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On November 8, 2021 New York Governor Kathy Hochul signed an amendment to the New York Civil Rights Law which requires employers provide notice to employees of electronic monitoring of telephone, email, and internet access and usage. The law, as described briefly below, is scheduled to go into effect on May 7, 2022.

Once effective, the law requires all New York employers (regardless of size) to provide written notice, upon hire, to new employees if the employer does and/or plans to monitor or intercept their telephone or email communications or internet usage. The notice must be in writing (either hard copy or electronic), and it must be acknowledged by new employees. Although employers need not obtain acknowledgements from existing employees, they will be required to post a notice in a “conspicuous place which is readily available for viewing” by existing employees subject to electronic monitoring.

The notice should inform employees that “any and all telephone conversations or transmissions, electronic mail or transmissions, or internet access or usage by an employee by any electronic device or system,” including, but not limited to, “computer, telephone, wire, radio or electromagnetic, photoelectronic or photo-optical systems,” may be subject to monitoring “at any and all times by any lawful means.”

“Conspicuous place” is not defined in the statute.  Therefore, employers who have safe harbor policies in their handbooks allowing electronic monitoring may consider posting a stand-alone notice of their electronic monitoring policy in a place in which employees can easily and readily access and review the policy.

Notably, the law does not apply to processes that:

1. are designed to manage the type or volume of incoming or outgoing electronic mail or telephone voice mail or internet usage;
2. are not targeted to monitor or intercept the activities of a particular individual; and
3. are performed solely for the purpose of computer system maintenance and/or protection.

Violations

There is no private right of action available for violations.  The Office of the New York State Attorney General is tasked with enforcing the law.  Employers who are determined to have violated the law will be subject to fines of up to $500 for the first offense, $1,000 for the second offense, and $3,000 for the third and each subsequent offense.

Takeaway

On or before the effective date (May 7), New York employers who currently and/or plan to conduct electronic monitoring of employees should prepare to provide: (1) an acknowledgement form to new employees upon hire; as well as (2) notice of the electronic monitoring policy to existing employees.

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The following Gibson Dunn attorneys assisted in preparing this client update: Harris Mufson, Danielle Moss, and Lizzy Brilliant.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment practice group, or the following:

Mylan Denerstein – New York (+1 212-351-3850, [email protected])

Gabrielle Levin – New York (+1 212-351-3901, [email protected])

Danielle J. Moss – New York (+1 212-351-6338, [email protected])

Harris M. Mufson – New York (+1 212-351-3805, [email protected])

Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, [email protected])

Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, [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.

In March 2022, the Securities and Exchange Commission approved a rule proposal for new climate change disclosure requirements for both U.S. public companies and foreign private issuers. In this webcast, a panel of Gibson Dunn lawyers provides an overview of the proposed requirements and discuss the key takeaways and the impact the proposal, if adopted, would have on public companies.

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Compared to 2021’s record level deal activity, the first quarter of 2022 has registered a dip in global M&A. Analysts report that for January through March of 2022, global M&A is down by approximately one-fifth relative to the same period last year when measured by both deal value and volume metrics. The total value of pending and completed deals announced in Q1 2022 is the lowest since the second quarter of 2020. Big deals are still being signed, including a range of high profile deals in the largest mega-deal bracket (i.e., deals valued at $10B or more), a category that includes, among others, Microsoft/Activision Blizzard ($68B) and TD Bank/First Horizon ($13.4B). Yet, during the early months of 2022, large and mid-market deals—those valued between $1B and $5B—declined 40% relative to last year.

A host of complex factors influence M&A activity at any given time, from inflation to global conflicts to liquidity factors to prevailing regulatory dynamics. To be sure, the current regulatory climate around antitrust issues presents a challenge for deal makers. Progressive leadership at the Federal Trade Commission (FTC) and the Department of Justice Antitrust Division (DOJ) (together, the Agencies) have articulated and begun to execute a broad anti-consolidation agenda, increasing uncertainty and heightening risk associated with the U.S. merger clearance process. Similar trends are playing out across the global antitrust enforcement community. This shift has implications for the costs, timeline, and business disruption associated with the merger clearance process, particularly in light of the Agencies’ movement towards disfavoring settlements. But unlike many of the factors that contribute to M&A trends, which are exogenous and uncontrollable by deal parties, concerns about antitrust risk can be assessed and managed.

Gibson Dunn is working actively with clients to ensure that unpredictability around the merger control process under the Biden administration does not create unnecessary barriers to lawful M&A transactions. In this climate, the clear and certain allocation of risk and articulation of regulatory obligations in transaction agreements is paramount. Where appropriate, merging parties should prepare to defend their transactions through federal court litigation in the event that the Agencies adopt theories of harm that depart from standing law or are inconsistent with business realities. Finally, parties should give broad consideration to the implications of Agency non-merger enforcement activity (i.e., investigative studies, conduct enforcement actions, and rulemakings) on potential transactions, and vice versa.

Heightened Uncertainty and Risk Associated With Merger Clearance in the U.S. and Beyond

Since coming to leadership, FTC Chair Lina Khan and Assistant Attorney General Jonathan Kanter of the DOJ have pursued a top to bottom reconsideration of the antitrust agenda. Through rulemaking, promises of tougher enforcement activity, and rescission and (eventual) replacement of key policy documents, the Agencies are seeking to broaden antitrust enforcement and, in so doing, discourage M&A activity. These policies stem, in part, from the Agencies’ belief that corporate consolidation has “harmed open markets and fair competition” under overly permissive enforcement regimes in the past decades.

Among the Agencies’ most significant departures from past merger review practice is their reconsideration of the Horizontal Merger Guidelines and withdrawal of the Vertical Merger Guidelines, which they deemed “narrow and outdated.” Historically, agency staff, as well as deal makers and advisors interpreting the merger laws, have relied heavily on the Horizontal Merger Guidelines and, to a lesser extent (due to their recent revision and the less developed state of vertical merger enforcement), the Vertical Merger Guidelines. Now, the relevancy of the past guidelines is in doubt, but the content and scope of new guidelines is also unknown. What is clear from Agency commentary is that new guidelines are likely to substantially expand the scope of merger enforcement and very well may embrace novel and untested theories of harm, including greater scrutiny of “non-horizontal” transactions (e.g., conglomerate mergers and cross market mergers), examination of the incentives created by the involvement of investment firms, and a newfound emphasis on harm to workers and small businesses.

The Agencies’ shifting policy around merger remedies is another source of unpredictability and increased deal risk. In recent remarks, AAG Kanter expressed concern that the Agencies’ historical approach to merger remedies has been ineffective. He went on to say that under his leadership the DOJ may be less willing to resolve competitive concerns through divestitures, particularly when a deal involves “innovative markets” or “evolving business models.” Instead, when enforcers “conclude[] that a merger is likely to lessen competition, in most situations” the Agency “should seek a simple injunction to block the transaction,” rather than trying to cure the harm through divestitures. Accordingly, relative to past practice, merging parties may find the Agencies unreceptive to settlement negotiations. At the least, parties will face more resistance and likely need to offer broader divestiture packages. And even where merger settlements are available, the Agencies have revived the practice of including in consent decrees prior notice and approval requirements in respect of future transactions, with the effect of complicating settlement negotiations and burdening future deals.

Outside of the merger context, the Agencies are taking action that is likely to have second-order effects for M&A. For example, the FTC is actively deploying its Section 6(b) authority, which enables the agency to conduct wide-ranging studies without a specific law enforcement objective. Section 6(b) scrutiny of particularly industries or issues (such as non-reportable technology transactions or particular healthcare sectors) is likely to create obstacles for mergers that coincide with the area of FTC scrutiny. For example, enforcers may be inclined to look more closely at a transaction that relates to an area of active study in order to further their study objectives. In addition, political or PR concerns may enter into the Agencies’ calculus about clearing mergers in an industry that is under active 6(b) scrutiny. The same is true for mergers in industries that are being investigated or prosecuted for anticompetitive practices; such mergers may face more intense and searching scrutiny.

Once the new merger guidelines are issued and AAG Kanter and Chair Khan’s new policies develop a track record of implementation, we will have a more precise understanding of the operative analytical framework and its implications for M&A transactions. But the practical consequences of Chair Khan and AAG’s Kanter’s antitrust rewrite are already playing out and the trajectory is unlikely to change: merging parties are bearing more second request risk, broader and longer investigations, less opportunity to resolve competitive concerns with settlements, and greater risk of enforcement action.

Practical Considerations for Dealmakers and Advisors

In light of antitrust’s gating function, it is fair to question whether the current antitrust climate has to some extent played a role in the Q1 M&A dip. Yet dealmakers have a range of tools to accommodate and manage the risk engendered by the current regulatory environment. Antitrust considerations should be raised in the earliest phases of deal negotiations. As transaction agreements are negotiated, clear articulation of regulatory obligations and risk allocation remains critical in the effort to  keep merging parties aligned and ultimately hold deals together when Agency scrutiny comes to bear. Before agreeing to particular efforts standards in purchase agreements in respect of obtaining antitrust approvals, parties should appreciate the possibility that those efforts standards may ultimately require time-consuming and costly litigation.

In some transactions, merging parties are unwilling to carry on if a second request is issued and their agreement reflects that fact. The signal that such a contractual provision sends to the Agencies and the incentives that it creates should be weighed carefully.

Appreciating that merger reviews are likely to be more time consuming, onerous, and costly (whether because the Agencies require more engagement and advocacy during the first 30 days, require a pull-and-refile, or issue a broad second request), parties should consider building flexibility or extra time into transaction timetables. For cross-border deals that may be subject to scrutiny in jurisdictions that move slowly or, like the U.S., are broadening their approach to merger enforcement, a sophisticated multi-jurisdiction analysis should be conducted early on so that deal timing can be formulated accordingly. The likelihood of protracted reviews should also be contemplated during deal financing.

Transaction rationale and economics should take account of the Agencies’ heightened skepticism of merger remedies and the possibility of the FTC imposing a prior approval clause in those consents that are achievable. Transactions in which divestiture of a full business is feasible will have a better chance of resolving Agency concerns with a remedy, whereas transactions involving dynamic markets are expected to face more settlement resistance.

In light of the FTC’s new practice of warning merging parties that they may keep investigations open beyond the expiration of the HSR Act waiting period, contractual language formulating closing conditions based on the status of antitrust review should be worded precisely. Likewise, in the context of cross-border transactions that must be notified in ex-U.S. jurisdictions that do not have a statutory bar on closing before the review is complete, merging parties should agree as to whether they will close the deal during an ongoing review, with the buyer bearing the risk of future action by competition authorities.

Even deals that do not present any facial competitive issue may face an uncertain regulatory path if the parties do business in a sector that is the subject of Agency interest, as evinced by 6(b) studies, the Executive Order on Promoting Competition in the American Economy, conduct investigations or enforcement activity, or the Agencies’ political agenda. Parties doing deals in these industries should actively consider this layer of risk in consultation with antitrust counsel, so as to ensure that all possible risks are understood and mitigated.

Finally, where possible, merging parties should consider including commitments to litigate in their transaction agreement to signal to the Agencies that they are committed to closing and will not be backed off by onerous second requests or a protracted review. Ultimately, merger guidelines and other enforcement policy statements do not bind federal courts. In the event that the Agencies depart significantly from established law and economics, merging parties may have good prospects of vindicating their deals in federal court.

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Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition or Mergers and Acquisitions practice groups, or the following:

Antitrust and Competition Group:
Sophia A. Vandergrift – Washington, D.C. (+1 202-887-3625, [email protected])
Adam Di Vincenzo – Washington, D.C. (+1 202-887-3704, [email protected])
Kristen C. Limarzi – Washington, D.C. (+1 202-887-3518, [email protected])
Joshua Lipton – Washington, D.C. (+1 202-955-8226, [email protected])
Michael J. Perry – Washington, D.C. (+1 202-887-3558, [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])
Ali Nikpay – Co-Chair, London (+44 (0) 20 7071 4273, [email protected])
Christian Riis-Madsen – Co-Chair, Brussels (+32 2 554 72 05, [email protected])

Mergers and Acquisitions Group:
Eduardo Gallardo – Co-Chair, New York (+1 212-351-3847, [email protected])
Robert B. Little – Co-Chair, Dallas (+1 214-698-3260, [email protected])
Saee Muzumdar – Co-Chair, New York (+1 212-351-3966, [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.

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Decided April 21, 2022

City of Austin, Texas v. Reagan National Advertising of Austin, Inc., No. 20-1029

Today, the Supreme Court held that a regulation treating on-premises signs—those that contain advertisements for the place where the signs are located—differently from off-premises signs is content neutral and therefore not subject to strict scrutiny under the First Amendment.

Background: The Sign Code of Austin, Texas permits the new construction only of signs and billboards that advertise for the place where they are located, which are known as on-premises signs. The Code similarly permits only on-premises signs to be equipped with electronic controls that, for example, allow billboards to cycle through digital advertisements. Advertisers wishing to convert off-premises billboards to digitally changeable displays sued, claiming that the Code discriminates based on the content of their speech in violation of the First Amendment. The Fifth Circuit agreed, holding that because the on-premises/off-premises distinction could be applied only by a person who reads and interprets the sign’s message, the regulation was content-based and subject to strict scrutiny. Finding no compelling government justification, the Fifth Circuit found the Code’s distinction unconstitutional.

Issue: Whether the Sign Code’s distinction between on- and off-premises signs is a content-neutral regulation of speech.

Court’s Holding: The Sign Code’s distinction between on- and off-premises advertisements is facially content-neutral and subject to intermediate scrutiny under the First Amendment. The Court remanded the case to the Fifth Circuit to apply that test, rather than strict scrutiny.

“[H]old[ing] that a regulation cannot be content neutral if it requires reading the sign at issue[ ] is too extreme an interpretation of this Court’s precedent.”

Justice Sotomayor, writing for the Court

What It Means:

• The Court’s decision clarifies that its 2015 case, Reed v. Town of Gilbert, does not hold that restrictions are content-based every time they require an official to read a sign to determine whether it complies with a regulation.  According to the Court, Reed involved “a very different regulatory scheme” that placed stricter limitations on some types of signs compared to others—for instance, by placing more restrictions on advertisements for religious services than on political messages.  In this case, by contrast, the “sign’s substantive message is irrelevant to the application of” the on-premises/off-premises distinction.
• The Court noted that regulations like Austin’s Sign Code are common, including in provisions of the federal Highway Beautification Act.  It expressed reluctance to question these rules where authorities claim they are necessary to combat distracted driving and reduce blight, and where an “unbroken tradition of on-/off-premises distinctions counsels against” invalidating the rule.
• The decision subjects regulations like Austin’s to intermediate scrutiny, which requires the government to show that the rule does not excessively restrict speech and serves an important government interest.  The Court reserved judgment on whether the Code would satisfy that test.
• In a dissenting opinion joined by Justices Gorsuch and Barrett, Justice Thomas wrote that the Court had departed from Reed’s “clear and neutral rule” that regulation of signs is content-based whenever enforcing the rule requires determining whether a sign conveys a particular message.  He predicted that the departure from Reed’s “bright-line rule” will lead to future confusion.

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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

Allyson N. Ho +1 214.698.3233 [email protected]	Thomas H. Dupree Jr. +1 202.955.8547 [email protected]	Julian W. Poon +1 213.229.7758 [email protected]
Lucas C. Townsend +1 202.887.3731 [email protected]	Bradley J. Hamburger +1 213.229.7658 [email protected]

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Decided April 21, 2022

Boechler, P.C. v. Commissioner of Internal Revenue, No. 20-1472

Today, the Supreme Court unanimously held that the Internal Revenue Code’s 30-day deadline for taxpayers to seek Tax Court review of “collection due process” determinations is a nonjurisdictional claims-processing rule that is subject to equitable tolling.

Background: When the IRS assesses a tax and the taxpayer doesn’t pay, the IRS can seize the taxpayer’s property to satisfy the outstanding amount. Since 1998, Congress has required the IRS to give advance notice to taxpayers before it levies their property to cover unpaid taxes. Taxpayers can challenge a proposed levy in an administrative hearing before the IRS’s Independent Office of Appeals, which issues the taxpayer a notice of determination stating its findings and decision. And the Internal Revenue Code provides that a taxpayer “may, within 30 days of a determination [from the Independent Office of Appeals], appeal such determination to the Tax Court (and the Tax Court shall have jurisdiction with respect to such matter).” 26 U.S.C. § 6330(d)(1).

Boechler, P.C. received an unfavorable determination from the IRS’s Independent Office of Appeals on a proposed levy but petitioned the Tax Court for review one day after the thirty-day deadline. The Eighth Circuit held that § 6330(d)(1)’s 30-day deadline is jurisdictional, meaning it could not be subject to equitable tolling.

Issue: Is § 6330(d)(1)’s 30-day deadline a jurisdictional requirement or a nonjurisdictional claims-processing rule? If it is a claims-processing rule, is it mandatory or subject to equitable tolling?

Court’s Holding: Section 6330(d)(1) is a nonjurisdictional claims-processing rule and is subject to equitable tolling.

“[The] 30-day time limit to file a petition for review of a collection due process determination is an ordinary, nonjurisdictional deadline subject to equitable tolling.”

Justice Barrett, writing for the Court

What It Means: 

• The Court’s decision reinforces the principle that filing deadlines are generally not jurisdictional unless the statute’s text or structure provides a clear statement to the contrary. In rejecting the Commissioner’s arguments, the Court reasoned that ambiguity in the text left “multiple plausible interpretations” and thus no clear statement of jurisdictional intent.
• The decision likewise confirms that nonjurisdictional filing deadlines are “presumptively subject to equitable tolling,” particularly where the statutory framework in question is likely to produce circumstances warranting exceptions to a statutory deadline—for instance, where the provision appears as part of a scheme in which unrepresented parties often initiate the process.
• The Court’s holding provides taxpayers with a limited opportunity to seek judicial review of unfavorable collection due process determinations even when they fail to petition the Tax Court for review within 30 days of the determination. That holding is consistent with the statute’s underlying purpose, which was to give taxpayers a way to seek administrative and judicial review before the IRS took the serious step of levying their property to satisfy unpaid taxes.
• The Court did not elaborate on the circumstances in which it would be appropriate for courts to toll § 6330(d)(1)’s 30-day deadline, leaving those arguments for further proceedings on remand. Lower courts are likely to encounter arguments for tolling featuring a wide variety of factual scenarios, including with respect to lower-income taxpayers, many of whom do not have counsel in collection due process proceedings.
• While the Court’s holding is limited to the deadline under § 6330(d)(1) for filing a collection due process case, the decision specifically calls into question a long line of cases holding that the 90-day deadline for invoking the Tax Court’s general deficiency jurisdiction under 26 U.S.C. § 6213(a) is jurisdictional. Section 6213(a) applies broadly when a taxpayer seeks to challenge an IRS audit determination or other income tax adjustment in Tax Court. Of the more than 150 million income tax returns filed each year, the IRS has historically issued far more than one million such adjustments, typically resulting in around 25,000 cases filed in Tax Court. If, following the Court’s holding, § 6213(a) is also found to be nonjurisdictional, it could open the door for a large number of taxpayers to argue for equitable tolling when they miss the 90-day general filing deadline.

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The Court’s opinion is available here.

Appellate and Constitutional Law Practice

Allyson N. Ho +1 214.698.3233 [email protected]	Thomas H. Dupree Jr. +1 202.955.8547 [email protected]	Julian W. Poon +1 213.229.7758 [email protected]
Bradley J. Hamburger +1 213.229.7658 [email protected]

Related Practice: Global Tax Controversy and Litigation

Michael J. Desmond +1 213.229.7531 [email protected]	Saul Mezei +1 202.955.8693 [email protected]	Sanford W. Stark +1 202.887.3650 [email protected]
C. Terrell Ussing +1 202.887.3612 [email protected]

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In March 2022, amidst an array of new proposals for sustainable products (including a proposed draft Regulation on Ecodesign for Sustainable Products) the European Commission announced an EU Strategy for Circular and Sustainable Textiles.

The Strategy envisages that “By 2030, textile products placed on the EU market are long-lived and recyclable, to a great extent made of recycled fibres, free of hazardous substances and produced in respect of social rights and the environment. Consumers benefit longer from high quality affordable textiles, fast fashion is out of fashion, and economically profitable re-use and repair services are widely available…..producers take responsibility for their products along the value chain, including when they become waste,…. incineration and landfilling of textiles is reduced to the minimum”.

The EC envisages numerous steps to achieve this strategy, including:

• Binding product-specific ecodesign requirements to increase durability, reusability, repairability and recyclability, and to address the unintentional release of microplastics in the environment.
• Development of criteria for safe and sustainable chemicals and materials- to reduce the presence of hazardous substances used in textile products.
• Introduction of a transparency obligation requiring large companies to publicly disclose the number of products they discard and destroy, including textiles.
• Introduction of a Digital Product Passport for textiles-based on mandatory information requirements on circularity and other key environmental aspects.
• Increased information and transparency for consumers at the point of sale, regarding the sustainability credentials of products.
• Extended producer responsibility requirements for textiles.

According to the EC’s Strategy Communication, the textiles and clothing sector comprises more than 160,000 companies and employs 1.5 million people, generating a turnover of EUR 162 billion in 2019. Global textile production has almost doubled between 2000 and 2015, with the consumption of clothing and footwear expected to increase by 63% by 2030, from 62 million tonnes now, to 102 million tonnes in 2030. The EC flags that in the EU, the consumption of textiles, most of which are imported, now accounts on average for the fourth highest negative impact on the environment and on climate change and third highest for water and land use from a global life cycle perspective. In circumstances where approximately 5.8 million tonnes of textiles are discarded every year in the EU, the impact of this Strategy could be significant.

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On 31 March 2022, the Hong Kong Securities and Futures Commission (“SFC”) released a new circular to licensed corporations (“LCs”) on the handling of client complaints,[1] alongside an Appendix setting out the SFC’s expected regulatory standards and suggested techniques and procedures for handling client complaints (collectively, the “Circular”).[2]

This client alert covers the key regulatory expectations imposed on LCs under the Circular and highlights suggested practices that LCs can adopt in order to meet these expectations. In particular, as discussed further below, the Circular continues the SFC’s increasing shift towards requiring LCs to allocate one or more of their Managers-in-Charge (“MIC”) with responsibility for a particular subject matter, by requiring the appointment of an MIC to oversee complaints handling. This follows the SFC’s October 2019 circular requiring LCs to appoint an MIC with specific responsibility for the use of external electronic data storage providers[3] and the June 2021 circular requiring LCs to appoint an MIC or responsible officer (“RO”) with specific responsibility for the operation of the LC’s bank accounts.[4] Further, by providing more granular and prescriptive guidance to LCs in relation to complaints handling, and in particular the expected timeframe for handling complaints, the Circular represents an important step towards alignment of regulatory standards in this area between LCs and authorized institutions which must comply with the HKMA’s Supervisory Policy Manual IC-4 (“SPM”).[5]

I. The SFC’s existing requirements for complaint handling

Paragraph 12.3 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code”)[6] sets out the standard of compliance expected of LCs with regards to complaint handling. In short, the Code requires LCs to handle complaints in a
“timely and appropriate manner”, to properly review the subject matter of the complaint, and to respond “promptly” to the complaints.

Similarly, Part V(5) of the Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the Securities and Futures Commission (the “Internal Control Guidelines”)[7] requires the management of LCs to establish, maintain and enforce “policies and procedures to ensure the proper handling of complaints from clients and that appropriate remedial action is promptly taken.”

The SFC’s new Circular supplements both the Code and Internal Control Guidelines, and provides important guidance and detail as to the SFC’s expectations of how LCs should adhere to the requirements set out in the Code and Internal Control Guidelines. In other words, compliance with the Circular is now required in order to ensure compliance with the Code and Internal Control Guidelines. As such, we strongly encourage LCs to adopt the suggested techniques and procedures laid out under the Circular as soon as practicable.

The Circular covers six key areas in relation to handling client complaints: (i) management oversight and complaint handling policies and procedures; (ii) disclosure of complaint handling procedures; (iii) identification and escalation of complaints; (iv) investigating complaints; (v) communicating outcomes with clients; and (vi) record keeping.

II. Responsibilities of senior management

The Circular emphasizes that senior management of LCs bear “primary responsibility” for ensuring appropriate standards of conduct and adherence to proper policies and procedures. As such, the SFC has indicated that LCs should designate a MIC to oversee complaint handling, including the setup, implementation and monitoring of complaint handling policies and process. Further, the Circular encourages LCs to ensure that regular reports on the progress of complaints handling are  made to senior management, with the SFC praising LCs which provided their senior management with reports on the types of complaints received, adherence to timelines, investigation results, remedial measures identified from investigations, and the implementation status thereof.

The SFC has also indicated that senior management should ensure that:

• LCs with large retail client bases dedicate sufficient resources to ensure proper governance over complaint handling, including through, for example, complaints committees staffed by MICs and ROs;
• at the conclusion of an investigation of a complaint, any remedial measures identified are promptly implemented so as to prevent the recurrence of similar issues; and
• regular training is provided to staff in relation to complaint handling techniques.

III. Complaint handling policies and procedures

The Internal Control Guidelines require LCs to set out their complaint handling policies and procedures in writing. The Circular supplements this by noting that LCs should ensure that their complaints handling policies set out:

• the expected timeframe for acknowledging the complaint upon receipt;
• responding to the complainant’s enquiries in relation to the complaint;
• providing a final response to the complaint.

Further, the Circular notes that while the timeframe required will vary depending on the nature of the complaint, as a rule of thumb, an acknowledgment of a complaint should be issued within seven days of receipt and a final response should be issued within two months. This is broadly consistent with the HKMA’s SPM which requires authorized institutions to provide an acknowledgment of receipt within seven days, and a final response within thirty days, or, if that is not possible, within a “reasonable period of time” (which the HKMA considers to be no longer than sixty days).

In order to preserve objectivity in investigations and to avoid potential conflict of interests, the SFC has also encouraged LCs to ensure that complaints are handled by compliance staff who are not directly involved in the subject matter of complaints.

IV. Disclosure of complaint handling procedures to clients in a clear, understandable manner

The Circular states that at a minimum, LCs should disclose key information about the different methods of lodging a complaint to the LC (for example, by email, telephone, letter, etc.); and the expected timeframe for processing the complaint under normal circumstances. However, the SFC has stopped short of mandating the manner in which this information must be conveyed, with the Circular noting that this standard of disclosure will be met as long as the required information is effectively conveyed to complainants. This may include, for example, posting the information in a prominent place on LC’s website, or to providing a leaflet with the necessary information to the client during account opening or upon receipt of their complaint.

V. Identification and escalation of complaints

The Code requires LCs to differentiate general enquiries from complaints for the purpose of ensuring compliance with the self-reporting requirements set out in para 12.5(a) of the Code. The Circular builds on this by:

• requiring the escalation of any serious or high-impact cases to senior management for prompt handling, including self-reporting to the SFC under para 12.5(a) where appropriate. The Circular suggests that this category of serious or high impact cases includes those involving fraud, staff misconduct, mass complaints involving multiple clients complaining about the same or similar issues, as well as those involving significant financial losses to clients or which may cause significant financial, operational and reputational risks for the LC; and
• recommending the provision of guidelines for staff to distinguish between the different nature and seriousness of complaints.

Further, the Circular also encourages LCs to regularly monitor feedback channels to ensure that all complaints are detected; for instance, by sample-checking tape recordings of telephone conversations between clients and customer service staff.

VI. Investigating complaints

The Circular notes that LCs should:

• properly review the subject matter of each complaint;
• maintain guidelines on when and how a complaint can be closed, including circumstances under which a complaint can be closed, and the approval procedures for different types of resolutions; and
• offer appropriate, consistent and fair resolutions to complainants; for example, where issues complained thereof are recurring or systematic, LCs should dig into the root causes of the problem rather than investigating at surface-level.

VII. Communicating outcomes to clients

LCs are expected to communicate their investigation results to complainants promptly and in doing so provide a clear description of the outcome of the investigation (i.e. whether the complaint is accepted or rejected, and any redress offered), alongside with an explanation of the outcome. The Circular further requires LCs to advise clients of any further steps which may be available to them where a complaint is not remedied promptly, including the right to refer a dispute to the Financial Dispute Resolution Centre.

VIII. Record keeping

The Internal Control Guidelines require LCs to keep proper records of all complainants and their complaints. The Circular extends this requirement by demanding LCs to review such records on a regular basis and to make them available to the SFC upon request during its ad hoc and routine reviews. While the Circular does provide LCs with some degree of flexibility by noting that LCs may adopt a pragmatic approach in deciding the level of detail to be retained in record-keeping, the Circular does also note that:

• complaint records will generally not be complete without details of the substance of the complaint and how it was resolved;
• details of follow up actions should be kept for any complaints relating to client assets; and
• a register of complaints should be made available to the SFC upon request.

IX. Conclusion

The Circular should be viewed as consistent with the SFC’s continued prioritization of senior management accountability as well as investor protection. As such LCs are encouraged to pay close attention to the SFC’s views and expectations as set out in the Circular and adopt appropriate implementation measures as soon as practicable.

________________________

   [1]   Circular to Licensed Corporations Handling of Client Complaints (31 March 2022), published by the Securities and Futures Commission, available at https://apps.sfc.hk/edistributionWeb/api/circular/openFile?lang=EN&refNo=22EC30.

   [2]   Expected Regulatory Standards and Suggested Techniques and Procedures for Handling Client Complaints (31 March 2022), published by the Securities and Futures Commission, available at https://apps.sfc.hk/edistributionWeb/api/circular/openAppendix?lang=EN&refNo=22EC30&appendix=0.

   [3]   Circular to Licensed Corporations – Use of external electronic data storage (31 Oct 2019), published by the Securities and Futures Commission, available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/intermediaries/supervision/doc?refNo=19EC59.

   [4]   Circular to licensed corporations Operation of bank accounts (28 June 2021), published by the Securities and Futures Commission, available at https://apps.sfc.hk/edistributionWeb/api/circular/openFile?lang=EN&refNo=21EC25.

   [5]   Supervisory Policy Manual IC-4 Complaints Handling Procedures (22 February 2002), published by the Hong Kong Monetary Authority, available at https://www.hkma.gov.hk/media/eng/doc/key-information/guidelines-and-circular/2002/IC-4.pdf.

   [6]   Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission, 27th edition (December 2020), published by the Securities and Futures Commission, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-commission/Code_of_conduct-Dec-2020_Eng.pdf.

   [7]   Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the Securities and Futures Commission (April 2003), published by the Securities and Futures Commission, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/management-supervision-and-internal-control-gu/management-supervision-and-internal-control-guidelines-for-persons-licensed.pdf.

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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.

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On March 30, 2022, the U.S. Securities and Exchange Commission (the “Commission”), by a three-to-one vote, issued a press release announcing proposed new rules (the “Proposal”) intended to enhance disclosure and investor protections in initial public offerings (“IPO”) by special purpose acquisition companies (“SPACs”) and in subsequent business combinations between SPACs and private operating companies (“de-SPAC transaction”).[1]

The Proposal provides a lengthy and comprehensive discussion that builds upon the Commission’s prior statements and actions regarding SPAC IPOs and de-SPAC transactions.[2] As noted by the Commission’s Chair, Gary Gensler, in the press release, the Proposal is intended to “help ensure” that “disclosure[,] standards for marketing practices[,] and gatekeeper and issuer obligations,” as applied in the traditional IPO context, also apply to SPACs.[3]  Chair Gensler further noted that “[f]unctionally, the SPAC target IPO is being used as an alternative means to conduct an IPO.”[4]

Overview

There are four key components of the Proposed Rules:

• Disclosure and Investor Protection. Proposes specific disclosure requirements with respect to, among other things, compensation paid to sponsors, potential conflicts of interest, dilution, and the fairness of the business combination, for both the SPAC IPOs and de‑SPAC transactions;
• Business Combinations Involving Shell Companies. Deems a business combination transaction involving a reporting shell company and a private operating company as a “sale” of securities under the Securities Act of 1933, as amended (the “Securities Act”), amends the financial statement requirements applicable to transactions involving shell companies, and amends the current “blank check company” definition to make clear that SPACs cannot rely on the safe harbor provision under the Private Securities Litigation Reform Act of 1995, as amended (the “PSLRA”) when marketing a de-SPAC transaction;
• Projections. Expands and updates the Commission’s guidance on the presentation of projections in filings with the Commission to address the reliability of such projections; and
• New Safe Harbor under the Investment Company Act of 1940. Proposes a safe harbor that SPACs may rely on to avoid being subject to registration as investment companies under the Investment Company Act of 1940, as amended (the “Investment Company Act”).  The safe harbor would (i) require SPACs to hold only assets comprising of cash, government securities, or certain money market funds; (ii) require the surviving entity to be engaged primarily in the business of the target company; and (iii) impose a time limit, from the SPAC IPO, of 18 months for the announcement (and 24 months for the completion) of the de-SPAC transaction.

We provide below our key takeaways, a summary of the Proposal, links to Commissioner statements regarding the Proposal, and a note regarding the comment period and process.

Key Takeaways

Below are the key takeaways from the Proposal:

• Timing. Although the proposed rules will not be in effect unless and until the Commission approves final rules after the public comment period and the Commission’s review process, existing SPACs and their targets should expect to receive comments from the Commission staff along the broader lines of the Proposal. SPACs and their targets also should consider the extent to which they will want to comply voluntarily with some of the proposed rules, especially those focused on financial statement requirements and enhanced disclosures.
• Conforming SPACs to Traditional IPOs. The Proposal goes to great lengths to contrast the current SPAC regulatory regime against the one applicable to traditional IPOs and to seek to “level” the playing field between the two.  Closer alignment of the two regimes may reduce some potential benefits of a de-SPAC transaction (e.g., availability of alternative financing sources and expedited path to becoming a public company) while also exposing the SPAC, its target and their advisors to additional liability.
• No PSLRA Protection. PSLRA safe harbor against a private right of action for forward-looking statements is not available in, among others, an offering by a blank check company or a “penny stock” issuer, or in an initial public offering.  Some market participants believe the PSLRA safe harbor is otherwise available in de-SPAC transactions when a SPAC is not a blank check company under Rule 419.  The Commission proposes to amend the current “blank check company” definition to remove the “penny stock” condition and make clear that SPACs may no longer rely on the safe harbor provision under the PSLRA as it relates to the use of projections and other forward-looking statements when marketing a de-SPAC transaction.  If the Proposal is adopted, it is unclear whether the lack of the PSLRA safe harbor, especially if coupled with proposed changes to regulations relating to projections, will lead to changes in the presentation of projections and assumptions, or the abandonment of projections.  If the latter, this could effectively eliminate the de-SPAC transaction as an alternative for target companies that do not have a lengthy operating history.
• Co-Registrant Liability. The Proposal would include target companies and their officers and directors as co-registrants under Form S-4 and Form F-4 filings, thus imposing Section 11 liability on such persons.  Liability will extend to both SPAC and target company disclosures contained in such filings.
• Extension of Current Disclosure Guidance (Projections, Dilution, Sponsor, Conflicts). Much of the Proposal is simply an extension of current guidance and practice by the Commission.  The Proposal does require additional information and specificity (in some cases, beyond current rules and guidance).  Nonetheless, some of the prescriptive rulemakings around enhanced disclosures—including the required financial statements, disclosure of sources of dilution, sponsor control and relationships, and potential conflicts of interest—are based on existing rules and guidance, and should not be particularly novel for practitioners.
• Fairness to Shareholders. The Proposal does not go as far as requiring a SPAC board to obtain a fairness opinion, although that seems the likely, practical outcome of the Proposal, since it requires more fulsome discussion of these matters and a determination by the board of directors of a SPAC regarding its reasonable belief as to the fairness of a de-SPAC transaction and related financings to the SPAC’s shareholders when approving a de-SPAC transaction.  Studies have indicated that only 15% of de-SPAC transactions disclose that they were supported by fairness opinions (compared to 85% of traditional mergers and acquisitions, excluding de-SPAC transactions).[5]  If the Proposal is adopted, a SPAC’s board of directors will need to consider obtaining a fairness opinion, and whether or not it obtains a fairness opinion, the bases for the SPAC’s reasonable belief as to the fairness of the transaction.
• Underwriter Liability. The Commission seeks to extend underwriter status (and resulting potential liability) in the de-SPAC transaction to those underwriters to SPAC IPOs involved, directly or indirectly, in the de-SPAC transaction (e.g., advisory services, placement agent services, and other activities related to the de-SPAC transaction would all be considered direct and indirect activities).  Underwriters to SPAC IPOs who participate in the de-SPAC transaction will need to consider whether to make changes to the typical de-SPAC transaction process, to ensure they have the benefit of their due diligence defense.
• SPAC Time Limits. In order to rely on a proposed safe harbor for SPACs under the Investment Company Act, SPACs would have a limited time period of no later than 18 months to announce a de-SPAC transaction (and no later than 24 months to complete a de-SPAC transaction) following the effective date of the SPAC’s registration statement for its IPO.  This would remove SPACs’ flexibility to seek extensions from its shareholders to their required liquidation date without running the risk of being considered to be an investment company subject to registration and regulation under the Investment Company Act.

Proposal Summary

New Subpart 1600 of Regulation S-K

The Proposal would create a new Subpart 1600 of Regulation S-K solely related to SPAC IPOs and de-SPAC transactions.  Among other things, this new Subpart 1600 would prescribe specific disclosure about the sponsor, potential conflicts of interest, and dilution.

Sponsor, Affiliates, and Promoters

To provide investors with a more complete understanding of the role of SPAC sponsors, affiliates, and promoters,[6] the Commission is proposing a new Item 1603(a) of Regulation S-K, to require:

• Experience. Description of the experience, material roles, and responsibilities of sponsors, affiliates, and promoters.
• Arrangements. Discussion of any agreement, arrangement, or understanding (i) between the sponsor and the SPAC, its executive officers, directors, or affiliates, in determining whether to proceed with a de-SPAC transaction and (ii) regarding the redemption of outstanding securities.
• Sponsor Control. Discussion of the controlling persons of the sponsor and any persons who have direct or indirect material interests in the sponsor, as well as an organizational chart that shows the relationship between the SPAC, the sponsor, and the sponsor’s affiliates.
• Lock-Ups. A table describing the material terms of any lock-up agreements with the sponsor and its affiliates.
• Compensation. Discussion of the nature and amounts of all compensation that has been or will be awarded to, earned by, or paid to the sponsor, its affiliates, and any promoters for all services rendered in all capacities to the SPAC and its affiliates, as well as the nature and amounts of any reimbursements to be paid to the sponsor, its affiliates, and any promoters upon the completion of a de-SPAC transaction.

Potential Conflicts of Interest

To provide investors with a more complete understanding of the potential conflicts of interest between (i) the sponsor or its affiliates or the SPAC’s officers, directors, or promoters, and (ii) unaffiliated security holders, the Commission is proposing a new Item 1603(b) of Regulation S-K.  This would include a discussion of conflicts arising as a result of a determination to proceed with a de-SPAC transaction and from the manner in which a SPAC compensates the sponsor or the SPAC’s executive officers and directors, or the manner in which the sponsor compensates its own executive officers and directors.

Relatedly, proposed Item 1603(c) of Regulation S-K would require disclosure of the fiduciary duties that each officer and director of a SPAC owes to other companies.

Sources of Dilution

In an effort to conform and enhance disclosure relating to dilution in SPAC IPOs and de-SPAC transactions, the Commission is proposing proposed Items 1602 and 1604 of Regulation S-K, respectively.

• IPO Dilution Disclosure. In providing disclosure pursuant to Item 506, SPACs currently provide prospective investors with estimates of dilution as a function of the difference between the initial public offering price and the pro forma net tangible book value per share after the offering, often including an assumption of the maximum number of shares eligible for redemption in a de-SPAC transaction.  The Proposal would require additional granularity on the prospectus cover page, requiring SPACs to present redemption scenarios in quartiles up to the maximum redemption scenario.  In addition to changes to the cover page, the Proposal would supplement Item 506 disclosure by requiring a description of material potential sources of future dilution following a SPAC’s initial public offering, as well as tabular disclosure of the amount of potential future dilution from the public offering price that will be absorbed by non-redeeming SPAC shareholders, to the extent quantifiable.
• De-SPAC Dilution Disclosure. In addition to disclosure at the IPO stage of a SPAC’s lifecycle, the Proposal would require additional disclosure regarding material potential sources of dilution as a result of the de-SPAC transaction.[7]  As seen in recent comment letters by the Commission, the Commission has requested additional granularity with respect to post-closing pro forma ownership disclosure, often requiring various redemption thresholds and the effects of potential sources of dilution.  The Proposal would codify this practice by requiring SPACs to affirmatively provide a sensitivity analysis in a tabular format that expresses the amount of potential dilution under a range of reasonably likely redemption levels.  The Proposal does not specify what are “reasonably likely” redemption levels, but looking at the proposed SPAC IPO dilution requirements (as discussed above), quartile disclosure up to the maximum redemption scenario may be acceptable.

Fairness of the De-SPAC Transaction and Related Financings

SPACs would be required to disclose whether their board of directors reasonably believes that the de-SPAC transaction and any related financing transaction are fair or unfair to the SPAC’s unaffiliated security holders, as well as a discussion of the bases for this statement.  Proposed Item 1606 of Regulation S-K would require a discussion, “in reasonable detail,” of the material factors upon which a reasonable belief regarding the fairness of a de-SPAC transaction and any related financing transaction is based, and, to the extent practicable, the weight assigned to each factor.  As noted by Commissioner Hester M. Peirce, “[w]hile this disclosure requirement technically does not require a SPAC board to hire third parties to conduct analyses and prepare a fairness opinion, the proposed rules clearly contemplate that this is the likely outcome of the new requirement.  For example, [proposed Item 1606] would require disclosure of whether ‘an unaffiliated representative’ has been retained to either negotiate the de-SPAC transaction or prepare a fairness opinion and [proposed Item 1607] would elicit disclosures about ‘any report, opinion, or appraisal from an outside party relating to . . . the fairness of the de-SPAC transaction.’”[8]

Relatedly, if any director voted against, or abstained from voting on, approval of the de-SPAC transaction or any related financing transaction, SPACs would be required to identify the director, and indicate, if known, after making reasonable inquiry, the reasons for the vote against the transaction or abstention.

Aligning De-SPAC Transactions with IPOs

Target Company as Co-Registrant

Under the current rules, only the SPAC and its officers and directors are required to sign the registration statement and are liable for material misstatements or omissions.  The Proposal would require the target company to be treated as a co-registrant with the SPAC when a Form S‑4 or Form F‑4 registration statement is filed by the SPAC in connection with a de-SPAC transaction.[9]  Registrant status for a target company and its officers and directors would result in such parties being liable for material misstatements or omissions pursuant to Section 11 of the Securities Act.  Under the Proposal, target companies and their officers and directors would be liable with respect to their own material misstatements or omissions, as well as any material misstatements or omissions made by the SPAC or its officers and directors.  As a result, the Proposal seeks to further incentivize target companies and SPACs to be diligent in monitoring each other’s disclosure.

Smaller Reporting Company Status

Currently, de-SPAC companies are able to avail themselves – as almost all SPACs have done since 2016[10] – of the smaller reporting company rules for at least a year following the de-SPAC transaction (and most SPACs would still retain this status at the time of the de-SPAC transaction when the SPAC is the legal acquirer of the target company).  The “smaller reporting company” status benefits the combined company after the de-SPAC transaction by availing it of scaled disclosure and other accommodations as it adjusts to being a public company.

Citing the disparate treatment between traditional IPO companies and de-SPAC companies (the former having to determine smaller reporting company status at the time it files its initial registration statement and the latter retaining the SPAC’s smaller reporting company status until the next annual determination date), the Proposal would require de-SPAC companies to determine compliance with the public float threshold (i.e., public float of (i) less than $250 million, or (ii) in addition to annual revenues less than $100 million, less than $700 million or no public float)[11] within four business days after the consummation of the de-SPAC transaction.

The revenue threshold would be determined by using the annual revenues of the target company as of the most recently completed fiscal year for which audited financial statements are available, and the de-SPAC company would then reflect this re-determination in its first periodic report following the closing of the de-SPAC transaction.

The Commission estimates that an average of 50 post-business combination companies following a de-SPAC transaction will no longer qualify as smaller reporting companies, when compared to current rules.[12]  Studies have indicated that the average size of a de-SPAC company has consistently remained north of $1 billion in 2021.[13]  Assuming this trend continues, there is an expectation that an increasing number of target companies will no longer qualify as smaller reporting companies after the de-SPAC transaction, and will need to adapt toward the enhanced public disclosure requirements.  This would include faster additional board and management training to prepare the post-de-SPAC company for additional disclosure requirements.

PSLRA Safe Harbor

The PSLRA provides a safe harbor for forward-looking statements under the Securities Act and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under which a company is protected from liability for forward-looking statements in any private right of action under the Securities Act or Exchange Act when, among other things, the forward-looking statement is identified as such and is accompanied by meaningful cautionary statements.

The safe harbor, however, is not available when the forward looking statement is made in connection with an offering by a “blank check company,” a company that is (i) a development stage company with no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person, and (ii) is issuing “penny stock.”[14]

Because of the penny stock requirement, many practitioners have considered SPACs to be excluded from the definition of blank check company for purposes of the PSLRA safe harbor.  The Proposal seeks to amend the current definition of “blank check company” to remove the penny stock requirement, thus effectively removing a SPAC’s ability to qualify for the PSLRA safe harbor provision for the de-SPAC transaction.

This inability to rely on the PSLRA is coupled with the Proposal’s addition of new and modified projections disclosure requirements (as further discussed below).  If the Proposal is adopted, it remains unclear whether that will lead to changes in projections and assumptions (especially considering the current environment where market participants, investors, and financiers have come to expect detailed projections disclosure, similar to what is used in public merger and acquisitions (“M&A”) transactions), or the abandonment of projections. The latter could effectively eliminate the de-SPAC transaction as an alternative for target companies that do not have a lengthy operating history.

Underwriter Status and Liability

Historically, Section 11 and Section 12(a)(2) of the Securities Act[15] have imposed underwriter liability on underwriters of a SPAC’s IPO.  The Proposal takes a novel approach in arriving at the conclusion that a de-SPAC transaction would constitute a “distribution” under applicable underwriter regulations and seeks to extend such underwriter liability to a de-SPAC transaction.  Proposed Rule 140a would deem a SPAC IPO underwriter to be an underwriter in the de-SPAC transaction, provided that such party is engaged in certain de-SPAC activities or compensation arrangements.

Specifically, an underwriter in a SPAC’s IPO would be deemed an underwriter for purposes of a de-SPAC transaction if such person “takes steps to facilitate the de-SPAC transaction, or any related financing transaction, or otherwise participates (directly or indirectly) in the de-SPAC transaction,” including if such entities are (i) serving as financial advisor, (ii) identifying potential target companies, (iii) negotiating merger terms, or (iv) serving as a placement agent in private investments in public equity (“PIPE”) or other alternative financing transactions.

While Proposed Rule 140a only addresses “underwriter” status in de-SPAC transactions with respect to those serving as underwriters to the SPAC’s IPO, the Commission leaves open the door for subsequent determinations for finding additional “statutory underwriters” in a de-SPAC transaction, suggesting that “financial advisors, PIPE investors, or other advisors, depending on the circumstances, may be deemed statutory underwriters in connection with a de-SPAC transaction if they are purchasing from an issuer ‘with a view to’ distribution, are selling ‘for an issuer,’ and/or are ‘participating’ in a distribution.”[16]

In addition to the potential chilling effect that underwriter status may have on financial institutions’ participation in a de-SPAC transaction, the Commission’s statement that other “statutory underwriters” may be designated in the future, coupled with the traditional “due diligence” defenses of underwriters,[17] suggests that SPACs and target companies should expect extensive diligence requests from financial institutions, advisors, and their counsel in connection with a de-SPAC transaction and other related changes to the de-SPAC transaction process that add complexity, time, and cost.

Business Combinations Involving Shell Companies

The Commission’s concern related to private companies becoming U.S. public companies via de-SPAC transactions is substantially related to the opportunity for such private companies “to avoid the disclosure, liability, and other provisions applicable to traditional registered offerings.”[18]

Proposed Rule 145a

Based on the structure of certain de-SPAC transactions, the Commission expressed concern that, unlike investors in transaction structures in which the Securities Act applies (and a registration statement would be filed, absent an exemption), investors in reporting shell companies may not always receive the disclosures and other protection afforded by the Securities Act at the time the change in the nature of their investment occurs, due to the business combination involving another entity that is not a shell company.

Proposed Rule 145a intends to address the issue by deeming any direct or indirect business combination of a reporting shell company involving another entity that is not a shell company to involve “an offer, offer to sell, offer for sale, or sale within the meaning of section 2(a)(2) of the [Securities] Act.”[19]  By deeming such transaction to be a “sale” of securities for the purposes of the Securities Act, the Proposal is intended to address potential disparities in the disclosure and liability protections available to shareholders of reporting shell companies, depending on the transaction structure deployed.

Proposed Rule 145a defines a reporting shell company as a company (other than an asset-backed issuer as defined in Item 1101(b) of Regulation AB) that has:

1. no or nominal operations;
2. either:
   
   1. no or nominal assets;
   2. assets consisting solely of cash and cash equivalents; or
   3. assets consisting of any amount of cash and cash equivalents and nominal other assets; and
3. an obligation to file reports under Section 13 or Section 15(d) of the Exchange Act.

The Proposal notes that the sales covered by Proposed Rule 145a would not be covered by the exemption provided under Section 3(a)(9) of the Securities Act, because the exchange of securities would not be exclusively with the reporting shell company’s existing security holders, but also would include the private company’s existing security holders.

Financial Statement Requirements in Business Combination Transactions Involving Shell Companies

The Proposal amends the financial statements required to be provided in a business combination with an intention to bridge the gap between such financial statements and the financial statements required to be provided in an IPO.  The Commission views such Proposal as simply codifying “current staff guidance for transactions involving shell companies.”[20]

Number of Years of Financial Statements

Proposed Rule 15-01(b) would require a registration statement for a de-SPAC transaction where the target business will be a predecessor to the SPAC registrant to include the same financial statements for that business as would be required in a Securities Act registration statement for an IPO of that business.

Audit Requirements of Predecessor

Proposed Rule 15-01(a) would require the examination of the financial statements of a business that will be a predecessor to a shell company to be audited by an independent accountant in accordance with the standards of the Public Company Accounting Oversight Board (“PCAOB”) for the purpose of expressing an opinion, to the same extent as a registrant would be audited for an IPO, effectively codifying the staff’s existing guidance.[21]

Age of Financial Statements of the Predecessor

Proposed Rule 15-01(c) would provide for the age of the financial statements of a private operating company as predecessor to be based on whether such private company would qualify as a smaller reporting company in a traditional IPO process, ultimately aligning with the financial statement requirements in a traditional IPO.

Acquisitions of Businesses by a Shell Company Registrant or Its Predecessor That Are Not or Will Not Be the Predecessor

The Commission is proposing a series of rules intended to clarify when companies should disclose financial statements of businesses acquired by SPAC targets or where such business are probable of being acquired by SPAC targets.  Proposed Rule 15-01(d) would address situations where financial statements of other businesses (other than the predecessor) that have been acquired or are probable to be acquired should be included in a registration statement or proxy/information statement for a de-SPAC transaction.  The Proposal would require application of Rule 3-05, Rule 8-04 or Rule 3-14 (with respect to real estate operation) of Regulation S-X to acquisitions by the private target in the context of a de-SPAC transaction, which the staff views as codifying its existing guidance.

Proposed amendments to the significance tests in Rule 1-02(w) of Regulation S-X will require the significance of the acquisition target of the private target in a de-SPAC transaction to be calculated using the SPAC’s target’s financial information, rather than the SPAC’s financial information.

In addition, Proposed Rule 15-01(d)(2) would require the de-SPAC company to file the financial statements of a recently acquired business, that is not or will not be its predecessor pursuant to Rule 3-05(b)(4)(i) in an Item 2.01(f) of Form 8-K filed in connection with the closing of the de-SPAC transaction where such financial statements were omitted from the registration statement for the de-SPAC transaction, to the extent the significance of the acquisition is greater than 20% but less than 50%.

Financial Statements of a Shell Company Registrant after the Combination with Predecessor

Proposed Rule 15-01(e) allows a registrant to exclude the financial statements of a SPAC for the period prior to the de-SPAC transaction if (i) all financial statements of the SPAC have been filed for all required periods through the de-SPAC transaction, and (ii) the financial statements of the registrant include the period on which the de-SPAC transaction was consummated.  The Proposal eliminates any distinction between a de-SPAC structured as a forward acquisition or a reverse recapitalization.

Other Amendments

In addition, the Proposal is also addressing the following related amendments:

• amendment of Rule 11-01(d) of Regulation S-X to expressly state that a SPAC is a business for purposes of the rule, effectively requiring an issuer that is not a SPAC to file financial statements of the SPAC in a resale registration statement on Form S-1;
• amendment of Item 2.01(f) of Form 8-K to refer to “acquired business,” rather than “registrant,” to clarify that the information required to be provided “relates to the acquired business and for periods prior to consummation of the acquisition”;[22] and
• amendment of Rules 3-01, 8-02, and 10-01(a)(1) of Regulation S-X to expressly refer to the balance sheet of the predecessors, consistent with the provision regarding income statements.

Enhanced Projections Disclosure

Disclosure of financial projections is not expressly required by the U.S. federal securities laws; however, it has been common practice for SPACs to use projections of the target company and post-de-SPAC company in its assessment of a proposed de-SPAC transaction, its investor presentations, and soliciting material once a definitive agreement is executed.  The Proposal seeks to amend existing regulations regarding the use of projections as well as add new, supplemental disclosure requirements.

Amended Item 10(b) of Regulation S-K

Under Item 10(b) of Regulation S-K, management may present projections regarding a registrant’s future performance, provided that (i) there is a reasonable and good faith basis for such projections, and (ii) they include disclosure of the assumptions underlying the projections and the limitations of such projections, and the presentation and format of such projections.  Citing concerns of instances where target companies have disclosed projections that lack a reasonable basis,[23] the Proposal seeks to amend Item 10(b) of Regulation S-K as follows:

• Clarification of Applicability to Target Company. Item 10(b) of Regulation S-K currently refers to projections regarding the “registrant.”  Proposed amendments would modify the language to clarify that the guidance therein applies to any projections of “future economic performance of persons other than the registrant, such as the target company in a business combination transaction, that are included in the registrant’s Commission filings.” Application of the term “persons other than the registrant” suggests that it is likely that the proposed amended guidance also would apply to the use of projections in non-SPAC transactions.
• Historical Results. Disclosure of projected measures that are not based on historical financial results or operational history should be clearly distinguished from projected measures that are based on historical financial results or operational history.
• Prominence of Historical Results. Similar to non-GAAP presentation, the Commission would consider it misleading to present projections that are based on historical financial results or operational history without presenting such historical measure or operational history with equal or greater prominence.
• Non-GAAP Measures. Presentation of projections that include a non-GAAP financial measure should include a clear definition or explanation of the measure, a description of the GAAP financial measure to which it is most closely related, and an explanation why the non-GAAP financial measure was used instead of a GAAP measure.  The Proposal notes that the reference to the nearest GAAP measure called for by amended Item 10(b) would not require a reconciliation to that GAAP measure; however, the need to provide a GAAP reconciliation for any non-GAAP financial measures would continue to be governed by Regulation G and Item 10(e) of Regulation S-K.

Proposed Item 1609 of Regulation S-K

In light of the traditional SPAC sponsor compensation structure (i.e., compensation in the form of post-closing equity) and the potential incentives and overall dynamics of a de-SPAC transaction, the Commission has proposed a new rule specific to SPACs that would supplement the proposed amendments to Item 10(b) of Regulation S-K (as discussed above).  Specifically, the Commission is proposing a new Item 1609 of Regulation S-K that would require SPACs to provide the accompanying disclosures to financial projections:

• Purpose of Projections. Any projection disclosed by the registrant must include disclosure regarding (i) the purpose for which the projection was prepared, and (ii) the party that prepared the projection.
• Bases and Assumptions. Disclosure would include all material bases of the disclosed projections and all material assumptions underlying the projections, and any factors that may materially impact such assumptions.  This would include a discussion of any factors that may cause the assumptions to be no longer reasonable, material growth rates or discount multiples used in preparing the projections, and the reasons for selecting such growth rates or discount multiples.
• Views of Management and the Board. Disclosure must discuss whether the projections disclosed continue to reflect the views of the board and/or management of the SPAC or target company, as applicable, as of the date of the filing.  If the projections do not continue to reflect the views of the board and/or management, the SPAC should include a discussion of the purpose of disclosing the projections and the reasons for any continued reliance by the management or board on the projections.

Like the proposed amendments to Item 10(b), the first two requirements summarized above should not come as a particular surprise to existing SPACs and their counsel as projections disclosure has been a significant area of scrutiny by the Commission in the registration statement and proxy statement review process.

We note, however, that the requirement under Item 1609 to add disclosure as to management’s and/or the board’s current views may obligate additional disclosure beyond what has been typical market practice.  In particular, projections disclosure in a registration statement or proxy statement is often made in the context of a historical lookback to the projections in place at the time the board of directors of the SPAC assessed whether to enter into a de-SPAC transaction with the target company.  These projections typically are not updated with newer data during the pendency of the transaction since the purpose of such disclosure is to inform investors of the board’s rationale for approving the transaction.  Proposed Item 1609 does not explicitly require the updating of projections, but it does require the parties to disclose whether the included projections reflect the view of the SPAC and the target company as of the date of filing.  Moreover, the potential to provide revised projections, coupled with obligations to disclose management’s and board’s continuing views, may prove challenging disclosure to be made between the signing of a business combination agreement and the filing of a registration statement or proxy statement and during the review period for such registration statement or proxy statement.

Status of SPACs under the Investment Company Act of 1940

Section 3(a)(1)(A) of the Investment Company Act defines an “investment company” as any issuer that is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities.  Given that SPACs, prior to a de-SPAC transaction, are not engaged in any meaningful business other than investing its IPO proceeds held in trust, there is a potential for SPACs to be treated as an “investment company.”

In recognition of the fact that SPACs are generally formed to identify, acquire, and operate a target company through a business combination and not with a stated purpose of being an investment company, the Proposal seeks to clarify SPAC status by providing a safe harbor under Section 3(a)(1)(A) of the Investment Company Act (the “Subjective Test Safe Harbor”).[24]  To qualify under the Subjective Test Safe Harbor:

• SPAC Assets. The assets held by a SPAC must consist solely of government securities, government money market funds, and cash items prior to the completion of the de-SPAC transaction.  The Proposal further notes that (i) all proceeds obtained by the SPAC, including those from any SPAC offering, cash infusion from the sponsor, or any interest, dividend, distribution, or other such return derived from the SPAC’s underlying assets, would need to be held in these asset classes, and (ii) SPACs may not acquire interests in an operating company prior to a de-SPAC transaction.
• SPAC Asset Management. Assets listed above may not at any time be acquired or disposed of for the primary purpose of recognizing gains or decreasing losses resulting from market value changes.  The Proposal notes that this is not intended to prohibit SPACs the flexibility to hold their assets consistent with cash management practices.
• De-SPAC Transaction. The SPAC must seek to complete a single de-SPAC transaction[25] where the surviving public company, either directly or through a primarily controlled company,[26] will be primarily engaged in the business of the target company or companies, which is not that of an investment company.
• Board Action. The board of directors of the SPAC would need to adopt a resolution evidencing that the company is primarily engaged in the business of seeking to complete a single de-SPAC transaction.
• Primary Engagement. Activities of the SPAC’s officers, directors, and employees, its public representations of policies, and its historical development must evidence that the SPAC is primarily engaged in completing a de-SPAC transaction.  Other than a requirement that the board of directors of the SPAC adopt a resolution, the Proposal does not provide examples of other definitive actions as to how SPACs may properly evidence compliance, instead noting that a SPAC may not hold itself out as being primarily engaged in the business of investing, reinvesting, or trading in securities.
• Exchange Listing. The SPAC must have at least one class of securities listed for trading on a national securities exchange “by meeting initial listing standards just as any company seeking an exchange listing would have to do.”
• De-SPAC Transaction Time Limits. The SPAC would have 18 months from its IPO to enter into a de-SPAC transaction and no more than 24 months from its IPO to complete its de-SPAC transaction.

While most SPACs should not have an issue with qualifying for the Subjective Test Safe Harbor, the proposed time limits may prove problematic for existing SPACs seeking amendments to their governing documents to extend the time necessary to complete a de-SPAC transaction.  Typically, these amendments are either sought when (i) a SPAC has a definitive transaction agreement entered into and needs some time to consummate the transaction, and/or (ii) a sponsor is willing to compensate existing securities holders by contributing additional amounts into a trust that is disbursable to shareholders upon lapse of the extension.  Moreover, stock exchange rules require a SPAC to complete a de-SPAC transaction within 36 months from its IPO, and with its truncated time periods, the Proposal would significantly constrain some of this timing flexibility for SPACs that would like to comply with the Subjective Test Safe Harbor.

Admittedly, a SPAC does not need to comply with the Subjective Test Safe Harbor, but the alternative would be to make an assessment that the SPAC does not qualify as an investment company, notwithstanding its non-compliance with the time limits in the Subjective Test Safe Harbor, or to register as an “investment company,” and with it, comply with the regulatory regime of the Investment Company Act on top of seeking the consummation of a de-SPAC transaction.

Conclusions

As noted by Chair Gensler, much of the Proposal seeks to impose traditional IPO concepts and regulations on the SPAC IPO and de-SPAC transaction process, as well as codify existing Commission guidance and practice.

That said, there are some notable deviations and provisions in the Proposal that, if implemented, could significantly impact the SPAC marketplace.  We note that certain provisions in the Proposal may have consequences for the future of SPACs as an alternative vehicle to traditional IPOs.

In particular, proposals regarding underwriter liability in the de-SPAC transaction context, unavailability of the PSLRA, and liquidation timeframes contemplated by the proposed new Investment Company Act safe harbor, all would curtail SPAC flexibility and/or increase the complexity and cost of completing a de-SPAC transaction.

We continue to monitor further developments and will keep you apprised of the latest news regarding this Proposal.

Commissioner Statements

For the published statements of the Commissioners, please see the following links:

Chair Gary Gensler

Commissioner Allison Herren Lee

Commissioner Caroline A. Crenshaw

Commissioner Hester M. Peirce (Dissent)

Comment Period

The comment period ends on the later of 30 days after publication in the Federal Register or May 31, 2022 (which is 60 days from the date of the Proposal).  Comments may be submitted: (1) using the Commission’s comment form at https://www.sec.gov/rules/submitcomments.htm; (2) via e-mail to [email protected] (with “File Number S7‑13‑22” on the subject line); or (3) via mail to Vanessa A. Countryman, Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.  All submissions should refer to File Number S7‑13‑22.

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  [1]  U.S. Securities and Exchange Commission, Proposed Rule (RIN 3235-AM90), Special Purpose Acquisition Companies, Shell Companies, and Projections (March 30, 2022), available at https://www.sec.gov/rules/proposed/2022/33-11048.pdf (hereinafter, the “Proposed Rule”).

  [2]  See Gibson, Dunn & Crutcher LLP, SEC Staff Issues Cautionary Guidance Related to Business Combinations with SPACs (April 7, 2021), available at https://www.gibsondunn.com/sec-staff-issues-cautionary-guidance-related-to-business-combinations-with-spacs/ (addressing the statement of the staff of the Commission’s Division of Corporation Finance about certain accounting, financial reporting, and governance issues related to SPACs and the combined company following a de-SPAC transaction (see Division of Corporation Finance, Announcement: Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies (March 31, 2021), available at https://www.sec.gov/corpfin/announcement/staff-statement-spac-2021-03-31), see also Gibson, Dunn & Crutcher LLP, Back to the Future: SEC Chair Announces Spring 2021 Reg Flex Agenda (June 21, 2021), available at https://www.gibsondunn.com/back-to-the-future-sec-chair-announces-spring-2021-reg-flex-agenda/ (discussing the inclusion of SPACs in Chair Gensler’s Spring 2021 Unified Agenda of Regulatory and Deregulatory Actions announced on June 11, 2021 (see U.S. Securities and Exchange Commission, Press Release (2021-99), SEC Announces Annual Regulatory Agenda (June 11, 2021), available at https://www.sec.gov/news/press-release/2021-99), and Gibson, Dunn & Crutcher LLP, SEC Fires Shot Across the Bow of SPACs (July 14, 2021), available at https://www.gibsondunn.com/sec-fires-shot-across-the-bow-of-spacs/ (discussing a partially settled Commission enforcement action against a SPAC related to purported misstatements on the registration statement concerning the target’s technology and business risks).

  [3]  U.S. Securities and Exchange Commission, Press Release (2022-56), SEC Proposes Rules to Enhance Disclosure and Investor Protection Relating to Special Purpose Acquisition Companies, Shell Companies, and Projections (March 30, 2022), available at https://www.sec.gov/news/press-release/2022-56.

  [4]  Id.

  [5]  Proposed Rule, p. 195 (citing on fn. 432 Michael Levitt, Valerie Jacob, Sebastian Fain, Pamela Marcogliese, Paul Tiger, & Andrea Basham, 2021 De-SPAC Debrief, FRESHFIELDS (Jan. 24, 2022), available at https://blog.freshfields.us/post/102hgzy/2021-de-spacdebrief, and on fn. 433 Tingting Liu, The Wealth Effects of Fairness Opinions in Takeovers, 53 FIN. REV. 533 (2018)).

  [6]  The term “promoter” is defined in Securities Act Rule 405 and Exchange Act Rule 12b-2.

  [7]  Proposed Item 1604(c)(1) suggests the following potential sources: “the amount of compensation paid or to be paid to the SPAC sponsor, the terms of outstanding warrants and convertible securities, and underwriting and other fees.”  Proposed Rule, p. 336.

  [8]  Commission Hester M. Peirce, Statement:  Damning and Deeming: Dissenting Statement on Shell Companies, Projections, and SPACs Proposal (March 30, 2022), available at https://www.sec.gov/news/statement/peirce-statement-spac-proposal-033022.

  [9]  Under Section 6(a) of the Securities Act, each “issuer” must sign a Securities Act registration statement.  The Securities Act broadly defines the term “issuer” to include every person who issues or proposes to issue any securities.

  [10]  Proposed Rule, p. 195.

  [11]  17 CFR 229.10(f)(1).

  [12]  Proposed Rule, p. 302 and fn. 575 (explaining that the “estimate is based, in part, on [the Commission’s] estimate of the number of de-SPAC transactions in which the SPAC is the legal acquirer”).

  [13]  See Jamie Payne, Market Trends: De-SPAC Transactions, LexisNexis (March 5, 2022), available at https://www.lexisnexis.com/community/insights/legal/practical-guidance-journal/b/pa/posts/market-trends-de-spac-transactions (“The average size of de-SPAC transactions remained consistent between $2.2 billion and $2.8 billion in 2021 until a significant decline to $1.4 billion in the fourth quarter.  The largest SPAC merger announced and closed in 2021, between Altimeter Growth Corp. and Grab Holdings Inc., was valued at $39.6 billion.”).

  [14]  The term “penny stock” is defined in 17 CFR 240.3a51-1.

  [15]  Section 11 of the Securities Act imposes on underwriters, among other parties identified in Section 11(a), civil liability for any part of the registration statement, at effectiveness, which contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, to any person acquiring such security.  Further, Section 12(a)(2) imposes liability upon anyone, including underwriters, who offers or sells a security, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading, to any person purchasing such security from them.

  [16]  The Proposal further notes that “Federal courts and the Commission may find that other parties involved in securities distributions, including other parties that perform activities necessary to the successful completion of de-SPAC transactions, are ‘statutory underwriters’ within the definition of underwriter in Section 2(a)(11).”  Proposed Rule, p. 98.

  [17]  Although the Securities Act does not expressly require an underwriter to conduct a due diligence investigation, the Proposal reiterates the Commission’s long-standing view that underwriters nonetheless have an affirmative obligation to conduct reasonable due diligence.  Proposed Rule, fn. 184 (citing In re Charles E. Bailey & Co., 35 S.E.C. 33, at 41 (Mar. 25, 1953) (“[An underwriter] owe[s] a duty to the investing public to exercise a degree of care reasonable under the circumstances of th[e] offering to assure the substantial accuracy of representations made in the prospectus and other sales literature.”); In re Brown, Barton & Engel, 41 SEC 59, at 64 (June 8, 1962) (“[I]n undertaking a distribution . . . [the underwriter] had a responsibility to make a reasonable investigation to assure [itself] that there was a basis for the representations they made and that a fair picture, including adverse as well as favorable factors, was presented to investors.”); In the Matter of the Richmond Corp., infra note 185 (“It is a well-established practice, and a standard of the business, for underwriters to exercise diligence and care in examining into an issuer’s business and the accuracy and adequacy of the information contained in the registration statement . . .  The underwriter who does not make a reasonable investigation is derelict in his responsibilities to deal fairly with the investing public.”)).

  [18]  Proposed Rule, p. 104, citing SEC v. M & A W., Inc., 538 F.3d 1043, 1053 (9th Cir. 2008) (“[W]e are informed by the purpose of registration, which is ‘to protect investors by promoting full disclosure of information thought necessary to informed investment decisions.’  The express purpose of the reverse mergers at issue in this case was to transform a private corporation into a corporation selling stock shares to the public, without making the extensive public disclosures required in an initial offering.  Thus, the investing public had relatively little information about the former private corporation.  In such transactions, the investor protections provided by registration requirements are especially important.”).

  [19]  Id., p. 343.

  [20]  Id., p. 112 (citing the staff guidance under the Division of Corporation Finance’s Financial Reporting Manual).

  [21]  Id., p. 112 (citing the staff guidance under the Division of Corporation Finance’s Financial Reporting Manual at Section 4110.5).

  [22]  Id., p. 124.

  [23]  For example, the Commission cites to recent enforcement actions against SPACs, alleging the use of baseless or unsupported projections about future revenues and the use of materially misleading underlying financial projections.  See, e.g., In the Matter of Momentus, Inc., et al., Exch. Act Rel. No. 34-92391 (July 13, 2021); SEC vs. Hurgin, et al., Case No. 1:19-cv05705 (S.D.N.Y., filed June 18, 2019); In the Matter of Benjamin H. Gordon, Exch. Act Rel. No. 34-86164 (June 20, 2019); and SEC vs. Milton, Case No. 1:21-cv-6445 (S.D.N.Y., filed July 29, 2021).

  [24]  Proposed Rule 3a-10.  The Proposal does not provide a safe harbor under Section 3(a)(1)(C) of the Investment Company Act, with respect to issuers engaged or proposing to engage in certain securities activities.

  [25]  The de-SPAC transaction may involve the combination of multiple target companies, so long as intentions of the SPAC are disclosed and so long as closing with respect to all target companies occurs contemporaneously and within the required time limits (as described below).  Proposed Rule, p. 145.

  [26]  “Primary Control Company” means an issuer that (i) “[i]s controlled within the meaning of Section 2(a)(9) of the Investment Company Act by the surviving company following a de-SPAC transaction with a degree of control that is greater than that of any other person” and (ii) “is not an investment company.”  Proposed Rule 3a-10(b)(2).

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Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Capital Markets, Mergers and Acquisitions, Securities Enforcement, or Securities Regulation and Corporate Governance practice groups, or the following authors:

Evan M. D’Amico – Washington, D.C. (+1 202-887-3613, [email protected])
Gerry Spedale – Houston (+1 346-718-6888, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])
Julia Lapitskaya – New York (+1 212-351-2354, [email protected])
Gregory Merz – Washington, D.C. (+1 202-887-3637, [email protected])
Rodrigo Surcan – New York (+1 212-351-5329, [email protected])
James O. Springer – Washington, D.C. (+1 202-887-3516, [email protected])

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

Mergers and Acquisitions Group:
Eduardo Gallardo – New York (+1 212-351-3847, [email protected])
Robert B. Little – Dallas (+1 214-698-3260, [email protected])
Saee Muzumdar – New York (+1 212-351-3966, [email protected])

Capital Markets Group:
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Hillary H. Holmes – Houston (+1 346-718-6602, [email protected])
Stewart L. McDowell – San Francisco (+1 415-393-8322, [email protected])
Peter W. Wardle – Los Angeles (+1 213-229-7242, [email protected])

Securities Regulation and Corporate Governance Group:
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James J. Moloney – Orange County (+1 949-451-4343, [email protected])
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Brian J. Lane – Washington, D.C. (+1 202-887-3646, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, [email protected])
Mike Titera – Orange County (+1 949-451-4365, [email protected])
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The UK’s competition watchdog has prohibited a proposed merger that the European Commission had cleared little more than one month ago. On the same day, the US Department of Justice announced that it considered the deal problematic. These developments highlight the growing uncertainties that companies now face in getting global deals through and underline the need for careful, strategic planning to manage competition law risks.

Divergence is real and it can hurt

The assumption that UK competition laws and policies would largely continue to match those of the EU has been a key underpinning of the advice most practitioners have given since Brexit. Whilst still valid in most areas as a matter of law, the approach adopted by the UK Competition and Markets Authority (CMA) has, in fact, been diverging from that of the European Commission (EC) for some time in the field of merger control.

This spilt out when the CMA publicly expressed skepticism of the EC’s Google/Fitbit clearance in early 2021. However, many commentators argued that this divergence was limited to digital markets and would not affect more traditional industries. The CMA would, it was asserted, do everything it could to coordinate and adopt an approach consistent with the EC particularly in deals in which neither party was a UK company.

That assumption can no longer be made.

Earlier this week, parties to a proposed merger abandoned their deal, which was already cleared by the EC, following a prohibition by the CMA. The CMA concluded that that the divestiture package that had been accepted by the EC was not clear-cut enough to be effective.

The blocked Cargotec/Konecranes merger serves as a stark reminder to companies that following the UK’s exit from the EU’s one stop shop merger regime, divergence in approach between the two authorities is real, and may lead to deals literally falling apart.

In this note, we consider the implications for parties facing parallel merger review before the EU and UK authorities and offer some practical tips to achieve the best outcome. It is clear that parties to transactions facing dual review in the EU and the UK need to pay close attention to the practice of both authorities, particularly in relation to remedies. Timing and cooperative engagement are paramount.

A brief look at the present case

Cargotec and Konecranes are Finnish companies offering container handling equipment and services to port terminals and industrial customers worldwide. The companies announced their proposed US$5 billion merger in October 2020. The deal was notified in a number of jurisdictions, including the UK, EU, U.S., Australia, New Zealand, Singapore and Israel.

When the deal ran into trouble, the parties proposed a divestment remedy which involved carving out asset packages from within each of their existing businesses to be sold as a new combined business.

In February, the EC announced its approval of the deal subject to the divestiture remedy. The EC’s Executive Vice-President Margrethe Vestager said “[f]ollowing the remedies offered by the two companies, customers in Europe will continue to have sufficient choice of port equipment and will continue benefitting from competitive prices and a great choice of technology”.

Vestager doubled down on the justification for the EC’s clearance of the deal in a speech on 25 March 2022. She asserted that the EC had made sure that the remedies addressed the EC’s concerns through the divestiture of “viable standalone businesses”.

Four days later the CMA announced that it would block the merger. The CMA was not satisfied with the parties’ proposed remedies, stating that the asset packages “would not enable whoever bought them to compete as strongly as the merging businesses do at present” and that the process of carving out the assets and knitting them together “would be complex and risky”.

Two days from then, Vestager returned to the fray, reiterating her message that the EC had made sure that the proposed remedies addressed its concerns and that the market had given positive feedback on them.

A sign of things to come

We should be cautious in drawing too firm a conclusion from one case. The US, EU and UK authorities regularly communicate with one another and have a strong record of coordinating their actions.

But the CMA’s prohibition of the Cargotec/Konecranes merger – and the EC’s very public support for the stand it took – suggests greater challenges lie ahead for parallel track cases, in particular when it comes to remedies: what is “clear-cut” for one authority appears no longer to be clear-cut for another. The CMA’s public criticism of the EC’s Google/Fitbit remedies provides support for the latter.

On the other hand, in September last year the CMA unconditionally cleared the Meta/Kustomer merger in Phase I, whilst the deal went to Phase II in Europe (it was ultimately cleared with remedies in January 2022 by the EC).

Global considerations

There was a broader global dimension to Cargotec/Konecranes, beyond the UK-EU divergence. In particular, on the same day as the CMA’s prohibition, the U.S. Department of Justice announced that the deal would have led to an “illegal consolidation” and that it had informed the parties that the proposed remedy was insufficient.

The ACCC has discontinued its review following the abandonment of the transaction, but it noted in its press release that Australian customers had expressed strong concerns on the proposed remedy.

These elements underline the need for merging parties to factor in potentially different approaches across multiple jurisdictions, and the possibility that a tougher approach by one or several authorities may jeopardise the approval prospects of a deal that is cleared in other jurisdictions.

How do you get your deal through unscathed?

There are four main things that companies need to bear in mind:

• Should the UK be a condition precedent: the UK merger regime is voluntary and is non-suspensory. As a result many companies opt not to have UK clearance as a condition precedent. Whilst this often makes sense, much greater thought than in the past needs to go into the question. Cargotec/Konecranes not only underlines that the CMA is now one of the toughest regulators in the world but also that it is willing to go its own way on remedies, even in deals between two non-UK companies.
• Timing: Having a robust, well thought out strategy on the timing of deal announcement and engagement with the authorities is critical. The merger review timetables of the EC and CMA do not line up – the CMA’s review period is longer than that of the EC. Parties may want to stagger their submissions so that the CMA and EC are reviewing remedy packages at the same time. There is also a disconnect between the stage at which each authority may be willing to accept large, upfront remedy packages. The EC does, in certain circumstances, accept these in Phase 1, whereas the CMA typically requires an in-depth investigation to get comfortable. On the face of it, it appears that Cargotec and Konecranes may have simply run out of time to get the CMA comfortable with a revised divestiture package.
• Defining the right remedy package: In cases where remedies are on the cards, plan them early, discuss them early with the authority and make them as clear-cut as commercially possible. Cargotec/Konecranes confirms that it is difficult to persuade authorities to accept mix-and-match remedies. Parties should avoid remedies that could be difficult to implement and must take into account the remedy preference of each authority (a one-size-fits-all remedy package is no longer always an option).
• Facilitate cooperation between agencies: It is clear that cooperation between the EC and the CMA is not at its strongest. That means that the parties and their advisors will need to work much more closely and proactively with both authorities; “leave it to the authorities to sort things out between themselves” is no longer a viable strategy (if it ever was!).

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The following Gibson Dunn lawyers prepared this client alert: Ali Nikpay and Mairi McMartin.

Gibson Dunn’s lawyers are available to assist in addressing any questions that you may have regarding the issues discussed in this update. For further information, 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:

Ali Nikpay – Co-Chair, Antitrust & Competition Group, London (+44 (0) 20 7071 4273, [email protected])

Attila Borsos – Partner, Antitrust & Competition Group, Brussels (+32 2 554 72 11, [email protected])

Deirdre Taylor – Partner, Antitrust & Competition Group, London (+44 20 7071 4274, [email protected])

Christian Riis-Madsen – Co-Chair, Antitrust & Competition Group, Brussels (+32 2 554 72 05, [email protected])

Nicholas Banasevic – Managing Director, Antitrust & Competition Group, Brussels (+32 2 554 72 40, [email protected])

Jessica Staples – Of Counsel, Antitrust & Competition Group, London (+44 (0) 20 7071 4155, [email protected])

Mairi McMartin – Associate, Antitrust & Competition Group, Brussels (+32 2 554 72 29, [email protected])

Rachel S. Brass – Co-Chair, Antitrust & Competition Group, San Francisco (+1 415-393-8293, [email protected])

Stephen Weissman – Co-Chair, Antitrust & Competition Group, 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.

Please join our distinguished panelists for a recorded discussion about the U.S. Sentencing Guidelines and how they apply in corporate enforcement actions. They discuss issues arising in white collar matters and strategies that can impact the calculation of the Sentencing Guidelines fine range, including gain from the offense, corporate recidivism, and cooperation, among other issues. Another area of focus is how the Guidelines address corporate compliance programs and how organizations can position themselves for maximum credit.

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Decided March 31, 2022

Badgerow v. Walters, No. 20-1143

Today, the Supreme Court held 8-1 that federal jurisdiction to confirm or vacate an arbitral award under Sections 9 and 10 of the Federal Arbitration Act must exist independent of the underlying controversy—that is, courts cannot “look through” to the underlying dispute to establish federal subject-matter jurisdiction.

Background: Under the Federal Arbitration Act (FAA), a party to an arbitration agreement may ask a federal court to confirm or vacate an arbitral award. 9 U.S.C. §§ 9, 10. A Louisiana resident initiated an arbitration against her Louisiana employer, alleging unlawful termination under federal and state law. After the arbitrators dismissed the claims, the plaintiff sued in state court to vacate the arbitral award. The defendant removed the case to federal court based on the underlying federal employment claims and asked the court to confirm the arbitrators’ decision. The Fifth Circuit held that the federal court had jurisdiction by “looking through” the plaintiff’s petition to the underlying federal employment claims.

Issue: Do federal courts have subject-matter jurisdiction to confirm or vacate an arbitral award under Sections 9 and 10 of the Federal Arbitration Act when the only basis for jurisdiction is that the underlying dispute involved a federal question?

Court’s Holding: No. Federal jurisdiction to confirm or vacate an arbitration award must exist independent of the underlying controversy, and it is not sufficient for federal jurisdiction that the underlying claim the parties arbitrated arose under federal law.

“Congress has made its call. We will not impose uniformity on the statute’s non-uniform jurisdictional rules.”

Justice Kagan, writing for the Court

What It Means:

• Today’s decision resolves a circuit split over whether the Court’s decision in Vaden v. Discover Bank, 556 U.S. 49 (2009)—which held that federal courts should look through to the underlying claims to determine whether they have jurisdiction over a petition to compel arbitration under FAA Section 4—applies to petitions to confirm or vacate arbitral awards under FAA Sections 9 and 10.
• The Court ruled that Vaden’s “look through” approach was based on textual indicia unique to Section 4, which Congress did not include in Sections 9 and 10. Therefore, the Court declined to extend Vaden to Sections 9 and 10.
• The Court’s holding that the “look through” approach is limited to petitions under Section 4 means that federal courts will lack jurisdiction over many petitions under Sections 9 and 10. In practice, unless there is a federal question on the face of the petition, or complete diversity between the parties and the amount of the arbitral award exceeds $75,000, federal courts are not likely to have jurisdiction over petitions to confirm or vacate an arbitral award.
• The Court’s decision does not extend to the enforcement of international arbitration awards under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, because the FAA independently confers federal jurisdiction over those cases.
• The decision demonstrates the Court’s commitment to applying statutes as written. The Court refused to allow policy concerns to override the “evident congressional choice” to “respect the capacity of state courts to properly enforce arbitral awards.” In contrast, Justice Breyer, writing in dissent, acknowledged that he was looking beyond “the statute’s literal words” to its “purposes” and “the likely consequences” flowing from a non-uniform approach to assessing jurisdiction over petitions filed under the FAA.

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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

Allyson N. Ho +1 214.698.3233 [email protected]	Mark A. Perry +1 202.887.3667 [email protected]	Lucas C. Townsend +1 202.887.3731 [email protected]
Bradley J. Hamburger +1 213.229.7658 [email protected]

Related Practice: Class Actions

Christopher Chorba +1 213.229.7396 [email protected]

Kahn A. Scolnick +1 213.229.7656 [email protected]

Related Practice: Labor and Employment

Jason C. Schwartz +1 202.955.8242 [email protected]

Katherine V.A. Smith +1 213.229.7107 [email protected]

Related Practice: Judgment and Arbitral Award Enforcement

Matthew D. McGill +1 202.887.3680 [email protected]

Robert L. Weigel +1 212.351.3845 [email protected]

Related Practice: International Arbitration

Rahim Moloo +1 212.351.2413 [email protected]

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On March 16, 2022, New York State Governor Kathy Hochul signed two new bills into law that expand non-discrimination protections in the workplace.  As a result, New York now prohibits employers from releasing employee personnel files in retaliation for such employee’s engagement in protected activity.  Additionally, the state will be announcing a state-run sexual harassment hotline that will need to be referenced in anti-harassment policies and postings.

There are also several bills working their way through the State Legislature that, if enacted, would significantly impact employers in New York.  We discuss those potential new laws below.

Newly Enacted Workplace Laws

New York recently enacted two new laws impacting employers.

The first makes it an unlawful retaliatory practice under the New York State Human Rights Law (“NYSHRL”) for an employer to disclose an employee’s “personnel files” because the employee has: (i) opposed any practices forbidden under the NYSHRL; or (ii) filed a complaint, testified, or assisted in any proceeding under the NYSHRL or any other judicial or administrative proceeding.  According to the statute, this is necessary to address “retaliation [that] frequently appears in the form of a leaking of personnel files with the intent to disparage or discredit a victim or witness of discrimination in the workplace.”  This law is effective as of March 16, 2022.  Significantly, the law expressly permits employers to disclose personnel files in the course of commencing or responding to a complaint in any judicial or administrative proceeding.

The second new law requires the State Division of Human Rights to work with the State Department of Labor to establish, by July 14, 2022, a toll-free, confidential hotline to provide counsel and assistance to individuals with concerns of workplace sexual harassment.  Employers will be required to include the hotline number in any sexual harassment postings and policies.  Once “live,” the hotline will be staffed by pro bono attorneys experienced in providing sexual harassment-related counsel, who will be recruited by the Division of Human Rights and organizations representing attorneys, such as the New York State Bar Association.

Bills Under Consideration

Two additional bills, if passed, would have significant implications for employers in New York.  Both of the following bills passed the New York State Senate on March 1, 2022, but have yet to pass the Assembly or be signed into law:

• No Rehire Provisions – Senate Bill S766 would render the release of claims in a settlement agreement between an employer and employee and/or independent contractor unenforceable if the agreement contains a no-rehire clause. No-rehire provisions are commonly included in separation and release agreements to prohibit the individual from applying for or accepting future employment with the employer and its related entities.Notably, under the proposed law, if a release is rendered unenforceable by the inclusion of a no-rehire provision, the employer would remain bound by all other provisions of the agreement, including the obligation to pay any agreed-upon settlement payment.  The bill does not, however: (i) prohibit termination of the employee if mutually agreed upon as part of a settlement; or (ii) automatically require an employer to rehire an employee who had previously settled a case against the employer.If passed, this law would take effect on the 60th day after being signed and would apply to all agreements entered into on and after that date.

• Nondisclosure Provisions in Settlement Agreements – Senate Bill S738 would render unenforceable a release of any claim of discrimination, harassment, or retaliation if the release is included in a settlement agreement that: (i) requires the aggrieved worker to pay liquidated damages for violation of a nondisclosure clause; (ii) requires the aggrieved worker to forfeit all or part of the consideration for violation of a nondisclosure clause; or (iii) contains any statement or disclaimer that the aggrieved employee was not in fact subject to discrimination, harassment, or retaliation.Currently under New York law, any provision in an agreement between an employer and an employee is void if it prevents the disclosure of information related to discrimination unless the employee is notified that they are not prohibited from speaking with law enforcement, the EEOC, the state or local commission of human rights, or an attorney.  If passed, this new law would also require employers to notify employees that nothing precludes them from speaking with the New York Attorney General.  It would also expand coverage to independent contractors.The proposed law would also amend New York General Obligations Law Section 5-336, which prohibits employers from including nondisclosure provisions in agreements resolving claims involving unlawful discrimination unless: (i) the provision is the complainant’s preference; (ii) the provision is set forth in writing; and (iii) the complainant is given twenty-one (21) days to consider and seven (7) days to revoke the agreement.  If passed, the new law would clarify that these requirements apply to agreements settling claims involving harassment and retaliation.  It would also clarify that the complainant may voluntarily agree to the confidentiality provision before the twenty-one (21) day waiting period has elapsed.

  This bill is similar to legislation that was recently enacted regarding settlement and separation agreements in California, but with a couple of notable differences – such as certain language that is required pursuant to California law and the amount of time complainants must be provided to consider the agreement.  Additional information on the California legislation is available here.

  If passed, this law would take effect immediately upon singing and would apply to all agreements entered into on or after that date.

Governor Hochul has indicated that she is likely to sign these bills into law if they pass in the State Assembly. That said, by rendering key provisions of a settlement agreement (i.e., the release itself) unenforceable, these bills may be subject to legal challenge if they are ultimately enacted.

Implications for Employers

In light of the newly enacted laws, New York employers should proceed with even greater caution when considering whether to release personnel file information, including when making public statements in response to an employee’s claim to the extent that the statement discloses information contained in a personnel file.  To that end, employers should consider counseling managers and updating their policies governing access to and disclosure of employee information to ensure compliance.

Employers should also plan to update their New York handbook policies, anti-harassment trainings, and postings with New York State’s anonymous hotline information once available.

We will continue to closely monitor the bills under consideration, which will impact the settlement of discrimination, harassment and retaliation claims.

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The following Gibson Dunn attorneys assisted in preparing this client update: Harris Mufson, Gabrielle Levin, Danielle Moss, Meika Freeman, and Alex Downie.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment practice group, or the following:

Mylan Denerstein – New York (+1 212-351-3850, [email protected])

Gabrielle Levin – New York (+1 212-351-3901, [email protected])

Danielle J. Moss – New York (+1 212-351-6338, [email protected])

Harris M. Mufson – New York (+1 212-351-3805, [email protected])

Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, [email protected])

Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, [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.

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Introduction

The European Union has reached political agreement on its landmark Digital Markets Act (DMA) legislation. The EU-wide DMA will apply in addition to competition law rules and targets the largest digital platforms. The legislation which introduces a broad-based regulation of digital markets should be formally adopted in the coming weeks and will enter into force at the beginning of 2023.

The DMA is one of the most important pieces of economic legislation in the EU of recent times. It will impose a broad set of upfront, legally binding conduct obligations (dos and don’ts) on companies operating in the EU whose products are determined to be an important gateway for businesses to reach consumers (gatekeepers). The DMA’s impact in European digital markets will be significant both because of the scope of the products that will be covered and because of the number of obligations that will apply.

It is not only gatekeepers who need to take note. All companies operating in the digital space need to be fully attuned to the implications of the DMA as it will likely impact their commercial activities directly or indirectly. They will need to implement a multi-faceted plan in relation to product design, commercial strategy and engagement with public authorities. They will also need to take account of the interplay between the DMA and other competition and regulatory initiatives, both within Europe and globally. Companies whose products are caught by the DMA will need to ensure that they comply with all of the relevant obligations, whilst companies which are not caught by the DMA will need to adjust to the changes in the commercial environment that the DMA will lead to.

What is new?

There has been broad agreement between EU Member States and the European Parliament on the principles of the DMA ever since the European Commission proposed the legislation in December 2020. Recent discussions have focussed on: (1) the turnover and market capitalization thresholds that would apply for companies to be subject to the DMA; (2) which products would be covered; (3) the precise nature of certain obligations; and (4) how the DMA would be enforced. On these points:

• The quantitative thresholds for a company to be caught have increased from an annual turnover of €6.5 billion in the European Economic Area (EEA) to €7.5 billion, and from a global market capitalization of €65 billion to €75 billion.
• Browsers and virtual assistants have been added as products to which the DMA’s obligations will apply.
• Some of the obligations which gatekeepers will have to comply with have been broadened, notably as regards: (1) interoperability between messaging services; (2) a requirement to have a consumer choice screen upon an end user’s first use of a search engine, a virtual assistant or a browser; (3) an extension of the “most-favoured-nation” parity clause provisions; and (4) a requirement to have fair access conditions for search and social networks (this obligation previously applied only to app stores).
• Whilst the European Commission will ultimately remain responsible for DMA enforcement, EU Member State competition authorities will play a supporting role.

Why should your company care?

The DMA will regulate the behaviour of so-called gatekeepers that operate “core platform services” which have a significant impact in the EU market. A company can be designated as a gatekeeper for one or more core platform services. The DMA contains a broad list of what are core platform services but the DMA’s obligations would only apply if a core platform service is an important gateway for business users to reach end users in the EU. The main way in which such designation will occur is via quantitative thresholds based on: (1) company size (EEA turnover and global market capitalization); and (2) product reach (number of active end users and active end users in the EEA for each core platform service).

Once a core platform service is designated as a gatekeeper, it must comply with every DMA obligation that can apply to that product. There are 18 obligations in total, some of which are imprecise and cover a wide variety of different provisions including data access, interoperability, and self-preferencing.

Gatekeepers should care because they will need to comply with the relevant obligations. Because gatekeepers are not specifically defined, companies should check if their products might be caught, either now or in the future and if so, what they should do. If not, your company may still be affected, either because it is doing business with a gatekeeper or because some obligations are imprecise and may lead to a number of consequences – intended and unintended – in digital markets. The DMA is an attempt to rapidly implement broad-based regulation and it will lead to a high degree of uncertainty in digital markets for years to come.

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The following Gibson Dunn lawyers prepared this client alert: Christian Riis-Madsen, Nicholas Banasevic, and Mairi McMartin.

Gibson Dunn’s lawyers are available to assist in addressing any questions that you may have regarding the issues discussed in this update. For further information, 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:

Nicholas Banasevic – Managing Director, Antitrust & Competition Group, Brussels (+32 2 554 72 40, [email protected])

Christian Riis-Madsen – Co-Chair, Antitrust & Competition Group, Brussels (+32 2 554 72 05, [email protected])

Ali Nikpay – Co-Chair, Antitrust & Competition Group, London (+44 (0) 20 7071 4273, [email protected])

Rachel S. Brass – Co-Chair, Antitrust & Competition Group, San Francisco (+1 415-393-8293, [email protected])

Stephen Weissman – Co-Chair, Antitrust & Competition Group, 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.

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In a closely followed decision that directly addresses an issue of critical importance for the interactive fantasy sports (“IFS”) industry, in which daily fantasy sports are a subset, the New York Court of Appeals held on March 22, 2022 that IFS contests do not constitute “gambling” within the meaning of New York’s constitutional prohibition on gambling.  White v. Cuomo, No. 12, 2022 WL 837573 (N.Y. Mar. 22, 2022).[1]  In doing so, New York’s highest court followed the reasoning set forth by the Attorney General and further developed in an amicus brief Gibson Dunn filed on behalf of DraftKings and FanDuel (available here), and joined other state courts holding that “it is now ‘widely recognized’ that IFS contests are predominately skill-based competitions” distinguishable from games of chance.  Id. at *7 (quoting Dew-Becker v. Wu, 178 N.E.3d 1034, 1041 (Ill. 2020)).  The White v. Cuomo case confirms the legality of daily fantasy sports in New York.  And it has important implications for the sports betting industry writ large, as it underscores the degree of deference courts must give the New York legislature’s interpretation of the State’s constitutional gambling provisions.

In this alert, we summarize and discuss: (1) the decision of the New York Court of Appeals in White v. Cuomo; and (2) the potential impact of White v. Cuomo on the constitutionality of mobile sports betting and other gambling-related legislation in New York.

White v. Cuomo Ruling

In White v. Cuomo, the New York Court of Appeals was called on to decide whether the legislature had violated the New York Constitution’s general prohibition on lotteries and “other forms of gambling” by enacting a law expressly authorizing and regulating IFS contests.  That legislation, known as article 14, also states that IFS contests do not constitute “gambling” because their outcomes depend on “the skill and knowledge of the participants,” rather than chance, and the “contests are not wagers on future contingent events not under the contestants’ control or influence.”  White, 2022 WL 837573, at *2 (quotation marks omitted).

In a lengthy decision penned by Chief Judge DiFiore, the New York Court of Appeals held that “[b]ecause ample support exists for the legislature’s determination that the IFS contests authorized in article 14 are properly characterized as lawful skill-based competitions for prizes under our precedent, plaintiffs have not met their burden to demonstrate beyond a reasonable doubt that article 14 is unconstitutional.”  White, 2022 WL 837573, at *1.  The Court’s decision has two particularly notable features.

First, the Court underscored the degree of deference due legislative judgments generally and those involving the constitutional prohibition on gambling specifically.  The Court stated that “[i]t is well settled that legislative enactments are entitled to a strong presumption of constitutionality,” and that “courts strike them down only as a last unavoidable result after every reasonable mode of reconciliation of the statute with the Constitution has been resorted to, and reconciliation has been found impossible.”  White, 2022 WL 837573, at *3 (cleaned up).  So great is this level of deference that, “[w]hile courts may look to the record relied on by the legislature, even in the absence of such a record, factual support for the legislation would be assumed by the courts to exist.”  Id. (quotation marks omitted).  Notably, the Court emphasized that this deference extends to legislative judgments regarding whether a particular activity falls within the constitutional prohibition on gambling.

Second, the Court applied the “dominating element” test used by many courts to confirm the legislature’s finding that IFS contests do not constitute gambling.  The “dominating element” is used to determine whether a game is one of “chance,” and therefore constitutes gambling, by evaluating whether the element of chance or skill predominantly controls the game’s result.  Relying heavily upon recent statistical studies demonstrating the importance of player skill in head-to-head fantasy sports games, the Court concluded that the outcomes of such games are predominantly skill-based, and therefore, not gambling.

The White v. Cuomo decision discussed, but ultimately rejected, another test that some courts have employed to determine whether a contest is one of skill or chance—the “material degree” test.  That test analyzes whether the game involves the element of chance to a material degree.  But as the Court of Appeals explained, the “material degree” test does not comport with the standard New York courts have historically applied in determining whether a particular activity constitutes a game of chance.  By adopting the “dominating element” test and rejecting the “material degree” test, the New York Court of Appeals joined a recent, high-profile decision by the Illinois Supreme Court holding that IFS contests are not gambling.

The White v. Cuomo decision was not unanimous, however.  In a dissent joined by two other judges, Judge Wilson  sharply questioned the majority’s deference to the legislature.  In addition, the dissenting judges criticized the majority’s decision to use the “dominating element” test to determine whether a game is one of “chance.”  But as the majority noted, the dissent “provid[ed] no discernable definition for the term ‘gambling’” or any “logical framework for assessing the constitutionality of any particular activity alleged to be ‘gambling.’”  White, 2022 WL 837573, at *10.

Potential Impact

The White v. Cuomo ruling has important implications for the IFS industry and, more broadly, the sports betting industry.  With respect to IFS contests, and most immediately, the ruling closes the chapter on five years of litigation contesting the legality of IFS contests in the largest market in the United States.  New York has decided, once and for all, that IFS contests do not constitute gambling.  The White v. Cuomo decision may also impact the IFS industry beyond the Empire State.  If other state courts follow the reasoning applied by the New York Court of Appeals in White v. Cuomo, IFS operators conducting business in those states will have greater certainty that their operations are not subject to the legal and regulatory hurdles and costs imposed by evolving, and at times ambiguous, laws and regulations in those states.

More broadly, the decision has important implications for the constitutionality of New York’s mobile sports betting legislation.

In 2013, New York voters approved a constitutional amendment to allow the legislature to authorize “casino gambling” “at” up to seven casinos in the State, and expressly delegated to the legislature the task of implementing relevant laws relating to wagering.  N.Y. Const. art I, § 9.  In particular, the constitutional amendment authorizes the legislature to permit gambling as long as (1) the gambling constitutes “casino gambling” and (2) it occurs “at” one of the facilities authorized and prescribed by the legislature.

In April 2021, acting upon this constitutionally delegated authority, the New York legislature enacted legislation authorizing mobile sports wagering, provided the wagers are transmitted to and accepted by servers located at a licensed gaming facility.  See N.Y. Rac. Pari-Mut. Wag. & Breed. Law § 1367-a.  Specifically, the legislation provides that “[a]ll sports wagers through electronic communication . . . are considered placed or otherwise made when and where received by the mobile sports wagering licensee on such mobile sports wagering licensee’s server . . . at a licensed gaming facility, regardless of the authorized sports bettor’s physical location within the state at the time the sports wager is placed.”  Id. § 1367-a(2)(d).  So, for example, a bet requested by an app user in Manhattan would be deemed to occur “at” the casino housing the server that accepts and places the bet.  The legislature further declared that “a sports wager that is made through virtual or electronic means from a location within New York state and is transmitted to and accepted by electronic equipment located at a licensed gaming facility . . . is a sports wager made at such licensed gaming facility.”  S.B. S2509, 2021 Leg., 2021–2022 Sess., Part Y, § 2 (N.Y. 2021).[2]  This statute went into effect on January 8, 2022, and generated nearly $70 million in tax revenue for New York in its first 30 days.  See Press Release, Governor Hochul Announces Nearly $2 Billion in Wagers Over the First 30 Days of Mobile Sports Wagering (Feb. 14, 2022), https://www.governor.ny.gov/news/governor-hochul-announces-nearly-2-billion-wagers-over-first-30-days-mobile-sports-wagering.

The White v. Cuomo decision greatly bolsters the constitutionality of New York’s mobile sports wagering legislation, and the likelihood that the legislature’s finding that mobile sports wagers are placed at the location of the servers would be found valid.  As discussed above, the White v. Cuomo decision underscored the strong deference deference afforded to legislative findings, including the legislature’s interpretation of the New York Constitution’s gambling provisions.  The Court reiterated that “when a legislative enactment is challenged on constitutional grounds, there is both an ‘exceedingly strong presumption of constitutionality’ and a ‘presumption that the [l]legislature has investigated for and found facts necessary to support the legislations.’”  White, 2022 WL 837573, at *3 (citation omitted).  This “exceedingly strong presumption of constitutionality” should apply to the legislature’s exercise of its constitutionally delegated authority to define the contours of legal gambling in the mobile sports wagering legislation and any future legislation enacted under such authority.

____________________________

[1]   Interactive fantasy sports involves the creation of a “virtual ‘team[]’ . . . composed of athletes who play for different real-life teams” and that is pitted against another “virtual team[] compiled by [an]other IFS contestant[].”  White, 2022 WL 837573, at *2.  “The performance of simulated players on an IFS roster corresponds to the performance of the real-life athletes,” but “the outcome of an IFS contest does not mirror the success or failure of any real-life athlete or sports team.”  Id.  That is because “IFS rosters do not replicate real-life teams, IFS scoring systems are premised on an aggregation of statistics concerning each individual athlete’s performance on specific tasks, and IFS contests pit the rosters of participants against one another rather than tying success to the outcome of sporting events.”  Id.

[2]   New York’s mobile sports wagering legislation adopted Gibson Dunn’s constitutional reasoning.  As Gibson Dunn attorneys argued in a 2020 New York Law Journal op-ed, the legislature had the authority to enact legislation legalizing online sports wagering for two reasons.  First, sports betting fits within the New York Constitution’s term “casino gambling,” because “casino gambling” would have been understood to include sports betting at the time the constitutional amendment was passed and adopted.  Second, based on general contract law principles, online sports wagering can be conducted “at” an authorized casino so long as the acceptance and ultimate placement of the wager occurs at a server located at one of the licensed casinos.  See Gibson Dunn, New York State Legalizes Online Sports Wagering (April 13, 2021), https://www.gibsondunn.com/new-york-state-legalizes-online-sports-wagering/.

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Litigation or Appellate and Constitutional Law practice groups, or the following authors:

Matthew L. Biben – New York (+1 212-351-6300, [email protected])

Mylan L. Denerstein – New York (+1 212-351-3850, [email protected])

Akiva Shapiro – New York (+1 212-351-3830, [email protected])

Alyssa B. Kuhn – New York (+1 212-351-2653, [email protected])

Todd W. Shaw – Washington, D.C. (+1 202-955-8245, [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.

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As Russia continues to wage its unlawful war against Ukraine, in recent weeks Russia has severely restricted free expression within its borders.  While journalists in Russia have long had to navigate a host of draconian laws designed to stifle free expression and limit media coverage critical of the government,[1] these new measures amount to a drastic escalation.  Through both administrative and legislative measures, Russia has totally restricted several media outlets from operating in Russia.  Among other things, Russia is threatening harsh criminal and monetary penalties against those who report on the conflict as a war or an invasion.

The catalyst for the new restrictions is Russia’s desire to control the public narrative associated with the war.  Russia’s media agency, Roskomnadzor, has blocked access to media platforms (including social media) and news outlets on a variety of alleged bases, including that certain outlets and platforms were allegedly spreading misinformation about Russia’s actions in Ukraine and restricting access to government-backed media.[2]

Concurrently, Russia adopted amendments to the Criminal Code that introduces prison terms of up to 15 years for persons convicted of disseminating “knowingly false information” about military operations.[3]  The same law introduces a maximum penalty of five years imprisonment for “discrediting” and “calling for obstruction” of the use of the Russian armed forces.[4]  In practice, these new measures grant Russia broad authority to impose harsh penalties for any criticism of Russia’s conduct against Ukraine.  Under the serious threat of criminal prosecution, major foreign news outlets as well as prominent independent Russian news outlets, have been forced to take significant measures.  Some have suspended operations in Russia,[5] removed content regarding Russia’s attacks on Ukraine,[6] or shut down entirely.[7]

In addressing recent legislative amendments, three Special Rapporteurs of the United Nations’ Human Rights Council have observed that “[w]hile the government claims that the purpose of the new legislation is to protect the ‘truth’ about what it euphemistically calls a ‘special military operation’ in Ukraine, in reality the law places Russia under a total information blackout on the war and in so doing gives an official seal of approval to disinformation and misinformation.”[8] The Special Rapporteurs explain that “[b]y restricting reporting and blocking access to information online the authorities are not only choking the last vestiges of independent, pluralistic media in Russia, but they are also depriving the population of their right to access diverse news and views at this critical time when millions of Russians legitimately want to know more about the situation in Ukraine.”[9]

Russia’s restrictions on the media violate its international human rights obligations.  In addition, Russia’s actions may also breach obligations it owes foreign investors under investment treaties to which it is party.  Below, we set out options that may be available to affected media companies and journalists seeking to challenge Russia’s actions.

Claims Before Human Rights Bodies

At this time and until September 16, 2022, Russia is a party to the European Convention on Human Rights (the “European Convention”).  While Russia was removed from the Council of Europe on March 16,[10] the Committee of Ministers (the Council of Europe’s statutory decision-making body)[11] and the European Court of Human Rights (“ECHR”)[12] have confirmed that Russia will remain a party to the European Convention until September 16.  Accordingly, the ECHR “remains competent to deal with applications directed against the Russian Federation in relation to acts or omissions capable of constituting a violation of the Convention provided that they occurred until 16 September 2022.”[13]

Pursuant to the European Convention, Russia must guarantee physical and legal persons in its jurisdiction basic human rights, including the right to free expression.[14]  Russia’s actions to suppress the media are clear violations of its obligations under the European Convention, and any effort by Russia to enforce its new censorship laws may amount to further violations.  Thus, media companies and journalists who have been impacted by Russia’s recent measures may be able to seek remedies for these violations before the ECHR.[15]

To successfully bring an application before the ECHR, applicants must: (i) satisfy the jurisdictional and admissibility criteria required by the European Convention; and (ii) demonstrate a violation of the European Convention.

To have standing before the ECHR, a person (either physical or legal) must be able to show that a party to the European Convention committed a violation of the European Convention against them within its jurisdiction,[16] and was “directly affected” by the violation.[17]  In addition, an applicant should seek to exhaust remedies in the jurisdiction whose actions are being challenged and bring a claim within four months of a final decision.[18]  This requirement, however, is not a hard and fast rule, and “must take realistic account not only of the existence of formal remedies in the legal system of the Contracting Party concerned but also of the general legal and political context in which they operate as well as the personal circumstances of the applicants.”[19]  In this case, an applicant could argue there is an “administrative practice” of censoring journalists in Russia that renders exhaustion of local remedies futile or ineffective.[20]  In this context, any application should be brought within four months of the applicant receiving notice of the act that is the subject of the application or any prejudicial effect arising from the act.[21]

On the merits, Russia’s measures appear to be clear violations of its obligations under the European Convention.  The European Convention states that “[e]veryone has the right to freedom of expression. This right shall include freedom to hold opinions and to receive and impart information and ideas without interference by public authority and regardless of frontiers.”[22] Legislation that causes potential authors to adopt a form of self-censorship, as is the case in Russia, can amount to an interference with the right to freedom of expression.[23]  Free expression can only be limited if the restriction is: (i) provided for by law, (ii) in pursuit of a legitimate aim, and (iii) necessary and proportionate to achieve that aim.[24]

With respect to (i), the ECHR has held that domestic laws that restrict freedom of expression must be formulated “with sufficient precision to enable the person concerned to regulate his or her conduct: he or she needed to be able – if need be with appropriate advice – to foresee, to a degree that was reasonable in the circumstances, the consequences that a given action could entail.”[25]  The ECHR has further emphasized that “indiscriminate blocking measure[s] which interfere[] with lawful content . . . as a collateral effect of a measure aimed at illegal content . . . amounts to arbitrary interference” with the right to free expression.[26]  Here, Russia has, for example, criminalized “discrediting” and “calling for obstruction” of the use of the Russian military.  These vague terms could arguably extend to any form of criticism of the Russian military.

With respect to (ii), while Russia contends that the restrictions are necessary for national security, it is widely acknowledged that the purpose of these restrictions is to suppress criticism and dissent of Russia’s unlawful war.  As the Special Rapporteurs note, these new restrictions are “yet another drastic step in a long string of measures over the years, restricting freedom of expression and media freedom and further shrinking the civic space in the Russian Federation.”[27]  Indeed, in recent cases against Russia, the ECHR has concluded that Russia has acted with an “ulterior purpose” to “suppress political pluralism.”[28]  In any event, the ECHR has concluded that where opinions do not incite violence, a state cannot rely on the defense of national security to restrict the public’s right to be informed by using criminal law to influence the media.[29]

With respect to (iii), there is no basis for Russia to contend that these laws are necessary and proportionate.  As Professor Marko Milanovic of the University of Nottingham School of Law has explained, these laws “are almost entirely divorced from addressing specific harms caused by speech, and they are so overbroad that they generate a veritable storm of chilling effects on speech in the public interest (indeed, that’s their whole point).”[30]  In cases involving the suspension of media publication and distribution, the ECHR has held that “[t]he practice of banning the future publication of entire periodicals . . . went beyond any notion of ‘necessary’ restraint in a democratic society and, instead, amounted to censorship.”[31]

A successful applicant will receive relief in the form of a declaration that the State’s laws or actions are in violation of the European Convention, as well as just satisfaction, i.e., monetary compensation, for damages incurred.[32]

In addition to the ECHR, other human rights mechanisms may be available to hold Russia accountable for its violations of human rights.  For example, Russia is also currently a State Party to the International Covenant on Civil and Political Rights (“ICCPR”) as well as the First Optional Protocol to the ICCPR.[33]   Similar to its obligations under the European Convention, Russia is also obligated under the ICCPR to guarantee persons in its jurisdiction basic human rights, including the right to free expression.[34]  Individuals who have been impacted by Russia’s recent measures may therefore also be able to seek remedies for violations of the ICCPR before the Human Rights Committee at the United Nations.  Unlike the ECHR, only physical persons can submit complaints to the Human Rights Committee.[35]  In addition, if the same matter has been submitted to another treaty body or regional human rights mechanism (like the ECHR), the Human Rights Committee cannot examine the complaint.[36]

Claims Under Bilateral Investment Treaties

As will be addressed in a forthcoming alert regarding potential international arbitration remedies arising from Russia’s recent conduct, Russia is a party to multiple bilateral investment treaties (“BITs”) pursuant to which it owes certain obligations to qualifying foreign investors from states with which it has BITs and their investments.  These obligations include, among others, the obligation to treat investors and their investments fairly and equitably and not to expropriate investments without the payment of adequate compensation.  To the extent media entities (or other companies and individuals) qualify as investors with investments under one of these treaties and have suffered breaches of a BIT due to Russia’s actions, these investors may be able to submit such claims in international arbitration directly against the Russian state.

____________________________

[1] See, e.g., Russia: New assault on independent media, NGOs and activists through suffocating fines, Amnesty International (Oct. 29, 2018), https://www.amnesty.org/en/latest/news/2018/10/russia-new-assault-onindependent-media-ngos-and-activists-through-suffocating-fines/; Russia: New bills criminalising insults to the State and spread of ‘fake news’ threaten freedom of expression, Article 19 (Jan. 25, 2019), https://www.article19.org/resources/russia-new-bills-criminalising-online-insults-of-state-and-the-spread-of-fake-news-threaten-freedom-of-expression/; Russia advances legislation on ‘fake news’ and ‘disrespecting authorities’, Committee To Protect Journalists (Mar. 7, 2019), https://cpj.org/2019/03/russia-advances-legislation-on-fake-news-and-disre/; Letter from Special Rapporteur on the promotion and protection of the right to freedom of opinion and expression to the Government of Russia (May 1, 2019), here; Russian Federation: “Fake News” Bill Prompted By COVID-19 Threatens Freedom Of Expression, Amnesty International (Apr. 3, 2020), https://www.amnesty.org/download/Documents/EUR4620932020ENGLISH.pdf.

[2] See, e.g., Elizabeth Culliford, Russia blocks Facebook, accusing it of restricting access to Russian media, Reuters (Mar. 4, 2022, 7:16 PM), https://www.reuters.com/business/media-telecom/russia-blocks-facebook-accusing-it-restricting-access-russian-media-2022-03-04/; Shannon Bond & Bobby Allyn, Russia is restricting social media. Here’s what we know, NPR (Mar. 11, 2022, 1:57 PM), https://www.npr.org/2022/03/07/1085025672/russia-social-media-ban; Russia blocks Ekho Moskvy and Dozhd TV, restricts social media access, Committee to Protect Journalists (Mar. 1, 2022, 5:48 PM), https://cpj.org/2022/03/russia-blocks-echo-of-moscow-and-dozhd-tv-restricts-social-media-access/.  See also Об ограничении доступа к социальной сети Instagram (About restricting access to the social network Instagram), Roskomnadzor (Mar. 11, 2022), https://rkn.gov.ru/news/rsoc/news74180.htm; Приняты меры по защите российских СМИ (Measures taken to protect Russian media), Roskomnadzor (Feb. 25, 2022), https://rkn.gov.ru/news/rsoc/news74108.htm; Приняты ответные меры на ограничение доступа к российским СМИ (Response measures taken to restrict access to Russia media), Roskomnadzor (Mar. 4, 2022), https://rkn.gov.ru/news/rsoc/news74156.htm.

[3] See UN rights experts raise alarm over Russia’s ‘choking’ media clampdown at home, UN News (Mar. 11, 2022), https://news.un.org/en/story/2022/03/1113762.

[4] See UN rights experts raise alarm over Russia’s ‘choking’ media clampdown at home, UN News (Mar. 11, 2022), https://news.un.org/en/story/2022/03/1113762.

[5] See, e.g., Michael M. Grynbaum, The New York Times Pulls Its News Staff From Russia, N.Y. Times (Mar. 8, 2022), https://www.nytimes.com/2022/03/08/business/media/new-york-times-russia-press-freedom.html; Oliver Darcy, CNN, BBC, and others suspend broadcasting from Russia after Putin signs law limiting press, CNN (Mar. 4, 2022, 10:05 PM), https://www.cnn.com/2022/03/04/media/bbc-cnn-russia-putin-media-law/index.html; Ukraine war: BBC News journalists resume English-language broadcasts from Russia, BBC News (Mar. 8, 2022), https://www.bbc.com/news/entertainment-arts-60667770.

[6] See, e.g., Russia’s Novaya Gazeta cuts Ukraine war reporting under censorship, Reuters, (Mar. 4, 2022, 11:55 AM), https://www.reuters.com/world/russias-novaya-gazeta-cuts-ukraine-war-reporting-under-censorship-2022-03-04/.

[7] See, e.g., Anton Troianovski, Russia Takes Censorship to New Extremes, Stifling War Coverage, N.Y. Times (Mar. 4, 2022), https://www.nytimes.com/2022/03/04/world/europe/russia-censorship-media-crackdown.html; Anton Troianovski, Last Vestiges of Russia’s Free Press Fall Under Kremlin Pressure, N.Y. Times (Mar. 3, 2022), https://www.nytimes.com/2022/03/03/world/europe/russia-ukraine-propaganda-censorship.html.

[8] UN rights experts raise alarm over Russia’s ‘choking’ media clampdown at home, UN News (Mar. 11, 2022), https://news.un.org/en/story/2022/03/1113762.

[9] UN rights experts raise alarm over Russia’s ‘choking’ media clampdown at home, UN News (Mar. 11, 2022), https://news.un.org/en/story/2022/03/1113762.

[10] Council of Europe, Ministers’ Deputies Decision CM/Del/Dec(2022)1428ter/2.3, Consequences of the aggression of the Russian Federation against Ukraine (Mar. 16, 2022), https://search.coe.int/cm/‌pages/result_details.‌aspx?objectid=‌0900001680a5d7d9.  See also Committee of Ministers, The Russian Federation is excluded from the Council of Europe, Council of Europe (Mar. 16, 2022), https://www.coe.int/en/web/cm/news/-/asset_publisher/‌hww‌luK1RCEJo‌/content/the-russian-federation-is-excluded-from-the-council-of-europe/16695; European Convention, Art. 58(3) (“Any High Contracting Party which shall cease to be a member of the Council of Europe shall cease to be a Party to this Convention under the same conditions.”).

[11] Council of Europe, Ministers’ Deputies Resolution CM/Res(2022)3, On legal and financial consequences of the cessation of membership of the Russian Federation in the Council of Europe (Mar. 23, 2022), https://search.coe.int/cm/pages/result_details.aspx?objectid=0900001680a5ee2f.  See also Committee of Ministers, Russia ceases to be a Party to the European Convention on Human Rights on 16 September 2022, Council of Europe (Mar. 23, 2022), https://www.coe.int/en/web/portal/-/russia-ceases-to-be-a-party-to-the-european-convention-of-human-rights-on-16-september-2022.

[12] European Court of Human Rights, Resolution of the European Court of Human Rights on the consequences of the cessation of membership of the Russian Federation to the Council of Europe in light of Article 58 of the European Convention on Human Rights (Mar. 23, 2022), here.

[13] European Court of Human Rights, Resolution of the European Court of Human Rights on the consequences of the cessation of membership of the Russian Federation to the Council of Europe in light of Article 58 of the European Convention on Human Rights (Mar. 23, 2022), here.

[14] Convention for the Protection of Human Rights and Fundamental Freedoms, Nov. 4, 1950, available at https://www.echr.coe.int/documents/convention_eng.pdf (hereinafter “European Convention”).

[15] The ECHR may receive applications from any “person, non-governmental organisation or group of individuals.”  European Convention, Art. 34.  This includes companies that do not exercise governmental or other powers beyond those conferred by ordinary private law.  See Slovenia v. Croatia, App. No. 54155/16, Grand Chamber Decision, Nov. 18, 2020, §§ 61-63, https://hudoc.echr.coe.int/eng?i=001-206897.

[16] See European Convention, Art. 1.

[17]Roman Zakharov v. Russia, App. No. 47143/06, Judgment, Dec. 4, 2015, § 164, https://hudoc.echr.coe.int/eng?i=001-159324.

[18] See European Convention, Art. 35(1).

[19] Akdivar and Others v. Turkey, App. No. 21893/93, Judgment, Sept. 16, 1996, § 69, https://hudoc.echr.coe.int/eng?i=001-58062.

[20] See Ukraine v. Russia (re Crimea), App. Nos. 20958/14 and 38334/18, Grand Chamber Decision, Dec. 16, 2020, §§ 260-63, 363-68, https://hudoc.echr.coe.int/eng?i=001-207622; Georgia v. Russia (II), App. No. 38263/08, Grand Chamber Judgment, Jan. 21, 2021, §§ 98-99, 220-21, https://hudoc.echr.coe.int/eng?i=001-207757.

[21] See Dennis and Others v. The United Kingdom, App No. 76573/01, Decision, July 2, 2002, https://hudoc.echr.coe.int/eng?i=001-22838 (“[T]he object of the [four] month time limit under Article 35 § 1 is to promote legal certainty, by ensuring that cases raising issues under the Convention are dealt with in a reasonable time and that past decisions are not continually open to challenge.”).

[22] European Convention, Art. 10.

[23] Altuğ Ganer Akçam v. Turkey, App. No. 27520/07, Judgment, Jan. 25, 2012, §§ 67-83, https://hudoc.echr.coe.int/eng?i=001-107206; Vajnai v. Hungary, App. No. 33629/06, Judgment, July 8, 2008, § 54, https://hudoc.echr.coe.int/eng?i=001-87404.

[24] See European Convention, Art. 10(2).

[25] Perinçek v. Switzerland, App. No. 27510/08, Grand Chamber Judgment, Oct. 15, 2015, § 131, https://hudoc.echr.coe.int/eng?i=001-158235.

[26] OOO Flavus and Others v. Russia, App. Nos. 12468/15, 23489/15, 19074/16, Judgment, June 23, 2020, § 38, https://hudoc.echr.coe.int/eng?i=001-203178.  See also Vladimir Kharitonov v. Russia, App. No. 10795/14, Judgment, June 23, 2020, § 46, https://hudoc.echr.coe.int/eng?i=001-203177 (“The Court reiterates that it is incompatible with the rule of law if the legal framework fails to establish safeguards capable of protecting individuals from excessive and arbitrary effects of blocking measures”).

[27] UN rights experts raise alarm over Russia’s ‘choking’ media clampdown at home, UN News (Mar. 11, 2022), https://news.un.org/en/story/2022/03/1113762.

[28] Navalnyy v. Russia (No. 2), App. No. 43734/14, Apr. 9, 2019, §§ 96-98, https://hudoc.echr.coe.int/eng?i=001-192203.  See also Marko Milanovic, The Legal Death of Free Speech in Russia, EJIL:Talk! (March 8, 2022), https://www.ejiltalk.org/the-legal-death-of-free-speech-in-russia/.

[29] See Gözel et Özer v. Turkey, App. Nos. 43453/04 and 31098/05, Judgment, July 6, 2010, § 56, https://hudoc.echr.coe.int/eng?i=001-99780.

[30] Marko Milanovic, The Legal Death of Free Speech in Russia, EJIL:Talk! (Mar. 8, 2022), https://www.ejiltalk.org/the-legal-death-of-free-speech-in-russia/.

[31] See Ürper and Others v. Turkey, App. Nos. 14526/07 et al., Judgment, Oct. 20, 2009, § 44, https://hudoc.echr.coe.int/eng?i=001-95201.

[32] European Convention, Art. 41.

[33] Ratification Status for Russian Federation, UN Treaty Body Database, here (last available Mar. 23, 2022).

[34] See International Covenant on Civil and Political Rights, Mar. 23, 1976, available at https://treaties.un.org/‌doc/Treaties/1976/03/19760323%2006-17%20AM/Ch_IV_04.pdf.

[35] See A Newspaper Publishing Company v. Trinidad and Tobago, Communication No. 360/1989, U.N. Doc. Supp. No. 40 (44/A/40) (1989).

[36] See Optional Protocol to the International Covenant on Civil and Political Rights, Mar. 23, 1976, available at https://treaties.un.org/doc/Treaties/1976/03/19760323%2007-37%20AM/Ch_IV_5p.pdf, Art. 5(2)(a).  See also European Convention, Art. 35(2)(b).

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The following Gibson Dunn lawyers prepared this client alert: Rahim Moloo, Charline Yim, Marryum Kahloon, and Nadia Alhadi in New York.

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 or Transnational Litigation practice groups, or the following authors:

Rahim Moloo – New York (+1 212-351-2413, [email protected])
Charline Yim – New York (+1 212-351-2316, [email protected])
Marryum Kahloon – New York (+1 212-351-3867, [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

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On March 15, 2022, President Joe Biden signed into law the Cyber Incident Reporting for Critical Infrastructure Act, which was included in an omnibus appropriations bill.[1]  Against the backdrop of high-profile cyberattacks on critical infrastructure providers and growing concerns of retaliatory cyberattacks relating to Russia’s invasion of Ukraine, the House approved the bipartisan legislation on March 9 and the Senate unanimously approved the legislation on March 11 after failing to pass similar legislation in recent years.

The Act creates two new reporting obligations on owners and operators of critical infrastructure:

• An obligation to report certain cyber incidents to the Cybersecurity and Infrastructure Security Agency (CISA) of the U.S. Department of Homeland Security (DHS) within 72 hours, and
• An obligation to report ransomware payments within 24 hours.

The new reporting obligations will not take effect until the Director of CISA promulgates implementing regulations, including “clear description[s] of the types of entities that constitute covered entities.”[2]  The Act does provide guideposts for which entities may be covered and refers to the Presidential Policy Directive 21 from 2013, which deems the following sectors as critical infrastructure: chemical; commercial facilities; communications; critical manufacturing; dams; defense industrial base; emergency services, energy; financial services; food and agriculture; government facilities; healthcare and public health; information technology; nuclear reactors, materials, and waste; transportation systems; and water and wastewater systems.[3]

The Act considerably expands the reporting obligations of covered entities and CISA’s role with respect to cyber reporting initiatives, the rulemaking process, and information sharing among federal agencies.  Below is a summary of the legislation, as well as key takeaways.

I. The Act’s Impact on Covered Entities

A.    Reporting Obligations

Under the Act, covered entities that experience a “covered cyber incident” are required to report the incident to CISA no later than 72 hours after the entity “reasonably believes” that such an incident has occurred.[4]  The Act defines a “covered cyber incident” as one that is “substantial” and meets the “definition and criteria” to be set by the CISA Director in the forthcoming rulemaking process.[5]  In addition, covered entities are also required to report any ransom payments made as a result of a ransomware attack to CISA no later than 24 hours after making the payment.[6]  Entities are required to report ransom payments even if the underlying ransomware attack is not a covered cyber incident.”[7]  If a covered entity experiences a covered incident and remits a ransom before the 72-hour deadline, it may submit a single report to satisfy both reporting requirements.[8]  Covered entities that are required to report cyber incidents or ransom payments also will be required to preserve relevant data.[9]  Although the Act specifies some of the content that reports should contain,[10] the CISA Director will further prescribe report contents through the rulemaking process.

After reporting a covered incident, covered entities will be required to submit updates as “substantial new or different information becomes available” until the covered entity notifies CISA that the incident has been fully mitigated and resolved.[11]  Such supplemental reports will need to address whether a covered entity made a ransom payment after submitting the initial report.

To “enhance the situational awareness of cyber threats,” the legislation provides for voluntary reporting of incidents and ransom payments by non-covered entities, as well as the voluntary provision of additional information beyond what is mandatory by covered entities.[12]  Required and voluntary reporting will receive the same protections, further described below.

Notably, the Act creates an exception whereby its reporting requirements will not apply to covered entities that, “by law, regulation, or contract,” are already required to report “substantially similar information to another Federal agency within a substantially similar timeframe.”[13]  However, this exception will be available only if the relevant federal agency has an “agency agreement and sharing mechanism” in place with CISA.

B.    Protections for Reporting Entities

Recognizing some of the concerns relating to reporting, the Act protects reporting entities from certain liability associated with the submission of required or voluntary reports.  Under the Act, submitted cyber incident and ransom payment reports cannot be used by CISA, other federal agencies, or any state or local government to regulate, including through enforcement action, the activities of the covered entity that submitted the report.[14]

In addition, submitted reports must:

• Be considered commercial, financial, and proprietary information if so designated;
• Be exempt from disclosure under freedom of information laws and similar disclosure laws;
• Not constitute a waiver of any applicable privilege or protection provided by law; and
• Not be subject to a federal rule or judicial doctrine regarding ex parte communications.[15]

Certain additional protections further encourage compliance and recognize the concerns that victim companies may face in providing notifications.  Notably, the required reports, and material used to prepare the reports, cannot be received as evidence, subject to discovery, or used in any proceeding in federal or state court or before a regulatory body.[16]  Also, no cause of action can be maintained based on the submission of a report unless it is an action taken by the federal government to enforce a subpoena against a covered entity.  These liability protections only apply to litigation based on the submission of a cyber incident or ransom payment report to CISA, not the underlying cyber incident or ransom payment.[17]

II. CISA’s Oversight and Responsibilities under the Act

By considerably expanding CISA’s role, the Act essentially establishes CISA as the central federal agency responsible for cyber reporting for companies operating within a critical infrastructure sector, advancing the forthcoming rulemaking process, and coordinating with other agencies with respect to information sharing and new initiatives.

A.    Forthcoming Rulemaking

The Act provides some parameters for key definitions and processes, but ultimately requires CISA to spell out various requirements via rulemaking.  The legislation requires the CISA Director—in consultation with Sector Risk Management Agencies, the Department of Justice, and other federal agencies—to issue a notice of proposed rulemaking within 24 months.[18]  The Director must issue a final rule within 18 months of issuing the proposed rule.[19]  Among other items, the Director will need to issue regulations concerning which entities are covered by the requirements, the types of substantial cyber incidents that the Act covers, data preservation, and the manner, timing, and form of reports.

Once the final rule is issued, CISA will conduct an outreach and education campaign to inform likely covered entities and supporting cybersecurity providers of the Act’s requirements.[20]

B.    Information Assessment and Sharing

The Act requires CISA to aggregate, analyze, and share information learned from submitted reports to provide government agencies, Congress, companies, and the public with an assessment of the constantly evolving cyber threat landscape.  (When sharing information with non-federal entities and the public, CISA is required to anonymize the victim entities that filed report(s).[21])

Some of the responsibilities of CISA’s National Cybersecurity and Communications Integration Center (“the Center”) include immediately reviewing submitted reports to determine whether the incident relates to an ongoing cyber threat or security vulnerability.[22]  Moreover, the legislation enhances federal cyber incident sharing.  The Center is required to make reports available to relevant Sector Risk Management Agencies and appropriate federal agencies within 24 hours of receipt.[23]  Similarly, federal agencies that receive incident reports (including from non-covered entities) must submit them to CISA no later than 24 hours following receipt.[24]

The Act sets forth authorized uses and sharing of submitted reports.  Information may be disclosed to, retained by, and used by federal agencies solely for: a cybersecurity purpose; to identify a cyber threat or security vulnerability; to respond to, prevent or mitigate specific threats of death, serious bodily harm, or serious economic harm; to respond to or prevent a serious threat to a minor; or to respond to an offense arising out of a reported incident.[25]

Among other items, the Center is tasked with establishing mechanisms to receive feedback from stakeholders, facilitating timely information sharing with critical infrastructure companies, and publishing quarterly unclassified reports on cyber incident trends and recommendations.[26]  The Act also imposes on CISA several congressional reporting requirements, including briefings to describe stakeholder engagement with rulemaking and enforcement mechanism effectiveness.[27]

C.    Enforcement

The Act provides several enforcement mechanisms.  If a covered entity fails to submit a required report, the CISA Director may obtain information about the cyber incident or ransom payment by directly engaging with the covered entity “to gather information sufficient to determine whether a covered cyber incident or ransom payment has occurred.”[28]  If the covered entity does not respond to the initial information request within 72 hours, the CISA Director may issue a subpoena.  Failure to comply with the subpoena – or information furnished in response to a subpoena – may result in the referral of the matter to the Department of Justice for enforcement.[29]

Additionally, the Act denies covered entities some of the protections detailed above if they do not comply with its reporting requirements.

Under the Act, the CISA Director must provide an annual report to Congress that conveys anonymized information about the number of initial requests for information, issued subpoenas, and referred enforcement matters.[30]  This report will be published on CISA’s website.

D.    Forthcoming Initiatives

Finally, the Act sets forth several initiatives to enhance cybersecurity coordination efforts:

• Cyber Incident Reporting Council: The Act calls for DHS to lead an intergovernmental Cyber Incident Reporting Council to “coordinate, deconflict, and harmonize Federal incident reporting requirements[.]”[31]
• Ransomware Vulnerability Warning Pilot Program: No later than one year after the Act’s enactment, CISA is required to establish a new Ransomware Vulnerability Warning Pilot Program.[32]  Leveraging existing authorities and technology, this program is tasked with identifying the most common security vulnerabilities used in ransomware attacks and techniques on how to mitigate and contain the security vulnerabilities.
• Joint Ransomware Task Force: The Act instructs the CISA Director to establish and chair the Joint Ransomware Task Force “to coordinate an ongoing nationwide campaign against ransomware attacks, and identify and pursue opportunities for international cooperation.”[33]

III. Takeaways

Once in effect, the Act will considerably expand reporting considerations for some entities.  Accordingly, companies should consider the following next steps:

• Companies in Many Sectors Are Potentially Subject to the New Reporting Requirements. Companies in the many industry sectors cited in Presidential Policy Directive 21 should closely monitor the proposed rulemaking and evaluate whether the Act’s requirements are likely to apply to their businesses.  Entities that may be covered by the Act may wish to comment during the rulemaking process, as the final rule will impose more detailed requirements.
• Companies Should Identify Existing Reporting Obligations and Monitor Interagency Sharing Agreements. Although the Act’s reporting obligations will not become effective for some time, critical infrastructure entities should take steps now to prepare for potentially overlapping disclosure obligations.  As detailed above, the Act creates an exception whereby its reporting requirements will not apply to covered entities that file a substantially similar report with another federal agency.  However, this exception will be available only if the relevant federal agency has an agreement and sharing mechanism in place with CISA.  The law also authorizes federal (but not state) agencies to coordinate, deconflict and harmonize federal incident reporting obligations.In order to monitor developments in the harmonization of federal incident reporting obligations, as well as track agency sharing mechanisms, potentially impacted entities should first assess their other federal cybersecurity disclosure obligations.  Some of these obligations may stem from reporting obligations imposed on federal government contractors and recent executive orders.  For instance, the Biden administration’s Executive Order in May 2021, “Improving the Nation’s Cybersecurity,” requires federal contractors to share information regarding incidents.[34]  In 2021, the Transportation Security Administration also issued a directive which requires pipeline entities to report confirmed and potential incidents.[35]Public companies should also consider whether reports submitted under the Act may prompt disclosures under the SEC’s newly proposed rule, which requires public disclosure of material cybersecurity incidents within four business days.[36]Finally, the recent reporting developments should be assessed against a heightened enforcement backdrop—namely, the DOJ’s Civil Cyber-Fraud Initiative, which seeks to leverage the False Claims Act to hold accountable contractors and recipients of federal funds and grants that knowingly violate contractual obligations to monitor and report cybersecurity incidents and breaches.[37]

• Companies May Need to Revisit their Cybersecurity Policies, Procedures, and Programs. In light of the Act’s requirements, potentially impacted entities should determine whether changes to their cyber programs may be required, examine their internal policies and procedures to reflect the Act’s requirements, and address and prepare for overlapping disclosure obligations under state, federal and international laws.

________________________

   [1]   See Cyber Incident Reporting for Critical Infrastructure Act of 2022, H.R. 2471, 116th Cong. (2022).

   [2]   H.R. 2471 § 2242(c)(1).  This provision provides that when promulging the final rule to define “covered entities,” the CISA Director must consider the national security, economic security, and public health and safety consequences of a potential cyberattack on the entity, the likelihood that such an entity could be targeted, and the extent to which a cyberattack will enable disruption of the reliable operation of critical infrastructure.

   [3]   H.R. 2471 § 2240(5).  See also White House, Office of the Press Secretary, Presidential Policy Directive — Critical Infrastructure Security and Resilience, Feb. 12, 2013, available at https://obamawhitehouse.archives.gov/the-press-office/2013/02/12/presidential-policy-directive-critical-infrastructure-security-and-resil; CISA, Critical Infrastructure Sectors, available at https://www.cisa.gov/critical-infrastructure-sectors.

   [4]   H.R. 2471 § 2242(a)(1)(A).

   [5]   Id. at § 2240(4).  The legislation does not define “substantial.”

   [6]   H.R. 2471 § 2242(a)(2)(A).

   [7]   H.R. 2471 § 2242(a)(2)(B).

   [8]   H.R. 2471 § 2242(a)(5)(A).

   [9]   H.R. 2471 § 2242(a)(4).

  [10]   At a minimum, covered incident reports must convey certain information about the incident, including:

• a description of the covered incident;
• a description of the vulnerabilities exploited, security defenses in place, and tactics, techniques, and procedures used to perpetrate the incident;
• information about the actor(s) reasonably believed to be responsible for the incident;
• and the identification of categories of information that were, or are reasonably believed to have been, accessed or acquired by an unauthorized person.See H.R. 2471 § 2242(c)(4).  The Act also details minimum reporting requirements for ransom payments.  See id. at § 2242(c)(5).

  [11]   H.R. 2471 § 2242(a)(3).

  [12]   H.R. 2471 § 2243.

  [13]   H.R. 2471 § 2242(a)(5).

  [14]   H.R. 2471 § 2245(a)(5)(A).

  [15]   H.R. 2471 § 2245(b).

  [16]   H.R. 2471 § 2245(c)(3).

  [17]   H.R. 2471 § 2245(c).

  [18]   H.R. 2471 § 2242(b)(1).

  [19]   H.R. 2471 § 2242(b)(2).

  [20]   H.R. 2471 § 2242(e)

  [21]   H.R. 2471 § 2245(d).

  [22]   H.R. 2471 § 2245(a)(2)(A).

  [23]   H.R. 2471 § 2241(a)(10).

  [24]   H.R. 2471 § 104(a)(1).

  [25]   H.R. 2471 § 2245(a)(1).

  [26]   H.R. 2471 § 2241(a).

  [27]   H.R. 2471 §§ 107; 2244(g).

  [28]   H.R. 2471 § 2244(a).

  [29]   H.R. 2471 § 2244(c)-(d).

  [30]   H.R. 2471 § 2244(g).

  [31]   H.R. 2471 § 2246(a).

  [32]   H.R. 2471 § 105.

  [33]   H.R. 2471 § 106(a)(1).

  [34]   See Exec. Order No. 14,028, 86 Fed. Reg. 26,633 (May 12, 2021).

  [35]   See Press Release, Dep’t of Homeland Security, DHS Announces New Cybersecurity Requirements for Critical Pipeline Owners and Operators (May 27, 2021), https://www.dhs.gov/news/2021/05/27/dhs-announces-new-cybersecurity-requirements-critical-pipeline-owners-and-operators.

  [36]   See Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure, Exchange Act Release, No. 34-94382 (Mar. 9, 2022), available at https://www.sec.gov/rules/proposed/2022/33-11038.pdf; see also Gibson Dunn’s client alert on the SEC’s proposed rule, available at https://www.gibsondunn.com/sec-proposes-rules-on-cybersecurity-disclosure/.

  [37]   See Press Release, U.S. Dep’t of Justice, Deputy Attorney General Lisa O. Monaco Announces New Civil Cyber-Fraud Initiative (Oct. 6, 2021), https://www.justice.gov/opa/pr/deputy-attorney-general-lisa-o-monaco-announces-new-civil-cyber-fraud-initiative.

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This alert was prepared by Ashlie Beringer, Alexander H. Southwell, Ryan T. Bergsieker, and Snezhana Stadnik Tapia.

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 and Data Innovation practice group:

United States
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, [email protected])
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])
Matthew Benjamin – New York (+1 212-351-4079, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [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])
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])
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])

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])

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The United States and the European Union have issued or announced new export controls targeting Russia, Belarus, and the Russia-backed separatist regions of Ukraine known as the Donetsk People’s Republic and the Luhansk People’s Republic. These new controls include a substantial expansion of item-based licensing requirements, an extension of export licensing requirements to new products using or made with certain controlled software and technology, an expansion of military end use and end user controls, changes to the license review policy, and the modification of existing license exceptions for the Russia- and Belarus-specific context. More recent changes include prohibitions on the export of oil and gas refining equipment, bank notes, and luxury goods.

These changes, and concurrent Entity List designations, reflect significant export controls cooperation both internationally and between U.S. government agencies. As tensions continue to rise, we will likely see more series of tools from the NATO countries and their allies to exert economic pressure on Russia to deescalate the ongoing crisis in Ukraine and withdraw its army from Ukraine’s borders. Hear from our experts about these developments and how companies should proactively assess their exposure to the export controls measures being discussed.

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On 2 March 2022, Heads of State, Environment Ministers, and representatives from 175 countries endorsed a resolution at the United Nations Environment Assembly (“UNEA-5”) in Nairobi to negotiate an international legally binding agreement to “end plastic pollution” by the end of 2024 (the “UNEA Resolution”).[1]  The UNEA Resolution, End Plastic Pollution: Towards an Internationally Legally Binding Instrument, is the culmination of several years of negotiations and advocacy by governments, international organizations, and the private sector,[2] which pledges to address the full lifecycle of plastic—including its production, design, and disposal.[3]  Its adoption has been described as “a cure” for “plastic pollution,”[4] and “the most significant environmental multilateral deal since the Paris Accord [on Climate Change].”[5]  As discussed below, the ultimate treaty could have major repercussions on how plastics are regulated and used around the world with material implications for business.

I. Background

Over the last 5-10 years, national, local, and regional governments and international organizations have adopted a growing number of action plans and instruments to address plastic pollution and its interlinkages with biodiversity, climate change, health, and social issues.  At the national level, many countries have moved to limit or ban single-use plastics.[6]  There has also been a surge of interest in this issue at the multilateral level, including:

• UN Environment’s Global Partnership on Marine Litter (2012);[7]
• UN Environment Assembly Resolutions on Marine Litter and Microplastics (2014-);[8]
• G7 Action Plan to Combat Marine Litter (2015),
• G20 Action Plan on Marine Litter (2017),[9]
• Ocean Plastics Charter (2018),[10]
• Amendments to the Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and their Disposal (“Basel Convention”) (2019),[11]
• G20 Osaka Blue Ocean Vision and Implementation Framework (2019),[12]
• Association of Southeast Asian Nations (“ASEAN”) Framework of Action on Marine Debris and the Bangkok Declaration on Combating Marine Debris (2019),[13]
• ASEAN Regional Action Plan for Combating Marine Debris in the ASEAN Member States (2021–25),[14]
• Asia-Pacific Economic Cooperation (“APEC”) Roadmap on Marine Debris (2019),[15]
• Caribbean Community (“CARICOM”) St. Johns Declaration to Address Plastic Pollution in Caribbean Sea (2019),[16]
• Alliance of Small Island States (“AOSIS”) Leaders Declaration (2021), and
• The Ministerial Conference on Marine Litter and Plastic Pollution (2021).[17]

Although ubiquitous, plastics are currently not subject to any single international treaty regime.  For example, the 2018 amendments to the Basel Convention meant that, for the first time, transboundary shipments of plastic scrap and waste would be regulated, leading to new export and import requirements for many companies, including U.S. businesses.[18]  However, this did not address the majority of plastic products.  In addition, the proliferation of local, national, and regional initiatives has given rise to often differing and incompatible rules, imposing greater costs on the regulated industry.

For these reasons, a new international “Plastics Treaty”—focused on plastics as the central issue rather than as an incident to other subject areas—increasingly came to be seen as a key step in regulating global plastic production, use, and disposal, and has been advocated by many businesses looking for harmonized regulatory standards, predictable national targets, and common metrics to make their short- and long-term operational and investment decisions.[19]

II. The Roadmap for a New “Plastics Treaty”

As described below, the UNEA Resolution[20] provides substantive guidance on its key provisions and sets out the procedural roadmap for the new treaty:

A. Substantive Roadmap

The UNEA Resolution also includes a number of provisions that will provide the likely contours of the new Plastics Treaty:

• First, contrary to widespread expectations, the UNEA Resolution is not limited to marine plastics or marine debris; it also covers “other environments,” including land-based sources.
• Second, it not only seeks to limit or reduce plastic pollution, but aims at “the long-term elimination of plastic pollution, in marine and other environments.”[21]
• Third, it adopts a “full lifecycle” of plastic, covering all aspects of its production, use, and disposal.[22]
• Fourth, it aims to foster coordination among existing international environmental treaties to “prevent plastic pollution and its related risks to human health and adverse effects on human well-being and the environment.”[23]
• Fifth, it seeks to address all aspects of the “sustainable production and consumption of plastics,” including improved waste management, greater resource efficiency and the adoption of “circular economy” approaches.[24]
• Sixth, it underlines the importance of sustainable design so that products and materials “can be reused, remanufactured or recycled and therefore retained in the economy for as long as possible along with the resources they are made of, as well as minimizing the generation of waste.”[25] This provision targets, in particular, single-use plastics.
• Seventh, it notes specifically the need to regulate “microplastics” (i.e., the miniscule plastic fragments that are created by the breakdown of plastics over time or are intentionally manufactured into some products, such as cosmetics).[26]
• Finally, it envisages a role for “all stakeholders, including the private sector,” in achieving the treaty objectives.[27]

B. Procedural Roadmap

The UNEA Resolution is but the first step in the treaty process, which is typical for the negotiation of multilateral environmental treaties.  It established an Intergovernmental Negotiating Committee (the “Committee”) that will begin its work during the second half of 2022, with the aim of completing a draft treaty by the end of 2024.[28]  The Committee will be working on the draft text, and attempt to resolve big divisions over how ambitious the treaty should be.  By the end of the year, the UN Environment Programme (“UNEP”) will also convene a stakeholder forum in conjunction with the first session of the Committee to share knowledge and best practices in different parts of the world.  When the Committee has completed its work on the draft text, UNEP will hold a diplomatic conference to formally adopt and open the new treaty for signature.[29]

III. Expectations of Global Divergence and Implications for Economy and Business

The new Plastics Treaty, if ultimately adopted, could have significant implications for the global economy and individual businesses.  The final Plastics Treaty will not spell an end for the use of plastics.  Indeed, the UNEA Resolution recognized “the important role of plastics for society.”[30]  However, the treaty, depending on its provisions, may lead to a sharp increase in compliance costs not only for the regulated industry and plastics manufacturers, but also for companies across the value chain, including consumer-facing companies.[31]

The treaty itself will likely not include detailed prescriptions: the UNEA delegates opted to model the Plastics Treaty on the 2015 Paris Agreement on Climate Change (the “Paris Agreement”), which, as a “bottom-up” treaty, relies on nationally-set commitments to attain the treaty’s objectives.  Under the Paris Agreement, countries can set their own binding targets using a range of policies.  Here too, we can expect that the final Plastics Treaty will allows individual States to adopt their own rules and regulations, in line with their national circumstances and capabilities, which will be reported and updated in national action plans.[32]

As a consequence, the final Plastics Treaty will likely eschew adopting a single approach and will allow the Contracting States to apply a range of approaches—from voluntary to binding rules.[33]  In terms of voluntary rules, many businesses already have in place targets for plastics through voluntary initiatives, such as the Global Commitment[34] and the Plastics Pact Network,[35] ReSource: Plastic,[36] and the World Economic Forum’s Global Plastic Action Partnership,[37] while some financial institutions are developing responsible investment practices that support a circular economy for plastics.[38]  But there is also a wide spectrum of binding rules, ranging from caps on plastic production, targets to increase waste collection and recycling, to commitments to phase out single-use plastics entirely or restrict manufacturing or design of plastic packaging, that could be imposed in implementation of the treaty.[39]  Finally, the treaty may provide a greater incentive for Governments to shift the cost of recycling or waste disposal to the manufacturers or, in the case of some developing countries, to the importers.  This too could impact long-term investment decisions and regulatory compliance for businesses across the value chain.

We can therefore expect to see considerable variation and stringency of rules across jurisdictions in terms of new regulatory measures aimed at curbing plastic pollution,[40] with the final rules being set by individual States.  Management of organizations will face the challenge trying to map out the implications for their business and business models—which for some industries and sectors are likely to be significant—while the final rules and their implementation at national level are still being crystallized.  In this regard, especially given the short treaty negotiation timetable, it will be important that individual businesses, management, and boards start tracking these unfolding developments at all levels of government and think proactively about these issues and how they will likely impact their operations, investment decisions, and compliance.

__________________________

   [1]   U.N. Env’t Assemb. Draft Res., U.N. Doc. UNEP/EA.5/L.23/Rev.1, End Plastic Pollution: Towards an International Legally Binding Instrument (Mar. 2, 2022) (“UNEA Resolution”).

   [2]   The Business Call for a UN Treaty on Plastic Pollution, https://www.plasticpollutiontreaty.org/ (last visited Mar. 20, 2022).

   [3]   See Nations Sign Up to End Global Scourge of Plastic Pollution, UN News (Mar. 2, 2022), https://news.un.org/en/story/2022/03/1113142 (last visited Mar. 20, 2022); Historic Day in the Campaign to Beat Plastic Pollution: Nations Commit to Develop a Legally Binding Agreement, UN Env’t, Press Release (Mar. 2, 2022), https://www.unep.org/news-and-stories/press-release/historic-day-campaign-beat-plastic-pollution-nations-commit-develop (last visited Mar. 20, 2022).

   [4]   See id. (quoting Espen Barth Eide, President of UNEA-5 and Norway’s Minister for Climate and the Environment).

   [5]   See id. (quoting Inger Andersen, Executive Director of UN Environment).

   [6]   See e.g., State Plastic Bag Legislation, Nat’l Conf. of State Legisl. (Feb. 8, 2021), https://www.ncsl.org/research/environment-and-natural-resources/plastic-bag-legislation.aspx (last visited Mar. 20, 2022); Victoria Masterson, As Canada Bans Bags and More, This Is What’s Happening with Single-Use Plastics Around the World, World Econ. Forum (Oct. 26, 2020), https://www.weforum.org/agenda/2020/10/canada-bans-single-use-plastics/ (last visited Mar. 20, 2022) (reviewing proposed ban in Canada and existing rules in Kenya, Zimbabwe, UK, New York, California, Hawaii, the EU, and China).  See also Kimiko de Freytas-Tamura, Public Shaming and Even Prison for Plastic Bag Use in Rwanda, N.Y. Times (Oct. 28, 2017), https://www.nytimes.com/2017/10/28/world/africa/rwanda-plastic-bags-banned.html (last visited Mar. 20, 2022).  Similarly, there are a number of such initiatives in the UK, including the UK Plastics Pact, a collaboration between businesses from across the entire plastics value chain, is supported by the UK Government and coordinated by the Waste and Resources Action Programme (“WRAP”).  See The UK Plastics Pact, WRAP, https://wrap.org.uk/taking-action/plastic-packaging/the-uk-plastics-pact (last visited Mar. 20, 2022).  The UK is also introducing a world-leading plastic packaging tax from 1 April 2022, set at £200 per ton, on plastic packaging which does not meet a minimum threshold of at least 30% recycled content.  See The Plastic Packaging Tax (Descriptions of Products) Regulations 2021, 2021 No. 1417.

   [7]   Global Partnership on Marine Litter, UN Env’t, https://www.unep.org/explore-topics/oceans-seas/what-we-do/addressing-land-based-pollution/global-partnership-marine (last visited Mar. 20, 2022).

   [8]   See U.N. Env’t Assemb. Res. 1/6, U.N. Doc. UNEP/EA.1/Res.6, Marine Plastic Debris and Microplastics (2014); Res. 2/11, U.N. Doc. UNEP/EA.2/Res.11, Marine Plastic Litter and Microplastics (Aug. 4, 2016); Res. 3/7, U.N. Doc. UNEP/EA.3/Res.7, Marine Litter and Microplastics (Dec. 5, 2017); Res. 4/6, U.N. Doc. UNEP/EA.4/Res.6, Marine Plastic Litter and Microplastics (Mar. 28, 2019); Res. 4/7, U.N. Doc. UNEP/EA.4/Res.7, Environmentally Sound Management of Waste (Mar. 28, 2019); Res. 4/9, U.N. Doc. UNEP/EA.4/Res.9, Addressing Single-use Plastic Products Pollution (Mar. 28, 2019).

   [9]   G20 Action Plan on Marine Litter, 2017 G20 Hamburg Summit (July 8, 2017).

  [10]   Ocean Plastics Charter, launched at the G7 Charlevoix Summit (2018).

  [11]   New International Requirements for the Export and Import of Plastic Recyclables and Waste, U.S. Env’t Protection Agency, https://www.epa.gov/hwgenerators/new-international-requirements-export-and-import-plastic-recyclables-and-waste (last visited Mar. 20, 2022).  See also Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and Their Disposal, opened for signature Mar. 22, 1989, 1673 U.N.T.S. 126 (entered into force May 5, 1992) [hereinafter Basel Convention]; The Secretariat of the Basil Convention, Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and Their Disposal: Text and Annexes Revised in 2019 (2020).

  [12]   Towards Osaka Blue Ocean Vision – G20 Implementation Framework for Actions on Marine Plastic Litter, G20 Implementation Framework for Actions on Marine Plastic Litter, https://g20mpl.org/ (last visited Mar. 20, 2022).

  [13]   ASEAN Framework of Action on Marine Debris, ASEAN, https://environment.asean.org/wp-content/uploads/2019/06/ASEAN-Framework-of-Action-on-Marine-Debris-FINAL.pdf (last visited Mar. 20, 2022).

  [14]   ASEAN Regional Action Plan for Combating Marine Debris in the ASEAN Member States (2021-2025), ASEAN, https://asean.org/book/asean-regional-action-plan-for-combating-marine-debris-in-the-asean-member-states-2021-2025-2/ (last visited Mar. 20, 2022).

  [15]   APEC Roadmap on Marine Debris, APEC, https://www.apec.org/meeting-papers/annual-ministerial-meetings/2019/2019_amm/annex-b (last visited Mar. 20, 2022).

  [16]   Fortieth Regular Meeting of the Conference of Heads of Government of the Caribbean Community (July 2019), CARICOM, https://caricom.org/wp-content/uploads/DECISIONS-40-HGC-JUL-2019.pdf (last visited Mar. 20, 2022).

  [17]   Ministerial Conference on Marine Litter and Plastic Pollution: Informal Consultations Addressing the Mandates of UNEA 3/7 and 4/6 towards the 5th UN Environmental Assembly (UNEA-5.2) jointly organized Ecuador, Germany, Ghana, and Vietnam, https://ministerialconferenceonmarinelitter.com/ (last visited Mar. 20, 2022).

  [18]   The new Basel Convention requirements for transboundary shipments of plastic scrap and waste took effect on January 1, 2021.  See U.S. EPA, supra note 11.

  [19]   See Business Call, supra note 2.

  [20]   UNEA Resolution, pmbl. (noting “with concern” that “the high and rapidly increasing levels of plastic pollution represent a serious environmental problem at a global scale, negatively impacting the environmental, social and economic dimensions of sustainable development.”).

  [21]   UNEA Resolution, pmbl.

  [22]   Id. ¶ 3.

  [23]   Id. pmbl.  This includes, inter alia, 1973 International Convention for the Prevention of Pollution from Ships and its 1978 Protocol, the Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and their Disposal, the Stockholm Convention on Persistent Organic Pollutants, the Rotterdam Convention on the Prior Informed Consent Procedure for certain Hazardous Chemicals and Pesticides in International Trade, the United Nations Convention on the Law of the Sea, the 1972 Convention on the Prevention of Marine Pollution by Dumping of Wastes and Other Matters and its 1996 Protocol, the Strategic Approach to International Chemicals Management, the United Nations Framework Convention on Climate Change, the Convention on Biological Diversity.

  [24]   Id. ¶ 3(b).

  [25]   Id. pmbl.

  [26]   Id. pmbl.

  [27]   Id. ¶ 3(l).

  [28]   UNEA Resolution, ¶ 1.

  [29]   See UN Env’t, supra note 3.

  [30]   Id. pmbl.

  [31]   John Geddie & Joe Brock, “‘Biggest Green Deal since Paris’: UN Agrees Plastic Treaty Roadmap,” Reuters (Mar. 2, 2022), https://www.reuters.com/business/environment/biggest-green-deal-since-paris-un-agrees-plastic-treaty-roadmap-2022-03-02/ (last visited Mar. 20, 2022).

  [32]   UNEA Resolution, ¶ 3.

  [33]   Id. pmbl. (“underlining that there is no single approach”).  See also id. ¶¶ 3, 4, 15.

  [34]   The Global Commitment 2021 Progress Report, Ellen MacArthur Found., https://ellenmacarthurfoundation.org/global-commitment/overview (last visited Mar. 20, 2022).

  [35]   The Plastics Pact Network, Ellen MacArthur Found., https://ellenmacarthurfoundation.org/the-plastics-pact-network (last visited Mar. 20, 2022).

  [36]   ReSource Plastic, https://resource-plastic.com/ (last visited Mar. 20, 2022).

  [37]   Global Plastic Action P’ship, https://globalplasticaction.org/ (last visited Mar. 20, 2022).

  [38]   See Business Call, supra note 2.

  [39]   Indeed, one of the key proponents and drafters of the UNEA Resolution, Rwanda, more than a decade ago adopted strict bans on the import, production, use or sale of plastic bags and packaging.  See The World Is Awash in Plastic. Nations Plan a Treaty to Fix That, N.Y. Times (Mar. 2, 2022), https://www.nytimes.com/2022/03/02/climate/global-plastics-recycling-treaty.html.  See also supra note 6.

  [40]   UNEA Resolution, pmbl., ¶¶ 3 & 4.

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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 Environmental, Social and Governance (ESG), Transnational Litigation, or International Arbitration practice groups, or the following authors:

Perlette M. Jura – Los Angeles (+1 213-229-7121, [email protected])
Susy Bullock – London (+44 (0) 20 7071 4283, [email protected])
Selina S. Sagayam – London (+44 (0) 20 7071 4263, [email protected])
Maria L. Banda – Washington, D.C. (+1 202-887-3678, [email protected])

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

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Susy Bullock – London (+44 (0) 20 7071 4283, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Perlette M. Jura – Los Angeles (+1 213-229-7121, [email protected])
Ronald Kirk – Dallas (+1 214-698-3295, [email protected])
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“Sandbagging” in the acquisition context refers to a situation where a buyer closes an acquisition on the basis of representations in the purchase agreement it knows to be false, then proceeds to sue the seller post-closing based on a breach of those same representations.  Although Delaware was historically regarded as a pro-sandbagging jurisdiction, the Delaware Supreme Court’s stance on sandbagging came into question following dicta contained in a 2018 decision, Eagle Force Holdings, LLC v. Campbell.  In Eagle Force, a footnote by Justice Valihura stated that the Supreme Court had not resolved the “interesting question” of “whether a party can recover on a breach of warranty claim where the parties know that, at signing, certain of them were not true,” while then-Chief Justice Strine in his partial dissent expressed “doubt” that a plaintiff can “turn around and sue because what he knew to be false remained so.”  But we now have a (mostly) clear statement on the subject from the Chancery Court.  In Arwood v. AW Site Services, LLC, Vice Chancellor Slights upheld a buyer’s claim for breach of representations, notwithstanding the sellers’ sandbagging objections based on the buyer’s extensive due diligence.

The Arwood decision arose out of a post-closing dispute over an alleged fraudulent billing scheme that caused a substantial overstatement of revenue.  After the closing, the sellers sued the buyer to release funds held in escrow.  The buyer countered with claims for fraud and breach of representations regarding the financial condition and lawful operations of the target business, in each case related to the alleged fraudulent billing scheme.  The Chancery Court dismissed most claims of both parties, but it upheld the buyer’s claim for breach of contract based on inaccurate representations.

Notably, the Court rejected the sellers’ sandbagging defense to the buyer’s breach of contract claim.  The sellers had asserted that, given the buyer’s intimate knowledge of the sellers’ business and unrestricted access to information in diligence, the buyer either knew the sellers’ representations to be untrue, or acted with reckless disregard for the truth.  As a result, the sellers contended, the buyer should be precluded from recovering based on breach of representations it knew or should have known to be false.  The Court disagreed: “In my view, Delaware is, or should be, a pro-sandbagging jurisdiction.  The sandbagging defense is inconsistent with our profoundly contractarian predisposition.”

The Court also distinguished between the standard required to prevail in a breach of contract claim as compared to a fraud claim.  The Court noted that, to prove fraud, the plaintiff must prove that its action was taken in justifiable reliance on the subject representation, and whether reliance is justified is measured in context, based on the plaintiff’s knowledge and experience as well as the relationship of the parties.  The Court concluded that recklessness on the part of the buyer in relying on representations it might easily have determined to be untrue can defeat a claim against the seller for fraud (because reliance was not “justified”), just as recklessness on the part of the seller in making inaccurate representations can result in fraud liability.  In the instant case, the Court found that the buyer’s complete access to information regarding the target business (where “the source of the fraud stared them in the face”), the buyer’s knowledge that the sellers did not have reliable financial systems and lacked sophistication, and the buyer’s financial savvy, rendered any reliance on the false representations unjustified.

However, the Court noted that reliance, justified or not, does not come into play in breach of contract cases premised on inaccurate representations.  All that mattered was that the seller made the representations as embodied within the contractual language.  “The reasonableness, or not, of [Buyer]’s reliance upon the sellers’ representations is not a relevant consideration in assessing the bona fides of [Buyer’s] indemnification claim.”  The sellers represented a fact to be true in the acquisition agreement and as such, the buyer was entitled to the benefit of the representation, regardless of any diligence conducted or what the buyer “should have known” as a result thereof.

Notwithstanding Arwood, the final word regarding Delaware’s position on sandbagging remains to be spoken: the opinion notes that, as expressed in Eagle Force, the Delaware Supreme Court has not yet conclusively resolved the issue.  In any event, under Arwood, to the extent the viability of sandbagging remains open in Delaware, it does so solely in the case of a buyer’s actual knowledge.  For Vice Chancellor Slights, whether a buyer had constructive knowledge of the truth is not relevant to the sandbagging inquiry, a position the Vice Chancellor believes is shared by the Delaware Supreme Court.  Or, as per an Arwood footnote, “I note that the term’s origin is consistent with this conclusion.  Sandbagging robbers knew their sock weapons were filled with sand; they did not swing socks at unsuspecting victims with reckless disregard for their weapons’ efficacy.”

Where does Arwood leave parties as to inclusion of sandbagging language in the acquisition agreement, and the effect of a buyer’s knowledge of falsity when the agreement is silent?  The Chancery Court indicated that in the absence of specific contractual language addressing the issue, the parties will have implicitly opted for Delaware’s default rule that permits sandbagging.  However, if the parties wish to  provide for a different result, they remain free to include express anti-sandbagging clauses, which per the Court constitute “effective risk management tools that every transactional planner now has in her toolbox.”

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Mergers and Acquisitions or Private Equity practice groups, or the authors:

Robert B. Little – Dallas (+1 214-698-3260, [email protected])
Marina Szteinbok – New York (+1 212-351-4075, [email protected])

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

Mergers and Acquisitions Group:
Eduardo Gallardo – New York (+1 212-351-3847, [email protected])
Robert B. Little – Dallas (+1 214-698-3260, [email protected])
Saee Muzumdar – New York (+1 212-351-3966, [email protected])

Private Equity Group:
Richard J. Birns – New York (+1 212-351-4032, [email protected])
Scott Jalowayski – Hong Kong (+852 2214 3727, [email protected])
Ari Lanin – Los Angeles (+1 310-552-8581, [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.

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On 2 March 2022, the United States signed the Convention of 2 July 2019 on the Recognition and Enforcement of Foreign Judgments in Civil or Commercial Matters (the “Hague Judgments Convention” or the “Convention”).[1]  The Hague Judgments Convention seeks to enhance access to justice and facilitate international trade and investment by encouraging the free flow of judgments across national borders.[2]  It does so by providing a set of clear, predictable rules under which civil and commercial judgments rendered by the courts of one Contracting State are recognized and enforced in other Contracting States.  While not yet in force, the Hague Judgments Convention could provide an important complement to the widely adopted 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards[3] (the “New York Convention”) (which provides for the recognition and enforcement of arbitral awards), as well as its sister treaty, the 2005 Hague Choice of Court Convention.[4]

I. Recognition of Foreign Judgments in the United States

At present, there is no federal law that governs the recognition of foreign judgments in the United States, nor is there an international treaty in force.  Rather, recognition and enforcement are a question of state law, although the rules are relatively consistent across all 50 U.S. states and the District of Columbia.[5]  Most U.S. states have modeled their approaches to foreign judgment recognition on the model laws promulgated by the National Conference of Commissioners on Uniform State Laws—the Uniform Foreign Money Judgments Recognition Act of 1962 (the “1962 Uniform Act”), or increasingly, the Uniform Foreign-Country Money Judgments Recognition Act of 2005 (the “2005 Uniform Act”).[6]

Generally, the United States favors recognition and enforcement of foreign judgments: in U.S. state and federal courts, foreign judgments are presumptively entitled to recognition and enforcement unless specific mandatory or discretionary grounds for non-recognition apply.[7]

II. The Hague Judgments Convention

The 2019 Hague Judgments Convention is the culmination of over 25 years of negotiations at the Hague Conference on Private International Law (the “Hague Conference”).[8]  The process began in 1992 at the request of the United States, which sought to develop a global approach to jurisdiction and recognition of judgments.[9]  The final text of the Hague Judgments Convention was eventually signed and opened for signature on 2 July 2019.  Signatory States in addition to the United States include Uruguay, Ukraine, Israel, Costa Rica, and the Russian Federation (in order of signature).[10]  The European Commission is also contemplating accession on behalf of the EU Member States.[11]  

Recognition of Arbitral Awards under the New York Conventions and Foreign Judgments under the Hague Judgments Convention

The Convention will enter into force as soon as the second State deposits its instrument of ratification, acceptance, approval, or accession.[12]  However, under Article 29 (the “bilateralization” clause), a Contracting State can prevent the application of the Convention to judgments rendered by the courts of a particular State by making a targeted declaration.[13]

The Convention applies to “the recognition and enforcement of judgments relating to civil or commercial matters.”[14]  It specifically excludes subjects that are fundamental to State sovereignty or public policy (such as criminal, revenue, customs, or administrative matters),[15] as well as other specialized areas, some of which are subject to other treaty regimes or where the rules vary more significantly across jurisdictions (such as matters involving family disputes, intellectual property, antitrust, defamation, privacy, or armed forces matters).[16]

The Convention, like most domestic laws, favors recognition.  It requires each Contracting State to recognize and enforce judgments from other Contracting States in accordance with its terms and permits refusal only on those grounds expressly set out in the Convention.[17]

Article 5(1) of the Convention sets out 13 “bases” of recognition and enforcement, including, inter alia, that:

1. The judgment debtor is habitually resident in the foreign forum;
2. The judgment debtor has their principal place of business in the foreign forum (and the claim on which the judgment is based arose out of the activities of that business);
3. The judgment debtor expressly consented to the foreign court’s jurisdiction;
4. The judgment debtor waived his jurisdictional objections by arguing on the merits in the forum state;
5. The judgment ruled on a lease of immovable property (tenancy) and it was given by a court of the State in which the property is situated; or,
6. The judgment ruled on a non-contractual obligation arising from death, physical injury, damage to or loss of tangible property, and the act or omission directly causing such harm occurred in the forum State, irrespective of where that harm occurred.

These bases for jurisdiction and enforcement echo the basic concepts found in domestic U.S. recognition and enforcement law,[18] including the constitutional due process requirements reflected in the notion of “minimum contacts” that U.S. courts require for the exercise of long-arm jurisdiction and the comity-based rules adopted by the U.S. Supreme Court in the seminal decision, Hilton v. Guyot, 159 U.S. 113 (1895).

If any of the jurisdictional tests (or “jurisdictional filters”[19]) in Article 5(1) is met, then the judgment is presumptively “eligible” for recognition and enforcement.[20]  Under Article 15, national law provides a further independent basis for recognition.[21]  In this sense, “the convention is a floor, not a ceiling.”[22]

Article 7 of the Convention, in turn, sets out discretionary bases for non-recognition, including, inter alia, the following:

1. The defendant was not notified, or the manner of notification was incompatible with fundamental principles of service of documents in the forum State;
2. The decision was obtained by fraud;
3. Recognition or enforcement would be “manifestly incompatible” with the public policy of the recognizing State;
4. The specific proceedings were incompatible with fundamental principles of procedural fairness of the recognizing State; or,
5. The judgment is inconsistent with a judgment given by a court of the recognizing State in a dispute between the same parties.[23]

This too reflects the traditional non-recognition grounds found in most national legal systems, including that of the United States, such as inconsistency with the forum State’s public policy, due process violations, fraud, lack of notice or proper service, and conflict with other judgments.[24]

The Hague Judgments Convention is therefore in line with many precepts of existing U.S. recognition and enforcement law reflected in the 2005 Uniform Act.[25]  However, the Convention covers not only foreign money judgments, but civil and commercial decisions generally.

III. Implications for the Recognition of Foreign Judgments in the United States

The Convention could be “a gamechanger for cross-border dispute settlement”[26] by providing a set of consistent rules for the recognition and enforcement of foreign judgments, much like the New York Convention has been for the widespread adoption of arbitral awards.  Ultimately, a judgment in an international dispute is only as valuable as the judgment creditor’s ability to have it recognized and enforced abroad (where the judgment debtor or its assets may be found).  However, making the enforcement of foreign judgments easier can be a double-edged sword.  While a more robust and predictable enforcement regime can certainly be beneficial, that is only the case where the foreign court provides due process and a just outcome.

Ultimately, the force of the Hague Judgments Convention will depend on how widely it is signed and ratified.  Following the U.S. signature, the Hague Judgments Convention will not automatically come into force in the United States.  It must first undergo a ratification process in U.S. Congress, a procedure that can in some cases take several years.  Ratification may be slower here due to the prevalence of state law (and absence of federal law) in this particular area.[27]

For U.S. litigants, if ultimately ratified by the United States, the Hague Judgments Convention could aid the recognition and enforcement of U.S. judgments in a wider range of countries, in particular in jurisdictions that may currently refuse recognition on reciprocity grounds (i.e., where a foreign court would not recognize a U.S. judgment unless convinced that its judgment would receive the same treatment by a U.S. court).  Similarly, the Convention could facilitate the recognition and enforcement of foreign judgments issued by courts of other Contracting States in U.S. courts (of course subject to the above-mentioned non-recognition defenses).  This would greatly increase the ability of both U.S. and non-U.S. litigants to obtain meaningful cross-border relief in transnational litigation.

Until the Hague Judgments Convention comes into force, global trade and investment will continue to be facilitated by alternative dispute resolution mechanisms, such as the New York Convention for arbitral awards, as discussed above, and the new Singapore Convention for international settlement agreements resulting from mediation.[28]  Thus, for now, international arbitration awards remain more portable than foreign judgments (in addition to other advantages of international arbitration, like the selection of a neutral forum to avoid any “home court” advantage).[29]

___________________________

   [1]   Convention on the Recognition and Enforcement of Foreign Judgments in Civil or Commercial Matters, July 2, 2019, https://www.hcch.net/en/instruments/conventions/full-text/?cid=137 (hereinafter “Convention”) (last visited Mar. 18, 2022).

   [2]   See Hague Conference on Private International Law, Explanatory Note Providing Background on the Proposed Draft Text and Identifying Outstanding Issues, Prel. Doc. No 2, 3 (2016) (“[T]he future Convention is intended to pursue two goals: to enhance access to justice; [and] to facilitate cross-border trade and investment, by reducing costs and risks associated with cross-border dealings.”)

   [3]   Convention on the Recognition and Enforcement of Foreign Arbitral Awards (hereinafter “New York Convention”), June 10, 1958, 21.3 U.S.T. 2517, 3 U.N.T.S. 330.

   [4]   Convention on Choice of Court Agreements, June 30, 2005, 44 I.L.M. 1294 (hereinafter “2005 Choice of Court Convention”).

   [5]   See Gibson Dunn, New York Updates Law on Recognition of Foreign Country Money Judgments to Bring in Line with Other U.S. Jurisdictions, June 22, 2021, https://www.gibsondunn.com/new-york-updates-law-on-recognition-of-foreign-country-money-judgments-bring-in-line-with-other-us-jurisdictions/.

   [6]   See id.

   [7]   See id.

   [8]   See generally Louise Ellen Teitz, Another Hague Judgments Convention? Bucking the Past to Provide for the Future, 29 Duke J. Comp. & Int’l L. 491 (2019) (reviewing the Convention’s negotiations history).

   [9]   See generally Ronald A. Brand, The Hague Judgments Convention in the United States: A “Game Changer” or a New Path to the Old Game?, 82 U. Pitt. L. Rev. 847 (2021).

  [10]   See Hague Conference on Private International Law, Status Table – Convention of 2 July 2019 on the Recognition and Enforcement of Foreign Judgments in Civil or Commercial Matters, https://www.hcch.net/en/instruments/conventions/status-table/?cid=137 (last visited Mar. 18, 2022).

  [11]   European Commission, Proposal for a Council Decision on the Accession by the European Union to the Convention on the Recognition and Enforcement of Foreign Judgments in Civil or Commercial Matters, COM (2021) 388 (July 16, 2021), here (last visited Mar. 18, 2022) (recommending accession to the Convention so as to ensure the circulation of foreign judgments beyond the EU area and to increase “growth in international trade and foreign investment and the mobility of citizens around the world”).

  [12]   See Convention, art. 28.

  [13]   See id. at art. 29.

  [14]   Id. at art. 1(1).

  [15]   See id. at art.1(2).

  [16]   See id. at art. 2.

  [17]   See id. at art. 4(1) (“A judgment given by a court of a Contracting State (State of origin) shall be recognised and enforced in another Contracting State (requested State) in accordance with the provisions of this Chapter. Recognition or enforcement may be refused only on the grounds specified in this Convention.”).

  [18]   See Gibson Dunn, New York Updates Law on Recognition of Foreign Country Money Judgments to Bring in Line with Other U.S. Jurisdictions, June 22, 2021, https://www.gibsondunn.com/new-york-updates-law-on-recognition-of-foreign-country-money-judgments-bring-in-line-with-other-us-jurisdictions/.

  [19]   See Brand, supra note 9, at 851.

  [20]   On the other hand, a judgment that ruled on rights in rem in immovable property “shall be recognised and enforced if and only if the property is situated in the State of origin.”  Convention, art. 6.

  [21]   Convention, art. 15 (“Subject to Article 6, this Convention does not prevent the recognition or enforcement of judgments under national law.”)

  [22]   Teitz, supra note 8, at 503.

  [23]   Convention, art. 7.

  [24]   See also 2005 Choice of Court Convention, art. 9 (setting forth grounds for non-recognition).

  [25]   See Gibson Dunn, New York Updates Law on Recognition of Foreign Country Money Judgments to Bring in Line with Other U.S. Jurisdictions, June 22, 2021, https://www.gibsondunn.com/new-york-updates-law-on-recognition-of-foreign-country-money-judgments-bring-in-line-with-other-us-jurisdictions/.

  [26]   Hague Conference on Private International Law, Gamechanger for Cross-Border Litigation in Civil and Commercial Matters to be Finalized in the Hague (June 18, 2019) (quoting the Secretary General of the Hague Conference), https://www.hcch.net/en/news-archive/details/?varevent=683 (last visited Mar. 18, 2022).

  [27]   The United States has been a member of the Hague Conference since 1964 and is currently a Contracting Party to seven Hague Conventions (Convention Abolishing the Requirement of Legalisation for Foreign Public Documents (“Apostille Convention”), Oct. 5, 1961, 527 U.N.T.S.; Convention on the Service Abroad of Judicial and Extrajudicial Documents in Civil or Commercial Matters (“Service Convention”), Nov. 15, 1965, 658 U.N.T.S. 163; Convention on the Taking of Evidence Abroad in Civil or Commercial Matters (“Evidence Convention”), Mar. 18, 1970, 847 U.N.T.S. 231; Convention on the Civil Aspects of International Child Abduction (“Child Abduction Convention”), Oct. 25, 1980, 1343 U.N.T.S. 89; Convention on Protection of Children and Co-operation in respect of Intercountry Adoption (“Adoption Convention”), May 29, 1993, 1870 U.N.T.S. 167; Convention on the Law Applicable to Certain Rights in respect of Securities Held with an Intermediary (“Securities Convention”), July 5, 2006, 46 I.L.M. 649; Convention on the International Recovery of Child Support and Other Forms of Family Maintenance (“Child Support Convention”), Nov. 23, 2007, 47 I.L.M. 257.  The U.S. has not yet ratified the 2005 Choice of Court Convention, often seen as the sister treaty to the Hague Judgments Convention.

  [28]   See generally United Nations Convention on International Settlement Agreements Resulting from Mediation, opened for signature Aug. 7, 2019 (adopted Dec. 20, 2018) (“Singapore Convention”), https://treaties.un.org/pages/ViewDetails.aspx?src=TREATY&mtdsg_no=XXII-4&chapter=22&clang=_en (last visited Mar. 18, 2022).

  [29]   For international commercial arbitration awards, the above map shows the broad reach of the New York Convention.

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The following Gibson Dunn lawyers prepared this client alert: Rahim Moloo, Lindsey D. Schmidt, Maria L. Banda, and Nika Madyoon.

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 International Arbitration, Judgment and Arbitral Award Enforcement or Transnational Litigation practice groups, or the following:

Rahim Moloo – New York (+1 212-351-2413, [email protected])
Lindsey D. Schmidt – New York (+1 212-351-5395, [email protected])
Anne M. Champion – New York (+1 212-351-5361, [email protected])
Maria L. Banda – Washington, D.C. (+1 202-887-3678, [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])

Judgment and Arbitral Award Enforcement Group:
Matthew D. McGill – Washington, D.C. (+1 202-887-3680, [email protected])
Robert L. Weigel – New York (+1 212-351-3845, [email protected])

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.