and ink in a tattoo are often thought of as part of the social body, and they are neither organic nor human.”[14]  Ramachandran’s portrayal of the social body de-emphasizes the importance of attachment by focusing on the function of an object.  While this view is indeed a step in the right direction, it does not go far enough to distance the conception of one’s “person” from one’s “body.”  As she points out, the role of artificial objects in the social body is rhetoric that can potentially be identified as a replacement for natural body parts.[15]  The term “social body” invokes a pretense, as if it is an invented term used to give artificial objects a more privileged role in our lives.  Arguably, changing the natural body to a social body continues to place some body at the center of personhood.

Moving Beyond the Body

The view advanced here responds to the introduction of the exoskeleton-bearing cyborg and the hidden cyborg by distancing the body from the person entirely.  What the cyborg shows us is that the body can be composed of any kind of part but the person is necessarily the agent which controls, benefits from, and depends upon these parts.  Human tissue, animal tissue, or mechanical “tissue” all allow a person to exercise their agency and interact with the world.  The type of body which a person controls need not be relevant.  Hence, determining when one has made contact with “the person of another” does not necessarily depend on the naturalness or composition of one’s body, but on the relationship between the object contacted and the person’s agency.  We can imagine a technologically advanced future in which people retain control over parts detached entirely from their body or in which one’s person is dispersed across great spaces.  Neuroprosthetics are the first phase of this development; they are prosthetics that are not only integrated with our bodies, but also with our cognition.  They directly respond to electro-chemical signals put off by our brains.  What constitutes a person, in these cases, is that all of these parts compose a single agent capable of controlling or sensing them in the same way that we currently control or sense our natural parts.  The distinction between person and body is not new, but throughout much of history the person has been limited, or contained in, the body.  The development of the cyborg represents an exciting change.  It is now possible to conceive of the person extending physically beyond the body via attachments, integrations, extensions, and even completely detached objects.[16]

* J.D., College of Law, Ph.D., philosophy, University of Illinois at Urbana-Champaign, expected 2015.

[1] Restatement (Second) of Torts § 13 (1965).

[2] Fisher v. Carrousel Motor Hotel, Inc., 424 S.W.2d 627, 629 (Tex. 1967).

[3] Respublica v. De Longchamps, 1 U.S. (1 Dall.) 111, 114 (1784).

[4] Restatement (Second) of Torts § 18 cmt. c (1965) (emphasis added).

[5] See Donna J. Haraway, A Manifesto for Cyborgs: Science, Technology, and Socialist Feminism in the 1980s, in The Haraway Reader 7, 11 (1985) (discussing three theoretical boundary breakdowns in modern society between human and animal, organism and machine, and physical and non-physical).

[6] Id.

[7]E.g., Miguel A. L. Nicolelis, Mind in Motion, Sci. Am, Sept. 2012, at 58; Emilia Mikołajewska & Dariusz Mikołajewski, Neuroprostheses for Increasing Disabled Patients’ Mobility and Control, 21 Advances Clinical & Experimental Med. 263 (2012), available at http://www.advances.am.wroc.pl/pdf/2012/21/2/263.pdf.

[8] Chris Wickham, UK Paraplegic Woman First to Take Robotic Suit Home, Reuters (Sept. 4, 2012), http://www.reuters.com/article/2012/09/04/us-science-exoskeleton-idUSBRE8830RZ20120904.

[9] Mikołajewska & Mikołajewski, supra note 7, at 264.

[10] Cary Wolfe, What is Posthumanism? 35 (2010).

[11] Gowri Ramachandran, Assault and Battery on Property, 44 Loy. L.A. L. Rev. 253, 259 (2010).

[12] Haraway, supra note 5, at 11–13.

[13] Ramachandran, supra note 11, at 263–66.

[14] Id. at 267.

[15] Id. at 275.

[16] Ramachandran, for example, willingly includes smartphones as part of the social body in the form of an “exo-brain.”  Id. at 275–76.  The introduction of external information processing has led some philosophers, such as extended mind theorists and transhumanists, to include the smartphone as a part of one’s person.  Id.

Posted on

Piercing the SHIELD Act

By Jessica Lanfordϯ

On August 1, 2012, Rep. Peter DeFazio (D-Or.) introduced a bipartisan bill that seeks to protect American start-ups from the destructive costs of frivolous lawsuits brought by patent trolls.[1]  Backed by the software and computer hardware companies that it seeks to protect, the Saving High-Tech Innovators from Egregious Legal Disputes Act (SHIELD) effectively forces Non-Practicing Entities (NPEs) to pay defendants’ legal costs.

This Article provides an overview of the bill, then analyzes its effectiveness by asking three questions: 1) What is the NPE problem? 2) Is fee-shifting a sensible policy instrument? and 3) Do we need to go beyond existing law to prevent frivolous lawsuits?  Ultimately, a closer look shows that the system proposed by the SHIELD Act is premature, ineffective, and unnecessary.

Overview of the SHIELD Act:

The SHIELD Act proposes a “loser-pays” system[2] for cases involving computer hardware or software patents, with the following language:

(a) In General—Notwithstanding section 285, in an action disputing the validity or alleging the infringement of a computer hardware or software patent, upon making a determination that the party alleging the infringement of the patent did not have a reasonable likelihood of succeeding, the court may award the recovery of full costs to the prevailing party, including reasonable attorney’s fees, other than the United States.[3]

The preamble suggests that the statute applies to both validity and infringement actions.  But the bill then limits the system to apply only against the party “alleging the infringement.”  Thus, the SHIELD Act is a one-way system: alleged infringers can recover their costs if they prevail in court—but patentees may not seek recovery against accused infringers who assert frivolous defenses.[4]

The bill also provides definitions for “Computer,” “Computer Hardware Patent,” and “Software Patent.”  If passed, the bill will define “software patent,” for the first time, to mean: a) “any process that could be implemented in a computer regardless of whether a computer is specifically mentioned in the patent,” or b) a “computer system that is programmed to perform [such] a process.”[5]  But the bill stops short of endorsing the controversial software patent with a disclaimer: the SHIELD Act should not be “construed as amending or interpreting categories of patent-eligible subject matter . . . .”[6]

1. NPE Problems: Where’s the Beef?

An NPE is defined as an entity that does not manufacture products itself—also known as a “patent troll.”[7]  Universities, independent inventors, and failed businesses are all examples of NPEs.  But the term “patent troll” can also mean a specific type of NPE that buys patents from others merely to assert them.  Critics liken these businesses to the fabled greedy troll who hijacks bridges, then threatens to gobble-up anyone who passes his way.[8]

Is the SHIELD Act really anti-troll legislation?  Supporters claim that the fee-shifting provision could help “the good guys” beat patent trolls.[9]  But the bill’s effects are far broader than its proponents suggest: any plaintiff that alleges infringement without a “reasonable likelihood of succeeding,” could be forced to foot its opponent’s legal bills.[10]  And by leaving the construction of “a reasonable likelihood of succeeding” up to the court, the SHIELD Act could end up creating more litigation than it seeks to prevent.[11]

In a news release, Rep. DeFazio claimed that patent trolls “pad their pockets by buying patents on products they didn’t create and then suing the innovators who did the hard work and created the product.”[12]  But current evidence of NPE activity seems to show otherwise.   For example, last year, one of the largest publicly traded NPEs reported that it paid more in royalties to inventors than it did to the patent attorneys who enforce their patents.[13]

Rep. DeFazio also claims that patent trolls’ lawsuits hurt American innovation and tech startups.[14]  His belief is widely shared, but it lacks credible support. [15]  In reality, NPE activity has the potential to spur innovation, and stimulate investment in start-ups.[16]   And the NPEs that Rep. DeFazio targets could actually help the little guy.  By buying patents from inventors and owners who can’t afford to market their own technologies, NPEs give non-manufacturing inventors the opportunity to monetize their patents—one that they may otherwise not have.

The bill is also intended to neutralize NPEs’ controversial business practices.  Specifically, Rep. DeFazio points to patent trolls’ habit of buying broad patents for the purpose of filing “flimsy lawsuits” for infringement.[17]  Perhaps he is unaware of recent evidence that the patents enforced by “trolls” are substantially similar to patents litigated by practicing entities.[18]  For example, patents litigated by NPEs have the same range of claims and references cited as other litigated patents.[19]  And contrary to popular belief, a recent study shows that the patents NPEs typically litigate are more important and influential than those litigated by non-NPE plaintiffs.[20]

Yet, no studies show that NPEs actually file frivolous lawsuits, or that they are routinely accused of Rule 11 violations.  So, where’s the beef?  Until we have a realistic understanding of so-called “patent troll” litigation and NPE behavior, we should refrain from passing laws aimed at limiting their activity.

2. Is Fee-Shifting a Sensible Policy Instrument?

For more than 200 years, litigants in the United States have operated under the “American Rule”: each party pays its own litigation costs, whether it wins or loses.  In contrast, under both the “English Rule” and the SHIELD Act, the loser pays.

Despite its effectiveness in discouraging frivolous lawsuits, the English Rule produces unwanted results.  First, in a “Loser Pays” world, a potential plaintiff decides whether to litigate by considering its financial risks, rather than the merits of its case.  As a result, plaintiffs with meritorious claims that are not sure-fire winners will give up on litigation for fear of paying the defendant’s costs.

Second, the English Rule encourages more litigation than its American counterpart by reducing settlements, particularly in cases involving higher stakes and confident parties.  Naturally, in a “Loser Pays” system, a confident high-stakes litigant will pursue trial for full recovery.  But the American Rule reduces litigation: a confident party will prefer to settle when the cost of doing so is less than the cost of victory at trial.

Finally, if the British experience is any indication, patent enforcement costs arising from the SHIELD Act could drown small businesses and startup patentees[21]—the same entities that the bill claims to protect.  Therefore, unless we want to limit small businesses’ access to courts, the SHIELD Act and its “Loser Pays” system is ineffective.

3. Do We Need to Go Beyond Existing Law to Prevent Frivolous Lawsuits?

If supporters of the SHIELD Act simply want protection from frivolous lawsuits, then why do they need this bill?  Existing patent law allows the court to award reasonable attorney’s fees to the prevailing party in “exceptional” cases, under Section 285.[22]  Courts typically award attorney’s fees under Section 285 when evidence shows that the plaintiff brought litigation in bad faith.[23]   But without a showing of bad faith, attorney’s fees under Section 285 are unavailable.[24]

A plaintiff of a frivolous lawsuit is also subject to sanctions under Rule 11 of the Federal Rules of Civil Procedure.  Under Rule 11, attorneys are required to certify that the papers they file are legally sound, rooted in fact, and “not interposed for any improper purpose.”[25]

Yet the SHIELD Act seeks to shift the standard’s focus from a plaintiff’s conduct to his or her perceived probability of success.  The bill proposes that even in the absence of bad faith, a patentee should be liable for attorney’s fees based on the court’s opinion of his or her “reasonable likelihood of success.”

The SHIELD Act is a hollow sword.

If passed, the SHIELD Act has the potential to hurt those that it claims to protect.  The threat of overwhelming legal costs will keep small innovators from litigating worthy claims, giving alleged infringers a free pass.  At the same time, the bill’s supporters seek to expand existing protections against frivolous lawsuits without any meaningful understanding of NPE activity.  Before we even consider passing legislation aimed at limiting the behavior of patent trolls, we need to take a close look at what they actually do.

ϯ J.D. Candidate, University of Illinois College of Law, expected 2013.

[1] Press Release, Congressman Peter DeFazio, DeFazio Introduces SHIELD Act to Protect American Innovation, Jobs (Aug. 1, 2012), available at http://defazio.house.gov/index.php?option=com_content&view=article&id=792:defazio-introduces-shield-act-to-protect-american-innovation-jobs&catid=69:2012-press-releases; Cong. Research Serv., H.R. 6245: Saving High-Tech Innovators from Egregious Legal Disputes Act of 2012, govtrack.us,  http://www.govtrack.us/congress/bills/112/hr6245 (last visited Oct. 15, 2012).

[2] Loser Pays System Introduced in Congress, PatentlyO (Aug. 9, 2012, 10:21 AM), http://www.patentlyo.com/patent/2012/08/loser-pays-system-introduced-in-congress.html.

[3] SHIELD Act of 2012, H.R. 6245, 112th Cong. (2012).

[4] Ron Katznelson, Here They Go Again – This Time with the Patent SHIELD Act, IPWatchdog (Aug. 26, 2012, 7:25 AM), http://www.ipwatchdog.com/2012/08/26/here-they-go-again-this-time-with-the-patent-shield-act/id=27476/.

[5] H.R. 6245.

[6] Id.

[7] Michael Risch, Patent Troll Myths, 42 Seton Hall L. Rev. 457, 459 (2008); David L. Schwartz & Jay P. Kesan, Analyzing the Role of Non-Practicing Entities in the Patent System 2 (July 25, 2012) (Ill. Program in Law, Behavior and Soc. Sci. Paper No. LBSS13-03; Ill. Pub. Law Research Paper No. 13-01; Chi.-Kent Coll. of Law Research Paper No. 2012-03), available at http://ssrn.com/abstract=2117421.

[8] Peter Christen Asbjørnsen & Jørgen Moe, Three Billy Goats Gruff, in 37 Popular Tales from the Norse 275–76 (George Webbe Dasent trans., London, George Routledge and Sons 2d ed.); Schwartz & Kesan, supra note 7, at 2.

[9] Julie Samuels, Can You Believe It? Legislation that Would Actually Help Fix the Patent System, Electronic Frontier Found. (Aug. 1, 2012), https://www.eff.org/deeplinks/2012/07/can-you-believe-legislation-would-actually-help-fix-patent-system.

[10] H.R. 6245.

[11] Timothy J. Maier, The Proposed Saving High-Tech Innovators from Egregious Legal Disputes (SHIELD) Act, Maier & Maier, PLLC (Aug. 10, 2012, 2:47 PM), http://www.postgrant.com/2012/08/the-proposed-saving-high-tech-innovators-from-egregious-legal-disputes-shield-act.html.

[12] Press Release, Congressman Peter DeFazio, supra note 1.

[13] ACACIA Research Grp., Annual Report (Form 10-K), (Feb. 29, 2012), available at http://biz.yahoo.com/e/120229/actg10-k.html; Schwartz & Kesan, Analyzing the Role of NPEs in the Patent System, Patentlyo (Aug. 21, 2012, 4:04 AM), http://www.patentlyo.com/patent/2012/08/analyzing-the-role-of-npes-in-the-patent-system.html.

[14] Press Release, Congressman Peter DeFazio, supra note 1.

[15] Risch, supra note 7, at 492–93.

[16] From Exposing NPE Myths to Explaining NPE Math, RPX, http://www.rpxcorp.com/index.cfm?pageid=14&itemid=25.

[17] Press Release, Congressman Peter DeFazio, supra note 1.

[18] Risch, supra note 7, at 480; Schwartz & Kesan, supra note 13.

[19] Risch, supra note 7, at 480.

[20] Id. at 481.

[21] Katznelson, supra note 4; Richard Tyler, Inventor Fury as Patents Prove Too Costly to Defend, Telegraph (Mar. 8, 2012, 11:11 AM), http://www.telegraph.co.uk/finance/yourbusiness/9130815/Inventor-fury-as-patents-prove-too-costly-to-defend.html.

[22] 35 U.S.C. § 285 (2006); Alexander Poltorak, Proposed SHIELD Law Is Nothing but a Gift to Infringers, Hill (Aug. 10, 2012, 3:15 PM), http://thehill.com/blogs/congress-blog/technology/243135-proposed-shield-law-is-nothing-but-a-gift-to-infringers.

[23] ICU Med., Inc. v. Alaris Med. Sys., Inc., 558 F.3d 1368, 1379–80 (Fed. Cir. 2009).

[24] Brooks Furniture Mfg. ., Inc. v. Dutailier Int’l, Inc., 393 F.3d 1378, 1381 (Fed. Cir. 2005).

[25] Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 393 (1990).

Posted on

The California Money Transmission Act: Boon to Consumers or Bane to Innovation?

By James Mariani*

I. Introduction

Recently California passed the Money Transmission Act (CA MTA), which some believe to be a threat to innovation in Silicon Valley and the death knell for certain types of startups.[1]  The CA MTA “prohibits a person from engaging in the business of money transmission in California or advertising, soliciting, or holding itself out as providing money transmission unless licensed [] or exempt from licensure,”[2] thus expanding California’s previous money transmission regulations and licensure requirements in broad terms while assigning regulation and licensing authority to the California Department of Financial Institutions (DFI).[3]  The Act now applies to domestic money transmitters and includes stored value device issuers, as well as other businesses that offer new types of alternative payment and mobile applications.

II. Background

Money transmission laws date back to 1936 in California after money transmitter businesses were created to take advantage of a new market of immigrants wishing to send money back to their native land.[4]  Regulations were originally designed to prevent money laundering, fraud, and other financial crimes, however after the events of September 11, 2001, the financing of terrorist activities jumped to the forefront prompting many states to pass money transmission laws. Congress responded with its own legislation, passing the USA PATRIOT Act, which among other things, amended 18 U.S.C. § 1960 criminalization of acting as an unlicensed money transmitting business in a state that requires such a license, by making the mens rea requirement one of general intent. The District of Columbia and 48 states have similar money transmitter laws, however none seem to be experiencing the uproar and criticism experienced in California.[5]  This can most likely be attributed to two issues: the CA MTA is broader and has more expensive licensing requirements than what is typical among the states and California has an environment of unique, highly entrepreneurial channels and a large startup volume.

III. The California Money Transmission Act

The CA MTA provides that “a person shall not engage in the business of money transmission in this state, or advertise, solicit, or hold itself out as providing money transmission in this state, unless the person is licensed or exempt from licensure . . . .”[6]  Based on findings that the failure of money transmission businesses to fulfill their obligations would cause harm to consumers and the state while undermining public confidence and general welfare, the legislature designed the act with the purported purpose of protecting the interest of persons in the state who use money transmission services, of providing for the safe and sound conduct of the business of licensees, and to maintain public confidence in licensees.

“Money Transmission” is defined broadly to mean selling or issuing payment instruments, selling or issuing stored value, or receiving money for transmission.[7]  A “payment instrument” is defined as an instrument for the transmission or payment of money or monetary value, whether or not negotiable, excluding issuers who also redeem the instrument for goods or services provided by the issuer.[8]  “Stored value” means monetary value representing a claim against the issuer that is stored on a digital or electronic medium and accepted as means of redemption for money or as payment for goods or services excluding cards issued by businesses that also redeem the card for goods or services provided by the issuer.[9]  Finally, “receiving money for transmission” broadly includes any transaction where money or monetary value is received for transmission within or outside the United States by electronic or other means—thus possibly including certain novel mobile payment applications and emerging payment platforms that are not offered by banks or other regulated depository institutions.[10]

These broad terms change existing regulations in several ways.  First of all, the Act combines three existing license regimes—traveler check issuers, money order sellers, and foreign money transmitters—into one. Secondly, it newly subjects domestic money transmitters and stored value, or open loop, issuers to licenses. Finally, it criminalizes engaging in money transmission in California without a license. It is important to note that this law applies to anyone who engages in its prohibitions in California or for California residents.

1. Licensure Requirements

Just as the CA MTA’s defining prohibition is seemingly broad and open-ended, likewise are its license requirements, which are more demanding than what is typical among the states.[11]  A license is only attainable by a corporation or limited liability company and is issued by the Commissioner of the California Department of Financial Institutions (Commissioner).[12]  An application requires a nonrefundable $5,000 fee along with a multitude of specified information provided “in a form and in a medium prescribed by the [C]ommissioner.”[13]  This section also includes a catchall provision entitling the Commissioner to “any other information the [C]ommissioner requires with respect to the applicant” as well as the ability to waive or replace specified information requirements.[14]  The Commissioner is authorized to conduct an examination of an applicant, at the applicant’s expense, and then approve its application if certain specific findings are made including that “the financial condition of the applicant is otherwise such that it will be safe and sound for the applicant to engage in the business of money transmission,” the applicant and its agents are of good character and sound financial standing, it is competent, its plan affords reasonable promise of successful operation, and it is reasonable to believe the applicant will be compliant once licensed.[15]  In addition to the broad terms of authorizing a license, § 2036 provides a supplementary and powerful catchall phrase entitling the Commissioner to “impose on any authorization, approval, license, or order issued pursuant to this chapter any conditions that he or she deems reasonable or necessary to the public interest,” including exemptions from the license requirement.[16]

          a.     The Net Worth or “Sound Financial Standing” Requirements

When designing the CA MTA, the California legislature found that “the failure of money transmission businesses to fulfill their obligations would cause loss to consumers, disrupt the payments mechanism in this state, undermine public confidence in financial institutions doing business in this state, and adversely affect the health, safety, and general welfare of persons in this state.”[17]  Based on this concern, the legislature added large security deposit requirements in order to ensure that licensees were of sound financial standing in order to prevent the failure of money transmission businesses and weed out “fly-by-night” company applicants.[18]  The security requirement however is ambiguous and broad—as is the trend throughout the Act—providing that as a security, a licensee will deposit cash, securities, or a surety bond in “such amount as the [C]ommissioner may find and order from time to time as necessary to secure the faithful performance of the obligations of the licensee . . . .” If a licensee sells or issues payment instruments or stored value, then it must maintain securities or a surety bond of at least $500,000 or 50 percent of the California average daily outstanding payment instrument and stored value obligations up to $2,000,000. A licensee that engages in receiving money for transmission must maintain a security or surety bond in an amount greater than the average daily outstanding obligations for money received for transmission in California ranging from $250,000 to $7,000,000. The security, money, bonds, and their proceeds are deposited with the State Treasurer and “shall constitute a trust fund for the benefit of persons in California” who were customers of the licensee in the event of its failure.[19]

          b.     Other Post-license Compliance Requirements

In addition to the security deposit requirements, the CA MTA also includes several regulatory compliance provisions such as paying an annual $2,500 fee (among other conditional licensee fees);[20] filing audit reports and specific informational reports—including total volume of activities, transactions, obligations, etc.;[21] and providing consumers with certain disclosures, notices, and records.[22]

2.    Noncompliance Penalties

The Commission has yet to exercise its enforcement capabilities, but they are broad and powerful as presented in the statute. The CA MTA authorizes the Commissioner to suspend or revoke a license if “the Commissioner finds that a licensee or agent of a licensee has, among other things, violated the provisions of the CA MTA or engaged in fraud or unsound practices . . . .”[23]  If a money transmitting business fails to attain a license and conducts business regardless, it could be faced with heavy civil penalties, criminal penalties, or both. Also frightening is the possibility that the CA MTA may, in conjunction with § 1960 of the USA PATRIOT Act, result in an unknowingly unlicensed money transmitting business being guilty of committing a federal general intent crime.  This fact is exceptionally worrisome, as many companies may not realize that they require a license due to the Act’s ambiguity.  Also, the expensive licensing requirements can be crippling to some startups that are unable to afford the license requirements.  As this Act only recently went into effect, it is difficult to predict the scope of the possible enforcement actions, the weight of their ensuing penalties, or how such actions will play out.

3.     Who Requires a License?

The breadth of the CA MTA has stirred sizeable criticism and prompted many to ask who exactly requires a license. “A spokewoman from the DFI advised companies to ask themselves simple questions:”

Do you take funds/value from A and agree to pay them to B on behalf of A; and/or Do you take funds/value from A, and store it so that A can make purchases from third parties or take cash out at a later date.[24]

This answer however, is no less broad than the language of the statute.  It could potentially cover a wide array of companies from Airbnb, for renting hosts’ rooms to travelers; to Apple, for taking money from customers and paying it to App developers; and to Zynga, for selling virtual currency. There has already been confusion between DFI and a company on the Act’s application; Airbnb believes the licensing requirements do not apply to them, and DFI believes the opposite. DFI has shown that it is willing to work with companies, like Square who didn’t even apply for a license until a year after the Act went into effect. This leniency though, might be temporary as the Act is relatively new and possesses penalties that are potentially crippling.  When interpretations between a company and DFI differ on the law’s application, litigation might be required.  In such cases, criminal enforcement and civil penalties may be at stake.  If a money transmitting business does fail, the security bond requirements of the Act are supposed to make consumers whole, which may or may not justify the high compliance cost.

FaceCash is a startup that stopped doing business in California because it couldn’t afford the security deposit requirements. The company was unable to receive an exemption from the state and embarked upon litigation against California. The CA MTA cannot be enforced against FaceCash because it discontinued its business in California, but what if it had not?  Companies that can’t afford the security deposits and aren’t sure whether the Act applies to them may be faced with asking themselves whether they should risk the potential penalties rather than try and comply with the Act’s high licensing requirements.

IV. Conclusion

The DFI publishes a list of the companies that currently are licensed under the CA MTA as a money transmitting business.[25]  The best strategy for a company presently is to look at this list and determine if its business model is similar to those companies that require and have attained a license. If its business model is innovative, using the plain English test passed down by the DFI is the next best choice. However, until the scope of the Act’s enforcement and penalties are clearer, many startup companies will be dissuaded from conducting possible money transmission business and risking high penalties and possible criminal prosecution. In this sense, the CA MTA is detrimental to innovation, and a new, expensive burden for the many startups that make their home in California.

*J.D., College of Law, University of Illinois, expected 2013

[1] Money Transmission Act, Cal. Fin. Code § 2000 (West 2012); see Chris Hinyub, The Money Transmission Act: A Boon to Banks, a Bane of Small Businesses, IVN.us (May 25, 2011), http://ivn.us/2011/05/25/money-transmission-act-boon-banks-bane-small-businesses/ (“[T]he Money Transmission Act is designed to kill innovation.”); Owen Thomas, This Innovation-Killing California Law Could Get A Host of Startups in Money Trouble, Business Insider (July 11, 2012, 6:21 PM), http://www.businessinsider.com/california-money-transmitter-act-startups-2012-7 (“[Startups’] entrepreneurial impulse could be stifled by a surprisingly broad statute governing money transmission in California . . . .”).

[2] Marie Hogan, California’s New Money Transmission Law Sweeps Up, Joseph & Cohen (May 19, 2011), http://josephandcohen.com/2011/05/californias-new-money-transmission-law-sweeps-up/.

[3]Jonathan Pompan, California Enacts Sweeping New Law Targeting Money Transmitters, Venable LLP (Oct. 2010), http://www.venable.com/california-enacts-sweeping-new-law-targeting-money-transmitters-10-05-2010/.

[4] Andrea Lee Negroni, Risky Business: State Regulation of Money Transmitters, CLEAR News (Goodwin Proctor LLP, Bos., Mass.) Spring 2003, at 1–2, available at http://www.goodwinprocter.com/~/media/Files/Publications/Attorney%20Articles/2003/Risky_Business_State_Regulation_of_Money_Transmitters.ashx.

[5] Jonathan L. Pompan, Understanding the Relationship Between Money Transmitter Laws and Regulations and Debt Management Plans, Venable LLP (Jan. 20, 2012, 9:30 AM), http://www.aiccca.org/images/AICCCA%20Presentation%20-%20Understanding%20the%20Relationship%20between%20Money%20Transmitter%20Laws%20and%20Regulations%20and%20Debt%20Management%20Plans%20(January%2020%202012).pdf.

[6] Money Transmission Act, Cal. Fin. Code § 2030 (West 2012).

[7] Id. § 2003(o).

[8] Id. § 2003(q); see Hogan, supra note 2 (listing as examples: a check, draft, or money order).

[9] Fin § 2003(v); see Hogan, supra note 2 (distinguishing Visa gift cards, which are included; from cards issued by leading coffee chains, which are excluded).

[10] Fin § 2003(s); Hogan, supra note 2.

[11] See Pompan, supra note 9 (explaining that typical requirements for state licensing include “good moral character”, “sufficient financial responsibility”, “business experience”, “confidence of the public”, “a minimum net worth of [e.g.] $150,000”, and “3 years experience in money transmission or other related financial services”).

[12] Money Transmission Act, Cal. Fin. Code § 2031 (West 2012); Pompan, supra note 2.

[13] See Fin. § 2032 (listing specified information requirements from § 2032(c)(1)–(22)).

[14] Id.

[15] See id. § 2033 (listing specific findings from  § 2033(b)(1)–(5)).

[16] See id. § 2036.

[17] Id. § 2001(c).

[18] Id. §§ 2033, 2037; Danielle Rodabaugh, California Money Transmitter Company Closes, Possibly to Avoid $750,000 Surety Bond, Suretybonds.com (July 8, 2011), http://www.suretybonds.com/blog/california-money-transmitter-company-closes-possibly-to-avoid-750000-surety-bond/1411 (“The state established the high surety bond requirement to keep fly-by-night companies out of the market.”).

[19] Fin. § 2037; Pompan, supra note 2.

[20] Fin. § 2038. See § 2038(e)–(h) for additional conditional fees.

[21] Id. § 2039 (listing specific requirements for respective required reports); Pompan, supra note 2.

[22] Fin. §§ 2100–2106; Pompan, supra note 2.

[23] Fin. § 2035; Pompan, supra note 2.

[24] Id.

[25] Directory of Money Transmitters, CA.gov, http://www.dfi.ca.gov/directory/mt.asp (last updated Sept. 5, 2012, 9:31:16 AM).