While Public Benefit Corporations (PBCs) have been around for a decade, with the increasing importance of environmental, social, and governance (ESG) considerations, their popularity has grown dramatically. Following the successful IPOs of several PBCs and the conversion of already publicly traded companies to PBCs over the past two years, many corporations are considering if becoming a PBC is right for them. In this webcast, lawyers from Gibson Dunn and Morris Nichols talk about what to consider when deciding if being a PBC is right for you. In particular, they discuss the following:

• How is a PBC different from a traditional corporation?
• How does a corporation become a PBC?
• What are the requirements that come with being a PBC?
• What are the risks and benefits of being a PBC?
• What is the difference between a PBC and a B Corp?

PANELISTS:

Stephen Glover is a partner in Gibson Dunn’s Washington, D.C. office and has served as Co-Chair of the firm’s Mergers and Acquisitions Practice Group. Mr. Glover has an extensive practice representing public and private companies in complex mergers and acquisitions, strategic alliances and joint ventures, as well as other corporate matters. Mr. Glover’s clients include large public corporations, emerging growth companies and middle market companies in a wide range of industries. He also advises private equity firms, individual investors and others.

Julia Lapitskaya is a partner in Gibson Dunn’s New York office and a member of the firm’s Securities Regulation and Corporate Governance practice group. Ms. Lapitskaya advises clients on a wide range of securities and corporate governance matters, with a focus on SEC and listing exchanges’ compliance and reporting requirements, corporate governance best practices, annual meeting matters, shareholder activism, board and committee matters, ESG and executive compensation disclosure issues, including as part of initial public offerings and spin-off transactions.

Harrison A. Korn is an associate in the Washington, D.C. office of Gibson, Dunn & Crutcher, where he is a member of the firm’s corporate department. His practice focuses on public and private mergers and acquisitions, the formation and operation of private equity and hedge funds, and capital markets and other corporate transactions, as well as general corporate matters, including securities law compliance and corporate governance.

Melissa DiVincenzo is a partner at the Wilmington, Delaware law firm Morris Nichols. Ms. DiVincenzo provides advice on corporate governance matters and private and public corporate transactions, including initial public offerings, mergers, asset sales, domestications, dissolutions and financing transactions. She has a specialized knowledge of Delaware law when structuring transactions and confronting complex or novel corporate issues.

MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 0.5 credit hour, of which 0.5 credit hour may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit.

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 0.75 hour.

California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.

Gibson Dunn’s summary of director education opportunities has been updated as of July 2022 and is available at the link below. Boards of Directors of public companies find this a useful resource as they look for high quality education opportunities.

This update includes a number of additional opportunities as well as updates to the programs offered by organizations that have been included in our prior summaries.

Read More

The following Gibson Dunn attorneys assisted in preparing this update: Hillary H. Holmes, Elizabeth A. Ising, Peter Wardle, and Justine Robinson. Thank you to summer associate Ruoqi Wei for her assistance with this quarter’s update.

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

China has finally amended its Anti-Monopoly Law, which will come into force on 1 August 2022 (the “Amended AML”).[1] The Amended AML has been more than two years in the making: the State Administration for Market Regulation (“SAMR”) first proposed amendments in early 2020 and a formal draft amendment was submitted to the Standing Committee of the National People’s Congress for a first reading on 19 October 2021 (the “Draft Amendment”).[2]

This client alert summarizes the main changes bought into effect by the Amended AML.

1.  Changes to the Merger Review Process

Review of non-threshold transactions

Article 19 of the Amended AML enables SAMR to require parties to a concentration (where the concentration does not otherwise trigger mandatory reporting obligations) to notify the transaction where “the concentration of undertakings has or may have the effect of eliminating or restricting competition.”[3]  Presumably, the obligation to submit a notification means that parties cannot close the transaction prior to obtaining clearance.

It is hard to say what practical effect Article 19 will have (if any). On the one hand, the introduction of this provision at least signals that SAMR seeks broader powers to review below threshold transactions. On the other hand, SAMR already had the right to review (although it did not have the power to require that parties notify) below threshold transactions under the State Council Regulation on the Notification Thresholds for Concentrations of Undertakings, but such power has rarely been exercised. The significance of Article 19 will be directly influenced by both SAMR’s appetite to formally review below threshold transactions, and its capacity to deal with such cases over and above its mandatory filing caseload.

Introduction of the stop-clock system

The Amended AML grants SAMR the power to suspend the review period in merger investigations under any of the following scenarios: where the undertaking fails to submit documents and materials leading to a failure of the investigation; where new circumstances and facts that have a major impact on the review of the merger need to be verified; or where additional restrictive conditions on the merger need to be further evaluated and the undertakings concerned agree.[4] The clock resumes once the circumstances leading to the suspension are resolved.  As noted in our previous client alert, it seems that this mechanism may be used to replace the “pull-and-refile” in contentious merger investigations.

This stop-clock system may lead to significantly longer investigations.

2.  Changes to the Rules on Anticompetitive Agreements

Abandoning per se treatment for resale price maintenance (“RPM”)

The Amended AML introduces a provision which states that a monopoly agreement between counterparties fixing the price or setting a minimum price for resale of goods to a third party “shall not be prohibited if the undertaking can prove that it does not have the effect of eliminating or restricting competition.”[5]  This provision essentially codifies the landmark 2018 decision of the Supreme People’s Court of China in Hainan Provincial Price Bureau v. Hainan Yutai Scientific Feed Company (“Yutai”).[6] In that case, the SPC addressed the divergent approaches taken by the Chinese antitrust authorities and the Chinese courts in respect of RPM, whereby the former treated RPM agreements as per se illegal, while the latter adopted a “rule of reason” approach. The SPC clarified that although Chinese antimonopoly authorities are able to rely on the presumption that RPM agreements eliminate or restrict competition and thus are illegal, this presumption is rebuttable by the undertaking adducing sufficient evidence to prove that the RPM agreement does not eliminate or restrict competition.

The Amended AML brings the legislation in line with Yutai, meaning that where a plaintiff alleges breach of the AML by way of a RPM agreement, it is open to a defendant to prove that the RPM agreement does not eliminate or restrict competition and therefore is not unlawful.

Safe harbours for vertical monopoly agreements

The Amended AML introduces a “safe harbour” for vertical monopoly agreements, in circumstances where “undertakings can prove that their market share in the relevant market is lower than the standards set by the anti-monopoly law enforcement agency of the State Council and meet other conditions set by the anti-monopoly law enforcement agency of the State Council shall not be prohibited.”[7]  This provision authorises SAMR to determine the threshold for the safe harbour, which we can expect in due course. The scope of the safe harbour under the Amended AML is narrower than that proposed under the Draft Amendment, which applied to both horizontal and vertical monopoly agreements. By contrast, it is clear from the Amended AML that the safe harbour only applies to vertical agreements, including, presumably, RPM agreements.

Cartel facilitators

The Amended AML provides that undertakings “may not organize other undertakings to reach a monopoly agreement or provide substantial assistance for other undertakings to reach a monopoly agreement.”[8]  This provision fills an arguable gap in the current AML, which means that cartel facilitators e.g., third parties that aid the conclusion of anti-competitive agreements or cartels, may be found in breach of the Amended AML.

3.  Increase in Fines Imposed

The Amended AML substantially increases the potential fines that could be imposed on different parties, and creates new fines. These include:

Penalties on cartel facilitators.  As explained above, under the Amended AML cartel facilitators will be liable for their conduct.  They risk penalties of not more than RMB 1 million (~$149,000).[9]

Increased penalties for merger-related conduct.  One of the commonly cited weaknesses of the current AML is the very low fines for parties failing to file or gun jumping (limited to RMB 500,000).  The Amended AML now states that where an undertaking implements a concentration in violation of the AML, a fine of less than 10% of the sales from the preceding year shall be imposed.[10] Where such concentration does not have the effect of eliminating or restricting competition, the fine will be less than RMB 5 million (~$745,000).

Superfine.  The Amended AML introduces a multiplier clause, pursuant to which SAMR can multiply the amount of the fine by a factor between 2 and 5 in case it is of the opinion that the violation is “extremely severe”, its impact is “extremely bad” and the consequence is “especially serious”.[11]  There is no definition of what these terms mean and this opens the door to very significant and potentially arbitrary fines.

Penalties for failure to cooperate with investigation.  Where an undertaking refuses to cooperate in anti-monopoly investigations, e.g. providing false materials and information, or conceals, destroy or transfer evidence, SAMR has the authority to impose a fine of less than 1% of the sales from the preceding year, and where there are no sales or the data is difficult to be assessed, the maximum fine on enterprises or individuals involved is RMB 5 million (~$745,000) and RMB 500,000 (~$75,000) respectively.

Penalties on individuals.  The Amended AML introduces individual liability for legal representatives, principal person-in-charge or directly responsible persons of an undertaking if that person is personally responsible for reaching an anticompetitive agreement. A fine of not more than RMB 1 million (~$149,000) can be imposed on that individual.[12] At this stage, however, cartel leniency is not available to individuals.

Public interest lawsuit.  Finally, under the Amended AML, public prosecutors (i.e. the people’s procuratorate) can bring a civil public interest lawsuit against undertakings they have acted against social and public interests by engaging in anticompetitive conduct.

4.  Further Targeting of the Digital Economy

Regulating the digital economy continues to be a focus of China’s legislative agenda. In 2021, SAMR published specific guidelines on the application of the AML to platforms. The Amended AML further targets the digital economy by adding language which prevents undertakings from “us[ing] data and algorithms, technologies, capital advantages, platform rules, etc. to engage in monopolistic behaviour prohibited by this Law.”[13]  This principle appears to apply to all monopolistic behaviour prohibited by the Amended AML, including monopoly agreements between undertakings, and is not limited to cases of abuse of market dominance.

In respect of abuse of market dominance, the Amended AML specifically adds that “[an] undertaking with a dominant market position shall not use data, algorithms, technologies, platform rules, etc. to engage in the abuse of a dominant market position as prescribed in the preceding paragraph”, which refers to the full list of acts considered to be abuse of dominant position.[14]

__________________________

[1]      Decision of the Standing Committee of the National People’s Congress on Amending the Anti-Monopoly Law of the People’s Republic of China (24 June 2022) available at http://www.npc.gov.cn/npc/c30834/202206/e42c256faf7049449cdfaabf374a3595.shtml.

[2]      National People’s Congress of the People’s Republic of China, “Draft Amendment to the Anti-Monopoly Law” (中华人民共和国反垄断法(修正草案)) (released on October 25, 2021), available at http://www.npc.gov.cn/flcaw/flca/ff8081817ca258e9017ca5fa67290806/attachment.pdf. See our client alert, China Publishes Draft Amendment to the Anti-Monopoly Law, published on 27 October 2021.

[3]      Amended AML, Article 26.

[4]      Draft Amendment, Article 32.

[5]      Amended AML, Article 18.

[6]      See our client alert Antitrust in China – 2019 Year in Review, for more detailed discussion of Yutai.

[7]      Amended AML, Article 18.

[8]      Amended AML, Article 19.

[9]      Amended AML, Article 56.

[10]    Amended AMl, Article 58.

[11]    Amended AML, Article 63.

[12]    Amended AML, Article 62.

[13]    Amended AML, Article 9.

[14]    Amended AML, Article 22.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition Practice Group, or the following authors in Hong Kong:

Sébastien Evrard (+852 2214 3798, [email protected])
Hayley Smith (+852 2214 3734, [email protected])

Please also feel free to contact the following practice leaders:

Rachel S. Brass – San Francisco (+1 415-393-8293, [email protected])
Ali Nikpay – London (+44 (0) 20 7071 4273, [email protected])
Christian Riis-Madsen – Brussels (+32 2 554 72 05, [email protected])
Stephen Weissman – Washington, D.C. (+1 202-955-8678, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On June 24, 2022, the Hong Kong Government gazetted the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (“Amendment Bill”)[1]. The Amendment Bill introduces changes to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (“AMLO”)[2], including the introduction of a licensing regime for virtual asset services providers (“VASPs”) and imposing statutory anti-money laundering and counter-terrorist financing (“AML/CTF”) obligations on VASPs in Hong Kong. A Legislative Council Brief on the Amendment Bill (“LegCo Brief”)[3] was also published on the same date, which provides valuable context for its introduction. The Amendment Bill follows the Consultation Conclusions[4] on this subject published by the Hong Kong government’s Financial Services and Treasury Bureau on May 21, 2021, as discussed in our previous alert.[5]

As noted by the LegCo Brief, the Hong Kong government considers its proposed VASP regime to be ‘more rigorous and comprehensive’ than the AML focused VASP regimes introduced in Singapore, the United Kingdom and Japan. To this end, and as discussed further below, the VASP regime is focused not only on AML related considerations but on ensuring adequate investor protection for virtual asset investors. As such, the VASP regime once implemented will not only impose a rigorous licensing regime on VASP operators, but will also criminalise a broad range of crypto-related misconduct, regardless of whether it takes place on a licensed VASP exchange. The regime also provides the SFC with an extensive range of supervisory powers.

I. Scope of proposed licensing regime for VASPs

As foreshadowed by the Consultation Conclusions last year, the Amendment Bill introduces a licensing regime for VASPs which provides that the business of operating a virtual asset (“VA”) service is a “regulated function” requiring a license when undertaken in Hong Kong.[6]

The Amendment Bill defines “VA service” as only including the operation of a VA exchange,[7] which is defined as the provision of services through means of electronic facilities whereby:

• offers to sell or purchase VAs are regularly made or accepted in a way that forms or results in a binding transaction; or
• persons are regularly introduced, or identified to other persons in order that they may negotiate or conclude, or with the reasonable expectation that they will negotiate or conclude sales or purchases of VAs in a way that forms or results in a binding transaction; and
• where client money or client VAs comes into direct or indirect possession of the person providing such a service.

While the scope of services covered by this definition is comparatively narrow in comparison to other crypto licensing regimes such as the Singapore Payment Services Act, we anticipate that this category of “VA service” may be expanded in the future to extend the VASP regime to other crypto-asset activities. This is particularly likely given that the Amendment Bill provides that the amendment of this definition would not require legislative change, but could instead be achieved by the publication of a notice in the Government Gazette by the Secretary for Financial Services and the Treasury.[8]

Further, we note that the above definition included in the Amendment Bill is broader than the definition proposed under the Consultation Conclusions, which contemplated licensing ‘any trading platform which is operated for the purpose of allowing an invitation to be made to buy or sell any VA in exchange for any money or any VA and which comes into custody, control, power or possession of, or over, any money or any VA at any time during the course of its business.’ As noted above, the Amendment Bill’s definition of “VA service” now also captures electronic facilities through which ‘persons are regularly introduced, or identified to other persons in order that they may negotiate or conclude, or with the reasonable expectation that they will negotiate or conclude sales or purchases of VAs in a way that forms or results in a binding transaction’. This is particularly significant to operators of peer-to-peer exchanges, given that this definition appears to capture at least some peer-to-peer platforms where those platforms constitute facilities through which parties are regularly introduced for the purpose of, or with the reasonable expectation of, negotiating or concluding sales of VAs. This is in contrast to the Consultation Conclusions’ statement that peer-to-peer trading platforms that only provide a forum where buyers and sellers of VAs can post their bids and offers “with or without automatic matching mechanisms” will not be covered under the definition of “VA exchange”. As such, it will be important for operators of peer-to-peer exchanges to review their Hong Kong activities and carefully consider whether they do fall within this additional limb of “VA exchange” as included in the Amendment Bill. We anticipate that it also may be necessary to seek further guidance from the SFC regarding their position on peer-to-peer platforms as part of the consultation process which is expected to take place regarding the SFC’s detailed regulatory requirements for the VASP regime. This consultation process is expected to take place during Q3-Q4 2022 once the Amendment Bill has been enacted and prior to the new regime taking effect.

The Amendment Bill has defined a “VA” as a digital representation of value that:

• is expressed as a unit of account or a store of economic value;
• either:
  
  • functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of debt, or for investment purposes; or
  • provides rights, eligibility or access to vote on the management, administration or governance of the affairs in connection with any cryptographically secured digital representation of value; and
• can be transferred, stored or traded electronically.[9]

Interestingly, the Consultation Conclusions did not contemplate the inclusion of the provision of rights, eligibility or access to vote as part of the definition of a “VA”. However, this addition means that governance tokens will likely be considered to be a VA. Further, while not referenced by name in the Amendment Bill or Legco Brief, we consider that, in line with the Consultation Conclusions, the definition of “VA” will capture stablecoins. Finally, while the definition of a VA does not currently cover non-fungible tokens, the Amendment Bill provides that the Secretary for Financial Services and the Treasury may expand the categories of tokens captured by the “VA” definition by publication of a notice in the Gazette.[10]

II. Licensing requirements for licensed VASPs

In order to be eligible for a VASP license, the VASP license applicant must be a locally incorporated company with a permanent place of business in Hong Kong or a company incorporated elsewhere but registered in Hong Kong under the Companies Ordinance (Cap. 622).[11]

An applicant wishing to be licensed as a VASP must demonstrate to the Securities and Futures Commission (“SFC”) that:

• it is a fit and proper person to be licensed to provide the VA service;
• it has at least 2 persons fit and proper to be responsible officers (“ROs”), each of whom are of sufficient authority within the applicant and at least one of whom must be an executive director;
• each director of the applicant is fit and proper; and
• the ultimate beneficial owner of the applicant is fit and proper to be the ultimate beneficial owner of a VASP licensee.[12]

The introduction of the fit and proper test is modelled on the fit and proper requirements for the licensing of regulated activities under the Securities and Futures Ordinance (Cap. 571) (“SFO”).[13] Given this, it is unsurprising that the factors that the SFC will consider in evaluating the fitness and properness of VASP applicants and associated individuals (e.g. ROs, directors and ultimate beneficial owners) are the same as those factors set out in the SFO in relation to licensed corporations and registered institutions. These factors include whether the applicant has been convicted of offences relating to money laundering / terrorist financing, fraud, corruption or dishonesty; the applicant’s financial status or solvency; its experience and qualifications; and its reputation, reliability and integrity.[14] Therefore, we recommend referring to the SFC’s Fit and Proper Guidelines[15] to understand the matters that the SFC will likely consider in evaluating whether a person is fit and proper in relation to a VASP licensee.

III. Licensing conditions and AML/CTF requirements

The Amendment Bill provides that the SFC may impose a range of licensing conditions on a VASP licensee, including, but not limited to, requirements in relation to:

• Financial conditions (e.g. capital requirements);
• Risk management policies and procedures;
• Anti-money laundering and counter-terrorism financing policies and procedures;
• Management of client assets;
• Financial reporting and disclosure;
• Virtual asset listing and trading policies;
• Market abuse policies;
• Cybersecurity; and
• Avoidance of conflicts of interest.[16]

We anticipate further details regarding the nature of these licensing conditions will be provided by the SFC in its forthcoming consultation on the detailed regulatory requirements applicable to VASPs (as referred to above). However, it is interesting to note that the list of license conditions included in the Amendment Bill does not include categories of clients to whom the VASP licensee may provide services. This is in contrast to the LegCo Brief’s statement that, in order to promote investor protection, the licensing regime will, at the initial stage, stipulate that VASPs can only provide services to professional investors (“PIs”) and that this restriction would be imposed by the SFC as a license condition (which is in keeping with the approach taken by the SFC to imposing the same restriction on certain licensed corporations). We consider that the use of the phrase “initial stage” and taking this approach to the imposition of the PI only restriction (rather than enshrining it in the legislation itself) suggests that the SFC may possibly allow expansion of VASP services to retail investors down the track when VA markets become more mature and regulated. This would be a welcome development for the virtual asset industry and would bring the Hong Kong regime into line with comparable regimes globally, including the Singapore regime.

The Amendment Bill also provides that licensed VASPs must comply with the AMLO’s requirements such as customer due diligence and record keeping requirements (e.g. Schedule 2 of the AMLO).[17]

IV. Key offences under the new VASP regime

The Amendment Bill also creates a significant new enforcement regime applicable to those providing VA services in Hong Kong or to the Hong Kong public. In particular, the Amendment Bill proposes that carrying on a business of providing a VA service without a license would be an offence punishable on conviction on indictment to a fine of HK$5 million and 7 years imprisonment, and in the case of a continuing offence, a further fine of HK$100,000 for every day during which the offence continues.

The Amendment Bill also introduces the following range of other offences punishable by significant fines and/or imprisonment:

• the offence of active marketing of a VA service by unlicensed persons, whether in Hong Kong or elsewhere, to the public of Hong Kong. This offence in particular is likely to have a significant impact on crypto exchanges based outside of Hong Kong and without a Hong Kong presence “on the ground” but which market their services to the Hong Kong public, including through, for example, Chinese language advertising;[18]
• the offence of making false or misleading statements in connection with an application for the grant of a license;
• the offence of making fraudulent or reckless misrepresentations with the intention to induce others to invest in VAs; and
• the offence of employing any deceptive or fraudulent device, scheme or act, directly or indirectly, in a transaction involving VA. We anticipate that this offence in particular will have a broad remit, given that it appears likely to extend to market manipulation and/or insider dealing in relation to virtual assets on the basis that such activities involve fraudulent and/or deceptive conduct.

Importantly, the offences of making fraudulent or reckless misrepresentations or employing deceptive or fraudulent devices, schemes or acts are not limited to transactions on licensed VASPs and as such will capture all individuals and/or firms engaging in this type of conduct with a substantial nexus to Hong Kong.

Finally, in the case of non-compliance with the statutory AML/CFT requirements, the licensed VASP and its ROs commit offences and upon conviction, each is liable to a fine of HK$1 million and 2 years  imprisonment. Further, licensed VASPs and ROs in contravention may also face disciplinary actions, including suspension or revocation of licenses.

V. Supervisory powers granted to the SFC over licensed VASPs

The Amendment Bill also provides the SFC with broad supervisory powers over licensed VASPs, these include the power to enter business premises of the licensed VASP and its associated entities for conducting routine inspections of business records;[19] to request the production of documents and other records;[20] to investigate non-compliances and impose disciplinary sanctions against licensed VASPs in contravention.[21]

The Amendment Bill also provides the SFC with a significant range of additional powers in relation to licensed VASPs, including:

• the power to appoint an auditor to investigate into the affairs of a licensed VASP and its associated entities if it has reasons to believe that the licensed VASP, or any of its associated entities, has failed to comply with provisions of the AMLO, code or guideline published under AMLO, or any licensing conditions imposed by the SFC;[22] and
• allowing the SFC to provide assistance to overseas regulators in investigations of any contraventions of VA requirements outside of Hong Kong. This is likely to be particularly significant given the global remit of many crypto businesses;[23] and
• powers to impose prohibitions or restrictions on the operation of a licensed VASP in a range of circumstances, including where the SFC considers the VASP not be fit and proper, or where there is a risk of dissipation of client assets.[24]

The Amendment Bill also provides the SFC with the power to seek certain orders from the Court of First Instance (“CFI”) in relation to contraventions of the VASP regime, including contraventions of the AMLO, any notice given under the AMLO or any conditions of a license granted under the AMLO.[25] This includes, significantly, the power to apply to the CFI for an order compelling a person who has been, is or may become, involved in the commission of the aforementioned contraventions, to take any step that the CFI directs, including to restore parties to any transaction to the position in which they were before the transaction was entered into.[26] This could expose persons who are the subject of such orders to liability to provide significant investor compensation in relation to losses suffered as a result of contraventions of the AMLO. However, the Amendment Bill notably does not give the SFC the power to seek such orders in relation to contraventions of codes and guidelines issued under the AMLO, in contrast to the power being sought by the SFC at present in its current consultation on amendments to its power to seek certain orders from the CFI under section 213 of the SFO.

VI. Timing

The first reading of the Amendment Bill was due to take place on June 29, but that first reading has now been rescheduled to July 6, 2022, with the provisions relating to the VASP regime due to take effect on March 1, 2023.

While the Amendment Bill provides for transitional arrangements for providers of VA services, these transitional arrangements do not extend to the offences set out above in relation to fraudulent conduct in relation to transactions in VAs, which will take effect from March 1, 2023.

While the Consultation Conclusions had contemplated a transitional period of 180 days for providers of VA services, the Amendment Bill provides that:

• there will be a transitional period for the first 12 months for any corporation carrying on a business of operating a VA exchange in Hong Kong prior to March 1, 2023 (i.e. regardless of whether they apply for a license); and
• corporations carrying on a business of operating a VA exchange in Hong Kong immediately prior to March 1, 2023 that file an application for a VA in the first 9 months (i.e. license by December 1, 2023) will be deemed to be licensed from the day after the expiry of the 12 month transitional period (i.e. March 2, 2024) until the SFC has made a decision to either approve or reject their license application, or the license applicant withdraws their application.

As such, prospective license applicants should ensure that they are operating in Hong Kong prior to March 1, 2023 to ensure that they are entitled to these transitional arrangements.

_________________________

   [1]   Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022, available at: https://www.gld.gov.hk/egazette/pdf/20222625/es32022262516.pdf

   [2]   Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615), available at: https://www.elegislation.gov.hk/hk/cap615

   [3]   Legislative Council Brief Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (June 22, 2022), published by the Financial Services and the Treasury Bureau, available at: https://www.fstb.gov.hk/fsb/en/legco/docs/AML(A)Bill%202022_legco%20brief_e%20(Issue).pdf

   [4]   Consultation Conclusions on Public Consultation on Legislative Proposal to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong (May 2021), published by the Financial Services and the Treasury Bureau, available at: https://www.fstb.gov.hk/fsb/en/publication/consult/doc/consult_conclu_amlo_e.pdf

   [5]   Licensing Regime for Virtual Asset Services Providers in Hong Kong, published by Gibson, Dunn and Crutcher (June 7, 2021), available at: https://www.gibsondunn.com/licensing-regime-for-virtual-asset-services-providers-in-hong-kong/#_ftn1

   [6]   Section 53ZRD(3), Amendment Bill

   [7]   Schedule B, Amendment Bill

   [8]   Section 53ZTL, Amendment Bill

   [9]   Section 53ZRA(1), Amendment Bill

  [10]   Section 53ZRA(4)(a), Amendment Bill

  [11]   Section 53ZRK(3)(a), Amendment Bill

  [12]   Section 53ZRK(3)(b), Amendment Bill

  [13]   See Section 129(1), Securities and Futures Ordinance (Cap. 571), available at: https://www.elegislation.gov.hk/hk/cap571

  [14]   Section 53ZRJ, Amendment Bill

  [15]   See SFC Fit and Proper Guidelines (January 2022), available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/fit-and-proper-guidelines/Fit-and-Proper-Guidelines.pdf

  [16]   Section 53ZRK(5), Amendment Bill

  [17]   Section 53ZRR, Part 3, Division 2, Paragraph 34, Amendment Bill

  [18]   We anticipate that the SFC will take a similar approach to “active marketing” in this context as it does to “active marketing” for the purposes of section 115 of the SFO. See, e.g., the SFC’s FAQ on this topic, available at: https://www.sfc.hk/en/faqs/intermediaries/licensing/Actively-markets-under-section-115-of-the-SFO#9CAC2C2643CF41458CEDA9882E56E25B

  [19]   Part 2, Division 2, Clause 11(1B), Amendment Bill

  [20]   Part 2, Division 2, Clause 11(3), Amendment Bill

  [21]   Section 53ZSO, Amendment Bill

  [22]   Section 53ZSG, Amendment Bill

  [23]   Part 2, Division 2, Clause 18(13B) and (13C), Amendment Bill

  [24]   Sections 53ZSX, 53ZSY, 53ZSZ and 53ZT, Amendment Bill

  [25]   See our previous alert on this topic – Hong Kong SFC Consults on Significant Reforms to the SFO Enforcement Provisions, published by Gibson, Dunn and Crutcher (June 14, 2022), available at: https://www.gibsondunn.com/hong-kong-sfc-consults-on-significant-reforms-to-the-sfo-enforcement-provisions/

  [26]   Section 53ZTG, Amendment Bill

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, Arnold Pun, and Jane Lu.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Crypto Taskforce ([email protected]) or the Global Financial Regulatory team, including the following authors in Hong Kong:

William R. Hallatt (+852 2214 3836, [email protected])
Grace Chong (+65 6507 3608, [email protected])
Emily Rumble (+852 2214 3839, [email protected])
Arnold Pun (+852 2214 3838, [email protected])
Becky Chung (+852 2214 3837, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

It is a well-recognized principle of international law that judicial power ends at the respective state’s border. Consequently, courts need to request judicial assistance if they wish to obtain evidence outside of their jurisdiction. Previously, German courts receiving a request for pre-trial discovery from a common-law jurisdiction would not execute this request – regardless of its content or origin. Due to a recent amendment to Germany’s Implementing Act to the Hague Convention on the Taking of Evidence Abroad in Civil or Commercial Matters (“Hague Evidence Convention”)[1], this situation may change in the future, thus, allowing for pre-trial discovery if certain conditions are met. Nevertheless, due to detailed prerequisites needed to execute a request, Germany is still taking a rather hesitant approach towards pre-trial discovery compared to other jurisdictions.

Status quo ante

In Germany, questions of judicial assistance for courts located outside of the European Union and regarding the taking of evidence are governed by the Hague Evidence Convention.[2] The Convention entered into force on October 7, 1972. Designed as a “bridge between common and civil law”[3], it established standardized procedures for handling Letters of Request to collect evidence abroad. As of today, 64 countries have become a contracting party to the Convention, including the US, the UK, China, the Russian Federation and a majority of European states.[4]

The Convention covers all types of taking evidence, including pre-trial discovery of documents. Nevertheless, due to concerns about invasive requests from common-law jurisdictions, the Hague Conference on Private International Law decided to allow Contracting States to declare a reservation regarding pre-trial discovery (Article 23).[5] So far, 28 countries have asserted an absolute, non-particularized reservation, while 19 states have declared that they would only execute a request within the meaning of Article 23 if it fulfilled certain requirements.[6]

When Germany joined the Hague Evidence Convention in 1977, it also decided to make use of Article 23, opting for a general, non-particularized reservation. In the following, it adopted the Implementing Act to the Hague Convention of 15 November 1965 on the Service Abroad of Judicial and Extrajudicial Documents in Civil or Commercial Matters and the Hague Convention of 18 March 1970 on the Taking of Evidence Abroad in Civil or Commercial Matters (“Implementing Act”). Section 14 of the Implementing Act provided that requests for mutual assistance relating to proceedings under Article 23 of the Convention shall not be executed.[7] Consequently, any requests concerning pre-trial discovery would not be carried out in Germany[8] – until now.

The new German rule

On January 19, 2022, the Federal Ministry of Justice submitted a draft amending the Implementing Act. The bill was passed by the Bundestag and the Bundesrat and will enter into force on July 1, 2022.[9] It includes a revision of Section 14 of the Implementing Act, converting the previous absolute reservation under Article 23 of the Hague Evidence Convention to a qualified, particularized one. The new Section 14 of the Implementing Act will provide that courts shall execute requests for mutual assistance on pre-trial discovery of documents if the following five requirements are met:

1. 1. The documents to be produced are specified in detail,
   2. the documents to be produced are of direct and clearly identifiable importance for the proceedings in question and their outcome,
   3. the documents to be produced are in the possession of a party involved in the proceedings,
   4. the request does not violate essential principles of German law, and,
   5. in case the documents to be produced contain personal data, the requirements for transfer to a third country pursuant to Chapter V of Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of individuals with regard to the processing of personal data, on the free movement of such data and repealing Directive 95/46/EC (General Data Protection Regulation) (“GDPR”) are met.[10]

With the amendment, Germany follows a recommendation of the Special Commission of the Hague Conference on Private International Law that has been reviewing the Evidence Convention and its application.[11] The Commission stated that the purpose of Article 23, namely “to ensure that a request for the production of documents [is] sufficiently substantiated so as to avoid requests whereby one party merely seeks to find out what documents may generally be in the possession of the other party to the proceeding”[12], could easily be achieved with a particularized declaration similar to the one submitted by the UK.[13] Germany had already tried to introduce an almost identical version of the new Section 14 in 2017 but withdrew the amendment from the bill at the last minute. At the time, the Judicial Affairs Committee doubted the benefit of the proposed rule and justified the withdrawal by arguing that the taking of evidence aimed at stating which documents were in one’s possession (“Ausforschungsbeweis”) was inadmissible[14] – even though such requests were (also) excluded in the 2017 draft and the German Federal Constitutional Court had explicitly stated in 2007 that pre-trial discovery per se was constitutional and did not violate fundamental principles of German law.[15] The unsatisfactory state of limbo since then has now been rectified by the modification.

Still, the recent amendment shows that Germany is taking a rather critical approach towards pre-trial discovery, defining more detailed and extensive requirements than the UK or other jurisdictions. Nevertheless, looking closely at the new provision, only one requirement may lead to blatant restrictions of document production. While the first two conditions reflect the basic rationale of the UK declaration to prevent unreasonable ‘fishing expeditions’, the fourth and fifth prerequisite are merely declaratory. Article 12 lit. b of the Evidence Convention already provides that a court may refuse execution of a request if it would prejudice the state’s sovereignty or security, thus containing an ordre public-reservation. Furthermore, German courts may also refer to potential violations of German local law to turn down a request pursuant to Article 11 of the Convention. Similarly, compliance with the GDPR as prescribed in Section 14 No. 5 of the Implementing Act is required within the EU in any case, thus creating no additional obstacles.[16]

The most significant limitation to pre-trial discovery requests, however, is the exclusion of third parties not involved in the proceedings (No. 3). No other Contracting State has issued a similar declaration. German civil procedure law does not recognize such a restriction either: In domestic proceedings, third parties can be obliged to produce documents pursuant to Section 142 of the German Code of Civil Procedure.[17] As a result, the Implementing Act’s new provision ultimately contradicts the German legislator’s intention to eliminate fundamental differences in obtaining evidence in domestic and international cases.[18]

Implications for future proceedings

The recent amendment will enable German courts to execute pre-trial discovery requests from foreign courts. Currently, Australia, Barbados, India, Syria, Seychelles, Singapore, South Africa, Sri Lanka, the UK and the US utilize this type of evidence taking and are Contracting States to the Evidence Convention.[19] Among these, requests from the US and the UK most likely have the greatest practical relevance.[20]

It remains to be seen whether Germany’s change in direction will have a significant impact on future transnational litigation. In the past, instead of referring to the Hague Evidence Convention, foreign courts often applied their own procedure law extraterritorially to fulfill pre-trial discovery requests in Germany.[21] It is unlikely that the recent amendment will put a halt to this practice. As it happens, the previous draft to the Implementing Act from 2017 had expressed the hope that an amendment would lead US courts to preferentially refer to the Hague Convention because they could count on an effective and fast execution of their requests. Whether this will actually happen is debatable – and quite possibly, somewhat naïve. Be that as it may, the new German Implementing Act offers foreign courts and parties an additional route to deal with pre-trial discovery request in Germany – and ultimately furthers the Hague Convention’s initial objective to strengthen the often shaky bridge between civil and common law.

_______________________

   [1]   Gesetz zur Ausführung des Haager Übereinkommens vom 15. November 1965 über die Zustellung gerichtlicher und außergerichtlicher Schriftstücke im Ausland in Zivil- oder Handelssachen und des Haager Übereinkommens vom 18. März 1970 über die Beweisaufnahme im Ausland in Zivil- oder Handelssachen [AusfG HZÜ/HBÜ] [Implementing Act to the Hague Convention of 15 November 1965 on the Service Abroad of Judicial and Extrajudicial Documents in Civil or Commercial Matters and to the Hague Convention on the Taking of Evidence Abroad in Civil or Commercial Matters], Dec. 22, 1977, BGBl. I at 3105, last amended Jan. 11, 2017, BGBl. I at 1607, see https://www.justiz.nrw.de/Bibliothek/ir_online_db/ir_htm/65_70_ausfuehrungsgesetz.htm.

   [2]   Evidence requests from one EU member state court to another are governed by the European Evidence Regulation (EU) 2020/1783, see https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32020R1783.

   [3]   See Hague Conference on Private International Law, Conclusions and Recommendations adopted by the Special Commission on the Practical Operation of the Hague Apostille, Evidence and Service Conventions (28 October to 4 November 2003),  p. 7, available at https://www.hcch.net/en/publications-and-studies/details4/?pid=3121&dtid=2.

   [4]   For an up-to-date status report on the Convention, see https://www.hcch.net/en/instruments/conventions/status-table/?cid=82.

   [5]   Article 23 Hague Evidence Convention: A Contracting State may at the time of signature, ratification or accession, declare that it will not execute Letters of Request issued for the purpose of obtaining pre-trial discovery of documents as known in Common Law countries, see https://assets.hcch.net/docs/dfed98c0-6749-42d2-a9be-3d41597734f1.pdf.

   [6]   See Regierungsentwurf [Cabinet Draft], Bundestag Drucksachen [BT] 20/1110, p. 34, available at https://dserver.bundestag.de/btd/20/011/2001110.pdf.

   [7]   § 14 AusfG HZÜ/HBÜ: (1) Rechtshilfeersuchen, die ein Verfahren nach Artikel 23 des Übereinkommens zum Gegenstand haben, werden nicht erledigt [free translation: Requests for mutual assistance concerning proceedings under Article 23 of the Convention shall not be executed.].

   [8]   See Oberlandesgericht Frankfurt [Higher Regional Court Frankfurt], Order dated May 16, 2013 – 20 VA 4/13, BeckRS 2013, 12264.

   [9]   See Gesetzesbeschluss [Law Decree], Bundesrat Drucksachen [BR] 225/22, Article 23, available at https://www.bundesrat.de/SharedDocs/drucksachen/2022/0201-0300/225-22.pdf?__blob=publicationFile&v=1.

  [10]   § 14 AusfG HZÜ/HBÜ-E: Rechtshilfeersuchen, die ein Verfahren nach Artikel 23 des Übereinkommens zum Gegenstand haben, werden nur erledigt, wenn 1. die vorzulegenden Dokumente im Einzelnen genau bezeichnet sind, 2. die vorzulegenden Dokumente für das jeweilige Verfahren und dessen Ausgang von unmittelbarer und eindeutig zu erkennender Bedeutung sind, 3. die vorzulegenden Dokumente sich im Besitz einer an dem Verfahren beteiligten Partei befinden, 4. das Herausgabeverlangen nicht gegen wesentliche Grundsätze des deutschen Rechts verstößt und, 5. soweit personenbezogene Daten in den vorzulegenden Dokumenten enthalten sind, die Voraussetzungen für die Übermittlung in ein Drittland nach Kapitel V der Verordnung (EU) 2016/679 des Europäischen Parlaments und des Rates vom 27. April 2016 zum Schutz natürlicher Personen bei der Verarbeitung personenbezogener Daten, zum freien Datenverkehr und zur Aufhebung der Richtlinie 95/46/EG (Datenschutz-Grundverordnung) (ABl. L 119 vom 4.5.2016, S. 1; L 314 vom 22.11.2016, S. 2; L 127 vom 23.5.2018, S. 2; L 74 vom 4.3.2021, S. 35) erfüllt sind [no official translation available].

  [11]   See Hague Conference on Private International Law, Conclusions and Recommendations of the Special Commission on the Practical Operation of the Hague Apostille, Service, Taking of Evidence and Access to Justice Conventions (2 to 12 February 2009), p. 9, available at https://www.hcch.net/en/publications-and-studies/details4/?pid=4694&dtid=2.

  [12]   Id. at 7.

  [13]   “In accordance with Article 23 Her Majesty’s Government declare that the United Kingdom will not execute Letters of Request issued for the purpose of obtaining pretrial discovery of documents. Her Majesty’s Government further declare that Her Majesty’s Government understand ‘Letters of Request issued for the purpose of obtaining pre-trial discovery of documents’ for the purposes of the foregoing Declaration as including any Letter of Request which requires a person: a. to state what documents relevant to the proceedings to which the Letter of Request relates are, or have been, in his possession, custody or power; or b. to produce any documents other than particular documents specified in the Letter of Request as being documents appearing to the requested court to be, or to be likely to be, in his possession, custody or power.”, see https://www.hcch.net/en/instruments/conventions/status-table/notifications/?csid=564&disp=resd.

  [14]   See Regierungsentwurf [Cabinet Draft], Bundestag Drucksachen [BT] 18/11637, p. 4.

  [15]   See Bundesverfassungsgericht [BVerfG] [Federal Constitutional Court], Order dated January 24, 2007 – 2 BvR 1133/04, BeckRS 2009, 71201, para. 15; a few years later, the court affirmed the decision and further stated that submitting to pre-trial discovery would not prevent recognition of the decision in Germany, see Order dated November 3, 2015 – 2 BvR 2019/09, BeckRS 2015, 55670, para. 43.

  [16]   For an overview of the GDPR, see https://www.gibsondunn.com/the-general-data-protection-regulation-a-primer-for-u-s-based-organizations-that-handle-eu-personal-data/.

  [17]   § 142 Code of Civil Procedure [ZPO]: (1) The court may direct one of the parties or a third party to produce records or documents, as well as any other material, that are in its possession and to which one of the parties has made reference. […] (2) Third parties shall not be under obligation to produce such material unless this can be reasonably expected of them, or to the extent they are entitled to refuse to testify pursuant to sections 383 to 385 [official translation]; the Max Planck Institute for Procedural Law and the Max Planck Institute for Private International Law have criticized the new version of the Implementing Act for this exact reason, see https://www.mpipriv.de/1496224/20222903-gemeinsame-stellungnahmen-zweier-max-planck-institute-fuer-das-bmj.

  [18]   See Regierungsentwurf [Cabinet Draft], Bundestag Drucksachen [BT] 20/1110, p. 34.

  [19]   Id. at 22.

  [20]   Post-Brexit, the European Evidence Regulation no longer applies to judicial assistance requests. Instead, these issues are now governed by the Hague Evidence Convention. Disclosure pursuant to Part 31 of the UK Civil Procedure Rules qualifies as pre-trial discovery within the meaning of Article 23 of the Evidence Convention.

  [21]   Societe Nationale Industrielle Aerospatiale v. U.S. Dist. Ct., 482 U.S. 519, 533, 539 (1987), holding that the Evidence Convention serves only as an optional supplement to the Federal Rules of Civil Procedure which provide ample means to obtaining evidence if the parties are subject to the court’s jurisdiction.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Transnational Litigation practice group, or the following authors:

Finn Zeidler – Frankfurt (+49 69 247 411 530, [email protected])
Annekathrin Schmoll – Frankfurt (+49 69 247 411 533, [email protected])

Please also feel free to contact the following practice leaders:

Transnational Litigation Group:
Susy Bullock – London (+44 (0) 20 7071 4283, [email protected])
Perlette Michèle Jura – Los Angeles (+1 213-229-7121, [email protected])
Andrea E. Neuman – New York (+1 212-351-3883, [email protected])
William E. Thomson – Los Angeles (+1 213-229-7891, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

The Hong Kong Court of Final Appeal (the “CFA”) [1] has recently confirmed that for the purpose of winding up foreign companies in Hong Kong, the requirement that the winding up must benefit the petitioner can include commercial pressure (in other words, leverage) to achieve the repayment of an undisputed debt.

The CFA’s reaffirmation of the threshold requirements for the court to exercise its jurisdictions, and in particular its clarification regarding the benefit requirement, is welcome. It demonstrates the court’s willingness in adopting a pragmatic approach in assessing whether it would be useful to entertain a winding-up petition in respect of a foreign company.

1. Factual Background and Procedural History in Hong Kong Courts

The Appellant was a PRC company listed in Hong Kong, and the Appellant and Respondent entered into a joint venture agreement. Following a dispute that led to an arbitral award against the Appellant, the Respondent served a statutory demand on the Appellant for the debt payable under the award. The Appellant failed to pay any part of the amounts demanded and sought an injunction to prevent the Respondent from presenting a winding-up petition as a creditor.

The Appellant’s case was that the Respondent could not satisfy the three core requirements for the court to exercise its jurisdiction to wind up a foreign-incorporated company when it is unable to pay its debts. The Appellant did not accept that the 2nd requirement was met, namely whether the winding-up order would benefit the petitioner. In particular, it did not accept that leverage (namely commercial pressure to achieve the repayment of an undisputed debt) could satisfy the 2nd requirement, as any benefit does not arise “as a consequence of the winding-up order being made”, but rather, would only be realised “if the winding-up order is either avoided or discharged”.

At the Court of First Instance, the Judge held that leverage created by the prospect of a winding-up petition constitutes sufficient benefit for the petitioner for the purposes of the 2nd requirement. The Court of Appeal upheld the Judge’s decision that there was a “real possibility of benefit” for the petitioner in making a winding-up order against the Appellant.

2. Nature of the Three Requirements for Winding Up Foreign-Incorporated Companies

The three “core requirements” previously approved by the CFA [2] which must be satisfied before a Hong Kong court will exercise its jurisdiction to wind up a foreign-incorporated company are that:

1. 1. 1. 1. There must be a sufficient connection with Hong Kong;
         2. There must be a reasonable possibility that the winding-up order would benefit those applying for it; and
         3. The court must be able to exercise jurisdiction over one or more persons in the distribution of the company’s assets.

The CFA noted that the three requirements are not derived from statutory provisions and should not be approached through the ordinary rule of statutory construction. Rather, they are self-imposed judicial restraints on the exercise of the court’s jurisdiction (discretion) but not on the existence of the jurisdiction (which is entirely statutory). The CFA therefore considered that it would be more appropriate to characterise these requirements as “threshold requirements” rather than “core requirements”.

3. “Benefit” under the 2nd Threshold Requirement

3.1. General Nature of ‘Benefit’ under the 2nd Threshold Requirement

The CFA held that a “pragmatic approach” should be adopted in assessing whether it would be useful to entertain a winding-up petition in respect of a foreign company. Whilst the benefit the petitioning creditors can rely on will vary case-by-case, the CFA made the following observations:

• There is no doctrinal justification for confining the relevant benefit narrowly to the distribution of assets by the liquidator in the winding up of the company;
• It is sufficient that the benefit would be enjoyed solely by the petitioner;
• There is also no doctrinal justification requiring the relevant benefit to come from the assets of the company;
• There are cases where even though there was nothing for the liquidator to administer, the courts did not find any difficulty in finding benefit so long as some useful purpose serving the legitimate interest of the petitioner can be identified;
• The benefit need not be monetary or tangible in nature; and
• The fact that a similar result could be achieved by other means does not preclude a particular benefit from being relied upon.

3.2. Leverage as a Legitimate Benefit

With this “pragmatic approach” in finding benefit in mind, the CFA held that leverage is a relevant benefit as it is a proper purpose for a creditor’s winding-up petition. The benefit is derived from the invocation of the court’s winding-up procedures. In finding leverage as a legitimate benefit, the CFA also made a few observations:

Undisputed/Disputed Debt

The distinction between disputed and undisputed debt is important. The presentation of a winding-up petition, where the debt is disputed, may amount to an abuse of process of the court given that there is often a real and substantial dispute of facts.

Statutory Demand Mechanism

Additionally, the CFA observed that the statutory demand mechanism [3] provides a convenient method for creditors to seek repayment of an undisputed debt through presenting a winding-up petition. Non-compliance with the statutory demand operates as conclusive proof of the company’s inability to pay its debts (irrespective of whether the company is, in fact, insolvent) for the purpose of establishing the court’s jurisdiction to make a winding-up order, and the CFA observed that case law recognises the propriety of the use of a winding-up petition as a means of applying commercial pressure to seek payment of undisputed debt. Thus, there is no reason to exclude leverage as a relevant benefit under the 2nd requirement.

“Real” Leverage

The CFA also held that the leverage must be “real” and its significance depends on the potential impact of a winding-up order. Where the foreign company has no incentive to avoid a winding-up order, there is not much leverage. However, in this case, the leverage stemmed from the adverse consequences on the listing status of the foreign company which the court found to be real and significant.

4. Comity Argument: Forum Conveniens Only a Factor but Not a Requirement

The Appellant also raised a further comity argument arguing that winding up a foreign company is only justified when the jurisdiction of incorporation cannot fulfil its function making it necessary to “fill the lacuna”. The CFA observed that the Appellant was attempting to impose an additional requirement for the court to exercise its jurisdiction and held that if sufficient connection is established under the 1st requirement, any such forum conveniens issue should only be a factor (rather than an essential requirement) that the court can consider in deciding if a winding-up order should be made.

5. Conclusion

It is clear from the CFA’s judgment that for the purpose of winding up foreign companies in Hong Kong, the 2nd requirement that the winding up must benefit the petitioners can include commercial pressure to achieve the repayment of an undisputed debt.

On the other hand, the CFA also usefully clarifies that whilst the court is prepared to adopt a pragmatic approach, any such leverage must be real and significant and that contrary to the view of the Court of First Instance, any moderation of this 2nd requirement is not appropriate.

___________________________

[1] Shandong Chenming Paper Holdings Limited v Arjowiggins HKK 2 Limited [2022] CFA 11. A copy of the judgment of the Court of Final Appeal is available here. The judgment in the Court of Appeal ([2020] HKCA 670) is available here. The judgment in the Court of First Instance (HCMP 3060/2016) is available here.

[2] In Kam Leung Sui Kwan v Kam Kwan Lai (2015) 18 HKCFAR 501, more commonly referred to as the “Yung Kee” case.

[3] Section 327(4)(a) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap.32). Under this section, a company is deemed unable to pay its debts if the company has failed to respond satisfactorily to a creditor’s written demand (by way of payment or otherwise) after 3 weeks of its service.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, or the authors and the following lawyers in the Litigation Practice Group of the firm in Hong Kong:

Brian Gilchrist (+852 2214 3820, [email protected])
Elaine Chen (+852 2214 3821, [email protected])
Alex Wong (+852 2214 3822, [email protected])
Rebecca Ho (+852 2214 3824, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

The Uyghur Forced Labor Prevention Act (“UFLPA” or “Act”)—and its stringent import restrictions—took effect on June 21, 2022.[1] The Act, the latest effort by the United States concerning the Uyghur population in China’s Xinjiang Uyghur Autonomous Region (the “XUAR” or “Xinjiang”), greatly increases the showing that companies need to make to prove that goods produced in the XUAR, in full or in part, are entitled to entry into the United States. All products manufactured in the region or produced by a list of entities that have now been designated by the interagency Forced Labor Enforcement Task Force (“FLETF”) are presumptively barred from entry into the United States unless the importer can present “clear and convincing” evidence that the product has not been tainted by the use of forced labor.[2]

As U.S. Customs and Border Protection (“CBP”) begins to enforce the Act, importers of certain products and products that may incorporate raw materials or manufactured parts or components that are suspected to have touchpoints with the XUAR or with several of China’s “anti-poverty alleviation” programs should be aware of heightened diligence and supply chain tracing requirements necessary to rebut the UFLPA’s presumptive import ban on XUAR-linked shipments.

I. Background

As we have shared in past client alerts, the UFLPA is the latest in a long line of U.S. executive and legislative efforts targeting alleged forced labor in the supply chains of goods entering the United States.

For nearly a century, the 1930 Tariff Act has authorized CBP to prevent the importation of “[a]ll goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part in any foreign country by . . . forced labor” by issuing Withhold Release Orders (“WROs”).[3] CBP’s authority under the Tariff Act was strengthened in 2016 when Congress eliminated a loophole that allowed importation of merchandise made with forced labor if the merchandise was not also available in the United States in quantities sufficient to meet U.S. consumptive demand.[4]

More recently, the U.S. reaffirmed its broad commitment to preventing imports tainted by forced labor in the 2020 United States-Mexico-Canada Agreement (“USMCA”). Under this free trade agreement, each North American country agreed to “prohibit the importation of goods into its territory from other sources produced in whole or in part by forced or compulsory labor.”[5] To oversee the implementation of this commitment, former President Trump issued an executive order creating the FLETF, chaired by the Secretary of Homeland Security and including representatives from the Departments of State, Treasury, Justice, Labor, and the Office of the U.S. Trade Representative.[6]

The measures described above target forced labor wherever it occurs, but, in recent years, the U.S. has focused increasingly on allegations of forced labor and other human rights abuses in the XUAR. New legislation authorized sanctions for these alleged abuses in 2020,[7] and, in 2021, CBP’s heightened scrutiny of imports from the XUAR led to a region-wide WRO affecting cotton and tomato imports[8] and an additional WRO targeting silica-based products from Xinjiang.[9]

After passing both houses of Congress with broad bipartisan support, President Biden signed the UFLPA into law on December 23, 2021.[10] The UFLPA represents the U.S.’s most forceful effort to date to address this issue in the XUAR. Experts estimate that the UFLPA will have an impact on the global economy “measured in the many billions of dollars.”[11]

The Act’s reach is broad, presumptively banning the importation of “any goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part in” the XUAR, as well as those produced by a number of entities identified by the FLETF.[12] To rebut this presumptive ban, importers must show: (1) their compliance with all of the Act’s implementing regulations and FLETF’s due diligence guidance,[13] (2) that they responded “completely and substantively” to all agency inquiries,[14] and (3) “clear and convincing evidence” that their goods were not produced with forced labor.[15]

II. FLETF Enforcement Strategy

The Act requires the FLETF to promulgate an enforcement strategy[16] which will include specific guidance to importers regarding due diligence, the amount and type of evidence that importers will need to show to rebut the Act’s presumption, and what entities will be presumptively barred.[17] In the months following the UFLPA’s enactment, the FLETF solicited input from the public to inform its eventual Enforcement Strategy,[18] holding a public hearing,[19] and receiving 180 written comments from U.S. and foreign businesses, industry associations, civil society, academics, and private individuals.[20] After the close of this public comment period, the FLETF published its enforcement strategy and submitted it as a report to Congress on June 17, 2022.[21] To supplement this strategy, CBP published “Operational Guidance for Importers“ on June 13, 2022.[22]

A. The UFLPA Entity Lists

In addition to presumptively prohibiting imports originating, in whole or in part, in the XUAR, the UFLPA’s rebuttable presumption extends to goods, wares, articles, and merchandise produced by various entities identified by the FLETF in its enforcement strategy.[23] These include entities that work with the XUAR government to recruit, transport, or receive alleged forced labor from the XUAR, as well as entities that participate in “poverty alleviation” and “pairing-assistance” programs in the XUAR.[24] These PRC government-administered labor programs reportedly target Uyghurs, Kazakhs, Kyrgyz, Tibetans, and other persecuted groups, placing them in farms and factories in the XUAR and across China. Workers in these schemes are reportedly subjected to systemic oppression through forced labor.[25] In “pairing-assistance” programs, for example, Chinese companies are reportedly encouraged to create satellite factories in the XUAR that then rely on internment camps for low-skilled labor.[26] The FLETF found that indicators of forced labor are particularly strong across the four sectors it has identified as high-priority sectors for enforcement under the UFLPA: apparel, cotton, silica-based products, and tomatoes.[27]

The UFLPA Entity List[28] that the FLETF published on June 17 remains relatively narrow, including only entities subject to existing WROs or listed to the Department of Commerce Bureau of Industry and Security’s (“BIS”) Entity List for their use of forced labor.[29] Notably, no downstream solar cell or solar module producers have been added to the UFLPA Entity List at this time, which was a specific concern raised by some in the solar industry.[30] A number of Chinese polysilicon firms, however, are listed.

However, the Act requires the FLETF to update the UFLPA Entity List at least annually, and the whole-of-government approach that the FLETF will be taking to identify new entities suggests that the FLETF could be aggressive in its designation of new Chinese entities linked to forced labor violation allegations going forward.

B. Priority Sectors for Enforcement

As part of its enforcement strategy, the UFLPA requires the FLETF to identify a list of “high-priority sectors for enforcement,” which the statute indicates must include cotton, tomatoes, and polysilicon.[31]

The enforcement strategy published on June 17, 2021 does not stray significantly from the statutorily mandated list of high-priority sectors. It expands this list slightly to include:

1. 1. 1. 1. Apparel;
         2. Cotton and cotton products;
         3. Silica-based products (including polysilicon); and
         4. Tomatoes and downstream products.

However, since there is no de minimis exception in the Act, importers of a wide range of products may find their products the target of a potential exclusion order, detention or seizure.  To illustrate, in its report to Congress, CBP notes that these silica-based products may include aluminum alloys, silicones, and polysilicon, which are themselves used in building materials, automobiles, petroleum, concrete, glass, ceramics, electronics, and solar panels, among other goods. Especially for importers with final products or with products that may have any of the foregoing as material inputs, importers will need to be familiar with and meet the evidentiary burden in reference to the entire supply chain, no matter how small or remote a supplier’s input may be to a final product.[32]

For XUAR-linked cotton, tomatoes, and polysilicon, CBP has published specific guidance on supply chain documentation that may be necessary to overcome the UFLPA’s rebuttable presumption against importation. While this recommended documentation varies slightly across the three sectors, at a high level, CBP recommends the following:

1. 1. 1. 1. Documentation showing the entire supply chain;
         2. A flow chart mapping all steps of the procurement and production processes;
         3. Maps of the region(s) where the production processes occur; and
         4. A list of all entities involved in each step of the production processes, with citations denoting the business records used to identify each upstream entity with whom the importer did not directly transact.

The CBP’s enforcement of the UFLPA’s presumptive import ban on each of these high-priority sectors will have a substantial effect on global supply chains involving these products. More than 40 percent of the world’s polysilicon, a quarter of its tomato paste, and a fifth of its cotton supplies originate in the XUAR.[33] Industry groups from these targeted sectors have already begun to prepare for increased scrutiny and mitigate the threat of supply shortages by developing industry-wide standards for supply chain traceability.[34] Even these standards, however, may not be sufficient to overcome the presumption that products which incorporate any amount of material sourced from the XUAR have been produced with prohibited labor inputs.

C. Guidance on Effective Due Diligence & Supply Chain Tracing

As a key element of their rebuttal to the UFLPA’s presumption, importers must show that they have complied with CBP and FLETF guidance on due diligence, including effective supply chain tracing and supply chain management practices. In its enforcement strategy, the FLETF outlines critical elements of this due diligence process, while also raising concerns that effective diligence may not always be possible in the XUAR.

1. Effective Due Diligence

The FLETF strategy refers largely to the Department of Labor’s Comply Chain program[35] in defining the elements of an effective due diligence system. These elements include:

1. 1. 1. 1. Engaging stakeholders and partners;
         2. Assessing risks and impacts;
         3. Developing a code of conduct;
         4. Communicating and training across the supply chain;
         5. Monitoring compliance;
         6. Remediating violations;
         7. Independent reviews; and
         8. Reporting performance and engagement.

However, FLETF raises concerns that some of these elements may not be possible when dealing with goods made in the XUAR or made using the labor of workers from certain PRC labor schemes. For example, the FLETF notes that importers may be unable to sufficiently engage with stakeholders, such as employees of its suppliers, or conduct credible audits due to restrictions on access to Xinjiang and reported government surveillance and coercion that renders witnesses unable to speak freely about working conditions.[36] At a minimum, because of these concerns, audits of compliance by suppliers and subcontractors in the XUAR must “go beyond traditional auditing.” The FLETF suggests that importers may need to use technology or partnerships with civil society to collect evidence to rebut the presumption, but does not provide more concrete guidance on the what technology and partnerships will be deemed by CBP to provide credible evidence.[37]

Additionally, an importer’s ability to conduct due diligence and remediate violations may be limited by Chinese laws, such as the PRC’s Anti-Foreign Sanctions Law. In fact, the FLETF received written comments from industry groups reporting that the Chinese government had retaliated against Chinese companies for complying with U.S. requirements to eliminate supply chain inputs from the XUAR.[38]

2. Effective Supply Chain Tracing

At a minimum, importers seeking to rebut the UFLPA’s presumption must conduct a complete mapping of the supply chains that provide inputs to their products, “up to and including suppliers of raw materials used in the production of the imported good or material.”[39] Per the FLETF enforcement strategy, effective supply chain mapping must go beyond a mere list of names of suppliers and their sub-tiers and include accounts of the conditions under which work is being done on the inputs at each step in the sourcing process.[40]

In addition to mapping, the FLETF strategy emphasizes the importance of identity preservation and segregation to prevent the commingling of inputs at any point in the supply chain. This risk is particularly high for importers whose suppliers source raw or partially processed material inputs from both Xinjiang and areas outside of the XUAR. Without strong identity preservation or segregation protocols, these importers risk their shipments being detained because of the difficulty of verifying that their supply chain uses only non-Xinjiang inputs.

3. Effective Supply Chain Management Measures

The FLETF defines “supply chain management measures” as those measures “taken to prevent and mitigate identified risks of forced labor.”[41] Such measures may involve processes to vet potential suppliers for forced labor prior to contracting or outlining specific consequences for a supplier’s breach of its forced labor commitments. Practically speaking, the design and implementation of these measures will require robust information systems to manage and regularly update supply chain data.

Notably, however, an importer’s ability to demand these supply chain management measures may be limited by the leverage it holds over its suppliers and its visibility into its supply chains. Therefore, importers with static supply chains involving long-term fulfillment contracts may be better positioned to enforce such measures than those participating in one-time transactions involving a supply chain with frequently changing inputs.

D. Guidance on the “Clear and Convincing” Standard

Neither the FLETF’s enforcement strategy nor CBP’s operational guidance clearly define the contours of the “clear and convincing” standard for evidence necessary to rebut the UFLPA’s presumption. In a series of unrecorded webinars, however, CBP officials have stated that they view this standard as higher than a preponderance of the evidence standard and will require a much greater showing than the current standard required for WROs.[42] CBP indicated that it would model its interpretation of this “clear and convincing evidence” standard on the Countering America’s Adversaries Through Sanctions Act (“CAATSA”) which it also applies to enforce import prohibitions on North Korea.[43]

As in the UFLPA, under CAATSA, only “clear and convincing evidence” can rebut the presumption that all North Korean labor is forced labor.[44] CBP interprets CAATSA’s “clear and convincing” standard to mean “highly probable,”[45] suggesting that the burden will only be met “if the material [] offered instantly tilt[s] the evidentiary scales in the affirmative when weighed against the evidence . . . offered in opposition.”[46]

Under this standard, much evidence which might have been sufficient under the WRO standard will not be adequate to rebut the presumption of exclusion. For example, while CBP staff indicated that supplier audits might be relevant evidence in determining whether forced labor was used while producing detained goods,[47] audits are likely insufficient on their own to overcome UFLPA’s presumption.[48] Amidst allegations of surveillance and harassment of auditors in the XUAR, employees may not feel free to fully discuss their employers, working conditions, or governmental programs, and local suppliers might limit the access of auditors to the premises.[49] As such, CBP staff implied that even third-party audits will be presumptively defective unless the company presents sufficient evidence to convince the agency of the audit’s independence and effectiveness.[50] Amidst these uncertainties, it is more likely that CBP will find that no one piece of evidence is sufficient on its own, and that importers’ efforts to support their arguments with multiple pieces of evidence will be more likely to be accepted as compelling by CBP.[51]

Furthermore, the fact that a product has received an exception to the presumption in the past is not a guarantee that the same supply chain will be approved in the future. While CBP stated that evidence of past exceptions is clearly relevant and should be submitted to the agency, it has not given any definitive rule regarding past exceptions.[52] However, this does imply that importers using more regular supply chains, involving the same suppliers and sub-tier suppliers over time, will be able to more easily provide clear and convincing evidence than will importers using less-regular supply chains.

III. Enforcement Procedures

A. Enforcement Timeline

The UFLPA’s changes to CBP’s mandate and authorities became effective on June 21, 2022.  Going forward, CBP will review each shipment for UFLPA applicability on a case-by-case basis, based on the UFLPA Entity List and a variety of other sources.

The UFLPA’s shortened timeline for CBP’s identification of dispositioning of potentially problematic imports places a premium on supplier planning and preparation. Under UFLPA, CBP derives its detention authority from 19 CFR § 151.16, making the timeline for enforcement much shorter than under the preexisting WROs.[53] As opposed to the 90-day period under a WRO, importers whose shipments have been detained pursuant to the UFLPA have only 30 days to challenge this detention.

After a shipment has been presented for examination, CBP will have five days, excluding weekends and holidays, to determine whether the shipment should be released or detained.[54] If CBP determines that a shipment falls within the scope of the UFLPA—either based on links to the XUAR or to listed entities—CBP will issue a detention notice instructing the importer to submit information rebutting the UFLPA’s presumption.[55] After 30 days, CBP is required to issue a final ruling on the goods’ admissibility.[56]

Because of this accelerated timeline for review, CBP has emphasized that importers should be prepared to submit evidence in support of their requests promptly and in accessible formats, noting that submitting documentation in English will facilitate an efficient review.[57] In turn, CBP will attempt to prioritize requests from importers who are Customs Trade Partnership Against Terrorism (CTPAT) Trade Compliance members in good standing.[58]

If CBP issues a final ruling excluding the shipment, the importer may protest that decision within 180 days.[59] CBP then has 30 days to respond to the protest, after which it will be deemed denied.[60] Having exhausted this administrative procedure, importers then have 180 days from the denial of the protest to file a court action challenging CBP’s ultimate decision.[61]

Certain shipments determined to be in violation of the UFLPA may be subject to seizure and forfeiture.[62] In an unrecorded webinar on June 7, 2022, however, CBP officials indicated that seizure would only occur in cases of obvious fraud, as opposed to good faith mistakes.[63]

B. Challenging Detention of a Shipment

An importer whose shipment has been detained pursuant to the UFLPA can pursue two different claims to obtain the release of their merchandise: (1) that the shipment is not subject to the UFLPA, and (2) that the shipment is entitled to an exception from the UFLPA.

Though both can result in a released shipment, these two claims apply in very different situations. The former arises when an importer alleges that their shipment does not contain any inputs linked to the XUAR or entities on the UFLPA Entity List. In contrast, the latter arises if the importer can prove that—even though the shipment is linked to the XUAR or an entity of the UFLPA entity list—no part of the shipment was produced with forced labor.

1. For Imports Not Subject to the UFLPA

A shipment is considered outside the scope of the UFLPA’s rebuttable presumption if both the imported goods and their inputs are “sourced completely from outside Xinjiang and have no connection to the UFLPA Entity List.”[64]

CBP’s operational guidance indicates that importers looking to establish that a shipment is not subject to the UFLPA must make showings under both of the following categories of evidence: (1) supply chain mapping information, and (2) evidence that the goods were not mined, produced, or manufactured wholly or in part in the XUAR. The former should include evidence pertaining to the overall supply chain, as well as to merchandise or any component thereof as well as to the miner, producer, or manufacturer. CBP’s guidance provides non-exhaustive examples of the types of evidence that might satisfy these requirements.

2. For Imports Subject to UFLPA’s Rebuttable Presumption

In contrast, shipments are subject to the UFLPA if they contain goods that are either “mined, produced, or manufactured wholly or in part in” the XUAR or produced wholly or in part by an entity on the UFLPA entity. These shipments will only be released if the importer requests an “exception” to the UFLPA and can demonstrate (1) their compliance with all of the Act’s implementing regulations and FLETF’s due diligence guidance,[65] (2) that they responded “completely and substantively” to all agency inquiries,[66] and (3) “clear and convincing evidence” that their goods were not produced with forced labor.[67]

To meet these requirements, CBP states that an importer must make a showing under each of the following categories of evidence:

1. 1. 1. 1. Due Diligence System Information
         2. Supply Chain Tracing Information
         3. Information on Supply Chain Management Measures
         4. Evidence Goods Originating in China Were Not Mined, Produced, or Manufactured Wholly or In Part by Forced Labor

In its guidance, CBP provides a non-exhaustive list of evidence that may be able to satisfy these requirements. If CBP determines that this evidence is “clear and convincing,” the presumption will be rebutted and the goods will be released under an exception to the Act. Within 30 days of any decision to grant an exception to the UFLPA, CBP must submit a publicly available report to Congress, outlining the evidence supporting this exception.[68] However, importers may seek to have certain information withheld from the public report pursuant to any applicable exemptions contained in the Freedom of Information Act.[69]

C. Predicting Enforcement Strategies and Trends

While the government has expressed an intent to enforce the UFLPA to its fullest extent, CBP resources are finite. In the immediate future, therefore, we expect to see enforcement focused on the UFLPA Entity List and on the four sectors identified by the FLETF as high-priority sectors: apparel, cotton, silica-based products, and tomatoes. Beyond these key sectors, CBP’s early enforcement attention will likely be focused by media reporting, Congressional scrutiny, and civil society tips.

Even U.S. companies not in any of these immediately prioritized enforcement sectors must, however, remain mindful of their supply chain exposure to the XUAR and be prepared to focus compliance program resources on their supply chains. This is especially true as enforcement of the UFLPA expands with the availability of new technologies, additional funding for UFLPA enforcement, and increased collaboration among enforcement agencies, industry groups, and civil society.

1. Enhanced Supply Chain Tracing Technologies

Given the ever-increasing complexity of global supply chains, effective identification of shipments subject to the UFLPA will require sophisticated supply chain tracing technologies. Accordingly, the FLETF enforcement strategy instructs CBP to prioritize a wide range of technological capabilities. These include:

• Advanced search engines that would allow CBP to more easily link known forced labor violators with related businesses, including shell companies and layered ownership structures;
• Foreign corporate registry data that would allow CBP to map the structures or multinational companies and networks;
• Scanning, translation, and data extraction of non-text-searchable documents;
• Remote sensors to support digital traceability of raw materials sourced from Xinjiang; and
• Enhanced modeling tools and machine leaning.[70]

As CBP acquires and refines these technologies, the agency will be able to expand enforcement of the UFLPA beyond shipments most obviously tied to listed entities and high-priority sectors in the XUAR.

2. Increased Funding for UFLPA Enforcement

Despite its intention to enforce the UFLPA robustly, CBP’s resources are finite. Various funding requests included in the FLETF’s enforcement strategy, however, indicate how the agency may scale its enforcement of the Act in the coming years.

In addition to budget requests related to the tracing technology discussed above, the strategy focuses largely on three areas for increased spending, both at CBP and at DHS: staffing, strategy and coordination, and outreach.[71] Notably, the strategy indicates that CBP has already received funding to create 65 additional positions, as well as funding to cover overtime, to ensure sufficient staffing to enforce the UFLPA.[72] Likewise, funding for strategy efforts will allow DHS to engage with international partners and coordinate other U.S. government initiatives related to Chinese forced labor.[73]

3. Inter-Agency Collaboration and Stakeholder Engagement

Lastly, the FLETF enforcement strategy emphasizes the need for coordination and collaboration with relevant stakeholders in order to effectively enforce the UFLPA. This collaboration will span the private sector, civil society, and other government agencies.

FLETF has indicated an intention to host a number of joint-interagency meetings and working-level meetings with both NGOs and the private sector to discuss UFLPA enforcement on at least a biannual basis.[74] While these meetings may allow industry groups to voice concerns with the UFLPA’s impact on their business, they will also facilitate NGO tips about forced labor in supply chains beyond the UFLPA’s high-priority sectors.

Moreover, increased interagency coordination may lead to the designation of additional entities to the UFLPA Entity List and the identification of additional high-priority enforcement sectors. For example, the Department of Labor regularly produces detailed reports on Goods and Products Produced by Forced or Indentured Child Labor. Although FLETF has focused UFLPA enforcement on apparel, cotton, silica-based products, and tomatoes, these Department of Labor reports already list a number of other products tainted by forced labor in China, such as bricks, electronics, and artificial flowers. Increased communication between the Department of Labor and the FLETF could lead to these additional sectors being designated as high-priority.

IV. Expected PRC Response

The PRC government has long denied any allegations of forced labor in the XUAR and has  viewed foreign attempts to address this issue as attacks on Chinese sovereignty.[75] Immediately following the passage of the UFLPA in December 2021, the PRC Ministry of Foreign Affairs reiterated these concerns, characterizing the act as “violat[ing] international law” and “grossly interfer[ing] in China’s internal affairs.”[76] In light of these comments, the PRC government is likely to view U.S. enforcement of the Act as an escalation of this perceived attack on Chinese sovereignty.

Given this strong reaction from Beijing, it is likely that China may implement new countersanctions and increase enforcement of its existing blocking statute, described in detail in our previous alert. By creating significant legal consequences for Chinese persons who comply with prohibited extraterritorial applications of foreign law, enforcement of this blocking statute will have the added effect of making effective diligence in the XUAR even more challenging. U.S. importers may be left unable to gather from their Chinese suppliers the documentation necessary to satisfy the UFLPA’s high evidentiary standard.

Notably, the increased tension between the U.S. and China caused by the UFLPA coincides with the continued economic isolation of Russia. In coming months, we can expect China to continue to be pushed closer toward Russia and the small group of non-aligned countries that have remained neutral with respect to Russia.

Despite the prospect of countersanctions and increased trade between China and Russia, neither the Biden administration nor the U.S. Congress are likely to be sympathetic to Chinese concerns about the UFLPA’s reach. Instead, robust enforcement of the UFLPA can be expected to continue, motivated by bipartisan support for forced labor initiatives and U.S. concerns about China’s position as an economic and strategic competitor. Companies with substantial resources may be able to leverage changes to their supply chains to comply with the UFLPA’s demands. Still, they may consider bifurcated supply chains, with one supply chain leading to the Chinese market and the other destined for the U.S. and other jurisdictions where forced labor initiates are on the rise. Companies with fewer resources, however, may be forced to source their raw materials and other inputs from other jurisdictions.

__________________________

   [1]   U.S. Customs & Border Prot., Fact Sheet: Uyghur Forced Labor Prevention Act of 2021 (2022), https://www.cbp.gov/sites/default/files/assets/documents/2022-Jun/UFLPA%20Fact%20Sheet_FINAL.pdf.

   [2]   Uyghur Forced Labor Prevention Act, Pub. L. No. 117-78, § 3(a), (b)(2) (2021).

   [3]   19 U.S.C. § 1307.

   [4]   Pub. L. No. 114-125 § 910 (2016)

   [5]   United States-Mexico-Canada Agreement art. 23.6, Dec. 10, 2019, Pub. L. 116-113 (2020).

   [6]   Exec. Order No. 13923, 85 Fed. Reg. 30587 (2020).

   [7]   Uyghur Human Rights Policy Act, Pub. L. No. 116-145 (2020).

   [8]   Press Release, CBP Issues Region-Wide Withhold Release Order on Products Made by Slave Labor in Xinjiang, U.S. Customs & Border Prot. (Jan. 13, 2021), https://www.cbp.gov/newsroom/national-media-release/cbp-issues-region-wide-withhold-release-order-products-made-slave?language_content_entity=en.

   [9]   Press Release, The Department of Homeland Security Issues Withhold Release Order on Silica-Based Products Made by Forced Labor in Xinjiang, U.S. Customs and Border Prot. (Jun. 24, 2021), https://www.cbp.gov/newsroom/national-media-release/department-homeland-security-issues-withhold-release-order-silica?language_content_entity=en.

  [10]   Uyghur Forced Labor Prevention Act, Pub. L. No. 117-78 (2021).

  [11]   Ana Swanson, Companies Brace for Impact of New Forced Labor Law, NY Times (Jun. 22, 2022), https://www.nytimes.com/2022/06/22/us/politics/xinjiang-uyghur-forced-labor-law.html?smid=em-share.

  [12]   Pub. L. No. 117-78 § 3(a) (2021).

  [13]   Id. § 3(b)(1)(A).

  [14]   Id. § 3(b)(1)(B).

  [15]   Id. § 3(b)(2).

  [16]   Id. § 2(c).

  [17]   Id. § 2(e).

  [18]   Notice Seeking Public Comments on Methods To Prevent the Importation of Goods Mined, Produced, or Manufactured With Forced Labor in the People’s Republic of China, 87 Fed. Reg. 3567 (Jan. 24, 2022).

  [19]   FLETF Public Hearing on the Uyghur Forced Labor Prevention Act, Regulations.gov, https://www.regulations.gov/document/DHS-2022-0001-0192 (last visited June 10, 2022).

  [20]   Report to Congress, Strategy to Prevent the Importation of Goods Mined, Produced, or Manufactured with Forced Labor in the People’s Republic of China at 8, U.S. Dep’t of Homeland Sec. (Jun. 17, 2022), https://www.dhs.gov/sites/default/files/2022-06/22_0617_fletf_uflpa-strategy.pdf (hereinafter “FLETF Enforcement Strategy”).

  [21]   Id.

  [22]   Uyghur Forced Labor Prevention Act: Operational Guidance for Importers, U.S. Customs & Border Prot. (Jun. 13, 2022), https://www.cbp.gov/sites/default/files/assets/documents/2022-Jun/CBP_Guidance_for_Importers_for_UFLPA_13_June_2022.pdf (hereinafter “CBP Operational Guidance for Importers”).

  [23]   Pub. L. 117-78 § 3(a) (2021).

  [24]   Id. at § 2(d)(2)(B).

  [25]   Xinjiang Supply Chain Business Advisory (Jul. 2, 2020, updated Jul. 13, 2021), U.S. Department of the Treasury, https://home.treasury.gov/system/files/126/20210713_xinjiang_advisory_0.pdf (joint advisory by Departments of Treasury, State, Commerce, Labor, and Homeland Security and the Office of the U.S. Trade Representative).

  [26]   FLETF Enforcement Strategy at 19.

  [27]   Id. at 18.

  [28]   UFLPA Entity List, U.S. Dep’t of Homeland Sec., https://www.dhs.gov/uflpa-entity-list (last visited Jun. 22, 2022).

  [29]   FLETF Enforcement Strategy at 22.

  [30]   Kelly Pickerel, Solar industry prepares for Uyghur Forced Labor Prevention Act implementation, Solar Power World (Jun. 20, 2022), https://www.solarpowerworldonline.com/2022/06/solar-industry-prepares-for-uyghur-forced-labor-prevention-act-implementation/.

  [31]   Pub. L. 117-78 § 2(d)(2)(B)(viii) (2021).

  [32]   Jane Luxton, Imports From China: The Clock Is Ticking On Implementation Of Uyghur Forced Labor Prevention Act, Lewis Brisbois (June 9, 2022), https://lewisbrisbois.com/newsroom/legal-alerts/imports-from-china-the-clock-is-ticking-on-implementation-of-uyghur-forced-labor-prevention-act?utm_source=Mondaq&utm_medium=syndication&utm_campaign=LinkedIn-integration.

  [33]   Swanson, supra note 11.

  [34]   See, Solar Supply Chain Traceability Protocol, Solar Energy Industries Assoc., https://www.seia.org/research-resources/solar-supply-chain-traceability-protocol (last visited Jun. 22, 2022).

  [35]   Comply Chain, U.S. Dep’t of Labor, https://www.dol.gov/ilab/complychain/ (last visited Jun. 22, 2022)

  [36]   FLETF Enforcement Strategy at 42, 44.

  [37]   Id. at 44.

  [38]   United States Council for International Business Comment to the Forced Labor Enforcement Task Force, Regulations.gov, 29 (Mar. 10, 2022), https://downloads.regulations.gov/DHS-2022-0001-0137/attachment_1.pdf.

  [39]   FLETF Enforcement Strategy at 45.

  [40]   Id. at 46.

  [41]   Id.

  [42]   Angela M. Santos et al., Uyghur Forced Labor Prevention Act Is Coming… Are You Ready?: CBP Issues Hints at the Wave of Enforcement To Come, NAT. L. REV. (June 2, 2022), https://www.natlawreview.com/article/uyghur-forced-labor-prevention-act-coming-are-you-ready-cbp-issues-hints-wave.

  [43]   Webinar with CBP staff (June 7, 2022). TJ Kendrick noted that “there is not much difference [between CAATSA and UFLPA] except we have a UFLPA strategy,” Joanne Colonnello referred to “several [CBP] rulings” regarding clear and convincing evidence (including on CAATSA) and Elva Muneton confirmed Kendrick and Colonnello’s observations.

  [44]   Countering America’s Adversaries Through Sanctions Act FAQs, DHS, February 11, 2021 (accessed: https://www.dhs.gov/news/2021/02/11/countering-america-s-adversaries-through-sanctions-act-faqs). Find CAATSA § 302A at 22 U.S.C. § 9241(a) and find a side-by-side comparison of the relevant sections of CAATSA and UFLPA in the Appendix.

  [45]   Id. See also, Poof Apparel Application for Further Review, HQ H317249, Protest No. 4601-21-125334 (Mar. 5, 2021), available at https://rulings.cbp.gov/ruling/H317249).

  [46]   Colorado v. New Mexico, 467 U.S. 310, 316 (1984) (finding in an equitable apportionment case that Colorado failed to meet the “clear and convincing” standard). Cited in Poof Apparel Application for Further Review, HQ H317249, Protest No. 4601-21-125334 (Mar. 5, 2021), available at https://rulings.cbp.gov/ruling/H317249).

  [47]   Luxton, supra note 32.

  [48]   Webinar with CBP staff (June 7, 2022).

  [49]   Alexandra Stevenson & Sapna Maheshwari, ‘Escalation of Secrecy’: Global Brands Seek Clarity on Xinjiang, New York Times (May 29, 2022), https://www.nytimes.com/2022/05/27/business/cotton-xinjiang-forced-labor-retailers.html.

  [50]   Webinar with CBP staff (June 7, 2022).

  [51]   See, e.g., 545231, Application for Further Review of Protest 1303-92-100212, U.S. Customs & Border Prot. (Nov. 5, 1993), https://rulings.cbp.gov/ruling/545231.

  [52]   Id.

  [53]   Santos et al., supra note 42. Furthermore, future actions taken under the current XUAR WROs will follow the UFLPA timeline. Webinar with CBP staff (June 7, 2022).

  [54]   19 C.F.R. § 151.16(b) (2022).

  [55]   Santos et al., supra note 42.

  [56]   19 C.F.R § 151.16(e) (2022).

  [57]   CBP Operational Guidance for Importers at 10.

  [58]   Id. at 9–10.

  [59]   19 C.F.R. § 174.12(e) (2022).

  [60]   Id. § 151.16(g).

  [61]   Santos et al., supra note 42.

  [62]   See 19 U.S.C. § 1595a; 19 C.F.R. Part 171

  [63]   Webinar with CBP staff (June 7, 2022). Joanne Colonnello cited as an example of obvious fraud a shipment from Malaysia where, upon opening the box, CBP could see a label stating “made with Xinjiang cotton.”

  [64]   FLETF Enforcement Strategy at 49.

  [65]   Id. § 3(b)(1)(A).

  [66]   Id. § 3(b)(1)(B).

  [67]   Id. § 3(b)(2).

  [68]   FLETF Enforcement Strategy at V.

  [69]   CBP Operational Guidance for Importers at 8.

  [70]   FLETF Enforcement Strategy at 31.

  [71]   Id. at 35–39.

  [72]   Id. at 37.

  [73]   Id. at 36.

  [74]   Id. at 53.

  [75]   China tells U.N. rights chief to respect its sovereignty after Xinjiang comments, Reuters (Sep. 11, 2018), https://www.reuters.com/article/us-un-rights-china/china-tells-u-n-rights-chief-to-respect-its-sovereignty-after-xinjiang-comments-idUSKCN1LR0L0.

  [76]   Press Release, Foreign Ministry Spokesperson’s Statement on US’ Signing of the So-called Uyghur Forced Labor Prevention Act, Ministry of Foreign Affairs of the PRC (Jan. 24, 2021), https://www.fmprc.gov.cn/mfa_eng/xwfw_665399/s2510_665401/2535_665405/202112/t20211224_10475191.html.

The following Gibson Dunn lawyers assisted in preparing this client update: Sean Brennan, Christopher Timura, Judith Alison Lee, Adam M. Smith, Fang Xue, and Perlette Jura.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s International Trade or Environmental, Social & Governance (ESG) practice groups:

International Trade Group:

United States
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, [email protected])
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, [email protected])
David P. Burns – Washington, D.C. (+1 202-887-3786, [email protected])
Nicola T. Hanna – Los Angeles (+1 213-229-7269, [email protected])
Marcellus A. McRae – Los Angeles (+1 213-229-7675, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, [email protected])
Laura R. Cole – Washington, D.C. (+1 202-887-3787, [email protected])
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, [email protected])
Samantha Sewall – Washington, D.C. (+1 202-887-3509, [email protected])
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, [email protected])
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Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, [email protected])

Asia
Kelly Austin – Hong Kong (+852 2214 3788, [email protected])
David A. Wolber – Hong Kong (+852 2214 3764, [email protected])
Fang Xue – Beijing (+86 10 6502 8687, [email protected])
Qi Yue – Beijing – (+86 10 6502 8534, [email protected])

Europe
Attila Borsos – Brussels (+32 2 554 72 10, [email protected])
Nicolas Autet – Paris (+33 1 56 43 13 00, [email protected])
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Richard W. Roeder – Munich (+49 89 189 33 115, [email protected])

Environmental, Social and Governance (ESG) Group:

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Ronald Kirk – Dallas (+1 214-698-3295, [email protected])
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, [email protected])
Selina S. Sagayam – London (+44 (0) 20 7071 4263, [email protected])

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In C v D [2022] HKCA 729, the Court of Appeal[1] confirmed the lower court’s decision that a dispute over a multi-tiered dispute resolution clause, which stipulates that the parties must first negotiate in good faith before resorting to arbitration, should be resolved by the arbitral tribunal and is not open to attack at the local courts. As the Court of Appeal itself succinctly summarised:

“…the question of whether the pre-arbitration procedural requirement …has been fulfilled is a question intrinsically suitable for determination by an arbitral tribunal, and is best decided by an arbitral tribunal in order to give effect to the parties’ presumed intention to achieve a quick, efficient and private adjudication of their dispute by arbitrators chosen by them on account of their neutrality and expertise.”

This decision is of general significance to arbitration law both in Hong Kong and internationally. From a local perspective, this judgment represents the highest authority in Hong Kong which recognises and draws a distinction between “jurisdiction” (namely whether the arbitral tribunal has the jurisdiction) and “admissibility” (namely whether the claim should be admissible to be heard by the arbitral tribunal). It seeks to align the Hong Kong court’s position with that adopted by other jurisdictions such as Singapore, United Kingdom and the United States, so as to ensure that Hong Kong does not fall out of line with major international arbitration centres like London or Singapore.

From an international view point, this decision is also important given that Hong Kong is an UNCITRAL Model law (the “Model Law”) jurisdiction with arbitration legislation similar to that of other Model Law jurisdictions. As it is common to have dispute resolution clauses in commercial contracts requiring that parties negotiate before commencing arbitration, this decision will also be relevant and persuasive in other jurisdictions which adopt the Model Law.

A. Introduction

Under the agreement in question, the dispute resolution provision mandates the parties to, in good faith,  resolve dispute by negotiation. Either party may through written notice refer a dispute to the Chief Executive Officers (“CEOs”) of the parties for resolution, and the CEOs shall then meet and attempt to resolve such dispute. It is only when a dispute cannot be resolved amicably within 60 business days that such dispute shall be referred to arbitration.

However, after an initial letter from the CEO of one party, C, to the Chairman of the other party, D, there was no further correspondence from D and neither party referred the dispute to the respective CEOs for negotiation. Instead, D commenced arbitration and C in turn claimed that the arbitral tribunal did not have jurisdiction to hear the dispute as there was no prior negotiation between the parties.

The arbitral tribunal issued an award (the “Partial Award”) in favour of D (the party who commenced the arbitration) and rejected C’s contention that the arbitral tribunal had no jurisdiction to hear the dispute. C then commenced proceedings in the High Court seeking a declaration that the Partial Award was made without jurisdiction hence not binding on C, and sought an order that the Partial Award be set aside under section 81 of the Arbitration Ordinance (Cap. 609, the “Ordinance”) which in turn refers to Article 34 of the Model Law.

Relevantly, Article 34 allows for the setting aside of an arbitral award if: “the award deals with a dispute not contemplated by or not falling within the terms of the submissions to arbitration” (Article 34(2)(a)(iii)) or “the composition of the arbitration tribunal or the arbitral procedure was not in accordance with the agreement of the parties” (Article 34(2)(a)(iv)).

At the Court of First Instance level, the Judge identified the main question for determination to be whether D had complied with the dispute resolution clause provided for in the agreement is a question of admissibility of the claim or a question of the tribunal’s jurisdiction, and does that question fall within section 81 of the Ordinance (hence Article 34 of Model law)?

The Judge held that: (i) notwithstanding that the Ordinance draws no distinction between “jurisdiction” and “admissibility”, C’s objection concerns the admissibility of the claim but not the jurisdiction of the tribunal, and hence such objection does not fall under Article 34(2)(a)(iii); and (ii) Article 34(2)(a)(iv) is also not applicable, as it concerns the way in which the arbitration was conducted but not the contractual procedures before the arbitration. In the appeal, C contends that these rulings are wrong.

B. The Court of Appeal’s decision

1. 1. 1st Main Ground – jurisdiction vs. admissibility and Article 34(2)(a)(iii) of the Model Law

The Court of Appeal noted that there is a substantial body of judicial and academic jurisprudence which supports the drawing of a distinction between “jurisdiction” and “admissibility” for the purpose of determining whether an arbitral award is subject to review by the court under Article 34(2)(a)(iii). Even though such distinction is not found in the language of Article 34(2)(a)(iii), it can be given recognition in the course of statutory construction, namely that a dispute which goes to the admissibility of a claim (but not jurisdiction of the tribunal) should be regarded as a dispute “falling within the terms of the submissions to arbitration”.

C also argued that its objection is in any event “jurisdictional” in nature, and the parties intend that there is no obligation to arbitrate unless the condition precedent has been satisfied. The Court of Appeal considered this to be oversimplifying matters, as the true and proper question is whether the parties’ intention (or agreement) that the question of fulfilment of such condition precedent is a matter to be determined by the arbitral tribunal, and as such falls “within the terms of the submissions to arbitration”. In other words, one has to look at whether an objection is “targeted at the tribunal” or “targeted at the claim”.

In this case, since C was not saying that D’s claim cannot be referred to arbitration but that the reference was premature, such objection was targeted “at the claim” but not “at the tribunal” and only goes to the “admissibility” of the claim. The Partial Award therefore was not subject to review by the court under Article 34(2)(a)(iii) and this ground of appeal was rejected.

For the sake of completeness, the Court of Appeal also mentioned that its conclusion would not have changed even if the distinction between “jurisdiction” and “admissibility” is disregarded. The Court of Appeal took the view that because the dispute resolution provision provides for “any” dispute which cannot be resolved amicably within 60 business days to be referred to arbitration, there is no reason to confine the scope of arbitrable disputes to substantive disputes, and exclude from it disputes on whether the pre-arbitration procedural requirement has been fulfilled.

1. 2. 2nd Main Ground – applicability of Article 34(2)(a)(iv) of th Model Law

This ground was not the focus of the appeal, and C seeks to argue that the phrase “arbitral procedure” as used in Article 34(2)(a)(iv) can encompass pre-arbitration condition precedent, and whether a condition precedent to arbitration is part of “arbitral procedure” depends on the intention of the parties, in particular whether they intended non-satisfaction of such condition precedent to bar arbitration altogether.

The Court of Appeal considered that since it has come to the conclusion that the parties intended the question of fulfillment of the pre-arbitration procedural requirement to be determined by arbitration, it follows that it was not their intention that non-satisfaction of such requirement would bar arbitration altogether and this ground was similarly dismissed.

C. Conclusion and Key Takeaways

Careful consideration during the negotiation and drafting stage of the contract: The Court of Appeal recognises that ultimately what goes to the issue of “jurisdiction” and what goes to the issue of “admissibility” is controlled by the parties’ agreement, given that arbitration is a consensual process and the parties determine the scope of the disputes which may be submitted to arbitration. If the parties wish to make satisfaction of a pre-arbitration condition precedent something which goes to the arbitral tribunal’s jurisdiction, explicit and unambiguous language should be used to indicate such intention in order to avoid any future dispute, although careful consideration should be given in making such a decision, bearing in mind the extra time and costs which may be involved in the court’s review of jurisdictional matters.

Other consequences of non-satisfaction of pre-arbitration condition precedent: The fact that  non-satisfaction of a contractual procedure before the arbitration will not bar arbitration does not mean that such clause is not important. The non-satisfaction can still have significant practical consequences, such as the arbitration proceedings being stayed pending the fulfillment of the contractual procedure, or the party who does not fulfill such contractual procedure could potentially face sanction on costs.

___________________________

   [1]   A copy of the judgement of the Court of Appeal is available here:
https://legalref.judiciary.hk/lrs/common/search/search_result_detail_frame.jsp?DIS=144748&QS=%2B%7C%28CACV%2C387%2F2021%29&TP=JU

The judgment of the Court of First Instance ([2021] HKCFI 1474) is available here:
https://legalref.judiciary.hk/lrs/common/search/search_result_detail_frame.jsp?DIS=136552&QS=%2B%7C%28HCCT%2C24%2F2020%29&TP=JU

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, or the authors and the following lawyers in the Litigation Practice Group of the firm in Hong Kong:

Brian Gilchrist (+852 2214 3820, [email protected])
Elaine Chen (+852 2214 3821, [email protected])
Alex Wong (+852 2214 3822, [email protected])
Rebecca Ho (+852 2214 3824, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On February 15, 2022, the Federal Supreme Court of the Republic of Iraq (“Iraq”) issued a sweeping decision upending the existing legal framework governing the oil sector in the country (“Court Decision”).[1]  The Government of Iraq has since taken numerous steps to implement the decision, which may have significant and far-reaching repercussions on international oil companies operating under petroleum contracts with the Kurdistan Regional Government (“KRG”).

The Court Decision, among other things, purports to (i) repeal the Kurdistan Region Oil and Gas Law (No. 22 of 2007) based on which the KRG has entered into Production Sharing Contracts (“PSCs”) with international oil companies, (ii) rule that the Federal Ministry of Oil is entitled to pursue the nullification of any contracts entered into by the KRG with third parties regarding oil exploration, extraction, export and sale, (iii) rule that the Ministry of Oil and the Federal Board of Supreme Audit are entitled to review and revise any oil contracts entered into by the KRG, and (iv) order the KRG to hand over to the federal government all oil production it has extracted from oilfields.

In response to the Court Decision, the KRG Prime Minister reaffirmed the KRG’s commitment to its contracts with international oil companies and emphasized that the KRG will not relinquish any of its rights.[2]  In addition, on May 30, 2022, Kurdistan’s Judicial Council released a statement challenging the legality of the Court Decision and the validity and competence of the Court itself.[3]

While the Court Decision does not automatically terminate contracts with international oil companies, the Government of Iraq has indicated that it intends to force the cancellation or substantial revision of such contracts.  On February 26, 2022, the Oil Minister of Iraq issued an order creating a committee with the purpose of executing the Court Decision.[4]  On March 24, 2022, the Oil Minister issued an order to the KRG to send for its review copies of all oil and gas contracts it has entered into since 2004.[5]  The Oil Minister has also proposed establishing a state-owned regional oil company that would manage oil assets in the KRG and that would be overseen by the Government of Iraq.[6]  More recently, the Oil Ministry has also commenced proceedings with several international oil companies, summoning such companies to appear before the Court in Baghdad on June 5, 2022.[7]  While the date of the initial hearing was postponed in order to allow for the summons to be perfected, the proceedings are ongoing.[8]

Such interference by the Iraqi Government seems all but certain to lead international oil companies to commence legal proceedings against Iraq if the matter is not resolved promptly.  The affected investors are expected to seek redress before international fora, in particular, contract-based arbitrations under the terms of the PSCs and, in parallel, treaty-based arbitrations under applicable international investment agreements.  Given the number of international oil companies operating in the Kurdistan Region pursuant to long-term contracts with the KRG (over 30), Iraq’s exposure to damages claims could well reach tens of billions of dollars.

I. Contract Claims under Production Sharing Contracts

Iraq could be held contractually liable for breaching the PSCs by taking any action to either terminate or modify these agreements.  It could also be held liable for violating the stabilization clause (contained within the KRG Model PSC (“Model PSC”)) if it takes any measure altering the fiscal or economic conditions resulting from laws or regulations in force on the date of signature of these agreements.[9]

Iraq could be contractually on the hook since, as a matter of Iraqi constitutional law, the KRG is a constituent subdivision of Iraq.[10]  In the circumstances, international and/or English legal principles such as attribution or alter ego are likely to be relevant (English law being the applicable law stipulated in the Model PSC).h .[11]  In this regard, Claimants could in particular point to a recent decision by the High Court of Justice in England which found, in connection with breaches of two oil and gas PSCs, that acts by the KRG “were done in exercise of the sovereign authority of the state of Iraq.”[12]

Investors are expected to initiate arbitrations seated in London, England, and governed by the London Court of International Arbitration (“LCIA”) Rules, as expressly provided for in the Model PSC.[13]  Notably, the Model PSC broadly defines the scope of “disputes” to cover, among other things, any dispute as to the “existence,” “validity,” “enforceability,” or “termination” of the contract.[14]

II. Treaty Claims under Applicable International Investment Agreements

Iraq has also entered into several Bilateral Investment Treaties (“BITs”) and multilateral Treaties with Investment Provisions (“TIPs”) that provide substantive protections to investors and commit Iraq to resolving disputes through arbitration.  For example, the Japan-Iraq Bilateral Investment Treaty (“BIT”) protects against “expropriation” and “arbitrary measures” and affirms that investors are to be afforded both “fair and equitable treatment” and “full protection and security.”[15]  Similarly, investors who are nationals of a member State of the Organization of the Islamic Conference (“OIC”) can initiate arbitration pursuant to the OIC Investment Agreement.  The OIC Investment Agreement both protects nationals of OIC Member States against expropriation and allows such nationals, through its most-favored-nation provision, to avail themselves of substantive protections contained in other investment treaties to which Iraq is a party.[16]

III. Conclusion

The international oil companies impacted by the Court Decision have numerous legal avenues for seeking redress as a result of the substantial harm they may suffer.  It is therefore very possible that Iraq will find itself subject to numerous claims in the range of tens of billions of dollars (if not more) before international fora for years to come due to the Court Decision and the Government’s actions to implement that decision.

______________________

[1]   Federal Minister of Oil and Ali Shadad Fares v. Minister of Natural Resources of the Kurdistan Region and Speaker of Parliament of the Kurdistan Region, Supreme Court of the Republic of Iraq, 59/Federal/2012 unified with 110/Federal/2019 (15 February 2022).

[2]   Press Conference of Masrour Barzani, Prime Minister of the Kurdistan Region of Iraq, 3 March 2022.

[3]   Statement of the Judicial Council of the Kurdistan Region of Iraq No. 1511, 30 May 2022.  The KRG maintains that the Court was not properly constituted as the Federal Supreme Court capable of determining matters of constitutional law.

[4]   Iraq Oil Reporter, Uncertainty Deepens After Landmark Ruling Against Kurdistan’s Oil Sector, 8 March 2022, accessible: https://www.iraqoilreport.com/news/uncertainty-deepens-after-landmark-ruling-against-kurdistans-oil-sector-44651/

[5]   Iraq Oil Reporter, Uncertainty Deepens After Landmark Ruling Against Kurdistan’s Oil Sector, 8 March 2022, accessible: https://www.iraqoilreport.com/news/uncertainty-deepens-after-landmark-ruling-against-kurdistans-oil-sector-44651/

[6]   Iraq Oil Reporter, Baghdad Launches Legal Action Against Kurdistan’s Oil Companies, 2 June 2022, accessible here.

[7]   Iraq Oil Reporter, Kurdistan Opens New Front in Baghdad Legal Battles, 9 June 2022, accessible: https://www.iraqoilreport.com/news/kurdistan-opens-new-front-in-baghdad-legal-battles-44896/

[8]   Iraq Oil Reporter, Kurdistan Opens New Front in Baghdad Legal Battles, 9 June 2022, accessible: https://www.iraqoilreport.com/news/kurdistan-opens-new-front-in-baghdad-legal-battles-44896/

[9]   Model Production Sharing Contract, Kurdistan Regional Government, Article 43.

[10]   See Constitution of the Republic of Iraq, Article 117.

[11]   Model Production Sharing Contract, Kurdistan Regional Government, Article 43; See Chevron Bangladesh Block Twelve, Ltd. and Chevron Bangladesh Blocks Thirteen and Fourteen, Ltd. v. People’s Republic of Bangladesh, ICSID Case No. ARB/06/10, Award (17 May 2010); Perenco Ecuador Limited v. Republic of Ecuador and Petroecuador, ICSID Case No. ARB/08/6, Decision on Jurisdiction (30 June 2011).

[12]   Dynasty Company for Oil and Gas Trading Limited v. Kurdistan Regional Government of Iraq and Dr. Ashti Hawrami, English High Court of Justice 2021 EWHC 953 (Comm) (23 April 2021).

[13]   Model Production Sharing Contract, Kurdistan Regional Government, Article 42.1.

[14]   Model Production Sharing Contract, Kurdistan Regional Government, Article 42.1.

[15]   Agreement between Japan and the Republic of Iraq for the Promotion and Protection of Investments, 25 February 2014, Articles 5(1), 5(2), and 5(3).

[16]   OIC Agreement, Articles 8 and 10.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s International Arbitration practice group, or the following authors:

Rahim Moloo – New York (+1 212-351-2413, [email protected])
Jeff Sullivan QC – London (+44 (0) 20 7071 4231, [email protected])
Abdallah Salam – New York (+1 212-351-2355, [email protected])

Please also feel free to contact the following practice group leaders:

International Arbitration Group:
Cyrus Benson – London (+44 (0) 20 7071 4239, [email protected])
Penny Madden QC – London (+44 (0) 20 7071 4226, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Decided June 15, 2022

Viking River Cruises, Inc. v. Moriana, No. 20-1573

Today, the Supreme Court held that individual claims arising under California’s Labor Code Private Attorneys General Act (“PAGA”) can be compelled to arbitration.

Background: PAGA permits an employee to sue her employer for Labor Code violations on behalf of the State of California and share in the recovery.  Moriana, an employee of Viking River Cruises, agreed to arbitrate all disputes and waived her ability to bring class-wide, representative, or PAGA claims.  She nevertheless brought a PAGA claim in California state court after her employment ended, alleging Labor Code violations affecting her and other employees and seeking aggregated penalties for all of the alleged violations.  The California Court of Appeal allowed the case to proceed, holding that under the California Supreme Court’s decision in Iskanian v. CLS Transport Los Angeles, LLC (2014), the waiver of representative PAGA claims in Moriana’s arbitration agreement was unenforceable.  Because under Iskanian, a PAGA claim cannot be divided into “individual” and “representative” claims brought in separate proceedings, the court permitted all of Moriana’s claims to proceed in court.

Issue: Does the Federal Arbitration Act require enforcement of a bilateral arbitration agreement with respect to an individual claim under PAGA?

Court’s Holding:

Yes.  The FAA preempts the California Supreme Court’s Iskanian decision insofar as it precludes the division of PAGA actions into individual and non-individual claims.  Viking may compel arbitration of Moriana’s individual PAGA claim, and the remaining non-individual PAGA claims must be dismissed because Moriana lacks statutory standing under PAGA without her having an individual claim in the action.  The FAA, however, does not preempt Iskanian’s prohibition on wholesale waivers of PAGA claims.

“We hold that the FAA preempts the rule of Iskanian insofar as it precludes division of PAGA actions into individual and non-individual claims through an agreement to arbitrate. This holding compels reversal in this case.”

Justice Alito, writing for the Court

What It Means:

• The Court’s decision is a victory for California employers that will likely lead to the enforcement of arbitration agreements in many PAGA actions—resulting in the compelling of individual PAGA claims to arbitration and the dismissal of non-individual PAGA claims in court—with some potential variation depending on the precise language of the arbitration agreements at issue.
• The Court’s reasoning turned on its conclusion that a PAGA claim can be divided into an individual PAGA claim (based on allegations of Labor Code violations specific to the named plaintiff) and a non-individual PAGA claim (based on allegations of Labor Code violations as to other employees not named in the action).  The Court held that the Iskanian decision, by mandating the joinder of non-individual PAGA claims with individual PAGA claims, led to a result “incompatible with the FAA.”
• In concluding that Moriana’s individual PAGA claim was subject to arbitration, the Court relied in part on a severability provision in the arbitration agreement to narrow an otherwise invalid wholesale waiver of PAGA claims.  This analysis suggests that whether courts will compel arbitration of individual PAGA claims may turn on the specific language of the arbitration agreement at issue.
• The Court held that the proper result, once Moriana’s individual PAGA claim is sent to arbitration, is dismissal of her non-individual PAGA claims, as she no longer would satisfy PAGA’s statutory standing requirement.  Justice Sotomayor in a concurring opinion suggested that the California courts could decide that the Court’s understanding of this aspect of California law is incorrect, or that the California legislature could modify PAGA’s standing requirement.

The Court’s opinion is available here.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:

Appellate and Constitutional Law Practice

Related Practice: Labor and Employment

Related Practice: Class Actions

At long last, and just over a month before the drafts were originally scheduled to be finalized, the California Privacy Protection Agency (CPPA) released its draft regulations for the California Privacy Rights Act (CPRA) on May 27, 2022, in advance of the CPPA’s June 8, 2022 meeting.  The CPRA will go into effect January 1, 2023.  Finalization of the regulations before the July 1, 2022 deadline is unlikely, according to the CPPA itself, and whether this delay will impact the CPRA’s enforcement date (as some commentators suggest) remains to be seen.

In August 2020, the California Attorney General released the final regulations for the California Consumer Privacy Act or CCPA, which is the comprehensive state privacy law that will be replaced by the CPRA in January 2023.  The May 2022 draft CPRA regulations redline the August 2020 CCPA regulations and mostly focus on the CPRA’s changes to the preexisting CCPA concepts.[1]  The draft regulations offer businesses a long-awaited roadmap to compliance with the law, albeit a roadmap with clarifications and finalization that remain outstanding.  Key regulations addressed by this initial draft include those relating to dark patterns, expanded rules for service providers, third-party contracts, third-party notifications, requests to correct, opt-out preference signals, data minimization, privacy policy rules, revised definitions, and enforcement considerations.  But this roadmap is subject to debate and change, and is not comprehensive.  Indeed, a number of key issues and inconsistencies were—to the disappointment of many observers—left unaddressed.

Days after the CPPA’s release of the draft regulations, both businesses and consumers expressed desire for further clarity on key issues during the CPPA’s June 8, 2022 Board Meeting, during which the Board formally voted 4-0 to begin the rulemaking process.  Once the Board files the notice and it is published in the California Regulatory Notice Register, the formal rulemaking process will actually commence.  Filing the notice will then begin a public comment period of at least 45 days during which stakeholders and interested parties can submit written comments, and a public hearing will be scheduled.  The earliest date that the regulations theoretically could be finalized would be late July.  Finalization is more likely to extend into Q3 or Q4, as additions and revisions are highly likely.  At the meeting, businesses requested at least a six-month enforcement deadline extension, noting (as the Board has previously recognized) that it will necessarily miss the July 1 deadline to finalize regulations.

Below, we discuss the key changes to the regulations, then discuss two key concepts that were not addressed by the first draft.  These revised regulations create significant impacts for all businesses and fill in key gaps created by the first draft of regulations.  The CPPA’s effort here indicates that it plans to take a very active role in defining the law and its vision of enforcement.

___________________

Table of Contents

Key Updates In the Initial Regulations

(1)   Dark Patterns

(2)   Rules for Service Providers and Contractors, Including Expanded Agreements and Service Provider Potential Liability

(3)   Rules Expanding Contractual Requirements with Third Parties

(4)   Notifications by a Business regarding Third-Party Data Collection

(5)   Sensitive Personal Information

(6)   Consumer Requests to Correct Information

(7)   Opt-Out Preference Signals

(8)   Data Minimization and Retention

(9)   Privacy Policy

(10) Significant Definitions

(11) Enforcement

What is Not Addressed By the First Draft

___________________

Key Updates in the Initial Regulations

Although the regulations are subject to change, they still provide helpful guidance for businesses that can be implemented now.  Below, we’ve highlighted what we believe to be some of the most interesting and potentially impactful draft regulations.

(1)   Dark Patterns

Similar to recent discussions and writings from the FTC,[2] the CPRA sought to address issues relating to dark patterns, which the CPRA defines as “[a] user interface designed or manipulated with the substantial effect of subverting or impairing user autonomy, decision-making, or choice, as further defined by regulation.”[3]  The CPRA introduced a new concept that was not contemplated directly by the CCPA:  the concept that dark patterns cannot be used to obtain valid consent (e.g., consent to track and share personal information).[4]  Draft regulation Section 7004 bears a “consent” heading and makes clear that any dark patterns used to obtain consent would vitiate consent.[5]  This section also concerns dark patterns affecting “methods for submitting CCPA requests.”[6]  In other words, these dark pattern rules also apply to other design choices such as the form a website uses to collect correction right requests, which is potentially broader than the dark pattern concerns expressed in the CPRA.[7]

The regulations define a dark pattern as any user interface that “has the effect of substantially subverting or impairing user autonomy, decisionmaking, or choice, regardless of a business’s intent” or anything that would otherwise “not comply” with the consent rules in Section 7004(a).[8]  This section provides about three pages of new content (as compared to the CCPA regulations) explaining how consent may be obtained, and announces five guiding principles to avoid vitiating consent via dark patterns.[9]  Specifically, user interface architecture must (1) be “[e]asy to understand[,]” (2) provide “[s]ymmetry in choice[,]” (3) “[a]void language or interactive elements that are confusing to the consumer[,]” (4) “[a]void manipulative language or choice architecture[,]” and (5) be “[e]asy to execute.”[10]  The regulations also include a number of illustrations and examples.  The substantial subversion concept, however, still warrants further elaboration, and one commenter during the June 8, 2022 CPPA Board Meeting suggested that the Agency adopt a “design practice[] that amount[s] to consumer fraud” standard instead.

This guidance suggests that, at least in the eyes of the CPPA, many widely used business practices may violate the CCPA.  Of note, according to the CPPA, dark patterns may include simply making consumers feel bad about their choices.  As one example provides, “[w]hen offering a financial incentive, pairing choices such as, ‘Yes’ (to accept the financial incentive) with ‘No, I like paying full price’ or ‘No, I don’t want to save money,’ is manipulative and shaming.”[11]  The “symmetry in choice” concept would also require material changes for many businesses.  As one example provides, “[a] website banner that serves as a method for opting out of the sale of personal information that only provides the two choices, ‘Accept All’ and ‘More Information,’ or ‘Accept All’ and ‘Preferences,’” is explicitly not permissible for opting out of the sale or sharing in this draft.[12]  These draft regulations signal that many businesses need to start thinking now about how their consent flows may fall into these broad definitions of dark patterns, given how common such practices are.

(2)   Rules for Service Providers and Contractors, Including Expanded Agreements and Service Provider Potential Liability

The draft regulations include several new and modified provisions impacting service providers and vendors, i.e., entities that collect and process data in the context of providing a service (including software-as-a-service or SaaS businesses) to another entity.  The regulations impose different obligations on the service provider and on the person or entity to whom the relevant services are provided.  The changes provide additional helpful detail regarding the CPRA’s requirements, including:  (i) expanding the applicability of service provider provisions while excluding cross-contextual advertising services; (ii) adding product or service improvements to the list of reasonable uses of personal information; and (iii) instituting explicit and specific requirements for contracts with service providers and contractors.

First, whereas the CCPA regulations applied only when the service provider provided a service to a “business”—as defined by the CCPA—the draft regulations state that a business that “provides services to a person or organization that is not a business, and that would otherwise meet the requirements and obligations of a ‘service provider’ or ‘contractor’” should still be considered a service provider or contractor.[13]  Therefore, the provisions now also may be read to apply to a service provider whose customer is, for example, a non-profit organization and not a business.  This expanded service provider definition does not apply to cross-contextual advertising services, i.e., services for online advertising where a customer provides a list of its own customers’ email addresses to the vendor.[14]  In that case, the vendor would not be considered a service provider, even if it otherwise met all of the requirements, if the customer was not a “business.”  Advertising services that do not rely on any transfer of personal information provided by the business are not considered cross-contextual advertising services.

This suggests that the draft intends service providers to be covered by the CPRA, even if its customers are not; nonetheless, service providers also have significantly reduced obligations under the CCPA and CPRA, as compared to a business.  For example, because a service provider does not determine the means and processing of the personal information it receives, it does not have to ensure that the information is being retained and processed only in the manner and for the purposes for which consent was obtained or disclosures were properly made.  Those concerns remain the province of the entity providing the information and may flow through to the service provider, but are not as restricting.  Still, the CPRA is of interest to all parties, in applying varying levels of requirements on entities processing personal information.

Second, in what may be a significant relief to many service providers, the draft regulations would explicitly allow service providers to use data, including personal information, obtained from one customer to improve the product or service for all customers, provided the personal information is not “used to perform services on behalf of another,” such as by marketing to the business’ customers on behalf of another company.[15]  Without this allowance, service providers may have been forced to include provisions in their agreements with businesses that would explicitly permit such a use of the personal information, which would in turn possibly have required businesses to disclose such uses by their service providers to consumers or even obtain opt-in consent (or opt out of sale).  Given the many difficulties likely to be encountered in obtaining all such contractual agreements and consents, many service providers could see their business models hamstrung and their product-improvement objectives severely undermined.

Third, the draft regulations flesh out the CPRA’s requirements that seek to restrict the service provider’s control of the personal information it receives from a business such that the service provider grants the same level of privacy protection as the business that is directly regulated by California privacy laws.  For instance, the CPRA requires that a service provider be contractually limited to processing personal information for the business purposes for which it has received the personal information from the business.  The draft regulations additionally require that the business purposes be listed with specificity beyond a mere reference to the purpose of the contract.

These requirements, particularly in combination with requirements for service provider agreements under other state privacy laws taking effect in 2023, are likely to require businesses and service providers to renegotiate their agreements.  Businesses may also need to revise their workflows and methods of cooperation to account for implementing consumer requests.

(3)   Rules Expanding Contractual Requirements with Third Parties

In addition to the service provider requirements, the draft regulations impose obligations on third parties that receive personal information from an entity other than the individual to whom the personal information belongs.  The term “third party” is not explicitly defined in the draft regulations, but appears to refer to any person or entity that receives personal information from a business and is not considered service provider or contractor.  The third party must honor requests to delete or opt out of the sharing of personal information as well as requests forwarded to the third party from the business from which the third party obtained the personal information.[16]

A business that sells or shares personal information with a third party[17] must also enter into an agreement with that third party that includes requirements substantially similar to those in service provider contracts.[18]  Among other requirements, the agreements with third parties must:  (i) require the third party to only use and retain the personal information for the narrow purposes for which the personal information is being sold or disclosed; (ii) require the third party to comply with the CPRA and the draft regulations, including by providing the same level of privacy protection; and (iii) allow the business to require the third party to verify its compliance with its obligations under the agreement as well as the CPRA and the draft regulations.[19]  Finally, any third party that does not have such an agreement in place would not be permitted to retain or process the personal information it receives from a business in any way.

Similar to service providers and contractors, the draft regulations apply to third parties receiving personal information from any entity, whether the entity is itself a “business” subject to the CPRA and the draft regulations or not.  Specifically, whether or not the contracting entity is a business, third parties cannot store or process personal information absent a compliant contract with the entity, and the third party must adhere to the terms of the contract under which it received personal information and otherwise comply with the CPRA and the draft regulations.

Finally, failure on the part of a business to conduct due diligence of any third parties with which it shares personal information may prohibit the business from using ignorance of any misuse of the personal information as a defense in the face of a breach or violation of the CPRA or the draft regulations.  This encourages businesses to ensure their due diligence processes are sufficient, and third parties such as data brokers may face some additional inquiries and contractual requirements.

(4)   Notifications by a Business regarding Third-Party Data Collection

The draft regulations add a new concept requiring the notification of third-party involvement in the collection of personal information.[20]  Specifically, if one business interacts with a consumer but another party is involved and “controls” the collection of personal information (e.g., a cookies analytics provider), then the first business needs to inform the consumer of the third-party collection and the identity of the third party.  The draft regulations indicate that this is also true for physical businesses that may allow a third party to collect personal information.  The CPPA provided the following example:  if a coffee shop allows a business providing Wi-Fi to collect personal information, then the coffee shop needs to inform customers of that third-party data collection through a sign or other signals of that collection.[21]

(5)   Sensitive Personal Information

The draft regulations operationalize the new right to limit the use of sensitive personal information under the CPRA.  The draft regulations add Section 7027, which concerns consumer requests to limit the use and disclosure of sensitive personal information.  The section primarily contemplates giving consumers the ability to limit use and disclosure “to that which is necessary to perform the services or provide the goods reasonably expected.”[22]  Businesses that process sensitive personal information for certain purposes must provide a notice of such processing.  Businesses using or disclosing personal information of this kind would be required to provide two or more designated methods for submitting requests to limit, and at least one of the methods must reflect the manner in which the business primarily interacts with the consumer (such as restrict processing to only permissible purposes through a “Limit the Use of My Sensitive Personal Information” link).[23]  However, businesses are permitted to use or disclose sensitive personal information without being required to offer consumers a right to limit when the information is necessary to perform the services or provide the goods reasonably expected by an average consumer who requests those goods or services; to detect security incidents to resist malicious or illegal attacks on the business; ensure the physical safety of natural persons; for short-term, transient use; perform services on behalf of the business; or verify or maintain the quality or safety of the business—a list that was not yet specified until the draft regulations.[24]

(6)   Consumer Requests to Correct Information

The draft regulations also operationalize the CPRA’s new right to correct inaccurate personal information.  The draft regulations add an entirely new section on consumer requests to correct information.[25]  At first glance, this regime is quite burdensome:  in evaluating whether personal information is accurate, businesses must first consider the totality of the circumstances, including the nature of the information, how it was obtained, and documentation relating to the accuracy of the information.[26]  While businesses may comply with a consumer’s request to correct by correcting the information and ensuring that the information it (and its service providers and contractors) holds remains correct, a business may also choose to delete the information if such deletion does not negatively impact the consumer or the consumer consents to the deletion.  Then, if the business were to deny the request for correction, they would be required to inform consumers of the basis for that denial, further outlining a procedure for consumers to respond in writing.[27]  This section also provides specific examples relating to data brokers:  if a business receives a request to correct information that it received from a data broker, it must both correct the information and ensure that it is not overridden by inaccurate information later re-received from the data broker.  Where a business is not the source of the inaccurate information, the business is required to disclose the name of the source (such as a data broker) supplying the inaccurate information to the consumer.[28]

(7)   Opt-Out Preference Signals

The draft regulations add a definition of an “opt-out preference signal,” which is a signal sent by a platform, technology, or mechanism on behalf of the consumer that communicates the consumer’s choice to opt out of the sale and sharing of personal information and that complies with the requirements set forth in the draft regulations.  Notably, the draft regulations require businesses to process all consumer opt-out preference signals that meet certain requirements.[29]  The details for these opt-out mechanisms are outlined in the new Section 7025.  This section dictates that when a business detects an opt-out signal, it must treat it as a bona fide opt-out request and cannot require additional information to be provided.  If the signal conflicts with a privacy setting or participation in some program, like a business’s financial incentive program that requires the consumer to consent to the sale or sharing of personal information, the business must provide notice to the consumer.  Businesses are instructed to process these opt-out signals in a frictionless manner.  Businesses are also required to display whether or not they have processed consumers’ opt-out preference signals, with the draft regulations suggesting the use of a banner, toggle, or radio button indicating to consumers that they have opted out of the sale of their personal information.

Revisions to Section 7026, meanwhile, indicate that requests to opt out of sales and/or sharing need not be verifiable and must be communicated to third parties.  Crucially, the draft regulations indicate that a self-serve cookie management control process alone would not be sufficient to effectuate requests to opt out of sales and/or sharing, because “cookies concern the collection of personal information and not the sale or sharing of personal information.”[30]

For those less familiar with the development of the CCPA and CPRA, opt-out signals (sometimes described as do-not-track signals) have been a source of ongoing confusion for businesses.  While the draft regulations provide additional clarification, technical questions remain as to how these signals may or may not be communicated to a business, and what choices business have to present opt outs, links, or otherwise to ensure they effectively respond to consumers’ opt-out signals.  Standardization of these signals may be necessary for businesses to meaningfully comply.

(8)   Data Minimization and Retention

The draft regulations include a section on the new data minimization requirement, which requires businesses to collect, use, retain and/or share consumers’ personal information in a way that is “reasonably necessary and proportionate” to the original purpose for collecting it.  The draft regulations define this standard tautologically as “what an average consumer would expect.”  Any collection, use, retention, or sharing that does not meet this standard requires additional notice and the consumer’s explicit consent.

Of particular note are the examples provided in this section.  Impermissible collection, use, retention, and sharing examples include:

• Collecting geolocation information through an app that does not primarily perform a geolocating function—e.g., a flashlight app.
• Using personal information provided to a SaaS company to research and develop “unrelated or unexpected new products”—e.g., where the service provided is cloud storage and the new product is a facial recognition service.
• Using personal information provided as part of a transaction for the marketing of other business’ products.
• Retaining customer files stored as a service after the customer deletes their account.
• Sharing geolocation information with data brokers without the consumer’s explicit consent, where the original collection was permissible as part of the suite of services the company provides—e.g., an internet service provider collecting geolocation information.

This new section drastically changes permissible practices with respect to consumer data, particularly around research for marketing purposes, and provides a hook for the enforcement agency to find impermissible processing of information, a concept that was largely missing from the CCPA.  We expect contentious debate around these new restrictions at the next stakeholder sessions.

Additionally, the draft regulations update the Privacy Policy and Notice sections to include a new requirement that businesses disclose how long they intend to retain personal information.[31]  To comply, businesses will need to develop data retention policies and a data purge protocol, and revise their privacy policies to note the relevant retention periods.

(9)   Privacy Policy

Section 7011 specifies the privacy policy requirements under the CCPA and CPRA.  The draft regulations in this section struck about three pages of text.  First, the regulations begin by largely reinstating disclosure requirements concerning the categories, purposes, and sources of personal information, as well as relevant third parties.[32]

Second, the amendments require that the privacy policy include a description of a consumer’s rights under the CCPA, including the new rights:

• the right to correct inaccurate personal information;
• the right to opt out of the sale or sharing of personal information; and
• the right to limit the disclosure of sensitive personal information.[33]

Third, the regulation amendments require privacy policies to include an explanation of how consumers exercise these rights, and notably add a requirement on how an opt-out request will be processed for the consumer (i.e., whether the opt-out preference signal applies to the device, browser, consumer account, and/or offline sales, and in what circumstances).[34]  Finally, the policy must also include the date it was last updated and, if applicable, a link to certain reporting requirements under Section 7102 for businesses that handle the personal information of more than 10,000,000 consumers in a calendar year.

(10)   Significant Definitions

The draft regulations propose numerous changes to the definitions section that inform entirely new provisions introduced as part of the CPRA and work to modify existing provisions by altering or refining the meanings of existing terms.[35]

Notable newly added terms include:

• “Disproportionate effort,” meaning instances where the effort on the part of the business to comply with a consumer’s legitimate request would be significantly out of proportion with the benefit to the consumer; and
• “Unstructured” as it relates to the nature of the data in which personal information is contained, including text, audio, or video files that contain personal information as part of their content but do not have a defined internal structure (as opposed to a database storing that same information).

“Disproportionate effort” and “unstructured” begin to grapple with the daunting realities faced by businesses attempting to comply with consumers’ requests.  Under the proposed regulations, businesses would be able to tailor their compliance to take into account overly burdensome or unreasonable requests based on the nature of the data at issue (e.g., large video files that are both cumbersome to access and difficult to search) and the burden that complying with such a request would place on the business.  These additions take a step toward balancing consumers’ legitimate rights and interests with the practical realities faced by businesses.

A notable change to the pre-existing terms:  the term “household” has been deleted, sunsetting a term that caused consternation for businesses seeking to comply with the regulations.

(11)   Enforcement

The draft regulations include a new section on enforcement actions.  Section 7300 provides guidance for filing a sworn complaint with the enforcement agency, including the requirements for identifying the alleged violation of the CCPA.  Sections 7302 outlines how the Agency shall conduct “probable cause hearings” which require notice to the alleged violator before conducting an “informal[]” hearing at which it makes a “probable cause determination,” later issued in writing.  Notably, notices of probable cause and probable cause determinations are not public, nor admissible in evidence in any action other than one enforcing the CCPA.  Section 7304, meanwhile, empowers the Agency to audit businesses to ensure compliance with the CCPA.

What Is Not Addressed by the First Draft

The CPPA has had little time to untangle a Gordian knot of competing consumer privacy interests, business compliance issues, and a hodgepodge of public demands.  The delay started early in the process and staffing and key developments came late (for example, the CPPA’s Executive Director was only selected in October 2021).  So it is not surprising that these regulations left many issues unaddressed, particularly those concerning measures added by the CPRA, including restrictions for automated decision-making, cybersecurity audits and data protection risk assessments.

One of the most conspicuous omissions concerns the lack of parameters for automated decision-making.  The CPRA defines “profiling” as “any form of automated processing of personal information, as further defined by regulations pursuant to paragraph (16) of subdivision (a) of Section 1798.185, to evaluate certain personal aspects relating to a natural person and in particular to analyze or predict aspects concerning that natural person’s performance at work, economic situation, health, personal preferences, interests, reliability, behavior, location, or movements,” leaving the contours relatively amorphous in scope.[36]  Contrary to the scope defined by other comprehensive state privacy laws (let alone the EU’s GDPR), commenters have pointed out that the CPRA’s language casts an incredibly wide net that could be argued to cover everything from pernicious forms of facial recognition in public places to humdrum automated processes like calculators and spellcheckers that may process personal information.  As expressed in many CPPA public record comments, numerous stakeholders hoped the initial set of regulations would at least clarify this definition, for example, by limiting it to automated technologies that could create a material impact on a person, similar to the EU’s GDPR.[37]  That task was punted in the current draft regulations, with an unknown timeline, leaving many in limbo.

Another significant omission concerns the CPRA’s requirement for businesses to conduct annual cybersecurity audits and risk assessments for businesses “whose processing of consumers’ personal information presents significant risk to consumers’ privacy or security.”[38]  This risk assessment was not contemplated by the CCPA.  The CPRA noted two key factors “ to be considered in determining when processing may result in significant risk to the security of personal information[,]” “the size and complexity of the business and the nature and scope of processing activities.”[39]  The CPRA required this risk assessment to be submitted to the CPPA on a regular basis.  This task will require an assessment of “whether the processing involves sensitive personal information, and identifying and weighing the benefits resulting from the processing to the business, the consumer, other stakeholders, and the public, against the potential risks to the rights of the consumer associated with that processing, with the goal of restricting or prohibiting the processing if the risks to privacy of the consumer outweigh the benefits resulting from processing to the consumer, the business, other stakeholders, and the public.”[40]  Businesses will need to make careful decisions about how to describe their business processes.

In addition, the proposed draft regulations do not extend the current partial exemptions for employees, job applicants, and independent contractors.  Since the draft regulations do not address limitations on the rights of these data subjects, businesses may need to be prepared to fully comply with all CCPA and CPRA obligations for employees, job applicants, and independent contractors by January 1, 2023, unless the law is amended.

***

These draft regulations are a key milestone for the CPPA’s rulemaking responsibilities and fill in key gaps to help businesses comply with the law.  We will continue to monitor regulatory developments, and are available to discuss these issues as applied to your particular business.

_____________________

   [1]   The regulations only explicitly reference the CCPA, but should be understood to concern the CPRA as well.

   [2]   Last year, the FTC hosted a workshop to explore pernicious dark pattern trends and issued a thorough report to explain the phenomenon.  Bringing Dark Patterns to Light:  An FTC Workshop, Federal Trade Commission (April 29, 2021), available at https://www.ftc.gov/news-events/events-calendar/bringing-dark-patterns-light-ftc-workshop.  Invigorated by the workshop, the FTC issued a policy statement and announced that it would prioritize enforcement against dark patterns—specifically those relating to recurring subscription fees.  FTC to Ramp up Enforcement against Illegal Dark Patterns that Trick or Trap Consumers into Subscriptions (Oct. 28, 2021), available at https://www.ftc.gov/news-events/news/press-releases/2021/10/ftc-ramp-enforcement-against-illegal-dark-patterns-trick-or-trap-consumers-subscriptions.

   [3]   Cal. Civ. Code § 1798.140(l).

   [4]   Id. § 1798.140(h).

   [5]   Draft Regulations § 7004(b).

   [6]   Id. § 7004(a).

   [7]   This expansion of the CPRA’s concept of dark patterns operates under the California Civil Code, subsections 1798.185(a)(4)-(7), which give the CPPA authority to establish rules and procedures to facilitate and govern the submission of consumer requests under the CCPA.

   [8]   Draft Regulations § 7004(b)-(c).

   [9]   Id. § 7004.

  [10]   Id. § 7004(a).

  [11]   Id. § 7004(a)(4)(A).

  [12]   Id. § 7004(a)(2)(C).

  [13]   Id. § 7050(a).

  [14]   Id. § 7050(c).

  [15]   Id. § 7050(b)(4).

  [16]   Id. § 7052.

  [17]   Whereas the focus of “selling” under the CCPA was on whether there was monetary or other valuable consideration for the disclosure of personal information, the concept of “sharing” under the CPRA focuses on whether personal information is used by third parties for cross-context behavioral advertising (whether or not for monetary or other valuable consideration).  Under the draft regulations, businesses may be required to offer the opportunity to opt out of any sharing (through a “Do Not Sell or Share My Personal Information” link) and provide notice of the right in their privacy notices.

  [18]   See Draft Regulations § 7053.

  [19]   Id. § 7053(a).

  [20]   Id. § 7012(g).

  [21]   Id. § 7012(g)(4)(B).

  [22]   Id. § 7027(a).

  [23]   Id. § 7014.

  [24]   Id. § 7027(l)(1)-(7).

  [25]   Id. § 7023.

  [26]   Id. § 7023(b).

  [27]   Id. § 7023(f).

  [28]   Id. § 7023(i).

  [29]   Id. § 7025(b).

  [30]   Id. § 7026(4).

  [31]   Id. § 7012.

  [32]   Id. § 7011(e)(1).

  [33]   Id. § 7011(e)(2).

  [34]   Id. § 7011(e)(3).

  [35]   Id. § 7001.

  [36]   Cal. Civ. Code § 1798.140(z) (emphasis added).

  [37]   The GDPR uses an impact to risk-based approach—only governing processing “which produces legal effects concerning him or her or similarly significantly affects him or her.”  GDPR at Art. 22(1) (emphasis added).  For example, this may include loan or employment applications.

  [38]   Cal. Civ. Code § 1798.185(a)(15).

  [39]   Id.

  [40]   Id.

The following Gibson Dunn lawyers prepared this client alert: Alexander Southwell, Ryan Bergsieker, Cassandra Gaedt-Sheckter, Abbey Barrera, Snezhana Stadnik Tapia, Tony Bedel, Warren Loegering, Raquel Sghiatti, Courtney Wang, Samantha Abrams-Widdicombe, and Leon Freyermuth.

Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the firm’s Privacy, Cybersecurity & Data Innovation practice group:

United States
Matthew Benjamin – New York (+1 212-351-4079, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, [email protected])
David P. Burns – Washington, D.C. (+1 202-887-3786, [email protected])
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, [email protected])
Svetlana S. Gans – Washington, D.C. (+1 202-955-8657, [email protected])
Nicola T. Hanna – Los Angeles (+1 213-229-7269, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Robert K. Hur – Washington, D.C. (+1 202-887-3674, [email protected])
Kristin A. Linsley – San Francisco (+1 415-393-8395, [email protected])
H. Mark Lyon – Palo Alto (+1 650-849-5307, [email protected])
Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Ashley Rogers – Dallas (+1 214-698-3316, [email protected])
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, [email protected])
Deborah L. Stein – Los Angeles (+1 213-229-7164, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, [email protected])
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])

Europe
Ahmed Baladi – Co-Chair, PCDI Practice, Paris (+33 (0) 1 56 43 13 00, [email protected])
James A. Cox – London (+44 (0) 20 7071 4250, [email protected])
Patrick Doris – London (+44 (0) 20 7071 4276, [email protected])
Kai Gesing – Munich (+49 89 189 33-180, [email protected])
Bernard Grinspan – Paris (+33 (0) 1 56 43 13 00, [email protected])
Penny Madden – London (+44 (0) 20 7071 4226, [email protected])
Michael Walther – Munich (+49 89 189 33-180, [email protected])
Alejandro Guerrero – Brussels (+32 2 554 7218, [email protected])
Vera Lukic – Paris (+33 (0) 1 56 43 13 00, [email protected])
Sarah Wazen – London (+44 (0) 20 7071 4203, [email protected])

Asia
Kelly Austin – Hong Kong (+852 2214 3788, [email protected])
Connell O’Neill – Hong Kong (+852 2214 3812, [email protected])
Jai S. Pathak – Singapore (+65 6507 3683, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

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Decided June 13, 2022

ZF Automotive US, Inc. v. Luxshare, Ltd., No. 21-401; and AlixPartners, LLP v. The Fund for Protection of Investors’ Rights in Foreign States, No. 21-518

Today, the Supreme Court held 9-0 that parties to private arbitrations abroad may not seek the assistance of federal courts in gathering evidence for use in those arbitrations.

Background: Congress has authorized district courts to order certain discovery “for use in a proceeding in a foreign or international tribunal.” 28 U.S.C. § 1782(a). Luxshare, Ltd. applied under Section 1782 for discovery from ZF Automotive US, Inc. for use in a planned arbitration under the rules of a private German association. The district court granted the application, holding that a private commercial arbitral body abroad qualifies as a “foreign or international tribunal” under Section 1782. The Supreme Court granted certiorari before judgment.

In a separate case, a Russian entity brought an arbitration against Lithuania pursuant to a bilateral investment treaty between Russia and Lithuania. The Russian entity applied under Section 1782 for discovery from U.S.-based third parties. The district court granted the application. The Second Circuit affirmed, holding that the arbitral panel was a “foreign or international tribunal” in large part because it derived its adjudicatory authority from the treaty.

Issue: Whether a private arbitral body is a “foreign or international tribunal” under 28 U.S.C. § 1782(a).

Court’s Holding:

Only a governmental or intergovernmental adjudicative body constitutes a “foreign or international tribunal” under 28 U.S.C. § 1782(a). Such bodies are those that exercise governmental authority conferred by one nation or multiple nations. Thus, a private commercial arbitration abroad does not qualify, nor does an arbitral panel formed pursuant to an international treaty unless the parties to that treaty conferred governmental authority on the arbitral panel.

“The statute reaches only governmental or intergovernmental adjudicative bodies, and neither of the arbitral panels involved in these cases fits that bill.”

Justice Barrett, writing for the Court

What It Means:

• The Court’s decision limits the ability of parties to private foreign and international arbitration proceedings to seek discovery under the United States’ discovery rules, which are relatively liberal compared to other nations’ rules. This might hamstring parties’ ability to develop evidence in private arbitration proceedings abroad, but it also might streamline those proceedings. Parties to these arbitrations may still, however, be able to use state-law remedies to obtain discovery assistance.
• This decision ensures that private foreign arbitrations do not have broader access to federal-court discovery assistance than do private domestic arbitrations. Under the Federal Arbitration Act, parties to private domestic arbitrations may not apply directly to a federal court for discovery assistance, but instead must seek discovery through the arbitrator.
• The Court’s ruling precludes the use of Section 1782 in arbitrations conducted pursuant to bilateral investment treaties, where the treaty does not confer governmental authority on the arbitral body. It remains to be seen whether that holding will prevent the use of Section 1782 in bilateral investment treaty arbitrations conducted through the International Centre for Settlement of Investment Disputes.
• Foreign and international arbitration proceedings are often confidential. The Court’s ruling helps preserve that confidentiality by preventing parties from initiating public litigation in federal courts under Section 1782.

The Court’s opinion is available here.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:

Appellate and Constitutional Law Practice

Related Practice: Judgment and Arbitral Award Enforcement

Related Practice: Transnational Litigation

Related Practice: International Arbitration

On June 10, 2022, the Securities and Futures Commission (“SFC”) published a consultation paper on proposed amendments to enforcement-related provisions of the Securities and Futures Ordinance[1] [2] (“SFO”) (the “Consultation Paper”). This is particularly noteworthy, as the Consultation Paper marks the first time that the SFC has consulted on changes to enforcement-related provisions since the introduction of the SFO 20 years ago. If all measures sought by the SFC are ultimately implemented, we consider it highly likely that we will see a more aggressive approach to enforcement by the SFC. In particular, the changes sought by the SFC to section 213 of the SFO would make it far easier for the SFC to obtain orders compelling licensed corporations / registered institutions that are found guilty of engaging in misconduct under the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (“Code of Conduct”) to provide investor compensation in relation to that misconduct. At present, there are significant limitations on the SFC’s power to obtain such investor compensation, which have largely shielded licenced corporations and registered institutions from the sort of significant investor compensation claims that have been awarded in other jurisdictions. As such, if this change is implemented, it may well be a “game changer” for the Hong Kong enforcement landscape.

The Consultation Paper also suggests that the SFC has developed a greater appetite for seeking legislative change rather than relying (as it has done in recent years) on providing guidance to the market through the issue of codes, guidelines and circulars. That said, given that many of the changes sought by the SFC could not be achieved through the issue of guidance (as they are largely intended to address the consequences of certain Court of Final Appeal cases and limitations in the drafting of the SFO itself), care must be taken not to assume that this suggests an entirely new approach by the SFC.

I. Expansion of section 213 of the SFO

The most significant and potentially wide reaching amendment sought by the SFC concerns section 213 of the SFO, which provides the SFC with power to seek and obtain injunctive relief from the Court of First Instance (“CFI”). At present, section 213 provides the SFC with the power to seek the following forms of relief:

• an order restraining or prohibiting a breach of the relevant provisions;
• an order requiring a person to take steps to restore the parties to any transaction to the position in which they were before the transaction was entered into;
• an order restraining or prohibiting a person from dealing in a specified property;
• an order appointing an administrator;
• an order declaring that a contract is void or voidable; and
• an order directing a person to do or refrain from doing any act to ensure compliance with any other court order made.

However, under the current drafting of section 213, the SFC may only seek this relief in order to provide remedies for persons affected by contraventions of another person of certain “relevant provisions” and any notice, requirement, conditions, and terms of any license or registration. “Relevant provisions” is defined comparatively broadly in Schedule 1 of the SFO as including the SFO, its subsidiary legislation and certain provisions of the AMLO, Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) and Companies Ordinance (Cap. 622). However, this definition does not include the SFC’s codes and guidelines, including most notably the Code of Conduct.

What this means in practice is that at present, as noted by the SFC in its Consultation Paper, the SFC cannot apply for the above orders under s 213 of the SFO when a regulated person has been found by the SFC through its disciplinary processes to be guilty of misconduct or to not be a fit and proper person to remain a regulated person under section 194 or 196 of the SFO, unless the conduct which gave rise to the SFC’s finding also constituted a contravention of the “relevant provisions” and any notice, requirement, conditions, and terms of any license or registration. However, in practice, the extent to which the SFC has relied upon the issue of codes, guidelines and circulars to communicate its regulatory expectations to the market in recent years means that it is comparatively rare for the conduct at the centre of the SFC’s disciplinary processes to give rise to a contravention of “relevant provisions”, as opposed to a breach of said codes, guidelines and circulars.

The SFC has therefore proposed in the Consultation Paper that section 213 be amended to, amongst other matters:

• introduce an additional ground in s 213(1) which would allow the SFC to apply for orders under section 213 where it has exercised any of its powers under sections 194(1), 194(2), 196(1) or 196(2) against a regulated person;
• introduce an additional order in section 213(2) that would allow an order to be made by the CFI to restore the parties to any transaction to the position in which they were before the transaction was entered into, where the SFC has exercised any of its powers under sections 194 or 196 in respect of the regulated person; and
• enable the CFI to make an order under section 213(8) against a regulated person to pay damages where the SFC has exercised any of its disciplinary powers against a regulated person.

The SFC has argued in the Consultation Paper that these changes are necessary to ‘give the SFC more effective means to protect investors and the interests of clients of regulated persons’. We consider that if these changes are implemented, these amendments will likely have a significant impact on the enforcement landscape in Hong Kong for several reasons:

• First, as noted above, the SFC’s current disciplinary powers in respect of breaches of its codes, guidelines and circulars are comparatively limited, particularly in relation to the implementation of financial penalties. At present, fines are capped at a maximum of HK$10 million or three times of the profit gained or loss avoided, whichever is the higher. While this methodology has still resulted in the imposition of a range of significant fines in recent years, these fines could pale in significance to the size of potential investor compensation claims that could be made in relation to future cases. We anticipate future investor compensation claims under an amended section 213 will be particularly significant in the context of IPO sponsor misconduct cases, where IPO sponsors have historically often be the last parties left standing after the collapse of a fraudulent listco – or will simply be the party left standing with the deepest pockets. Similarly, misselling / suitability cases would also expose regulated firms to both SFC disciplinary action as well as significant investor compensation orders, compelling the regulated firm to restore the investors in question to the position they would have been in if not for the regulated firm’s misconduct.
• Second, the SFC has suggested in the Consultation Paper that the CFI should be able to make an order under section 213(8) against a regulated person to pay damages where the SFC has exercised any of its disciplinary powers against a regulated person. As noted above, the SFC’s fining power is currently capped at a maximum of $10 million or three times of the profit gained or loss avoided, whichever is the higher. Any order to pay damages under the amended section 213(8) would presumably not be subject to the current cap on the SFC’s fining powers, meaning that we may also see a significant increase in the penalties imposed on regulated persons by way of damages orders (in addition to investor compensation claims).
• Third, the non-financial disciplinary measures currently available to the SFC are primarily focused on impacting a licensed firm and/or individual’s ability to continue to be licensed (e.g. licence revocation and suspension). However, these measures are limited in effectiveness where dealing with individuals or firms that have no desire to continue to be licensed or who are no longer employed in the industry. Allowing the SFC to more easily seek one or more of the wide range of orders available under section 213 in relation to these individuals and firms is likely to increase the effectiveness of sanctions against such persons.

II. Amendment to PI exemption to the s 103 prohibition on the issue of advertisements

The second change proposed by the SFC concerns section 103 of the SFO. Section 103(1) makes it a criminal offence to issue or be in possession for the purposes of issue an advertisement, invitation or document which, to the person’s knowledge, contains an invitation to the public to enter into an agreement to deal in securities or any other structured products, to enter into regulated investment agreements, or to participate in a collective investment scheme, unless authorized by the SFC to do so. Section 103(3)  further contains a list of exemptions to the marketing restrictions under s 103, including s 103(3)(k), which provides an exemption from the authorization requirement for advertisements of offers of investments that are disposed of, or intended to be disposed of, only to professional investors (the “PI Exemption”).

In its Consultation Paper, the SFC aims to right what it considers to be a “wrong” in the CFA’s interpretation of the PI Exemption in the 2015 case of Pacific Sun Advisors Ltd & Anor v Securities and Futures Commission.[3] In that case:

• The SFC had commenced proceedings against a licensed corporation and its chief executive officer for contravention of section 103(1) in relation to emails sent to all potential investors and publications on the licensed corporation’s website marketing the launch of a fund. The advertisements contained disclaimers stating that the materials ‘should not be construed as an offer to sell nor a solicitation of any offer to buy shares in any fund’. The SFC argued that for the PI Exemption to apply to advertising materials, the advertising material itself must make clear that the advertised investment product is or is intended only for PIs, which these emails did not do.
• However, Pacific Sun argued that while the advertisements were issued to the general public, it was sufficient that the fund itself was intended to be sold and had in fact only been sold to PIs, even though this intention was not clearly stated in the advertisements.

The CFA agreed with Pacific Sun in its decision, and found that the PI Exemption did apply in this case.

In the Consultation Paper, the SFC proposes the amendment of s 103(3)(k) to focus on the point in time when the advertising materials are issued, by exempting from the authorisation requirement those advertisements which are issued only to PIs. This would mean that following this amendment,  unauthorised advertisements of investment products which are or are intended to be sold only to PIs may only be issued to PIs who have been identified as such in advance by an intermediary through its know-your-client and related procedures, regardless of whether or not such an intention has been stated on the advertisements.

The SFC argues that this amendment is necessary on the basis that the Pacific Sun decision has created a situation in which:

• unauthorized advertisements of products unsuitable for retail investors may be issued to the general public even if only intended for sale to PIs, exposing retail investors to offers to invest in risky and unsuitable products; and
• enforcement action may not take place until the sale of a product has taken place in order to determine to whom it has been sold and whether the section 103(3)(k) exemption applies to the advertisement prior to that sale, notwithstanding the fact that section 103(1) clearly only regulates the issue of advertisements rather than the sale of such products. The SFC has noted that this, combined with the fact that a mere intention to sell investment products only to PIs would suffice for an exemption from the authorization regime under section 103(1), ‘makes the regime extremely difficult, if not impossible to enforce’, and contradicts the intention and purpose of section 103.

III. Amendment to territorial scope of insider dealing provisions

The final change proposed by the SFC concerns the civil and criminal regimes under sections 270 and 291 of the SFO in respect of insider dealing, both of which currently apply to insider dealing concerning Hong Kong-listed securities or their derivatives, and securities that are dual-listed in Hong Kong and another jurisdiction or their derivatives. However, as noted by the SFC, the current regime leaves a regulatory lacuna with regard to market misconduct or insider dealing:

• committed in Hong Kong with respect to overseas listed securities or their derivatives; and
• committed outside of Hong Kong in respect of Hong Kong listed securities or their derivatives.

The SFC proposes to close this gap in the legislation by extending the scope of the insider dealing provisions in Hong Kong to address insider dealing in Hong Kong with regard to overseas-listed securities or their derivatives, and to address conduct outside of Hong Kong in respect of Hong Kong listed securities or their derivatives. To support this proposal, the SFC has argued in the Consultation Paper that these amendments are necessary in order to ensure that they have the power to tackle cross-border insider dealing and market misconduct in order to preserve the integrity and reputation of Hong Kong’s financial industry and market. To support this position, the SFC has cited the case of Securities and Futures Commission v Young Bik Fung & Ors as justification.[4] In that case, the Hong Kong based defendants dealt in shares of a bank listed on the Taiwan Stock Exchange with insider knowledge. However, the fact that the shares were not listed in Hong Kong meant that the SFC had to rely on section 300 of the SFO to prosecute the defendants. Section 300 criminalizes fraudulent or deceptive acts, practices, schemes, or devices. The difficulty of using section 300 in an insider trading case, however, is that section 300 is designed to cover transactions involving specific persons rather than conduct that impacts the integrity of the financial market as a whole.

The SFC has further cited an example of a matter in which it was unable to take enforcement action against a Hong Kong licensed intermediary who dealt in the securities of an overseas-listed entity ahead of the announcement of a placing exercise, when in possession of inside information released to them by another licensed intermediary based in Hong Kong. This was on the basis that although the acts relating to the offence, except for the mechanics of trading, were committed in Hong Kong and the suspect’s conduct appeared to fall within section 300, the SFC did not have sufficient evidence to establish that the suspect had engaged in any fraudulent or deceptive acts in the relevant transactions, and therefore no action could be taken under section 300.

Finally, the SFC has also noted that the insider dealing laws of comparable common law jurisdictions such as Australia, Singapore and the UK govern both overseas conduct relating to securities of local issuers as well as local conduct relating to securities of overseas issuers, and that as such it is important to ensure that the SFO is aligned with those of other major common law jurisdictions and the other market misconduct provisions of the SFO. In particular, the SFC has noted that following the launch of Stock Connect, the proposed amendments would strengthen the SFC’s regulatory powers in tackling insider dealing conducted in Hong Kong involving A-shares listed in mainland China. While not expressly noted by the SFC, the reverse is presumably also true and that this would strengthen the SFC’s powers to tackle insider dealing in mainland China in relation to Hong Kong listed securities.

IV. Conclusion

The Consultation Paper proposes important changes to the SFC’s enforcement regimes. If such changes are passed into legislation, they may have a significant impact on the enforcement landscape in Hong Kong. Interested parties are encouraged to submit written comments in response to the proposed amendments prior to the close of the consultation period on August 12, 2022.

_________________________

   [1]   Consultation Paper on Proposed Amendments to Enforcement-related Provisions of the Securities and Futures Ordinance (June 10, 2022), published by the Securities and Futures Commission, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/consultation/doc?refNo=21CP3

   [2]   Securities and Futures Ordinance (Cap. 571), available at https://www.elegislation.gov.hk/hk/cap571?xpid=ID_1438403472945_001

   [3]   Pacific Sun Advisors Ltd & Anor v Securities and Futures Commission [2015] 2 HKC, available at: https://legalref.judiciary.hk/lrs/common/search/search_result_detail_frame.jsp?DIS=97598&QS=%2B&TP=JU

   [4]   Securities and Futures Commission v Young Bik Fung & Ors [2019] HKC 254, available at https://legalref.judiciary.hk/lrs/common/search/search_result_detail_frame.jsp?DIS=112192&QS=%2B&TP=JU

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, and Jane Lu.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong:

William R. Hallatt (+852 2214 3836, [email protected])
Emily Rumble (+852 2214 3839, [email protected])
Arnold Pun (+852 2214 3838, [email protected])
Becky Chung (+852 2214 3837, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On 5 May 2021, the European Commission (EC) proposed a new Regulation on the grant of subsidies from foreign Governments outside the European Union (foreign subsidy) to companies active within the European Union (EU) which are considered to distort competition in the EU (the Proposed Regulation).

The Proposed Regulation is extremely far reaching.

First, it gives the EC the power to, on its own motion, require companies operating in the EU, which have received a foreign subsidy that is considered to distort EU competition, to take measures in order to eliminate the distortive effect of the subsidy. To this end the EC may demand the recipient company to reduce its EU activities, refrain from investments, divest assets or grant access to infrastructure. Given that it is up to the EC to determine in which circumstances a foreign subsidy may be considered to distort EU competition, the EC may apply its powers irrespectively of the amount of the subsidy granted and irrespectively of the level of the company’s turnover within the EU. In other words, the EC may, on its own motion, require foreign companies that sell goods or services into the EU to undertake various rather invasive measures in order to mitigate alleged distortive effect of a foreign subsidy irrespectively of whether the amount of the foreign subsidy is minimal and whether the recipient has a relatively small turnover in the EU.  Given the fact the Regulation provides that the statute of limitation for ex officio cases is 10 years, the Regulation is extremely far reaching.

Second, the Proposed Regulation also gives the EC the power to prohibit a concentration (i.e., an acquisition, a merger or a joint venture) that has been notified to the EC pursuant to the Regulation. In particular, the Regulation requires companies to notify concentrations to the EC (a) where one of the parties to the concentration active in the EU has received a foreign subsidy of at least EUR 50 million within the last three calendar years; and (b) where at least one of the merging undertakings, or in the case of an acquisition, the acquiring party, or in the case of a joint venture, the joint venture or one of its parents, is established in the EU and has an aggregate turnover exceeding EUR 500 million. The statute of limitation for concentrations is three years.

Third, the Proposed Regulation requires a bidder participating in a public tender conducted by the national authorities in an EU Member State to notify the receipt of a foreign subsidy of  EUR 50 million (or more) to the national authorities if the value of the contract to be awarded exceeds EUR 250 million. If the national authorities receive such a notification it must notify the EC and, if the EC considers that the subsidy distorts competition within the EU, it may decide that the national authorities may not award the contract to the bidder. The statute of limitation for public procurement awards is three years.

While it is possible for companies targeted by the EC in any of the above scenarios to offer remedies in order to remedy the distortive effect of foreign subsidy, the Proposed Regulation makes it clear that if the EC does not consider such remedies to satisfactorily eliminate the distortive effect of the foreign subsidy, the EC may impose remedies on the company.

Amendments to the Proposed Regulation in the Trialogue Procedure

The EC’s adoption of a proposal on the new Regulation kick-started the trialogue procedure between the EC, the Council of the European Union (the Council) and the European Parliament (EP), during which the Council and EP propose and discuss their amendments with the EC as an observer. Recently, on 4 May 2022 both the EP and the Council adopted their proposed amendments to the Regulation and started discussions in order to agree on the final text of the Regulation. Once an agreement has been reached, the Regulation will be formally adopted at a plenary session of the EP. It is expected that the Regulation will be adopted by the end of this year or early next year and enter into force in 2023.

1. The definition of a foreign subsidy

The EC proposed that a foreign subsidy includes (a) the transfer of funds or liabilities by a foreign State (such as capital injections, grants, loans, loan guarantees); (b) the foregoing of revenue otherwise due to a foreign State; and (c) the provision of goods or services or the purchase of goods and services by a foreign State. Both the Council and the EP have proposed to widen the definition of a foreign subsidy to include the grant of exclusive or special rights (for example the right to exploit State owned resources such as gas reserves, forests or mines) without the payment of adequate (market based) remuneration.

Comment

This proposed widening of the definition of a foreign subsidy is entirely in line with the EU State aid rules, which also provide that the grant of exclusive rights without adequate remuneration constitutes State aid.

2. New notification thresholds

With their proposed amendments, the Council and the EP have proposed new thresholds for the notification of both concentrations and public procurement contracts. While the Council desires more transaction to be notifiable to the EC by proposing to increase the notification thresholds for concentrations (from a turnover of EUR 500 million to EUR 600 million) and for public procurement contracts (from a contract value of EUR 250 million to EUR 300 million), the EP seeks to limit the amount of notifications by proposing to reduce the notification thresholds for concentrations (from a turnover of EUR 500 million to EUR 400 million) and for public procurement contracts (from contract value of EUR 250 million to EUR 200 million).

Comment

While the notifiable transactions will undoubtedly play an important role for the EC’s attempt to curb the grant of foreign subsidies to companies active in the EU, it overlooks that the real power given to the EC for that purpose lies in the EC’s powers to investigate, on its motion, and outside the scope of any merger or public procurement procedure, foreign subsidies granted for any amount to companies with small EU turnovers. Indeed, there is no doubt that if in the context of a notified merger or public procurement contract, the parties are not willing to offer the remedy required by the EC, the EC may, besides prohibiting the concentration in question, be able to pursue the company outside the scope of the notified procedure based on its ex officio powers. However, neither the Council nor the EP appear to have picked up on the significant effects that the EC’s ex officio powers may have.

3. Member States’ ability to inform the EC of suspected foreign subsidies

While the EC proposal envisaged that the EC will be informed of the subsidy through notifications or market information, the Council and the EP propose that Member States should also be able to report foreign subsidies to the EC. The EP even proposes that companies should be able to consult informally with the EC in order to determine whether a subsidy must be notified and that the EC may initiate a dialogue with foreign governments to discuss the grant of systemic distortive foreign subsidies.

Comment

These proposed amendments will strengthen the role that national authorities of EU Member States play viz a viz foreign Governments. Clearly when negotiating contracts with foreign Governments it is helpful for EU Governments to have the ability to rely on the possibility to inform the EC of any intentions of foreign Governments to assist their national companies.

4. Limitations in the EC’s powers to investigate

While the Proposed Regulation entitles the EC to investigate any subsidy for any economic activity in the EU (irrespectively of its economic value), it also provides that subsidies with a value below EUR 5 million should be considered unlikely to distort competition. The EP now proposes that this threshold should be reduced to EUR 4 million.

Also, while both the Council and the EP consider that the 10-year period during which the EC may retrospectively investigate subsidies granted before the entry into force of the Proposed Regulation should be reduced, the Council wants to reduce this period to 5 years, while the EP wants to reduce it to 7 years.

Both the Council and the EP propose to cut red tape by reducing the period during which the EC may conduct its preliminary investigation after the notification of the subsidy from 60 days to 20 working days (the Council) or to 40 days (the EP) and that the period for in-depth investigations should be reduced from 200 days to 110 working days (the Council) or 120 days (the EP).

5. Assessment of the distortive effects of the foreign subsidy – the balancing exercise

The Proposed Regulation provides that the EC must assess how distortive a foreign subsidy is by balancing the negative effects of the foreign subsidy against its positive effects. If the negative effects outweigh its positive effects, the EC may impose remedies or accept remedies proposed by the parties. If the EC considers that the negative effects cannot be repaired through remedies it may prohibit (i) the concentration (i.e., the merger, acquisition or joint venture); or (ii) prevent the recipient company from being awarded a public procurement contract.

The Council and the EP have proposed that the EC must issue guidance on how it will determine whether the subsidy distorts competition. Further the Council considers that if a company submits that the subsidy has positive effects relating to EU policies (such as the protection of the environment, R&D&I or social standards), the EC must be obliged to take them into account. The Council also considers that information submitted by Member States must be given considerable weight. The EP proposes various amendments that will guide the assessment of the distortive effect. To this end the EP considers that the EC must be obliged to consider that the subsidy is more likely to distort competition the larger the company is, the higher the value of the subsidy is and the more control a foreign Government has.

In cases of public procurement, the Council proposes that the EC must consider that if alternative sources of supply for the goods and services concerned are limited, the subsidy is less likely to be distortive.

Comments

The proposed Regulation fails to address the main flaw of the balancing exercise. For the purposes of subsidies granted by EU governments subject to the EU State aid rules, the starting point of the balancing exercise is that the aid has positive effects (e.g. environmental protection, R&D, infrastructure construction etc.). However, under the Regulation the starting point is that the subsidy has negative effects (namely that it will distort competition). In addition, while under the EU State aid Guidelines the identification of the positive effects depends on the objective of the specific Guideline (e.g. R&D, environmental protection, employment, regional cohesion etc.), under the Regulation the potential positive effects are limited to a vague reference to the “effect on the development of the relevant economic activity”.

This reverse presumption will make it more difficult to have a foreign subsidy authorised under the Regulation. This is all the more so given that in the context of the EU State aid Guidelines the EC’s counterpart is the Member State that granted the subsidy (which has more political leverage) while under the Regulation the EC’s counterpart is the company receiving the subsidy (which has less or no political influence). Thus, the EC should be required to consider whether the foreign subsidy has any of those positive effects that have been established in the numerous intra-EU State aid Guidelines and only if the negative effects are able to outweigh these positive effects should the EC be able to impose commitments or adopt a negative decision.

While the fact that both the Council and the EP intend to amend the EC’s proposal by requiring the EC to adopt guidance on how it will conduct the balancing exercise is a step on the way to align the foreign subsidy assessment with that under the EU State aid rules, the adoption of this guidance will not remedy the fact that the EC’s assessment starts with the presumption that the grant of the subsidy entails negative effects.

The following Gibson Dunn lawyers prepared this client update: Lena Sandberg, Attila Borsos, Yannis Ioannidis, and Pilar Pérez-D’Ocon.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition practice group, or the following authors:

Attila Borsos – Brussels (+32 2 554 72 10, [email protected])
Lena Sandberg – Brussels (+32 2 554 72 60, [email protected])

Please also feel free to contact the following practice leaders:

Christian Riis-Madsen – Co-Chair, Brussels (+32 2 554 72 05, [email protected])
Ali Nikpay – Co-Chair, London (+44 (0) 20 7071 4273, [email protected])
Rachel S. Brass – Co-Chair, San Francisco (+1 415-393-8293, [email protected])
Stephen Weissman – Co-Chair, Washington, D.C. (+1 202-955-8678, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Decided June 6, 2022

Southwest Airlines Co. v. Saxon, No. 21-309

Today, the Supreme Court held that a ramp agent supervisor whose work frequently requires her to move baggage and other cargo on and off airplanes is a transportation worker exempt from the Federal Arbitration Act’s provisions requiring enforcement of arbitration agreements.

Background: The Federal Arbitration Act, or FAA, generally requires courts to enforce agreements to arbitrate. Section 1 of the FAA exempts from that requirement “contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce.” 9 U.S.C. § 1. The Supreme Court previously held that § 1’s residual clause covering workers engaged in foreign or interstate commerce applies only to “transportation workers.” Circuit City Stores v. Adams, 532 U.S. 105, 119 (2001).

Latrice Saxon, a ramp-agent supervisor who frequently loads and unloads cargo on and off airplanes, agreed to arbitrate wage disputes against Southwest on an individual basis. After Saxon brought a federal class action against Southwest seeking overtime wages, the airline moved to compel arbitration. Saxon opposed arbitration, arguing that she was a “worker[] engaged in foreign or interstate commerce” and thus was exempt from the FAA. The U.S. Court of Appeals for the Seventh Circuit agreed, holding that ramp agents and their supervisors are transportation workers exempt from the FAA.

Issue: Whether supervisors of airline ramp agents are “workers engaged in foreign or interstate commerce” exempt from the Federal Arbitration Act’s provisions requiring enforcement of agreements to arbitrate.

Court’s Holding:

A ramp agent supervisor who frequently moves cargo on and off airplanes plays a direct role in the cross-border transportation of goods and therefore is exempt from the Federal Arbitration Act under § 1’s residual clause.

“We think it . . . plain that airline employees who physically load and unload cargo on and off planes traveling in interstate commerce are, as a practical matter, part of the interstate transportation of goods.”

Justice Thomas, writing for the Court

What It Means:

• In defining the relevant class of workers, courts must focus on the day-to-day duties of the workers themselves. The Court rejected Saxon’s argument that what matters is the customary work of businesses in the broader industry in which the employer operates, explaining that § 1 does not exempt “virtually all employees of major transportation providers.”
• The Court reiterated that, to determine whether § 1’s exemption applies, the relevant class of workers must be compared to the “seamen” and “railroad employees” whom Congress specifically exempted from the FAA in 1925. The closer a class of workers comes to those groups, the more likely the workers will be deemed exempt from the FAA under § 1’s residual clause.
• The Court expressly declined to decide how the FAA’s transportation-worker exemption applies to other industries and classes of workers whose duties are “further removed from the channels of interstate commerce or the actual crossing of borders.”
• Employees who may be exempt from the FAA might still be required to arbitrate their claims under state arbitration statutes, many of which require enforcement of arbitration agreements without an exemption for transportation workers.

The Court’s opinion is available here.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:

Appellate and Constitutional Law Practice

Related Practice: Labor and Employment

Related Practice: Class Actions

The webcast provides analysis of the significant and high-profile cases before the Supreme Court this Term, including those affecting the business community.

Class actions have gradually taken root outside the US in recent years. We highlight common pitfalls and early advocacy problems that defendants typically face in these new regimes and provide an overview in which direction international class actions will develop in the years to come.

View Slides (PDF)

PANELISTS:

Eric Bouffard is a French qualified partner in the Paris office of Gibson Dunn & Crutcher, where he serves as a member of the firm’s International Arbitration, Litigation and Business Restructuring Practice Groups. Mr. Bouffard is particularly active in cross-border litigation, commercial arbitration, commercial law (including insolvency and recovery of debt), industrial risk (latent defects, interruption of production, delay and disruption claims, consequential losses), international trade and insurance before both judicial courts and arbitral tribunals. He is regularly involved in M&A disputes, shareholders and more generally project partners disputes.

Jean-Pierre Farges is a partner in the Paris office of Gibson, Dunn & Crutcher LLP, Global Co-Chair of the firm’s Business Restructuring & Reorganization Practice Group and member of the firm’s Litigation Practice Group. Mr. Farges specializes in complex M&A litigation, arbitration, industrial risk, construction, international trade, insurance, reinsurance, equity capital insolvency dispute matters and public and administrative law disputes and regulatory issues. He has been involved in a number of major disputes before state courts and arbitral tribunals, acting for banks, funds companies and listed industrial companies.

Osma Hudda is an English qualified partner in Gibson, Dunn & Crutcher’s London office and is a member of the Firm’s Dispute Resolution Group. Ms. Hudda has broad-based dispute resolution experience including litigation, international arbitration and regulatory investigations. Ms. Hudda’s litigation experience has involved representing clients in Employment Tribunals, the High Court and Court of Appeal. In arbitration she has represented clients from a wide variety of industries, particularly oil & gas, before arbitral tribunals including the ICC and LCIA. She has also defended companies involved in regulatory investigations in the UK and internationally as well as assisting clients in large scale internal investigations and related compliance issues.

Markus Rieder is a partner in the Munich office of Gibson, Dunn & Crutcher. He is a member of the firm’s Class Actions, Transnational Litigation, Securities Litigation and International Arbitration Groups. Mr. Rieder focuses his practice on complex commercial litigation, both domestic and cross-border, and national and international arbitration, as well as on compliance and white collar defense. He has substantial experience in the automotive, industrial and manufacturing sectors. Mr. Rieder is regularly recommended by the leading legal publications.

Cassie Aprile is a dual-qualified Associate in the London office of Gibson, Dunn & Crutcher, practising in the firm’s Dispute Resolution Group. Ms. Aprile qualified as a solicitor in Australia in 2010, and as a solicitor in England & Wales in 2018. Ms. Aprile specialises in commercial litigation and has experience advising clients on a broad range of complex disputes across various industry sectors, including mining and energy, property, development, banking and general commercial. Most recently, Ms. Aprile has assisted in the defence of a UK retailer in the largest private sector equal pay claim to be heard in the English courts.

Alexander Horn is an associate in the Munich office of Gibson, Dunn & Crutcher. He is a member of the firm’s Litigation, Class Actions, Securities Litigation, Transnational Litigation and International Arbitration Practice Groups. Mr. Horn has experience in a wide variety of complex litigation and international arbitration matters. This includes several contract, post-M&A, and corporate disputes before German Regional Courts as well as representing a financial services company in Germany’s largest arbitration to date. Handelsblatt / The Best Lawyers™ in Germany 2021/2022 have recognized Mr. Horn in the inaugural list “Ones to Watch” for International Arbitration.

Lauren Blas is a partner in the Los Angeles office of Gibson, Dunn & Crutcher where her practice focuses on class actions, labor and employment litigation, and complex commercial litigation in the trial courts and on appeal.

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This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit.

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 hour.

California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

Congress continues to debate enactment of the Build Back Better Act, which is expected to include major changes to the federal tax law. Meanwhile, other recently enacted tax legislation, including the sweeping tax reform enacted in 2017, continues to generate significant regulatory activity at the Treasury Department and IRS. And recent increases in IRS funding are leading to an uptick in audit activity for the first time in many years, focused in part on partnerships and multi-national businesses.

This panel provides an overview of these legislative, regulatory and enforcement developments.

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The recent expansion of New York’s law regarding so-called strategic lawsuits against public participation (“SLAPP”) has created some uncertainty regarding what standards apply to currently pending matters arising under New York law involving public petition and participation.  The New York legislature and courts are actively engaged in considering these questions, and a new proposed piece of legislation, if adopted, may clarify what standards apply in pending actions.

On July 22, 2020, the New York State Senate and Assembly passed legislation that expanded First Amendment protections under New York’s anti-SLAPP law by providing new tools for defendants to challenge frivolous lawsuits.  The bill was signed into law by former Governor Andrew M. Cuomo on November 10, 2020.  The law amended and extended New York’s existing statute (sections 70-a and 76-a of the New York Civil Rights Law) addressing so-called SLAPP suits:[1] suits that seek to punish and chill the exercise of the rights of petition and free speech by subjecting defendants to expensive and burdensome litigation.[2]  New York’s previous anti-SLAPP law, enacted in 2008, was limited to litigation arising from a public application or permit, often in a real estate development context.[3]

The amendments, which took effect immediately upon enactment, introduced the following key changes to New York law:

• Expanded the statute beyond actions “brought by a public applicant or permittee,” to apply to any action based on a “communication in a . . . public forum in connection with an issue of public interest” or “any other lawful conduct in furtherance of the exercise of the constitutional right of free speech in connection with an issue of public interest, or in furtherance of the exercise of the constitutional right of petition.”[4]
• Confirmed that “public interest” should be construed broadly, including anything other than a “purely private matter.”[5]
• Required courts to consider anti-SLAPP motions to dismiss based on the pleadings and “supporting and opposing affidavits stating the facts upon which the action or defense is based.”[6]
• Provided for a stay of all proceedings—including discovery, hearings, and motions—pending determination of a motion to dismiss an action under the anti-SLAPP law, except that the court may order limited discovery where necessary to allow a plaintiff to respond to an anti-SLAPP motion.[7]
• Provided that the court must award attorneys’ fees, and does not have discretion over whether to do so, when it grants such a motion.[8]

New York’s existing anti-SLAPP law already provided that a plaintiff in an “action involving public petition and participation” was required, as a matter of state law separate and apart from federal constitutional law, to satisfy the “actual malice” standard first promulgated by the United States Supreme Court in the seminal First Amendment decision New York Times v. Sullivan.[9]  By expanding the definition of an “action involving public petition and participation,” the 2020 amendments require plaintiffs in a wider range of actions to satisfy that standard.[10]

When passed, commentators observed that courts would be asked to determine whether the revised statute was “retroactive” in effect, i.e., whether it would apply to actions already pending at the time it became effective, or if it would only have effect in subsequently filed actions.  Under New York law, whether a statute is “retroactive” is “a matter of judgment made upon review of the legislative goal,” based on “whether the Legislature has made a specific pronouncement about retroactive effect or conveyed a sense of urgency; whether the statute was designed to rewrite an unintended judicial interpretation; and whether the enactment itself reaffirms a legislative judgment about what the law in question should be.”[11]

The first courts to consider the issue uniformly held that the amended anti-SLAPP law did apply retroactively to actions pending as of the date the amendments were passed.  For example, on December 29, 2020, United States District Judge Rakoff of the Southern District of New York held in Palin v. New York Times Company that the law was retroactive.”[12]  Judge Rakoff explained that “It is clear that the [amended law] is a remediate statute” that “should be given retroactive effect in order to effectuate its beneficial purpose” and that “[o]ther factors in the retroactivity analysis include whether the Legislature has made a specific pronouncement about retroactive effect or conveyed a sense of urgency; whether the statute was designed to rewrite an unintended judicial interpretation; and whether the enactment itself reaffirms a legislative judgment about what the law in question should be.”[13]  In Judge Rakoff’s view, “the legislative history demonstrates that the amendments to [the anti-SLAPP law] were intended to correct the narrow scope of New York’s prior anti-SLAPP law” such that “the remedial purpose of the amendment should be effectuated through retroactive application.”[14]  In the Palin case, this determination meant that under the amended anti-SLAPP law, New York state law as well as federal constitutional law both separately required the plaintiff to meet the “actual malice” standard to establish her defamation claims.  Over the following 14 months, almost 20 other state and federal courts—every court to consider the same question—came to the same conclusion.[15]

But on March 10, 2022, the First Department departed from that building consensus and held that the 2020 amendments to New York’s anti-SLAPP law do not apply retroactively.[16]  In Gottwald v. Sebert,* involving defamation claims brought by music producer Lukas Gottwald, known as Dr. Luke, against the pop star Kesha Rose Sebert, known as Kesha, the First Department held that the anti-SLAPP law does not apply to claims commenced before the November 2020 amendments were passed.[17]  In that litigation, the New York trial and appellate courts had previously held that Dr. Luke did not qualify as a public figure and so was not required to meet the actual malice standard as a matter of federal constitutional law.[18]  Kesha sought a ruling that the amended New York anti-SLAPP law applied retroactively to Dr. Luke’s claims, which had been filed before the amendments to the anti-SLAPP law were enacted, and so required Dr. Luke to meet the actual malice standard under New York state law.[19]  Kesha also sought to bring new anti-SLAPP counterclaims against Dr. Luke under the amended New York anti-SLAPP law which would have allowed her, if she prevailed, to recover attorneys’ fees.[20]  However, because the claims at issue were brought prior to November 2020, the First Department held that the “actual malice” standard did not apply and that Kesha could not bring anti-SLAPP counterclaims.[21]

The First Department explained that there was “insufficient evidence supporting the conclusion that the legislature intended” the recent amendments to the anti-SLAPP law “to apply retroactively to pending claims,” like those asserted by Dr. Luke against Kesha.[22]  The First Department held that to defeat the strong presumption against applying laws retroactively, there would need to be clear evidence that the law was intended to apply retroactively.  It reasoned that, despite evidence that the amendments were intended to remediate the prior anti-SLAPP provision by broadening its scope, retroactive application of new statutes is so disfavored that it must be made explicit in the statutory text.[23]

Kesha has moved for reargument of that decision or for leave to appeal to the New York Court of Appeals, New York’s highest court.[24]  Her motion is supported by a number of amici, including New York State Senator Brad Hoylman, who co-authored the 2020 amendments to New York’s anti-SLAPP law.[25]  Senator Hoylman asserted in his proposed amicus brief in support of Kesha’s motion that the legislature did intend for the law to have retroactive effect, explaining that the drafting history of the amendments and his personal understanding of the amendments support applying them retroactively.[26]  Dr. Luke responded by arguing, among other things, that Senator Hoylman’s brief improperly seeks to “influence the judicial interpretation of a statute” post-enactment, which “threaten[s] to undermine fundamental separation of powers principles,” and disputed his interpretation of the drafting history.[27]

Most recently, on May 12, 2022, Senator Hoylman introduced a new bill to further amend the New York anti-SLAPP law, seeking among other things to “clarify” that the amended statute applies retroactively by appending language unambiguously providing retroactive effect.[28]  The bill also clarifies the “substantial basis” standard applicable to motions to dismiss actions under the anti-SLAPP statute.[29]

The new proposed amendments are at the beginning of the legislative process.  It remains to be seen whether the new amendments will receive support in the legislature and be enacted into law by the Governor’s signature, and if so, on what timeline.  The current amended anti-SLAPP law was initially introduced on January 9, 2019, was passed on July 22, 2020, and was signed into effect on November 10, 2020.[30]  A similar time frame for the new proposed amendments would see them take effect in the middle of 2024.  And separately, it remains to be seen how the courts, including the First Department and perhaps the Court of Appeals in Gottwald v. Sebert and other pending actions, will construe the new proposed amendments in determining whether the existing anti-SLAPP law already applies retroactively.  Further developments in this complicated and important area of New York law are sure to follow in the near future.

* Gibson, Dunn & Crutcher LLP represented Sony Music Entertainment in Gottwald v. Sebert,
No. 653118/2014 (Sup. Ct. N.Y. Cty.).

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   [1]   2020 N.Y. Senate Bill No. 52-A/Assembly Bill No. 5991A (July 22, 2020), https://www.nysenate.gov/legislation/bills/2019/s52/amendment/a.

   [2]   Understanding Anti-SLAPP Laws, Reporters Committee for Freedom of the Press, https://www.rcfp.org/resources/anti-slapp-laws/ (last visited May 17, 2022).

   [3]   2020 N.Y. Senate Bill No. 52-A/Assembly Bill No. 5991A (July 22, 2020), https://www.nysenate.gov/legislation/bills/2019/s52/amendment/a.

   [4]   Id. (emphasis added).

   [5]   Id.

   [6]   Id.

   [7]   Id.

   [8]   Id. (emphasis added).

   [9]   Palin v. New York Times Co., 510 F. Supp. 3d 21, 28–29 (citing New York Times v. Sullivan, 376 U.S. 254 (1964) and N.Y. Civil Rights Law § 76-a(2)).

  [10]   Id.

  [11]   Nelson v. HSBC Bank USA, 87 A.D.3d 995, 997–98 (N.Y. App. Div. 2d Dep’t 2011).

  [12]   510 F. Supp. 3d 21, at 27 (S.D.N.Y. 2020); see also Novagold Resources, Inc. v. J Capital Research USA LLC, 2022 WL 900604, *9 (E.D.N.Y. Mar. 28, 2022) (applying New York’s anti-SLAPP amendment retroactively); Coleman v. Grand, 2021 WL 768167, at *8 (E.D.N.Y. Feb. 26, 2021) (same); Sackler v. American Broadcasting Companies, Inc., 144 N.Y.S.3d 529, 532 (Sup. Ct. 2021) (same).

  [13]   Id. at 26–27 (quoting Matter of Gleason, 96 N.Y.2d 117, 122 (2001)) (internal quotation marks omitted)..

  [14]   Id. at 27 (citation omitted).

  [15]   Memorandum of Law in Support of Motion of Defendant-Respondent for Reargument or, in the Alternative, Leave to Appeal, Gottwald v. Sebert, No. 2021-03036, Dkt. 20 at 15 n.1 (N.Y. App. Div. 1st Dep’t Apr. 11, 2022).

  [16]   Gottwald v. Sebert, 203 A.D.3d 488 (N.Y. App. Div. 1st Dep’t 2022).

  [17]   Id. at 489.

  [18]   See Gottwald v. Sebert, 193 A.D.3d 573, 576–78 (N.Y. App. Div. 1st Dep’t 2021).  That decision has been appealed to the New York Court of Appeals, New York’s highest court, which has not resolved the question of Dr. Luke’s public figure status.  See Gottwald v. Sebert, No. 2020-01908, Dkt. 69 (N.Y. App. Div. 1st Dep’t Jul. 22, 2020).

  [19]   Defendant Kesha Rose Sebert’s Memorandum of Law in Support of her Motion for a Ruling that Civil Rights Law Section 76-a Applies to Plaintiffs’ Defamation Claims and for Leave to Assert a Counterclaim, Gottwald v. Sebert, No. 653118/2014, Dkt. 2303 at 1 (Sup. Ct. N.Y. Cnty. Apr. 6, 2021).

  [20]   Id.

  [21]   Gottwald, 203 A.D.3d at 489.

  [22]   Id. at 488.

  [23]   Id.

  [24]   Memorandum of Law in Support of Motion of Defendant-Respondent for Reargument or, in the Alternative, Leave to Appeal, Gottwald v. Sebert, No. 2021-03036, Dkt. 20 (N.Y. App. Div. 1st Dep’t Apr. 11, 2022).

  [25]   See Notice of Motion for Leave of Senator Brad Hoylman to Participate as Amicus Curiae, Gottwald et al. v. Sebert, No. 2021-03036, Dkt. 25 (1st Dep’t) (filed April 15, 2022).

  [26]   Id., Proposed Amicus Brief at 4–5.

  [27]   Omnibus Opposition to Motions For Leave to File Amicus Curiae Briefs In Support of Respondent’s Motion for Reargument or Leave to Appeal, No. 2021-03036, Dkt. 26 at 10–11 (1st Dep’t) (filed April 22, 2022).

  [28]   2022 N.Y. Senate Bill No. S9239 (May 12, 2022), https://www.nysenate.gov/legislation/bills/2021/s9239.

  [29]   Id.

  [30]   2020 N.Y. Senate Bill No. 52-A/Assembly Bill No. 5991A (July 22, 2020), https://www.nysenate.gov/legislation/bills/2019/s52/amendment/a.

The following Gibson Dunn lawyers assisted in the preparation of this client update: Anne Champion, Connor Sullivan, Dillon Westfall, and Randi Brown.

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The Federal Trade Commission recently doubled down on its efforts to combat perceived deception and privacy violations in the education sector, and in particular, perceived violations by education technology providers and for-profit educational institutions.

On May 19, 2022, the FTC commissioners unanimously[1] voted to adopt a new Policy Statement on educational technology and the Children’s Online Privacy Protection Act (COPPA). In the Policy Statement, the agency promised to “scrutinize compliance with the full breadth of the substantive provisions of the COPPA rule and statutory language,” with a particular focus on protecting children who are required to use certain technology to complete schoolwork.[2] The Policy Statement is one in a series of signals that the FTC will aggressively enforce COPPA, specifically in the context of technology used for school—a scenario in which “children are a captive audience,” according to the FTC.[3]

FTC Chair Lina Khan reinforced these sentiments at the FTC’s May 19 open meeting, stating that COPPA is not merely a notice and consent framework, but places clear restrictions on the data that companies may collect from children. She expressed particular concerns over children “surrender[ing their data] to commercial surveillance practices,” in order to access educational resources online. She also expressed concerns over “targeting” and “profiling” of children, across various platforms.[4]

With the Policy Statement, the FTC sends a reminder that covered businesses bear “the responsibility for COPPA compliance . . . not schools or parents.” Specifically, the agency will prioritize enforcement against:

(1) mandatory collection of information as a condition of participation, or collection of data beyond what is reasonably necessary;

(2) use of children’s data outside of the authorized limited purpose;

(3) the retention of information for longer than is reasonably necessary; and,

(4) the failure to maintain the confidentiality, security, and integrity of children’s personal information.

The FTC further made clear that it will take the position that a company is in violation of COPPA’s security provisions if the company fails to take reasonable security precautions, regardless of whether an actual breach occurs.[5]

President Joe Biden commended the FTC “for unanimously taking a big step” toward answering his call to strengthen privacy protections for children with the Policy Statement, and reiterated his stated intention to strengthen privacy protections and ban targeted advertising to children delivered in his State of the Union address.[6]

The FTC has been grappling with the perceived “proliferation of technologies that monetize the collection of personal information,” especially as it relates to children for over a decade. The FTC has been charged with enforcing COPPA since it took effect in 2000, and the agency amended COPPA in 2013 to broaden its scope to include previously unregulated information, such as “persistent identifiers,” as well as photographs and voice recordings, and to encompass third parties that have actual knowledge that they’re collecting personal information from children.[7] With the proliferation of online learning, the FTC wants to ensure that “ed tech doesn’t become a pretext for companies to collect personal information in the classroom and in the home.”[8] Indeed, the FTC opened a review of the COPPA Rule in 2019, ahead of the regulatory review schedule, to explore whether amendments are needed in light of rapid technological advancements, and asking specific questions concerning the EdTech industry, including whether to change requirements concerning the deletion of children’s information and parental consent. The FTC received 170,000 public comments in this review, setting the record for any proceeding.[9]

The FTC issued the May 19 Policy Statement even though the agency’s COPPA review is still pending. FTC Commissioner Christine Wilson asked the agency to prioritize the conclusion of this review, given that it has been pending for three years.

The May 19 Policy Statement is not the only recent development related to COPPA. In March 2022, the FTC settled a matter over allegations that a company collected data from children without proper parental consent.[10] As part of the settlement, the company paid a $1.5 million penalty, was required to delete all personal information that was collected in a manner that violated COPPA, and had to destroy all models or algorithms developed in whole or in part using improperly collected personal information. More than a mere interest in enforcing COPPA generally, this case signals the Commission’s focus on the use of children’s data to create advanced algorithms, and therefore, the destruction of such algorithms as a remedy for COPPA violations.

The FTC also signaled its interest in how children interpret advertising, both in the context of COPPA and its Guides on Endorsements and Testimonials. The same day the FTC issued the Policy Statement, the agency announced an October workshop focusing on “stealth advertising” to children—a phenomenon where the line between paid advertisements and unsponsored influencer content has become blurred—particularly with respect to the rise of the child influencer.[11] The workshop will feature legal experts as well as scientists to discuss the development of children’s brains and the impact of stealth advertising on impressionable children, in order to develop strategies to best protect kids. The FTC is currently seeking research papers and written comments on topics including children’s capacity at different ages and developmental stages to recognize and distinguish advertising content, the “harms to children” caused by a failure to recognize advertising, and what measures should be taken to protect children.[12]

EdTech is not the FTC’s only educational sector interest area.  The agency recently issued Warning Letters in the for-profit education space, as well. Specifically, the FTC put 70 for-profit educational institutions on notice that the agency will seek to impose civil penalties on any institution that commits acts that have been previously found to be unfair or deceptive under Section 5,[13] using its Penalty Offense Authority.[14] The Commission cautioned these companies against deceptive advertising, making false promises of jobs or other favorable employment outcomes, and driving students into debt. Educational institutions found to be in violation of these rules could face “steep penalties”—including fines of more than $46,000 per violation.

Companies and other entities engaged in the education sector should be particularly mindful of the FTC’s activities in this space, especially if they collect any information from children, and ensure their practices do not run afoul of COPPA, the FTC Act, or related requirements.

We are closely monitoring FTC developments, and are available to discuss these issues as applied to your particular situation.

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   [1]   While every Commissioner ultimately voted to adopt the Policy Statement, 4 Commissioners (out of 5) issued their own, individual statements on the issue, noting a spectrum of opinions. In fact, Commissioner Wilson only “reluctantly vot[ed] yes” on the Policy Statement; and even so, only because the Statement “neither expands the universe of entities covered by the COPPA Rule nor the circumstances under which the Commission will initiate enforcement.”  Oral Remarks of Commissioner Wilson at the Open Commission Meeting (May 19, 2022), https://www.ftc.gov/system/files/ftc_gov/pdf/P155401WilsonRemarks_0.pdf.  Notably, the May 19 open meeting was the first for newly installed Commissioner Alvaro Bedoya.  He stated that the Policy Statement reinforced original intent of Congress to go beyond the notice and consent framework. Oral Remarks of Commissioner Bedoya at the Open Commission Meeting, 13 (May 19, 2022), https://www.ftc.gov/system/files/ftc_gov/pdf/Transcript-Open-Commission-Meeting-May-19-2022.pdf. He also expressed the view that children have different online experiences based on family circumstances.  “Kids from working-class families … [are] more likely to use free apps, which track much more data than paid apps, and for a variety of reasons, they end up giving up much more sensitive information about themselves.”  Id. at 14. Hence, Commissioner Bedoya was encouraged by Chair Khan’s call for “systemic responses to problems.” While some tracking is benign, “I want to push back on the idea that we need all this tracking . . . to make better apps for kids.” Id.

   [2]   Federal Trade Commission, Policy Statement of the Federal Trade Commission on Education Technology and the Children’s Online Privacy Protection Act (2022).

   [3]   Id.

   [4]   Oral Remarks of Commission Chair Lina Khan at the Open Commission Meeting (May 19, 2022), https://www.ftc.gov/system/files/ftc_gov/pdf/Transcript-Open-Commission-Meeting-May-19-2022.pdf.

   [5]   Id.

   [6]   The White House, Statement from President Biden on FTC Vote to Protect Children’s Privacy (May 19, 2022), https://www.whitehouse.gov/briefing-room/statements-releases/2022/05/19/statement-from-president-biden-on-ftc-vote-to-protect-childrens-privacy.

   [7]   See, https://www.ftc.gov/business-guidance/blog/2022/05/ftc-ed-tech-protecting-kids-privacy-your-responsibility.

   [8]   Id.

   [9]   See, FTC, Student Privacy and Ed Tech (December 2017), https://www.ftc.gov/news-events/events/2017/12/student-privacy-ed-tech.

  [10]   FTC, FTC Takes Action Against Company Formerly Known as Weight Watchers for Illegally Collecting Kids’ Sensitive Health Data, https://www.ftc.gov/news-events/news/press-releases/2022/03/ftc-takes-action-against-company-formerly-known-weight-watchers-illegally-collecting-kids-sensitive.

  [11]   https://www.ftc.gov/news-events/news/press-releases/2022/05/ftc-hold-virtual-event-protecting-kids-stealth-advertising-digital-media.

  [12]   Id. The FTC will continue to accept comments and papers until July 18, 2022.

  [13]   https://www.ftc.gov/news-events/news/press-releases/2021/10/ftc-targets-false-claims-profit-colleges.

  [14]   FTC, Notices of Penalty Offenses, https://www.ftc.gov/enforcement/penalty-offenses. See also, Gibson Dunn, The FTC at Full Strength: What to Expect Next (May 16, 2022), https://www.gibsondunn.com/the-ftc-at-full-strength-what-to-expect-next/.

The following Gibson Dunn lawyers prepared this client alert: Svetlana S. Gans and Brendan Krimsky.

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