Decided July 1, 2021

Americans for Prosperity Foundation v. Bonta, No. 19-251, consolidated with Thomas More Law Center v. Bonta, No. 19-255

Today, the Supreme Court held 6-3 that California’s requirement that non-profit organizations disclose their donor lists unconstitutionally burdens those organizations’ expressive association rights, in violation of the First Amendment.

Background:
The California Attorney General requires private charities that operate or fundraise in California to register annually with the state. Registration entails filing various tax forms, including Schedule B to IRS Form 990—which requires charitable organizations to list the names and addresses of contributors that donated more than $5,000 or 2% of the organization’s budget during the tax year. California informed charities that their Schedule B disclosures would be kept confidential; in reality, however, California law required public disclosure of these documents until 2016. The state’s asserted justification for the disclosure requirement is a law-enforcement interest in regulating non-profit activity. Two non-profit organizations challenged the disclosure requirement as unconstitutional, arguing that it chills expressive association by exposing donors to harassment and that less-restrictive means are available to California to further its asserted interest. The Ninth Circuit upheld the disclosure requirement, holding that “exacting” scrutiny—not “strict” scrutiny—applied, and the requirement was sufficiently related to an important government interest.

Issue:
(1) Whether exacting scrutiny or strict scrutiny applies to disclosure requirements that burden nonelectoral, expressive association rights; and (2) whether California’s disclosure requirement violates charities’ and their donors’ freedom of association and speech facially or as applied to Petitioners.

Court’s Holding:
(1) The Court’s holding on the standard of review was fractured: A three-Justice plurality stated that disclosure laws like California’s must satisfy exacting scrutiny. While one Justice in the majority would have applied strict scrutiny, two others declined to resolve the issue. (2) A majority of the Court held that California’s law is facially unconstitutional under exacting scrutiny. California’s interest in administrative convenience is weak, and a blanket disclosure requirement for organizations not suspected of wrongdoing is not narrowly tailored to this interest.

“There is a dramatic mismatch . . . between the interest that the Attorney General seeks to promote and the disclosure regime that he has implemented in service of that end.”

Chief Justice Roberts, writing for the Court

What It Means:

• The Court’s ruling protects the sensitive donor information of non-profit organizations, ensuring that individuals may contribute to charitable organizations without fear of harassment from compelled disclosure. The ruling also calls into question the constitutionality of similar donor disclosure requirements in the federal “For the People Act” reintroduced in January 2021, and which has passed in the House and currently awaits a vote in the Senate.
• Today’s decision may have implications for mandatory disclosure requirements beyond the associational context. In writing for the Court, the Chief Justice emphasized that “[t]he ‘government may regulate in the [First Amendment] area only with narrow specificity,’ . . . and compelled disclosure regimes are no exception.” Op. 10. The Court’s holding suggests that other compelled disclosure regimes that lack narrow tailoring could be challenged under the First Amendment. It remains to be seen how the Court will apply today’s decision to other compelled disclosures.
• The Court’s decision continues its trend of affording robust constitutional protection to non-profit organizations, but leaves the standard of review for compelled-speech cases undefined. The Court has often employed strict scrutiny in assessing other First Amendment free-speech and religious liberty-challenges brought by non-profit organizations, and the Court could find only a plurality for the “exacting scrutiny” standard of review applied here. Other members of the Court indicated that government regulation of a wide range of protected First Amendment activity generally must pass strict scrutiny.
• A plurality of the Court applied Buckley v. Valeo, 424 U.S. 1 (1976)—which applied exacting scrutiny to limits on expenditures by political campaigns—to the broader context of compelled speech, and did not cabin it to the context of elections.
• In an opinion by Justice Sotomayor, three Justices dissented on the ground that California’s disclosure requirement did not burden the donors’ First Amendment rights, and so no tailoring of the law was required.

---

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]

Thomas G. Hungar +1 202.887.3784 [email protected]

Douglas R. Cox +1 202.887.3531 [email protected]

Jason J. Mendro +1 202.887.3726 [email protected]

Decided June 29, 2021

Minerva Surgical Inc. v. Hologic Inc., No. 20-440

Today, the Supreme Court upheld the doctrine of assignor estoppel in patent cases, concluding in a 5-4 decision that a patent assignor cannot, with certain exceptions, subsequently challenge the patent’s validity.

Background:
Csaba Truckai co-invented the NovaSure system, a medical device that uses radiofrequency energy to perform endometrial ablations. In 1998, Truckai and his four co-inventors filed a patent application covering the NovaSure system and later assigned their interest in the patent application and any future continuing applications to Truckai’s company, Novacept. Truckai sold Novacept to Cytyc Corporation in 2004, and Hologic acquired Cytyc in 2007.

In 2008, Truckai founded Minerva and developed a new device that uses thermal energy, rather than radiofrequency energy, to perform endometrial ablations. In 2015, Hologic sued Minerva, alleging that Minerva’s device infringed one of its NovaSure patents. The district court held that the doctrine of assignor estoppel barred Minerva from challenging the patent’s validity. The Federal Circuit affirmed in relevant part, declining to abrogate the doctrine, which federal courts have applied since 1880.

Issue:
May a defendant in a patent infringement action who assigned the patent, or is in privity with an assignor of the patent, have a defense of invalidity heard on the merits?

Court’s Holding:
Sometimes. The doctrine of assignor estoppel survives, although it applies only when the invalidity defense conflicts with an explicit or implicit representation the assignor made in assigning her patent rights. Absent that kind of inconsistency, a defendant in a patent infringement action who assigned the patent may have a defense of invalidity heard on the merits. 

What It Means:

• This decision marks the first time that the Supreme Court has directly considered the viability of the assignor estoppel doctrine (the Supreme Court implicitly approved of the doctrine in 1924), and it largely secures the interests of assignees who have relied on the unanimous consensus of federal courts upholding this longstanding doctrine.
• However, the Court indicated that the doctrine may have been applied too broadly in the past, and that assignors should be estopped from contesting validity only when they have made a representation regarding validity as part of the assignment.
• The Court provided three examples of when an assignor has an invalidity defense: (1) when an employee assigns to her employer patent rights to future inventions before she can possibly make a warranty of validity as to specific patent claims, (2) when a later legal development renders irrelevant the assignor’s warranty of validity at the time of assignment, and (3) when the patent claims change after assignment and render irrelevant the assignor’s validity warranty.
• The Court reasoned that assignor estoppel furthers patent policy goals: The doctrine gives assignees confidence in the value of what they have purchased by preventing assignors (who are “especially likely infringers because of their knowledge of the relevant technology”) from raising invalidity defenses. The Court explained that this confidence will raise the price of patent assignments and in turn may encourage invention.

---

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: Intellectual Property

Kate Dominguez +1 212.351.2338 [email protected]

Josh Krevitt +1 212.351.4000 [email protected]

Y. Ernest Hsin +1 415.393.8224 [email protected]

Jane M. Love, Ph.D. +1 212.351.3922 [email protected]

On this episode of the podcast, Ted Olson and Ted Boutrous talk about the landmark court cases that helped to define marriage equality in the United States, including their work in overturning California’s Proposition 8. You’ll hear them discuss the legal strategies at play and why it was important to win over the hearts and minds of the American public.

Previous Episode | Next Episode

All episodes of The Two Teds are available on GibsonDunn.com and wherever you listen to podcasts. You can also subscribe to be notified of new episodes via e-mail.

---

HOSTS:

Ted Boutrous – Theodore J. Boutrous, Jr., a partner in the Los Angeles office of Gibson, Dunn & Crutcher LLP, is global Co-Chair of the firm’s Litigation Group and previously led the firm’s Appellate, Crisis Management, Transnational Litigation and Media groups.  He also is a member of the firm’s Executive and Management Committees.  Recognized for a decade of excellence in the legal profession, the Daily Journal in 2021 named Mr. Boutrous as a  Top Lawyer of the Decade for his victories. As a tireless advocate and leader for high-stakes and high-profile cases, Mr. Boutrous was also named the 2019 “Litigator of the Year, Grand Prize Winner” by The American Lawyer.

Ted Olson – Theodore B. Olson is a Partner in Gibson, Dunn & Crutcher’s Washington, D.C. office; a founder of the Firm’s Crisis Management, Sports Law, and Appellate and Constitutional Law Practice Groups. Mr. Olson was Solicitor General of the United States during the period 2001-2004. From 1981-1984, he was Assistant Attorney General in charge of the Office of Legal Counsel in the U.S. Department of Justice. Except for those two intervals, he has been a lawyer with Gibson, Dunn & Crutcher in Los Angeles and Washington, D.C. since 1965.

Decided June 17, 2021

Fulton v. City of Philadelphia, No. 19-123

Today, the Supreme Court held 9-0 that Philadelphia violated the First Amendment by refusing to contract with a Catholic agency for declining to certify same-sex couples as foster parents.

Background:
Philadelphia contracts with private agencies to place children with foster parents. The city’s contracts incorporate a city ordinance prohibiting sexual-orientation discrimination in public accommodations. Catholic Social Services (“CSS”) contracted with the city to provide foster-care placement services. After learning that CSS would not certify same-sex couples as foster parents based on its religious beliefs regarding marriage, the city refused to renew its contract with CSS. CSS sued, alleging that the city had violated CSS’s First Amendment rights.

The Third Circuit, applying Employment Division v. Smith, 494 U.S. 872 (1990), held that the city’s nondiscrimination policy is a neutral, generally applicable law, and that CSS failed to show that the city either treated CSS differently than secular organizations or had ill will against religion.

Issue:
Whether the First Amendment prohibits the government from forcing a religious agency to comply with a non-discrimination requirement in order to participate in the foster-care system, where compliance requires the agency to take actions and make statements contrary to its religious beliefs.

Court’s Holding:
Yes, at least where, as here, the non-discrimination requirement is not generally applicable and the government fails to offer a compelling reason to deny the religious agency an exemption. 

“The refusal of Philadelphia to contract with CSS for the provision of foster care services unless it agrees to certify same-sex couples as foster parents cannot survive strict scrutiny, and violates the First Amendment.”

Chief Justice Roberts, writing for the Court

What It Means:

• Today’s decision reiterates that the government must have a compelling reason to enforce a nondiscrimination policy that burdens religious exercise if the policy otherwise permits exemptions.
• Because the Court determined that strict scrutiny applied regardless of Employment Division v. Smith, it “ha[d] no occasion to reconsider that decision.” The decision thus leaves the door open to further litigation involving the intersection of faith-based organizations and government nondiscrimination policies. If a nondiscrimination policy is subject to exemptions, the government’s failure to grant religious exemptions likely will be subject to strict scrutiny.
• The Court’s narrow, fact-specific ruling leaves unanswered whether the First Amendment mandates religious exemptions to nondiscrimination policies in other contexts. Any such religious objections will have to be evaluated on their own merits under the appropriate level of scrutiny.
• Although the majority declined to address the continued viability of Employment Division v. Smith, three justices (Justices Thomas, Alito, and Gorsuch) would have overruled Smith and two more (Justices Barrett and Kavanaugh) suggested that the “textual and structural arguments against Smith” were “compelling.”

---

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]

Decided June 17, 2021

Texas v. California, No. 19-1019, consolidated with California v. Texas, No. 19-840

Today, the Supreme Court rejected another challenge to the Affordable Care Act’s individual mandate because the plaintiffs lacked standing to challenge it.

Background:
In 2012, the Supreme Court rejected constitutional challenges under the Commerce Clause to the requirement in the Affordable Care Act (“ACA”) that individuals must maintain health insurance coverage. The Court reasoned that the ACA was not a command to buy health insurance—which Congress would lack the power to enact—but merely a tax for not doing so. In December 2017, Congress amended the ACA to eliminate the penalty for not buying health insurance, but Congress did not eliminate the ACA’s individual mandate to maintain health insurance coverage.

Two individuals and several states, including Texas, then challenged the individual mandate as unconstitutional, arguing that because it no longer carried a penalty, it no longer qualified as a tax. They also argued that because the individual mandate is essential to the ACA, the entire statute must be struck down. The Trump Administration refused to defend the ACA’s constitutionality. Several states, including California, intervened to defend the statute and challenge the plaintiffs’ Article III standing. The Fifth Circuit held that the plaintiffs possessed standing, held the individual mandate is unconstitutional, and directed the district court to consider an appropriate remedy on remand.

Issue:
(1) Whether the plaintiffs have Article III standing to challenge the constitutionality of the ACA’s individual mandate; (2) whether the individual mandate is unconstitutional because it no longer qualifies as a tax, and (3) if the individual mandate is unconstitutional, whether the entire ACA must be struck down.

Court’s Holding:
The individual plaintiffs do not have Article III standing to challenge the ACA’s individual mandate. Even if payments necessary to hold the insurance coverage required by the ACA were an injury, that injury is not traceable to the government, because without any penalty for noncompliance the statute is unenforceable. The states do not have Article III standing either, because they have not shown their injuries are fairly traceable to unlawful government conduct.

“Neither the individual nor the state plaintiffs have shown that the injury they will suffer or have suffered is ‘fairly traceable’ to the ‘allegedly unlawful conduct’ of which they complain.”

Justice Breyer, writing for the Court

What It Means:

• The Court’s ruling leaves unresolved the merit questions presented in the case: whether the individual mandate is constitutional or whether it is severable from the rest of the ACA. The Court will likely be asked to revisit these legal issues in the future.
• This decision is the latest of several high-profile cases this Term in which the Court has declined to reach the merits because of a lack of Article III standing. The Court similarly found a lack of Article III standing in Trump v. New York and Carney v. Adams.
• Two dissenting Justices, in an opinion written by Justice Alito and joined by Justice Gorsuch, would have held that (1) the state plaintiffs possess standing in light of the increased regulatory and financial burdens from complying with the ACA, and they did not forfeit these claims, and (2) the individual mandate is unconstitutional and not severable from the rest of the ACA.

---

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]

Ethan Dettmer +1 415.393.8292 [email protected]

Lucas C. Townsend +1 202.887.3731 [email protected]

Bradley J. Hamburger +1 213.229.7658 [email protected]

Decided June 17, 2021

Nestlé USA, Inc. v. Doe, No. 19-416, consolidated with Cargill, Inc. v. Doe, No. 19-453

Today, the Supreme Court held 8-1 that plaintiffs suing domestic corporations for aiding and abetting international law violations overseas had failed to allege a sufficient domestic nexus for the conduct to support liability under the Alien Tort Statute.

Background:
The Alien Tort Statute (“ATS”) gives federal courts jurisdiction over “any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States.” 28 U.S.C. § 1350. The plaintiffs in these consolidated cases sued Nestlé USA, Inc. and Cargill, Inc.—both domestic corporations—under the ATS for allegedly aiding and abetting the use of child slavery on cocoa farms in Côte d’Ivoire. The defendants sought dismissal on the ground that the ATS reaches only domestic violations, and that the plaintiffs’ injuries were incurred entirely overseas. The defendants argued also that under Jesner v. Arab Bank, PLC, 138 S. Ct. 1386 (2018)—in which the Court held that foreign corporations may not be sued under the ATS—domestic corporations are not liable for violations of international law under the ATS.

The Ninth Circuit disagreed and permitted the plaintiffs to proceed with their claims. It held that the ATS covers any conduct that might constitute aiding and abetting, and that the plaintiffs’ claims were not extraterritorial under that standard because the plaintiffs had alleged that the defendants had provided personal spending money to Côte d’Ivoire farmers to maintain their loyalty. The Ninth Circuit further held that Jesner addressed only whether foreign corporations may be sued under the ATS, as suits against domestic corporations do not raise the same foreign affairs concerns.

Issue:
Does the ATS extend liability to domestic corporations?

Does the ATS extend to suits alleging that a domestic corporation aided and abetted illegal conduct by unidentified foreign actors based on corporate activity in the United States?

Court’s Holding:
The ATS does not extend to suits alleging that general corporate activity in the United States aided and abetted violations of the law that ultimately occurred overseas through unrelated, foreign third parties. 

“[A]llegations of general corporate activity—like decisionmaking—cannot alone establish domestic application of the ATS.”

Justice Thomas, writing for the Court

What It Means:

• Plaintiffs bringing suit under the ATS must establish a strong, domestic nexus for their claim. It is not sufficient for plaintiffs merely to allege general corporate decisionmaking in the United States.
• Domestic corporations will have strong arguments that they cannot be held liable in suits brought under the ATS simply for participating in a global supply chain in which foreign third parties may have violated international law.
• The Court did not resolve the issue whether corporations can held liable under the ATS, although five Justices indicated their view that corporations are not immune from liability under the ATS.
• Although not decided in this case, the various separate opinions indicate disagreement among the Justices as to whether courts are empowered to recognize new causes of action under the ATS, or whether they are confined to the three specific torts (violation of safe conducts, infringement of the rights of ambassadors, and piracy) identified in Sosa v. Alvarez Machain, 542 U.S. 692 (2004).

---

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: Transnational Litigation

Perlette Michèle Jura +1 213.229.7121 [email protected]

The People’s Republic of China is clamping down on the extraction of litigation- and investigation-related corporate and personal data from China—and this may squeeze litigants and investigation subjects in the future. Under a new data security law enacted late last week and an impending personal information protection law, China is set to constrict sharing broad swaths of personal and corporate data outside its borders. Both statutes would require companies to obtain the approval of a yet-to-be-identified branch of the Chinese government before providing data to non-Chinese judicial or law enforcement entities. As detailed below, these laws could have far-reaching implications for companies and individuals seeking to provide data to foreign courts or enforcement agencies in the context of government investigations or litigation, and appear to expand the data transfer restrictions set forth in other recent Chinese laws.[1]

Data Security Law of the People’s Republic of China

On June 10, 2021, the National People’s Congress passed the Data Security Law, which will take effect on September 1, 2021. The legislation contains sweeping requirements and severe penalties for violations. It governs not only data processing and management activities within China, but also those outside of China that “damage national security, public interest, or the legitimate interests of [China’s] citizens and organizations.”[2]

The Data Security Law generally requires entities and individuals operating within China to implement systems designed to protect in-country data. For example, entities that handle “important” data—a term not yet defined by the statute—must designate personnel responsible for data security and conduct assessments to monitor potential risks.[3] Chinese authorities may issue fines up to 500,000 CNY (approximately $78,000) and mandate remedial actions if an entity does not satisfy these requirements.[4] If the entity fails to implement required remedial actions after receiving a warning and/or its failure to implement adequate controls result in a large-scale data breach, the entity may be subject to a fine of up to 2 million CNY (approximately $313,000). Under these circumstances, authorities also may revoke the offending entity’s business licenses and issue fines to responsible individuals.[5]

The Data Security Law also states that a “violation of the national core data management system or endangering China’s national sovereignty, security, and development interests” is punishable by an additional fine up to 10 million CNY (approximately $1.56 million), suspension of business, revocation of business licenses, and in severe cases, criminal liability.[6] The Data Security Law broadly defines “core data” to include “data related to national security, national economy, the people’s welfare, and major public interests.”[7]

Most notably, Article 36 of the Data Security Law prohibits “provid[ing] data stored within the People’s Republic of China to foreign judicial or law enforcement bodies without the approval of the competent authority of the People’s Republic of China.”[8] The law does not identify the “competent authority” or outline the approval process. Failure to obtain this prior approval may subject an entity to a fine of up to 1,000,000 CNY (approximately $156,000), as well as additional fines for responsible individuals.[9] Although the Data Security Law discusses different categories of covered data elsewhere in the legislative text—referring to, for example, the “core data” discussed above[10]—Article 36, as written, appears to apply to the transfer of any data, regardless of subject matter and sensitivity, so long as it is stored in China. The final legislative text also includes additional, heavier penalties for severe violations that had not been included in prior drafts, including a fine of up to 5 million CNY (approximately $780,000), suspension of business operations, revocation of business licenses, as well as increased fines for responsible individuals. The statute does not, however, define what violations would be considered “severe.”

While the legal community in and outside of China will certainly seek additional guidance from the Chinese government, it is unclear whether the Chinese government will release implementing regulations or other guidance materials before September 1, 2021, when the law takes effect. As a point of reference, the Chinese government has not issued additional guidance on the International Criminal Judicial Assistance Law, which prohibits, among other things, unauthorized cooperation of a broad nature with foreign criminal authorities, since the law was passed in 2018. Nevertheless, given that data security and privacy are one of Beijing’s areas of focus, it is possible that the Chinese government will issue regulations, statutory interpretation, or guidance to clarify certain key requirements in the Data Security Law.

Personal Information Protection Law of the People’s Republic of China

On April 29, 2021, China released the second draft of its Personal Information Protection Law, which seeks to create a legal framework similar to the European Union’s General Data Protection Regulations (“GDPR”). The draft Personal Information Protection Law, if passed, will apply to “personal information processing entities (“PIPEs”),” defined as “an organization or individual that independently determines the purposes and means for processing of personal information.”[11] The draft Personal Information Protection Law defines processing as “the collection, storage, use, refining, transmission, provision, or public disclosure of personal information.”[12] The draft Personal Information Protection Law also defines “personal information” broadly as “various types of electronic or otherwise recorded information relating to an identified or identifiable natural person,” but excludes anonymized information.[13]

The draft Personal Information Protection Law requires PIPEs that process certain volumes of personal data to adopt protective measures, such as designating a personal information protection officer responsible for supervising the processing of applicable data.[14]  PIPEs also would be required to carry out risk assessments prior to certain personal information processing and conduct regular audits.[15]

Under Article 38 of the draft Personal Information Protection Law, the Cyberspace Administration of China (“CAC”) will provide a standard contract for PIPEs to reference when entering into contracts with data recipients outside of China. The draft Personal Information Protection Law provides that PIPEs may only transfer personal information overseas if the PIPE: (1) passes a security assessment administered by the CAC; (2) obtains certification from professional institutions in accordance with the rules of the CAC; (3) enters into a transfer agreement with the transferee using the standard contract published by the CAC; or (4) adheres to other conditions set forth by law, administrative regulations, or the CAC.[16] Like the Data Security Law, the draft Personal Information Protection Law does not elaborate on this requirement, including what types of certifications would satisfy the requirement under Article 38 or what “other conditions set forth by law, administrative regulations, or the CAC” entail.

Similar to Article 36 of the Data Security Law, Article 41 of the draft Personal Information Protection Law prohibits providing personal data to judicial or law enforcement bodies outside of China without prior approval of competent Chinese authorities.[17]  As with the Data Security Law, neither the “competent Chinese authority” nor the approval process is further defined, however.

The draft Personal Information Protection Law does not include penalties specifically tied to Article 41, but does set forth general penalty provisions in Article 65, which include confiscation of illegal gains, and a basic fine of up to 1 million CNY (approximately $156,000) for companies and between 10,000 CNY and 100,000 CNY (approximately $15,600 to $156,000) for responsible persons.[18] “Severe violations,” which the statute does not define, may be punishable by a fine up to 50 million CNY (approximately $7.8 million ) or up to five percent of the company’s annual revenue for the prior financial year, as well as fines between 100,000 CNY to 1 million CNY (approximately $156,000 to $1.56 million) for responsible persons. Additionally, companies found to have violated the Personal Information Protection Law may be subject to revocation of business permits or suspension of business activities entirely.

The Data Security Law and Personal Information Protection Law in Context 

The Data Security Law and, if enacted, the Personal Information Protection Law add to a growing list of Chinese laws that restrict the provision of data to foreign governments. For example:

• The International Criminal Judicial Assistance Law bars entities and individuals in China from providing foreign enforcement authorities with evidence, materials, or assistance in connection with criminal cases without the consent of the Chinese government.[19]
• Article 177 of the China Securities Law (2019 Revision), prohibits “foreign regulators from directly conducting investigations and collecting evidence” in China and restricts Chinese companies from transferring documents related to their securities activities outside of China unless they obtain prior approval from the China Securities Regulatory Commission.
• The newly released draft amendment to China’s Anti-Money Laundering Law contains disclosure and pre-approval requirements for Chinese companies responding to data requests by foreign regulators.
• As Gibson Dunn has previously covered, the Rules on Counteracting Unjustified Extraterritorial Application of Foreign Legislation and Other Measures, issued by the Ministry of Commerce of the PRC in January 2021, established a mechanism for the government to designate specific foreign laws as “unjustified extraterritorial applications,” and subsequently issue prohibitions against compliance with these foreign laws.

The Data Security Law and draft Personal Information Protection Law, however, appear to surpass these prior prohibitions in several key respects. In contrast to the International Criminal Judicial Assistance Law, for example, the Data Security Law and draft Personal Information Protection Law do not require the data to be provided in the context of a criminal investigation for the transfer prohibitions to apply. The new restrictions ostensibly apply to data transfers in connection with a civil enforcement action or investigation, such as those conducted by the U.S. Securities and Exchange Commission. (They might also create yet another impediment to the provision of audit work papers by China-based accounting firms to the SEC and the Public Company Accounting Oversight Board.) As written, the Data Security Law and draft Personal Information Protection Law prohibitions also would also apply to Chinese parties in civil litigation before foreign courts that may need to submit evidence in connection with ongoing cases. In fact, the current language could be read to prohibit non-Chinese citizens residing in China from providing information about themselves to their own government regulators, so long as the data is “stored in China.” The Data Security Law does not explain when data is “stored in China,” or how to address potential scenarios in which entities or individuals may have a legal obligation to submit information to foreign judicial or law enforcement authorities.

The Data Security Law, draft Personal Information Protection Law and earlier laws restricting data transfers create a great deal of uncertainty for companies operating in China. Because these laws do not specify the process for obtaining government approvals, the criteria for approval, or the responsible government agency, it has become increasingly difficult for companies to determine how to respond to foreign regulators’ demands to produce data that may be stored in China, conduct internal investigations in China in the context of an ongoing enforcement action or foreign government investigation, or comply with disclosure and cooperation obligations under various forms of settlement agreements with foreign authorities such as deferred prosecution agreements. Companies considering self-reporting potential legal violations in China to their foreign regulators, as well as cooperating in ensuing  investigations conducted by those regulators, also will need to consider whether any of the relevant data was previously “stored in China,” and if so, whether they are permitted to submit such data to foreign authorities without approval by Chinese authorities. The new statutes also raise concerns for professional services organizations, such as law firms, accounting and forensic firms, litigation experts, and others whose work product may reflect data that was “stored in China.” The new laws do not make clear how they might apply to work product that is simply based on, reflects or incorporates data stored in China, and whether professional services firms are required to seek approval from relevant Chinese authorities before sharing such work product in foreign judicial proceedings or with enforcement authorities.

Gibson Dunn will continue to closely monitor these developments, as should companies operating in China, in order to minimize the risks associated with being caught in the vice of inconsistent legal obligations.

________________________

   [1]   Please note that the discussions of Chinese law in this publication are advisory only.

   [2]   Data Security Law, Art. 1 and 2.

   [3]   Data Security Law, Art. 27, 29, 30.

   [4]   Data Security Law, Art. 45

   [5]   Data Security Law, Art. 45.

   [6]   Data Security Law, Art. 45.

   [7]   Data Security Law, Art. 21.

   [8]   Data Security Law, Art. 36.

   [9]   Data Security Law, Art. 48.

  [10]   Data Security Law, Art. 21.

  [11]   Draft Personal Information Protection Law Art. 4, 72.

  [12]   Draft Personal Information Protection Law, Art. 4.

  [13]   Ibid.

  [14]   Draft Personal Information Protection Law, Art. 52.

  [15]   Draft Personal Information Protection Law, Art. 54, 55.

  [16]   Draft Personal Information Protection Law, Art. 38

  [17]   Draft Personal Information Protection Law, Art. 41.

  [18]   Draft Personal Information Protection Law, Art. 65.

  [19]   International Criminal Judicial Assistance Law, Art. 4.

---

The following Gibson Dunn lawyers assisted in preparing this client update: Patrick F. Stokes, Oliver Welch, Nicole Lee, Ning Ning, Kelly S. Austin, Judith Alison Lee, Adam M. Smith, John D.W. Partridge, F. Joseph Warin, Joel M. Cohen, Ryan T. Bergsieker, Stephanie Brooker, John W.F. Chesley, Connell O’Neill, Richard Roeder, Michael Scanlon, Benno Schwarz, Alexander H. Southwell, and Michael Walther.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Anti-Corruption and FCPA, White Collar Defense and Investigations, International Trade, and Privacy, Cybersecurity and Data Innovation practice groups:

Asia:
Kelly Austin – Hong Kong (+852 2214 3788, [email protected])
Connell O’Neill – Hong Kong (+852 2214 3812, [email protected])
Oliver D. Welch – Hong Kong (+852 2214 3716, [email protected])

Europe:
Benno Schwarz – Munich (+49 89 189 33 110, [email protected])
Michael Walther – Munich (+49 89 189 33-180, [email protected])
Richard W. Roeder – Munich (+49 89 189 33-160, [email protected])

United States:
Judith Alison Lee – Washington, D.C. (+1 202-887-3591, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, [email protected])
John W.F. Chesley – Washington, D.C. (+1 202-887-3788, [email protected])
Joel M. Cohen – New York (+1 212-351-2664, [email protected])
John D.W. Partridge – Denver (+1 303-298-5931, [email protected])
Michael J. Scanlon – Washington, D.C. (+1 202-887-3668, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [email protected])
Alexander H. Southwell – New York (+1 212-351-3981, [email protected])
Patrick F. Stokes – Washington, D.C. (+1 202-955-8504, [email protected])
F. Joseph Warin – Washington, D.C. (+1 202-887-3609, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

On March 31, 2021, President Biden unveiled the American Jobs Plan (“Jobs Plan”), a sweeping $2.25 trillion proposal designed to create jobs through upgrading public infrastructure, revitalizing manufacturing, prioritizing workforce training, and expanding long-term health care services. The Jobs Plan, one of the most ambitious federal spending proposals in American history, is the first of a two-part package to revive the economy from the COVID-19 recession. The second portion—the American Families Plan (“Families Plan”)—which President Biden released on April 28, 2021, is a $1.8 trillion investment to expand health insurance coverage, childcare subsidies, and education access, among other proposals.[1]

The Jobs Plan and Families Plan would be historic investments. The Jobs Plan combines spending and tax credits to modernize the nation’s infrastructure, including the construction of roads, bridges, and ports, and also invests in climate change-related and racial equity priorities. The Jobs Plan encompasses four categories of investments: (1) transportation infrastructure; (2) utilities infrastructure; (3) care infrastructure; and (4) investments in manufacturing, innovation and the workforce. The Families Plan (1) adds at least four years of free education to community colleges; (2) provides direct support to children and families; and (3) extends tax cuts for families with children and American workers, restoring the highest income tax bracket to 39 percent and implementing income tax rates on capital gains for high-income earners.

To offset the costs of both proposals, the Biden administration released the Made in America Tax Plan (“Tax Plan”) on April 7, 2021. The Tax Plan generally sets forth tax proposals to pay for the infrastructure investments. It would raise the corporate tax rate and global minimum tax, measures that would largely reverse the 2017 Trump administration’s tax plan. The Tax Plan increases corporate tax rates from 21 percent to 28 percent and proposes a minimum tax on multinational corporations. The Biden administration projects that the Tax Plan’s overhaul of corporate tax policy would generate $2 trillion over the next 15 years.

Passing these Plans through Congress has been a challenge, particularly in an equally divided, Democratically controlled Senate. Republicans opposed the Jobs Plan due to its breadth, cost, and reliance on corporate tax increases. Furthermore, dueling infrastructure proposals exist after Senate Republicans released several counterproposals of their own infrastructure plan, which narrowly focus on physical infrastructure and cost less than the Jobs Plan, all of which were rejected by the Biden White House.[2] As of this week, it remains unclear which proposal could achieve the 60 votes required to overcome a filibuster in the Senate.

On June 10, 2021, a bipartisan group of Senators reached a compromise on infrastructure, which would spend $1.2 trillion over eight years, a key step towards achieving an infrastructure bill that can pass Congress and be signed into law by the President. The deal still needs to be approved by the White House and Senate Republican Conference and the legislative text must still be approved by all the parties as well. While light exists at the end of the tunnel, challenges remain as the infrastructure deal has received bipartisan criticism—Republicans are concerned about the deal’s cost being too large, its tax increases are controversial, and the prospect of a major legislative accomplishment for a Biden administration and Democrats are concerned that the deal’s cost is too small, the strategies to pay for it are problematic, and the deal fails to address climate change—and it may not achieve a filibuster-proof supermajority in the Senate.

If the bipartisan deal in the Senate breaks down, Democrats may pass the Jobs Plan on their own, using a legislative process known as reconciliation that permits the passage of certain legislation with only a majority of votes. Alternatively, Democrats may decide to move a physical infrastructure-focused bill with Republican support and use reconciliation to move their broader policy priorities, like climate change, at a later date.

1.      Overview of the American Jobs Plan

 The Jobs Plan seeks to rejuvenate the American economy by prioritizing investments in green infrastructure while addressing climate change, racial inequities, and employees’ rights.

a.   Common Themes

Consistent among the various types of investments in the Jobs Plan is a focus on green infrastructure. Indeed, around 56 percent of the Jobs Plan’s expenditures can fairly be said to relate to climate change.[3] Of the various provisions in the Jobs Plan, improvements to transportation infrastructure, including a wide-scale investment in electric power, are mostly climate-driven. Tackling both mass transit and electric vehicles, the Jobs Plan allocates $85 billion for public transit and $80 billion for Amtrak in an effort to make public transport options more reliable and accessible, thus encouraging people to transition away from single-occupancy vehicles, which are a major source of greenhouse gas emissions. The Jobs Plan also directs $174 billion to electric vehicles to build up charging infrastructure and provide point-of-sales rebates and tax incentives to customers buying electric vehicles.

Beyond transportation investments, another green infrastructure investment is the $100 billion set aside for electric grid infrastructure and the extension and expansion of renewable energy tax credits. The Jobs Plan creates a “Clean Electricity Standard,” a federal mandate requiring that a certain percentage of electricity in the United States be generated by zero-carbon energy sources, such as wind and solar. The Jobs Plan also puts aside $35 billion toward clean-energy technology, new methods for reducing emissions, and other broad-based climate research.

Also embedded throughout the Jobs Plan is an emphasis on closing racial gaps in the economy, which according to administration officials have been created or exacerbated by previous federal spending efforts, such as interstate highway developments that have cleaved communities of color or air pollution that affects a majority of Black and Latino communities near power plants. These inequities have become even more pronounced during the coronavirus pandemic. For example, Black and Latino households are less likely to have access to home broadband Internet than White households. Addressing this disparity, the Jobs Plan prioritizes building broadband infrastructure in unserved and underserved areas to ensure the country reaches comprehensive high-speed broadband coverage. The Jobs Plan’s investments in workforce development also seek to advance racial equity, setting aside $100 million in workforce development programs that specifically target support services for communities of color. And, in order to boost minority-owned manufacturing, the Jobs Plan markedly increases support for the Manufacturing Extensions Partnership, which will increase the involvement of minority-owned and rurally located small- and medium-size enterprises.

The Jobs Plan also seeks to strengthen unions and collective bargaining rights for employees, including guaranteeing union and bargaining rights for public service workers.[4] President Biden has signaled his support for the Protecting the Right to Organize (PRO) Act,[5] which would make sweeping changes to federal labor law. Moreover, the Jobs Plan invests $10 billion to strengthen the capacity of labor enforcement agencies, and imposes increased penalties for employers who violate workplace safety and health rules.[6]

b.   Transportation Infrastructure

The plurality of the $2 trillion dollar Jobs Plan package, approximately $620 billion, will be dedicated to transportation infrastructure, including:

• $174 billion in grants and other incentives to encourage state and local governments to partner with the private sector to build electric vehicle (“EV”) charging infrastructure, incentivize EV purchases, and support the transition away from diesel transit vehicles. The Jobs Plan would electrify 20 percent of the nation’s fleet of yellow school buses and would convert the entire U.S. Postal Service fleet to electric;
• $115 billion to revamp 20,000 miles of highways and roads, including improvements to 10 of the most economically important bridges across the country, as well as to thousands of smaller bridges in need of reconstruction;
• $85 billion to modernize and expand bus, rapid transit and rail services in order to reduce congestion and improve equitable access to these modes of transportation;
• $80 billion targeted to address Amtrak’s repair backlog and modernize the busy Northeast Corridor, as well as improve and expand existing corridors and enhance passenger and freight rail safety;
• $50 billion in grants and tax incentives to improve infrastructure resilience by safeguarding critical infrastructure and services from extreme weather events;
• $25 billion to upgrade airports and support a new program that aims to renovate terminals, as well as additional funding for the Airport Improvement Program, Federal Aviation Administration assets;
• $20 billion to incentivize new programs increase access and opportunity and work toward racial equity and environmental justice;
• $20 billion to improve road safety for cyclists and pedestrians, including the Safe Streets for All Program, which funds state and local “vision zero” plans to reduce crashes and fatalities; and
• $17 billion to improve inland waterways and shipping ports.

c.   Investment in “How We Live at Home”

The Jobs Plan’s second major category of investments focuses on how Americans live at home. Among other things, the President’s proposal calls upon Congress to dedicate billions to improve the nation’s affordable housing supply, power infrastructure, clean water, broadband access, schools and childcare facilities, and the manufacturing sector.

i.   Affordable Housing

With an eye towards addressing the “severe shortage of affordable housing in America,”[7] the Jobs Plan allocates $213 billion to address the nation’s affordable housing shortage using primarily a two-pronged approach: (1) building, preserving, and retrofitting more than two million commercial buildings and homes; and (2) eliminating state and local exclusionary zoning laws through a competitive grant program.

Building and Improving Housing Stock

Key to the Jobs Plan’s proposed increase in the amount of affordable housing in the nation is to build, renovate, and retrofit part of our current housing and commercial building stock. Specifically, the President’s plan calls upon Congress to pass the Neighborhood Home Investment Act (“NHIA”), which would offer $20 billion in tax credits over the next five years towards renovating or building 500,000 homes in distressed areas.

The NHIA is a centerpiece of the President’s affordable housing plan and already has bipartisan support. U.S. Senators Ben Cardin (D-Md) and Rob Portman (R-Ohio) have introduced the NHIA in the Senate as S. 98,[8] while Representative Brian Higgins has introduced the accompanying bill in the House of Representatives, H.R. 2143.[9] Under the NHIA proposal, states would establish a Neighborhood Homes Credit Agency which would allocate the tax credits to qualified home builds or renovations.[10] Project sponsors—such as developers—would be responsible for developing or rehabilitating the home, condominium, or qualified cooperative, receiving a tax credit once the home or project has been sold to a qualified buyer.[11] Qualified projects must be certified by a Neighborhood Homes Credit Agency and located in a qualified census tract where certain conditions are met.[12] Specifically, the project must be in a census tract where (1) the median gross income which does not exceed 80 percent of the applicable area median gross income; (2) the poverty rate that is not less than 130 percent of the applicable area poverty rate; and (3) a median value for owner-occupied homes does not exceed the applicable area median value for owner-occupied homes.[13] To receive the tax credit, the project must be sold to a qualified buyer, who are individuals that will use the qualified residence as their principal residence and whose income does not exceed 140 percent of the applicable area median gross income for where the home is located.[14]

The tax credit awarded would cover the gap between development cost and sales price of new homes, but is capped at 35 percent of the cost of construction or 35 percent of 80 percent of the national median sale price for new homes as determined according to the most recent census data, whichever is less.[15] For homes that are rehabilitated, the NHIA tax credit would cover the gap between the rehabilitation cost and the homeowner’s contribution, for up to 35% of the rehabilitation cost.[16]

The Jobs Plan uses block grant programs, the Department of Energy’s Weatherization Assistance Program,[17] and commercial efficiency tax credits, to renovate additional structures. The proposal also creates a $27 billion Clean Energy and Sustainability Accelerator to mobilize private investment into energy resources, retrofits of residential, commercial and municipal buildings, and clean transportation. The American Jobs Plan also tackles public housing, asking Congress to invest $40 billion to improve public housing in the country.

Eliminating State and Local Exclusionary Zoning Laws

The Jobs Plan also calls upon Congress to enact a new competitive grant program that awards funding to jurisdictions willing to eliminate “exclusionary zoning laws” that have prevented the creation of more homes. The Jobs Plan provides examples of such exclusionary laws, suggesting that “minimum lot sizes [requirements], mandatory parking requirements, and prohibitions on multifamily housing” have “inflated housing and construction costs and locked families out of areas with more opportunities.”[18]

ii.   Upgrading and Reorienting Power Infrastructure

Modernizing Power Infrastructure

Another key aspect of the proposal is to reenergize America’s power infrastructure. As part of this effort, the Jobs Plan calls on Congress to invest $100 billion in investment tax credits to incentivize the buildout of, at minimum, 20 gigawatts of high-voltage capacity power lines and to mobilize private capital into re-energization efforts. The Jobs Plan also establishes the Grid Deployment Authority at the Department of Energy, designed to better utilize existing right-of-ways that can help create additional transmission lines as well as support financing tools for those kinds of projects. Additionally, the Jobs Plan proposes a 10-year extension and phasedown of an expanded direct-pay investment tax credit and production tax credit for clean energy and storage. States and local governments will also have access to clean energy block grants if they prioritize power grid modernization, which can be used to support clean energy, worker empowerment, and environmental justice programs.

Eliminating Hazardous Energy-Related Sites

The proposal also makes key investments in improving energy-related sites throughout the country. For example, the proposal invests $16 billion to plug hundreds of thousands of former orphan oil and gas wells, along with abandoned mines, which pose serious safety hazards and can be a source of environmental harm. The Jobs Plan also calls for a $5 billion investment in the remediation and redevelopment of former industrial and energy sites that contain hazardous substances (known as Brownfield and Superfund sites). The Jobs Plan also calls for further aide to communities around such sites, through investments to the Economic Development Agency’s Public Works program, lifting the cap on projects. Additionally, the proposal asks for additional economic development efforts through the Appalachian Regional Commission’s Partnerships for Opportunity and Workforce and Economic Revitalization (“POWER”) grant program, which aids regions affected by job losses in coal mining, coal power plant operations, and coal-related supply chain industries. The Jobs Plan also invests in the Department of Energy’s retooling grants for idle factories through Section 132 of the Energy Independence and Security Act, which has never been funded. Section 132’s grant program was designed “to encourage domestic production and sales of efficient hybrid and advanced diesel vehicles” with “priority . . . given to the refurbishment or retooling of manufacturing facilities that have recently ceased operation or will cease operation in the near future.”[19]

Energy-Related Goals and Financial Commitments

President Biden’s proposal makes significant energy-related commitments. Among them is the creation of the Energy Efficiency and Clean Electricity Standards, aimed at cutting electricity bills and pollution, to move toward “100 percent carbon-pollution free [sic] power by 2035.” President Biden has also pledged that the federal government will purchase 24/7 clean power for federal buildings to help support these efforts.

iii.   Clean Water

The Jobs Plan also invests $111 billion to replace all of the nation’s lead pipes and service lines, to ensure that lead pipes do not deliver drinking water to any home in the country. To accomplish this goal, President Biden’s Plan calls on Congress to invest $45 billion in the Environmental Protection Agency’s Drinking Water State Revolving Fund and in Water Infrastructure Improvements for the Nation Act (“WIIN”) grants. The Jobs Plan also allocates $56 billion to help modernize the country’s aging water systems, providing grants and low-cost flexible loans to states. An additional $10 billion is dedicated to monitoring and remediating per- and polyfluoroalkyl substances (“PFAs”) in drinking water and to invest in rural small water systems and household well and wastewater systems, including drainage fields.

iv.   Expanding Broadband Access

Recognizing the Internet as “the new electricity,” the Jobs Plan also pledges $100 billion to expand broadband access to everyone, including to Americans living in areas with no broadband infrastructure with minimal access to the Internet. The money will go towards building high-speed broadband infrastructure and providing temporary, short-term subsidies to cover the costs of overpriced Internet services. However, President Biden also pledges in his proposal to work with Congress to find a permanent solution to reduce Internet prices for everyone and “hold providers accountable.”

v.   Investment in Repairs of Schools, Community Colleges, Childcare Facilities, Federal Buildings, and the Veteran Hospital System

Improvements in Public Schools and Community Colleges

The Jobs Plan also sets aside $100 billion to upgrade and build new public schools, $50 billion of which will be provided in direct grants and the other $50 billion in bonds. The funding is designed to improve school safety, make technological improvements to schools, and create more energy-efficient school buildings. The Jobs Plan also calls for $12 billion dedicated to expanding the nation’s community college infrastructure, giving states the ability to address existing physical and technological infrastructure needs.

Improvements to, and the Creation of, Childcare Facilities

The Jobs Plan dedicates $25 billion to a Child Care Growth and Innovation Fund, which states it will use to upgrade childcare facilities and build additional childcare facilities in high-need areas. The Jobs Plan also expands tax credits to encourage businesses to build childcare facilities. Under the proposal, employers will receive 50 percent of the first $1 million of construction costs per facility to create on-site childcare.

Additionally, the Jobs Plan calls for $18 billion dedicated to the modernization of Veterans Affairs hospitals and clinics. An additional $10 billion will go towards a Federal Capital Revolving Fund to support investment in a major purchase, construction or renovation of federal facilities.

vi.   Manufacturing and Strengthening of Supply Chains as Well as Increasing Access to Capital for Domestic Manufacturers

President Biden’s Plan also dedicates $300 billion to revitalize American manufacturing and supply chains. Specifically, the proposal calls for $50 billion in semiconductor manufacturing and research dollars; $30 billion in pandemic-ready-related manufacturing and research and development; and $36 billion towards the manufacture of “clean” cars, ports, pumps, along with advanced nuclear reactor sand fuel. Additionally, President Biden proposes that Congress invest more than $52 billion in domestic manufacturers, expanding their access to capital. The Jobs Plan also calls for modernizing supply chains, including the auto sector, through specific programs, such as extending the Advanced Energy Manufacturing Tax Credit Program, also known as the “48C tax credit,” which helps promote clean energy projects. The Jobs Plan also contains an additional $31 billion in investments designed to give small business manufacturers access to credit, venture capital, and R&D dollars, to increase their ability “to compete in a system that is so often titled in favor of large corporations and wealthy individuals.”

d.   Care Infrastructure

The third major category of investments focuses on expanding access to home and community-based services to bolster America’s “care economy.” The Jobs Plan sets out to address the current “caregiving crisis” by improving access to, and quality of, home care for individuals who qualify under Medicaid, creating additional home care jobs, and supporting home care workers. To do so, the Jobs Plan asks Congress to put $400 billion toward “expanding access to quality, affordable home-or community-based care for aging relatives and people with disabilities.” In addition to facilitating access to care, these investments are intended to increase the pay and benefits for those in the caregiving industry and create an opportunity for these workers “to organize or join a union and collectively bargain.”

The Jobs Plan sets forth a two-pronged approach to accomplish these objectives: (1) expand access to long-term care services under Medicaid and (2) put in place an infrastructure to create middle-class jobs with the opportunity to participate in collective bargaining. The Jobs Plan will expand access to home- and community-based services (“HCBS”) and extend existing Medicaid long-term care programs such as the “Money Follows the Person” program, which is designed to move nursing home residents out of nursing homes and back into their own homes, or the home of family members. The HCBS expansion will be designed to support well-paying caregiving jobs and permit joining a union, in an effort to “improve wages and quality of life for essential homecare workers and yield significant economic benefits for low-income communities and communities of color.”[20]

e.   Investments in Jobs, Manufacturing, and Innovation

i.   Research and Development

The Jobs Plan envisions investment in research and development (“R&D”) as serving multiple administration priorities, not the least of which is keeping pace with—and pushing back against—China on advanced and emerging technologies. That strain runs throughout this section of the Jobs Plan, which first notes, “[c]ountries like China are investing aggressively in R&D” before proposing $180 billion in investment to “win the 21st century economy” by “investing in the researchers, laboratories, and universities across our nation.” Specific to these emerging technologies, the Jobs Plan proposes $50 billion for the National Science Foundation; $30 billion for generalized innovation and job creation, including in rural areas; and $40 billion to upgrade research infrastructure across various government agencies.

It is clear that the Jobs Plan envisions investment in R&D as a way to advance other aspects of the Biden Agenda. For example, the Jobs Plan calls for “$35 billion in the full range of solutions needed to achieve technology breakthroughs that address the climate crisis and position America as the global leader in clean energy technology and clean energy jobs.” This includes launching “APRA-C,” a climate-focused counterpart to the Defense Advanced Research Projects Agency (“DARPA”), along with other projects focused on energy storage, carbon capture, hydrogen and nuclear technologies, wind, biofuel, quantum computing and electric vehicles. In addition, the Jobs Plan views R&D as a means by which to confront racial and gender inequities, stating: “Persistent inequities in access to R&D dollars and to careers in innovation industries prevents [sic] the U.S. economy from reaching its full potential.” Accordingly, the Jobs Plan proposes $10 billion in funding for R&D investment at Historically Black Colleges and Universities (“HBCUs”) and $15 billion to create research incubators at HBCUs and other minority-serving institutions.

ii.   Domestic Production

In seeking an additional $300 billion in funding for domestic manufacturing—“a critical node that helps convert research and innovation into sustained economic growth”—the Jobs Plan attempts to bolster the middle class and reinforce union support while expanding growth to rural areas. Proposed funding under this category likewise reflects the administration’s focus on the COVID-19 recovery, supply chain independence, and combating climate change. The Jobs Plan calls for $50 billion to advance semiconductor manufacturing and research along with $30 billion to address job losses caused by the pandemic and to “shore up our nation’s strategic national stockpile,” including funding for measures designed to address a future pandemic, such as prototype vaccines and therapeutic treatments.

The Jobs Plan also sees a role for clean energy manufacturing—“[t]o meet the President’s goals of achieving net-zero emissions by 2050, the United States will need more electric vehicles, charging ports, and electric heat pumps for residential heating and commercial buildings.” To these and related projects, the Jobs Plan proposes $46 billion. A further $20 billion is proposed under this category for investment in regional innovation hubs to “leverage private investment to fuel technology development, link urban and rural economics, and create new business in regions beyond the current handful of high-growth centers.” The Jobs Plan also specifically addresses rural and Tribal communities, proposing $5 billion for a Rural Partnership Program to “build on their unique assets and realize their vision for inclusive community and economic development.”

iii.   Workforce Development

The Jobs Plan seeks a further $100 billion for a range of workforce development initiatives. This would include next-generation training programs, $40 billion to address sector-based and dislocated worker training and $12 billion in targeted workforce development in underserved communities, $5 billion of which would go toward community violence prevention programs. The Jobs Plan also calls for $48 billion for apprenticeships, career pathway programs in middle and high schools prioritizing STEM careers, and community college partnerships.

f.   Strengthening Employee Rights

The Jobs Plan guarantees that public service workers will have collective bargaining rights.[21] Moreover, the Jobs Plan calls upon Congress to pass the Protecting the Right to Organize (“PRO”) Act.[22]  A version of the PRO Act has already passed the House of Representatives, with five Republicans joining Democrats in favor of it.[23] If enacted, the House version of the PRO Act would make significant changes to federal labor law. Some of these changes include invalidating state right-to-work laws and limiting arbitration agreements between employers and employees.[24] While an increasing number of Senate Democrats have come out in support of the PRO Act, it is unlikely that bill can generate enough support to overcome a filibuster and ultimately pass in the Senate.[25]

II.     Made in America Corporate Tax Reform Plan

The Tax Plan overhauls corporate and international taxation.[26] The Tax Plan includes proposals to raise the U.S. federal corporate income tax rate, establish an international agreement on global taxation, dis-incentivize inversions and offshore profit shifting to low-tax countries, incentive domestic spending, and enact minimum corporate taxes.[27] The Tax Plan is expected to raise over $2 trillion over the next 15 years,[28] which would fully fund the American Jobs Plan.[29]

a.   Increase Federal Corporate Income Tax Rate to 28 Percent

One of the most noteworthy aspects of the Tax Plan is the increase in the U.S. federal corporate income tax rate. The Tax Plan would raise the corporate income tax rate from 21 percent to 28 percent.[30] This proposal would reverse the reduction in the corporate income tax rate in the 2017 Tax Cuts and Jobs Act (“TCJA”), which lowered the rate from 35 percent to 21 percent.[31] Revenues from the tax increase would help fund investments in infrastructure, clean energy, and research and development.[32]

The Tax Plan’s proposed tax hike on corporate income tax is drawing resistance, even from members of President Biden’s own political party. Senator Joe Manchin of West Virginia, who holds a key moderate vote in a 50-50 Senate, has come out in opposition of the proposal.[33] A compromised corporate income tax rate increase to 25 percent will likely appease the White House and moderate Democrats.[34]

b.   Strengthen the Global Minimum Tax on U.S. Multinational Corporations

The Tax Plan would revise the “global intangible low taxed income” (“GILTI”) regime that was enacted as part of the TCJA.[35] The GILTI regime was intended to discourage moving intangible assets and related profits outside the United States.[36] U.S.-controlled foreign corporations are given a tax exemption on the first 10 percent of returns on foreign tangible assets,[37] and GILTI is taxed at approximately half of the corporate tax rate (10.5 percent).[38] Under the current regime, GILTI tax liabilities are currently calculated on a global basis.[39]

President Biden’s Tax Plan would revise the GILTI regime in the following manner:

• Eliminate the tax exemption on the first ten percent of returns on foreign tangible assets;[40]
• Increase the GILTI minimum tax on U.S. corporations to 21 percent;[41] and
• Calculate the GILTI minimum tax on a country-to-country basis to prevent corporations from shifting profits to low-tax countries.[42]

c.   Negotiating Multilateral Agreement on International Minimum Taxes

The Tax Plan indicates that the United States will lead a multilateral effort to impose a global minimum tax and strengthen anti-inversion provisions.[43] Pursuant to the Organisation for Economic Co-operation and Development/G20 Inclusive Framework on Base Erosion and Profit, the United States and the international community are negotiating a global agreement that would enact minimum tax rules worldwide.[44] This agreement would allow home countries of multinational corporations to apply a minimum tax when offshore affiliates are taxed below an agreed-upon minimum tax rate.[45] Foreign corporations based in countries that do not adopt a strong minimum tax would be denied deductions on payments that could allow them to strip profits out of the United States.[46] These proposals would repeal and replace the Base Erosion and Anti-Abuse Tax (“BEAT”),[47] which was enacted under the TCJA.[48]

The Tax Plan would also strengthen anti-inversion provisions to prevent U.S. corporations from inverting.[49] Corporations that merge while retaining management and operations in the United States would be treated and taxed as a U.S. company.[50] More specific details regarding anti-inversion provisions will likely emerge as negotiations on the proposed legislation continue.

d.   Eliminate Deductions for “Offshoring” Jobs and Credit Expenses for “Onboarding” Jobs

The Tax Plan would eliminate deductions for expenses arising from offshoring jobs and provide tax credits for on-shoring jobs.[51] Currently, the Tax Plan does not provide additional details on this proposal.

e.   Repeal TCJA’s Foreign Derived Intangible Income (“FDII”) Deduction

The FDII deduction was introduced as part of the 2017 TCJA.[52] FDII is income that comes from exporting products tied to intangible assets held in the United States.[53] FDII is currently taxed at a reduced rate of 13.125 percent, rather than the regular 21 percent.[54] This reduced rate was meant to encourage U.S. corporations to export more goods and services, and locate more intangible assets in the United States.[55]

The Tax Plan would repeal the FDII regime in its entirety,[56] and use the generated revenues to incentivize research and development directly,[57] which would include providing stronger tax-based incentives to increase research and development in the United States.[58]

f.   Corporate Minimum Taxation

The Tax Plan would enact a 15 percent minimum tax on the income corporations use to report to their investors—which the Tax Plan refers to as “book income.”[59] Under this proposal, corporations that report high profits would be required to make an additional payment to the IRS for the excess of up to 15 percent on their book income over their regular tax liability.[60] This tax would “apply only to the very largest corporations”[61]—but there is currently no further guidance on which corporations would be subjected to this tax.

III.     The American Families Plan

President Biden’s Families Plan provides billions of dollars designed to improve childcare opportunities, expand access to early-childhood education and higher education, create a national paid leave program, improve school nutrition, and modernize the unemployment system. The Jobs Plan also makes key revisions to the tax code, restoring the highest income tax bracket to 39 percent and ending capital gains rates for high-income earners, among other things. Specifically, the Jobs Plan calls for $200 billion for free universal preschool for all three- and four-year-olds; $109 billion for two years of free community college; $80 billion towards Pell Grants; $62 billion to strengthen retention rates at community colleges; $46 billion in Historically Black Colleges and Universities (“HBCUs”), Tribal Colleges and Universities (“TCU”), and Minority Serving Institutions (“MSIs”); and $9 billion to train, equip, and diversify teachers.

a.   Direct Support to Children and Families

Under President Biden’s plan, low- and middle-income families will pay no more than seven percent of their income on high-quality childcare. Specifically, the Jobs Plan invests $225 billion so that low-income families pay nothing for childcare while those families earning 1.5 times their state median income will pay no more than seven percent of their income to childcare. The Jobs Plan also invests in childcare providers to help them cover the costs associated with early childhood care and provide inclusive curriculums. The Jobs Plan also ensures a $15 minimum wage for early childhood staff.

b.   Paid Leave

President Biden’s plan calls for the creation of a national paid family and medical leave program, that will build over ten years. By year 10, the program will guarantee twelve weeks of paid parental, family, and personal illness leave. The Jobs Plan also ensures that workers get three days of bereavement leave per year starting in year one. The leave will provide workers with up to $4,000 a month, with a minimum of two-thirds of average weekly wages replaced, rising to 80 percent for the lowest-wage workers. The Jobs Plan is projected to cost $225 billion over a decade.

c.   Nutrition

President Biden’s plan is also calling upon Congress to invest $45 billion to expand summer EBT Demonstrations. Seventeen billion of this will go towards expanding free meals for children in the highest-poverty districts. Another $1 billion will go towards launching a healthy-foods incentive demonstration to help schools expand healthy food offerings, allowing schools that adopt specified measures that exceed current school meal standards to receive an enhanced reimbursement rate.

d.   Unemployment Insurance Reform

President Biden’s plan also calls upon the Rescue Plan’s $2 billion allocation that was put towards Unemployment Insurance system modernization. The Jobs Plan also calls for investments to ensure equitable access to the unemployment insurance system, along with fraud prevention efforts. President Biden also calls upon Congress to automatically adjust the length and amount of unemployment insurance benefits unemployed workers receive depending on economic conditions.

e.   Tax Reforms

i.   Expanding Tax Credits

President Biden’s plan also makes changes to the current tax code, expanding certain credits and revising tax rates in key areas. Specifically, President Biden’s plan would:

• Invest $200 billion in health care premium reductions;
• Extend the Child Tax Credit, allowing for $3,000 per child (6 years old and above), and $3,600 per child for children under 6; make 17-year-olds eligible for the first time; and make the credit fully refundable to be paid on a regular basis;
• Make permanent the temporary Child and Dependent Care Tax Credit (“CDCTC”) expansion enacted in the American Rescue Plan. Families will receive a tax credit for as much as half of their spending on qualified childcare for children under age 13, up to a total of $4,000 for one child, or $8,000 for two or more. A 50 percent reimbursement will also be available to families making less than $125,000 a year, with families making between $125,000 and $400,000 receiving a partial credit;
• Make the Earned Income Credit Expansion for childless workers permanent; and
• Give IRS the authority to regulate paid tax preparers.

ii.   Tax Code Revisions

In an effort to ensure more oversight over the tax liability of higher earners, President Biden’s plan also requires financial institutions to report information on account flows so that earnings from investments and business activity are subject to reporting more like wages. The Jobs Plan also increases investment in the IRS to help ready enforcement “against those with the highest incomes, rather than Americans with actual income less than $400,000.” The Jobs Plan is projected to raise $700 billion over 10 years.

In a key change, President Biden’s plan also returns the top income tax rate to 39.6 percent from the current 37 percent rate. With respect to capital income, households making over $1 million will pay the 39.6 percent rate on all their income, equalizing the rate paid on investment returns and wages. Additionally, the Jobs Plan ends the ability of accumulated gains to be passed down across generations untaxed, ending the practice of “stepping-up” the basis for gains in excess of $1 million. Additionally, hedge fund partners will be required to pay ordinary income rates on their income. Finally, the Jobs Plan ends the special real estate tax break that allows real estate investors to defer taxation when they exchange property.

IV.     Political Landscape

Infrastructure has long been a bipartisan issue in Washington, but the parties differ over the scope of what should be included in an infrastructure package and how to pay for it. President Biden’s Jobs Plan represents a sprawling, ambitious proposal to overhaul the country’s infrastructure, from how electricity is generated to the quality of the country’s drinking water, to the breadth and speed of Internet connectivity. The Families Plan is also a massive package that extends or makes permanent federal investments in education, childcare and paid family leave. While the Jobs Plan includes major physical infrastructure improvements that both major political parties have long supported, it is far from certain the Jobs Plan will be signed into law.

As detailed below, a bipartisan deal has been struck in principle that may allow for an infrastructure bill to move in Congress, at least on physical infrastructure. But if that deal breaks down for any reason, which remains a real possibility given the bipartisan concerns about the compromise, then President Biden will need to overcome a host of challenges in order to achieve a legislative win on infrastructure this year.

First, the President will have to navigate the challenges of moving legislation via the budget process of reconciliation, which would allow him to pass a bill through Congress by a majority vote and avoid Republican support. But adopting that path requires navigating complex, and time-consuming procedural rules that make reconciliation a difficult option to choose.

Second, the President will have to negotiate a deal that allows him to keep his caucus together and pursue a one-party bill that may be difficult to achieve given the intra-party ideological concerns from his own party and from industry. Or the President will have to pursue a bipartisan option that may cause him to lose support from his own party.

Third, given the reality of a 50-50 Senate and bipartisan concerns over the Senate deal, moving the infrastructure plan through reconciliation may be a realistic option for Democrats to achieve a major legislative victory on infrastructure.

a.   Reconciliation Challenges

President Biden has stated a desire for the Jobs Plan to garner bipartisan support.  While the President campaigned on restoring bipartisanship to Washington, D.C., garnering Republican support would also obviate the need for Democrats to use budget reconciliation to pass the infrastructure package. Most legislation requires 60 votes to advance in the Senate, which is a substantial hurdle. Reconciliation is a procedural maneuver that allows Congress to fast-track, via a simple majority vote, revenue and spending measures to align with the annual budget resolution. In practice, this means Congress can pass legislation on taxes, spending, and the debt limit with only a majority (51 votes, or 50 votes if Vice President Harris breaks a tie) in the Senate, avoiding a filibuster, which would require 60 votes to overcome.[62]

Democrats now control the political branches—the Executive Branch and both chambers of Congress by a slim majority—which unlocks the reconciliation tool as a potential vehicle to pass legislation along partisan lines. Hence, Democrats could use reconciliation to push through the infrastructure package, which is a major part of President Biden’s Build back Better agenda, thus it is not surprising Congressional Democrats are eyeing the budget process once again to pass major legislation.

Even so, in order to pass the infrastructure package via reconciliation, Democrats would need to revise portions of the bill to ensure it complies with the complex reconciliation procedures. The Byrd Rule limits legislation that can be passed under reconciliation. The “Byrd Rule,” named after then-Senator Robert C. Byrd (D-WV), was intended to prevent majority parties from abusing the reconciliation process by ramming through non-budgetary legislation that could not otherwise pass under regular order and prevent major policy changes from being undertaken through the use of this filibuster-circumventing maneuver. Specially, the Byrd Rule prohibits a reconciliation bill from containing proposals that are “extraneous” to the budget.[63]

The Byrd Rule’s ban on extraneous policy language outlines six possible violations, including having no budgetary impact, having a “merely incidental” budget impact, or being outside the reporting committees’ jurisdiction.[64] Policy proposals in the infrastructure plan that may be considered extraneous—and thus be unable to pass through reconciliation procedures—include the PRO Act and strengthening collective bargaining rights for employees, since these proposals are not budgetary in nature.

Even if Senate Democrats resign themselves to using the reconciliation procedures, there reconciliation is by no means a quick process. While the Senate floor consideration of an infrastructure bill under reconciliation can be expedited with debate limited to 20 hours on the bill and 10 hours on the conference report, actually getting legislation to the floor is a multi-stage process that can take months. First, Congress must pass a budget resolution that instructs specific committees to produce legislation that either increases or reduces the deficit. Second, committees then markup their reconciliation text in business meetings and report it to the Budget Committee. Third, the Budget Committee compiles the committee approved bills and reports the combined legislation to the chamber floor. Fourth, the House and Senate debate and pass their respective reconciliation bills. Fifth, the chambers convene a conference committee to reach agreement on legislative text.  Sixth, the House and Senate must pass identical versions of the resulting conference report. And lastly, the measure is sent to the President for signature. This is a time-consuming, complex process that can drag on for months and cause delay.[65]

Furthermore, a recent decision by the Senate Parliamentarian has added an additional barrier that may make it difficult for Democrats to pass an infrastructure bill through reconciliation and without the support of Senate Republicans. Generally, Congress can only use reconciliation twice in a two-year Congress, one for each fiscal year.[66] Senate Democrats already used one reconciliation vehicle associated with one fiscal year to pass the $1.9 trillion COVID relief package earlier this year. So Congress could use only the second reconciliation for the upcoming fiscal year for infrastructure. But passing a budget resolution this year in an equally divided Senate is not an easy task.

Senate Democrats came up with an unprecedented solution. Because the plain text of Section 304 of the Budget Act, which governs reconciliation, says that Congress “may” include reconciliation directives, such as “revises” the budget “concurrent resolution for the fiscal year already agreed to,”[67] Senate Democrats asked the Senate Parliamentarian if they could use the same reconciliation vehicle that passed earlier this year on multiple occasions to trigger the fast-track reconciliation process rather than deal with a new reconciliation package for infrastructure. No prior Congress has ever tried to use a reconciliation measure twice in one year.

On April 5, 2021, the Senate Parliamentarian reportedly advised Senate Democrats that the Budget Act could be used to create multiple reconciliation bills within one fiscal year,[68] which would allow Senate Democrats multiple bites at the apple to pass legislation, like infrastructure, through the Senate on a majority vote.

On May 28, 2021, the Senate Parliamentarian made a second decision that could effectively thwart Senate Democrats from using reconciliation to achieve its infrastructure goals. The Senate Parliamentarian reportedly advised that a revised budget reconciliation measure must pass through “regular order,” meaning it must go through committee and have floor amendment votes during a “vote-a-rama.”[69]  A “vote-a-rama” is a lengthy process that forces Senators to take challenging partisan votes on a wide variety of issues.

The effect of both rulings by the Senate Parliamentarian mean that, even though Senate Democrats may revamp the old reconciliation vehicle used for the coronavirus relief package, the process will be just as onerous for two reasons.

First, by the Senate Parliamentarian ruling that a revised budget resolution must go through committee (as opposed to being automatically discharged from committee) that means Senate Democrats would need at least one Republican on the evenly divided, 11-11, Senate Budget Committee to vote with them, which is not an easy task.

Second, by the Senate Parliamentarian signaling that Senate Democrats must go through a “vote-a-rama” that means potentially exposing moderate Democrats who are up for re-election next year to tough votes on politically charged amendments, which is a major consideration given the balance of power in the Senate for a Democratic majority hangs by a single vote (50-50 Senate, with the Vice President breaking the tie). Third, it means that Senate Democrats can only use one more reconciliation vehicle to pass Biden’s key legislative priorities this year, so they will not be able to divide up the Jobs and Families Plans as they had originally intended.

Another implication of the Senate Parliamentarian’s ruling poses an equally challenging barrier for the infrastructure Plans to move in Congress. Reportedly, the Senate Parliamentarian ruled that reasons beyond “political expediency” must be present to trigger the majority vote threshold of reconciliation, such as an economic downturn.[70] It is unclear how the Senate Parliamentarian would determine the meaning of “political expediency,” but this decision poses an obstacle for using reconciliation to pass an infrastructure bill.

b.   Ideological Challenges

Another challenge for Senate Democrats is that even if they choose to use reconciliation, no guarantee exists that they will successfully keep their caucus together on a historically expensive and expansive proposal. Moderate Democrats like Senator Joe Manchin (D-WV) have raised their concerns with the proposed hike of the corporate tax rate. Indeed, Senator Manchin went so far as to say that increasing the corporate tax rate to 28 percent is a nonstarter and that “this whole thing here has to change.”[71] Senator Manchin has also expressed his preference for a bill that targets physical infrastructure, rather than the “soft infrastructure” spending currently in the President’s infrastructure proposals.[72]

Furthermore, it is unclear if Senate Democratic Moderates will want to break with a party-only bill that defies the Senate’s traditional process of “regular order,” the idea that a bill should move through a hearing, a committee vote, and a floor vote with the possibility of a filibuster proof 60-vote threshold.[73] Rather than use the fast-track, one-party rule vehicle of reconciliation, Senator Manchin, for example, has expressed his preference for a bipartisan bill that moves through regular order, saying “If the place works . . . let it work.”[74] Given the 50-50 Senate, the loss of even one Democratic Senator’s vote will bar reconciliation as an option. Thus, although Leader Schumer seeks to move the infrastructure package in July, that timeline may depend upon whether moderate Democratic Senators, like Senator Manchin, will agree that a bipartisan approach is no longer viable.

Progressive Democrats, on the other hand, are concerned the Jobs Plan doesn’t go far enough, citing President Biden’s campaign promise to spend $2 trillion over four years on infrastructure. Progressive Democrats worry that “bipartisanship” may be a cloak for cutting a deal on moving the Jobs Plan, legislation on physical infrastructure only, rather than the Families Plan, a human infrastructure proposal, that progressives view as a once in a generation opportunity to secure legislative victories for families by expanding family leave and child tax credits and for climate change by investing in green energy. Indeed, House Progressives like Rep. Ruben Gallego (D-AZ) have questioned whether Republicans are being “even players” and noted that now is the time to “just move on without them.”[75]

To achieve the votes needed to pass the Jobs Plan in both chambers of Congress, Democrats will rely on the votes of Progressives who are requiring human infrastructure as the price for their support, which makes a deal with Republicans who oppose human infrastructure politically tricky. As a result, Progressives will have leverage in shaping what infrastructure plan passes in Congress as Democratic Leadership will count on votes from Progressives in order to pass infrastructure legislation, via a majority vote in the House and Senate (via reconciliation), if a bipartisan deal is not reached. Indeed, in the strongest sign yet that Progressives are willing to use their leverage, House Progressives sent a letter to Speaker Pelosi and Majority Leader Schumer, noting that Democrats should pursue a multi-billion dollar omnibus bill combining the Jobs and Families Plans together because now is the time for “a single ambitious package combing physical and social investments [to go] hand in hand.”[76]

Republicans, however, believe President Biden’s infrastructure Plan goes too far. Republicans have already criticized the Jobs Plan’s cost and the Tax Plan’s proposal to raise corporate taxes to cover the cost as non-starters. Republicans have also emphasized that any bipartisan deal can only focus on physical infrastructure, like roads and bridges, similar to bills that usually make up a surface transportation reauthorization bill. Republicans have significant leverage in the negotiations due to the narrow Democratic majority in the House and the 50-50 Senate, which, when combined with rifts in the Democratic caucus, make it harder for Democrats to have the votes to move forward with their own unilateral approach like they did last March with enacting into law the trillion dollar coronavirus relief bill.  Also, even if Democrats lose a couple of Senate Democrats they can still achieve a win on infrastructure if they pick up enough Republican votes, which is why the White House has engaged in negotiations with Senate Republicans in the hopes of achieving a compromise.

c.   Road to Achieving a Compromise

The path to achieving a bipartisan deal in Congress has been long and, while there is now light at the end of the tunnel, challenges still remain and the deal “in principle” must still be agreed to by various political actors leaving the final status of infrastructure legislation possible, but still not fully guaranteed.

How did this we get here? Taking advantage of their leverage, Senate Republicans, through their main negotiator Senator Shelley Moore Capito (R-WV), released their first counteroffer to President Biden’s infrastructure Plans. On April 22, Senator Capito issued a $568 billion infrastructure proposal, which costs only about a quarter of President Biden’s $2 trillion package costs.[77] Consistent with Republican criticism of the Jobs Plan’s broad interpretation of what is considered infrastructure, this proposal did not address policies such as care for elderly and disabled people or funding for affordable housing. Instead, the Republican framework focuses on roads and bridges, public transit systems, rail, water infrastructure, airports, and broadband infrastructure. The Republican proposal also diverged from the Jobs Plan in its approach to funding, prioritizing joint spending from state and local governments and encouraging private-sector investments and financing. Republicans also called for funding offsets to cover the cost of the programs and did not propose any corporate or international tax increases. The proposal also leaves in place the 2017 tax cuts passed under President Trump.

On May 21, 2021, President Biden issued a counter-offer to the Republican proposal, cutting his original proposal by $550 billion down to $1.7 trillion. To add pressure on Republicans, President Biden insisted that if a bipartisan deal cannot be reached, Democrats were prepared to move forward on a one-party legislative solution. Indeed, White House senior advisor Cedric Richmond noted that President Biden “wants a deal . . . But again, he will not let inaction be the answer. And when he gets to the point where it looks like that is inevitable, you’ll see him change course.”[78]

On May 27, 2021 Senate Republicans, through Senator Capito, released a second counteroffer, totaling $928 billion. The second Republican counteroffer included $604 billion for physical infrastructure, including roads, bridges, transit systems, rail, water infrastructure, airports and broadband, an increase in funding of almost $40 billion more in funding than the $568 billion for physical infrastructure in Senate Republicans’ first counteroffer.[79] An agreement was still not reached.

On June 4, 2021, President Biden rejected the third counteroffer from Senate Republicans, proposed by Senator Capito, to add about $50 billion to the Senate Republicans’ $928 billion infrastructure plan. White House Press Secretary Jen Psaki said that Senate Republicans’ third counteroffer “did not meet [President Biden’s] objectives to grow the economy, tackle the climate crisis, and create new jobs,” but that the President would continue negotiations with bipartisan Senators on a “more substantial package.”[80] One challenge for President Biden, who cut the size of his infrastructure package to $1.7 trillion during the negotiations, was that he requested at least $1 trillion in new spending over current levels, but Senator Capito’s third proposal increased new investments by only $150 billion.

On June 8, 2021, President Biden ended his infrastructure negotiations with Senator Capito,[81] and started new negotiations with a separate bipartisan group of Senators who drafting their own infrastructure proposal (“Group of Ten”).[82]  Members of the Group of Ten include Senators Rob Portman (R-Ohio) Kyrsten Sinema (D-AZ), the leaders of the group, which also includes Senators Bill Cassidy (R-LA), Lisa Murkowski (R-AK), Susan Collins (R-ME), Mitt Romney (R-UT) on the Republican side and Senators Jon Tester (D-MT), Joe Manchin (D-WV), Jeanne Shaheen (D-NH), and Mark Warner (D-VA) on the Democratic side.[83] The Group of Ten had been drafting an $880 billion infrastructure bill, which would be circulated to a broader group of about 20-centrist Senators for their support.[84] Senator Manchin, a moderate and key Senate swing vote, has said he is “very confident” a bipartisan compromise on infrastructure can still be worked out.[85]

While the first three Republican counteroffers signal that Senate Republicans remain interested in pursuing a bipartisan path forward with the White House and Senate Democrats, but significant challenges remained in achieving a deal, even with the new Group of Ten negotiations. First, the third Republican counteroffer of $978 billion and the bipartisan bill of $880 billion are both significantly less than the President Biden’s $1.7 trillion initial proposal, so Senate Republicans remain far apart from the White House on how much to spend on physical. Second, the third Republican counteroffer did not deliver on the key priorities that Progressives seek, most prominently, it failed to include human infrastructure and it is doubtful the bipartisan group’s proposal will include human infrastructure too. Third, the Republican counteroffers were silent on how to pay for an infrastructure bill, which will be key for reaching a deal.

In sum, both parties are about $700 billion apart on a deal, they lack a common definition of infrastructure, and an open question remains on how to pay for an infrastructure bill.[86] And finally, even with the Group of Ten discussions ongoing it may be difficult for 10 or more Senate Republicans—the threshold needed to overcome a filibuster—to support and vote for an infrastructure bill that goes too far beyond Senator Capito’s negotiations with the White House.

On June 10, 2021, the Group of Ten announced a bipartisan deal on a “compromise framework” to invest $1.2 trillion in physical infrastructure over the next eight years, including $974 billion over five years invested in physical infrastructure.[87]  Importantly, the deal reportedly would not increase taxes even though it does include an option to index the gas tax to inflation.[88] Additionally, the deal includes a new energy section, which President Biden called for Congress to include in an infrastructure deal.[89] Furthermore, the deal would provide $579 billion in new funding, meaning funding over what would otherwise be spent without any new legislation. [90]Hence, the deal would be fully paid for without any tax increases, which is makes the deal likely to be able in theory to pass both chambers of Congress.

However, the deal must still be signed off on by the Biden White House and the Senate Republican Conference in order to guarantee its safe passage, none of which are guarantees. And the option to index the gas tax for inflation may be a tough sale for the broader Senate Democratic Caucus. And the $1.2 trillion spending figure may also raise cost concerns, at least insofar as finding broad agreement in the Senate on how to pay for that spending, but the $1.2 trillion figure is similar to the $1.25 trillion in infrastructure spending proposed by the bipartisan House Problem Solvers Caucus, which could help smooth the path.  And of course the devil may be in the details, so the actual legislative text would need to be acceptable to the White House and both parties in Congress as well. So the bipartisan agreement among the Group of 10 is a significant step, but far from a guarantee that the deal will pass in a divided Senate, even though it creates more optimism that an infrastructure legislative victory is possible. The next step is to sale the deal to the White House and the broader Senate Republican and Democratic caucuses.

The final remaining question is whether the White House would pursue a bipartisan compromise strategy that would require at least 10 Republican votes to overcome a filibuster or if it will decide on a reconciliation strategy to pass a Democratic-only bill that may satisfy the Democratic base, but lose Republican support. Given the push from Progressives for the Families Plan in addition to the Jobs Plan to be included in any deal to retain their support, the Biden administration has a thin-line to walk. The consequences of which path it chooses could risk alienating either Republicans or Progressive Democrats.

The other key interest to watch that may shape how Washington’s negotiations on infrastructure turn out is the business community, which both moderate Democrats and Republicans court. The business community has generally supported the infrastructure spending promised by the Jobs Plan, but has criticized the Tax Plan intended to cover its costs. Some companies may be able to tolerate an increase of the corporate tax rate from 21 percent to up to 25 percent, which Democrats support. But most companies, including small businesses, may prefer the alternative financing plans proposed by Republicans, such as user fees and the creation of a federal infrastructure bank, as more palatable. Indeed, business trade associations have noted that raising the corporate tax rate may harm the business community because it will simply reduce the amount of private investment into infrastructure.

In response, the Biden administration has reportedly had conversations with business leaders to pitch the President’s infrastructure Plans as beneficial to companies, emphasizing the importance of the “soft infrastructure” such as job-training programs, as well as physical infrastructure like better roads.[91] But the question of whether the business community will support the Tax Plan needed to pay for the infrastructure package, and how that will impact what infrastructure legislation will come out of Washington, will be a key issue to watch closely.

d.   Path Forward

The easiest path forward now would be for the Group of 10 to persuade the White House and Senate Democratic Caucus, and at least enough Republicans to achieve 60 votes in the Senate for a physical infrastructure bill. If that is achieved, then the Senate will likely move this bill through the committees of jurisdiction and vote on the Senate floor with enough votes to overcome a filibuster. The Group of 10 would also need the House Democrats to pass a mirror image of the Senate bill in order to for legislation to arrive on the President’s desk for him to sign, which of course the White House would have to support.

If the deal breaks down, Senate Democrats have a way forward by using reconciliation to push the President’s infrastructure Plans through Congress, significant political and procedural challenges remain if Democrats attempt a one-party solution. A partisan infrastructure bill is still possible, but these conditions are making it much harder to actually do it.

Democrats can navigate this political landscape and pass President Biden’s infrastructure Plans by choosing one of three alternate paths. First, Democrats can pass the entire package through budget reconciliation. This path requires that Democrats garner 50 votes in the evenly-divided Senate, with Vice President Kamala Harris casting the tie-breaking vote in favor of the plan. Second, Democrats can attempt to break up the infrastructure plan and pass three separate reconciliation bills. However, as stated above, it is now unlikely that Senate Democrats will be permitted to pass three reconciliation bills in a single fiscal year. If Democrats pursue this path, Senate Majority Leader Chuck Schumer will have to persuade the Senate Parliamentarian to allow the Democrats to amend the 2021 fiscal year resolution to include instructions for an additional reconciliation bill,[92] which given the latest ruling of the Senate Parliamentarian, seems unlikely. Third, Democrats can pass a bipartisan bill with Republican support on portions of the infrastructure plan that has bipartisan support, and then use the reconciliation process to pass other elements of the infrastructure plan. If the Group of Ten can achieve broader Republican support for the infrastructure deal, which as stated above may be difficult to achieve, then this may be the best path forward for Democrats to pass the President’s infrastructure Plans.

Congress must still introduce legislative text to track the Jobs, Families, and Tax Plans’ broad contours. The extent to which that legislative text will mirror the Biden administration’s policy goals will undoubtedly be shaped by the political reality on Capitol Hill, especially if the bipartisan Group of Ten’s compromise breaks down. If Senate Democrats pursue reconciliation, they will need to receive at least 50 votes in the evenly-divided Senate—as opposed to 60 votes to defeat a filibuster—with Vice President Kamala Harris casting the tie-breaking vote in the Democrats’ favor. The infrastructure bill would then have to pass in House of Representatives, where the Democrats hold a slight majority (218 Democrats and 212 Republicans). The infrastructure bill would only become law after it passes both chambers of Congress and is signed by President Biden.  Currently, Senate Majority Leader Schumer (D-NY) has proposed an infrastructure vote in July[93] and House Speaker Pelosi (D-CA) has set the Fourth of July as a deadline for a House floor vote on infrastructure.[94]

As detailed above, if Democrats and Republicans in Congress pass the compromise on infrastructure, then a bill will likely arrive on the President’s desk before the August recess. Otherwise, if a deal breaks down, Senate Democrats will need to go back to the drawing board and likely move a one-party bill through a Democratic Congress. Facing opposition from Republicans, the Biden White House has already attempted to redefine the meaning of “bipartisanship” as a concept that does not require support of Congressional Republicans.[95] Even if an infrastructure bill ultimately passes without a single Republican vote in Congress, the Biden White House is expected to herald it as “bipartisan” legislation with broad support from the American public.[96] But passing a one-party bill is not easy, and the political and procedural conditions have made it harder to do, but if the bipartisan compromise breaks down, it may be the best option for Democrats to move the infrastructure Plans this year through a 50-50 Senate.

____________________

   [1]   Siegel, R., What’s in Biden’s $1.8 trillion American Families Plan?, The Washington Post, https://www.washingtonpost.com/us-policy/2021/04/28/what-is-in-biden-families-plan/ (last visited April 29, 2021).

   [2]   Snell, K., Countering Biden, Senate Republicans Unveil Smaller $568 Billion Infrastructure Plan, NPR, https://www.npr.org/2021/04/22/989841527/countering-biden-senate-republicans-unveil-smaller-568-billion-infrastructure-pl (last visited Feb. 28, 2021)

   [3]   Carey, L. et al., “The American Jobs Plan Gets Serious about Infrastructure and Climate Change,” Center for Strategic & International Studies (Apr. 2, 2021), available at https://www.csis.org/analysis/american-jobs-plan-gets-serious-about-infrastructure-and-climate-change.

   [4]   FACT SHEET: The American Jobs Plan Empowers and Protects Workers, THE WHITE HOUSE (Apr. 23, 2021) [hereinafter EMPLOYEE FACT SHEET].

   [5]   Alex Gangitano, Biden calls for passage of PRO Act, $15 minimum wage in joint address, THE HILL (Apr. 28, 2021), https://thehill.com/homenews/administration/550845-biden-calls-for-passage-of-pro-union-pro-act-and-15-minimum-wage.

   [6]   EMPLOYEE FACT SHEET, supra note 4.

   [7]   FACT SHEET: The American Jobs Plan, THE WHITE HOUSE (Mar. 31, 2021) [hereinafter JOBS PLAN FACT SHEET].

   [8]   S. 98, 117th Cong. (2021).

   [9]   H.R. 2143, 117th Cong. (2020).

[10]   S. 98, 117th Cong. § 42A (2021).

[11]   Id.

[12]   Id.

[13]   Id. Qualified census tracts also include projects located in a city with: (1) a population of more than 50,000; (2) a poverty rate not less than 150 percent of the applicable poverty rate; (3) a median gross income that does not exceed the applicable area median gross income; and (4) a median value for owner-occupied homes that does not exceed 80 percent of the applicable area median value for owner-occupied homes. Qualified projects may also be located in a nonmetropolitan county which has a median gross income that does not exceed the applicable area median gross income, and has been designated by a neighborhood comes credit agency as such.

[14]   Id.

[15]   Id.

[16]   Id.

[17]   The Department of Energy’s Weatherization Assistance Program is designed “to increase the energy efficiency of dwellings owned or occupied by low-income persons, reduce their total residential energy expenditures, and improve their health and safety, especially low-income persons who are particularly vulnerable, such as the elderly, the disabled, and children.” Department of Energy, About the Weatherization Assistance Program, https://www.energy.gov/eere/wap/about-weatherization-assistance-program (last accessed Apr. 21, 2021).

[18]   JOBS FACT SHEET, supra note 7.

[19]   Energy Independence and Security Act of 2007, 121 Stat. 1511 (2007) (codified and amended at 42 U.S.C. § 16062).

[20]   EMPLOYEE FACT SHEET, supra note 4.

[21]   EMPLOYEE FACT SHEET, supra note 4.

[22]   Id.

[23]   Don Gonyea, House Democrats Pass Bill that Would Protect Worker Organizing Efforts, NPR (Mar. 9, 2021), https://www.npr.org/2021/03/09/975259434/house-democrats-pass-bill-that-would-protect-worker-organizing-efforts.

[24]   Philip B. Phillips, The Protecting the Right to Organize (PRO) Act Gains Momentum, The National Law Review (Mar. 9, 2021), https://www.natlawreview.com/article/protecting-right-to-organize-pro-act-gains-momentum.

[25]   Eleanor Mueller & Holly Otterbein, Unions warn Senate Democrats: Pass the PRO Act, or else, POLITICO (Apr. 22, 2021), https://www.politico.com/news/2021/04/22/unions-senate-democrats-pro-act-484280.

[26]   JOBS PLAN FACT SHEET, supra note 7; THE MADE IN AMERICA TAX PLAN, U.S. DEPT. OF TREAS. 1-2 (Apr. 2021) [hereinafter TAX PLAN].

[27]   TAX PLAN, supra note 26.

[28]   JOBS PLAN FACT SHEET, supra note 7.

[29]   Id.

[30]   TAX PLAN, supra note 26.

[31]   Id.

[32]   Id. at 10.

[33]   Thomas Franck, Biden says higher corporate tax won’t hurt economy; Manchin opposes 28% rate, CNBC (Apr. 5, 2021), https://www.cnbc.com/2021/04/05/biden-higher-corporate-tax-would-not-hurt-economy-manchin-opposes-28-percent-rate.html.

[34]   Hans Nichols, Senate Democrats settling on 25% corporate tax rate, Axios (Apr. 18, 2021), https://www.axios.com/senate-democrats-tax-rate-biden-63190a59-0436-40d9-a8a3-fa21ef616412.html.

[35]   Id. at 8.

[36]   Tax Policy Center, What is global intangible low-taxed income and how is it taxed under the TCJA, Briefing Book, https://www.taxpolicycenter.org/briefing-book/what-global-intangible-low-taxed-income-and-how-it-taxed-under-tcja.

[37]   Id.

[38]   Id.

[39]   TAX PLAN, supra note 26.

[40]   Id. at 11.

[41]   Id.

[42]   Id.

[43]   Id. at 12.

[44]   Id.

[45]   Id.

[46]   Id.

[47]   The BEAT limits the ability of multinational corporations to shift profits by making deductible payments to their affiliates in low-tax countries. Tax Policy Center, What is the TCJA base erosion and anti-abuse tax and how does it work?, Briefing Book, https://www.taxpolicycenter.org/briefing-book/what-tcja-base-erosion-and-anti-abuse-tax-and-how-does-it-work.

[48]   Id. at 11.

[49]   Id.

[50]   Id.; JOBS PLAN FACT SHEET, supra note 7.

[51]   JOBS PLAN FACT SHEET, supra note 7.

[52]   Tax Policy Center, What is foreign-derived intangible income and how is it taxed under the TCJA, Briefing Book, https://www.taxpolicycenter.org/briefing-book/what-foreign-derived-intangible-income-and-how-it-taxed-under-tcja.

[53]   Id.

[54]   Id.

[55]   Id.

[56]   TAX PLAN, supra note 26.

[57]   Id.

[58]   Id.

[59]   Id.

[60]   Id.

[61]   JOBS PLAN FACT SHEET, supra note 7.

[62]   Congressional Research Service, “The Budget Reconciliation Process: Stages of Consideration,” R44058 (Jan. 25, 2021), available at https://fas.org/sgp/crs/misc/R44058.pdf [hereinafter Budget Reconciliation Process].

[63]   2 U.S.C. § 644.

[64]   See id.

[65]   See Budget Reconciliation Process, supra note 62.

[66]   Tonja Jacobi and Jeff VanDam, “The Filibuster and Reconciliation: The Future of Majoritarian Lawmaking in the U.S. Senate at 30 (2013), available at file:///C:/Users/22855/Downloads/SSRN-id2221712.pdf.

[67]   Section 304 of the Congressional Budget Act (1974) (Pub. L. 97-344), codified at 2 U.S.C. 635.

[68]   Kelsey Snell, “Ruling by Senate Parliamentarian Opens Up Potential Pathway for Democrats,” NPR, available at https://www.kpbs.org/news/2021/apr/05/ruling-by-senate-parliamentarian-opens-up/.

[69]   Erik Wasson, “Schumer’s Infrastructure Path May Get Trickier After Ruling,” Bloomberg, available at https://www.bloomberg.com/news/articles/2021-06-02/senate-ruling-may-complicate-democrats-infrastructure-push.

[70]   Igor Derysh, “Senate parliamentarian’s surprise decision threatens to derail Democrats’ infrastructure plans,” Salon (June 2, 2021), available at https://www.salon.com/2021/06/02/senate-parliamentarians-surprise-decision-threatens-to-derail-democrats-infrastructure-plans/.

[71]   Everett, Burgess, “2 Dem senators balk at Biden’s new spending plan,” Politico (Apr. 5, 2021), available at https://www.politico.com/news/2021/04/05/manchin-biden-spending-plan-479058.

[72]   “Pivotal U.S. Senate Democrat wants ‘more targeted’ infrastructure bill,” Reuters (Apr. 25, 2021), available at https://www.reuters.com/world/us/key-us-senate-democrat-favors-smaller-infrastructure-bill-2021-04-25/.

[73]   Id.

[74]   Seung Min Kim & Tony Romm, “Bipartisan group of senators prepares new infrastructure plan as talks stall between White House and GOP,” Washington Post (May 25, 2021), available at https://www.washingtonpost.com/us-policy/2021/05/25/white-house-republicans-infrastructure-talks/.

[75]   Burgess Everett & Sarah Ferris, “Liberals to Biden: Ditch the infrastructure talks with Republicans,” Politico, (May 19, 2021), available at https://www.politico.com/news/2021/05/19/biden-liberals-republicans-infrastructure-489418.

[76]   Letter from Rep. Pramila Jayapal et al., to Rep. Nancy Pelosi & Sen. Chuck Schumer (May 17, 2021), available at https://jayapal.house.gov/wp-content/uploads/2021/05/Jayapal_Size-Scope-Speed-Letter.pdf.

[77]   Snell, supra note 2.

[78]   Devan Cole, “Biden adviser: President will ‘change course’ in infrastructure talks if inaction seems inevitable,” CNN (May 23, 2021), available at https://www.cnn.com/2021/05/23/politics/cedric-richmond-infrastructure-bill-biden-cnntv/index.html.

[79]   Alexander Bolton, “Senate Republicans Pitch $928 billion infrastructure offer,” The Hill (May 27, 2021), available at https://thehill.com/homenews/senate/555700-senate-republicans-pitch-928-billion-infrastructure-offer.

[80]   Jacob Pramuk and Christina Wilkie, “Biden rejects new GOP infrastructure offer but will meet with Sen. Capito again Monday,” CNBC (June 4, 2021), available at https://www.cnbc.com/2021/06/04/joe-biden-and-shelly-moore-capito-to-hold-more-infrastructure-talks.html.

[81]   Brett Samuels, “Biden ends infrastructure talks with key Republican,” The Hill (June 8, 2021), available at https://thehill.com/homenews/administration/557417-white-house-to-end-infrastructure-talks-with-capito-shift-focus-to.

[82]   Id.

[83]   Id.

[84]   Jordan Carney, “Bipartisan group prepping infrastructure plan as White House talks lag,” The Hill (June 7, 2021), available at https://thehill.com/homenews/senate/557263-bipartisan-group-prepping-infrastructure-plan-as-white-house-talks-lag.

[85]   Id.

[86]   Jacob Pramuk and Christina Wilkie, supra n. 75.

[87]   Alexander Bolton, “Bipartisan Senate group announces infrastructure deal,” The Hill (June 10, 2021), available at https://thehill.com/homenews/senate/557816-romney-tentative-deal-on-key-elements-of-bipartisan-infrastructure-package.

[88]   Id.

[89]   Id.

[90]   Id.

[91]   Alex Leary & Emily Glazer, “Business Leaders Push for Infrastructure Deal, Minus the Corporate Tax Hikes,” Wall Street Journal (May 13, 2021), available at https://www.wsj.com/articles/business-leaders-push-for-infrastructure-deal-minus-the-corporate-tax-hikes-11620907204.

[92]   Li Zhou & Ella Nilsen, “Democrats’ new plan for passing more bills with 51 votes, explained,” Vox (Mar. 29, 2021), available at https://www.vox.com/2021/3/29/22356453/chuck-schumer-budget-reconciliation-filibuster.

[93]   Morgan Chalfant, “Biden talks reconciliation with Schumer as infrastructure negotiations falter,” The Hill (June 2021), available at https://thehill.com/homenews/administration/557435-biden-talks-reconciliation-with-schumer-as-infrastructure.

[94]   Christopher Wilson, “Senate group tries one last-ditch attempt at bipartisan infrastructure deal,” Yahoo (June 9, 2021), available at https://www.yahoo.com/news/infrastructure-bipartisan-senate-negotiations-biden-cassidy-manchin-174623680.html.

[95]   Ashley Parker, “Facing GOP opposition, Biden seeks to redefine bipartisanship,” Washington Post (Apr. 11, 2021), available at https://www.washingtonpost.com/politics/biden-bipartisan/2021/04/11/65b29ad8-96f0-11eb-b28d-bfa7bb5cb2a5_story.html.

[96]   Id.

---

The following Gibson Dunn lawyers assisted in preparing this client update: Michael D. Bopp, Roscoe Jones, Jr., Chantalle Carles Schropp, Christopher Wang, Amanda Sadra, and Brian Williamson.

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

Public Policy Group:

Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Roscoe Jones, Jr. – Washington, D.C. (+1 202-887-3530, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

On June 11, 2021, the Second Circuit issued its decision in 1-800 Contacts, Inc. v. FTC,[1] an appeal of an administrative litigation brought by the Federal Trade Commission against 1-800 Contacts. The decision—which rejected the FTC’s claim that several trademark settlements by 1-800 Contacts violated the antitrust laws —found that the trademark settlement agreements at issue were “typical” and procompetitive, and provides crucial guidance for parties considering settling trademark disputes. The decision also has broader implications for antitrust claims involving the enforcement of intellectual property rights and will likely serve as an important precedent in such cases. From a substantive trademark perspective, the decision also confirms that the law over the use of another party’s trademarks as search engine keywords remains “unsettled.”

The FTC’s Case Against 1-800 Contacts

The FTC’s case challenged thirteen agreements that 1-800 Contacts had signed with competitors to settle trademark infringement claims where it alleged that those competitors’ online advertisements infringed 1-800 Contacts’ trademarks.[2] The settlements restricted competitors’ use of search advertising by requiring them (1) to refrain from bidding on 1-800 Contacts’ trademarks in search-engine auctions, and (2) to affirmatively bid on negative keywords that would prevent their ads from being displayed when a consumer searched for a 1-800 Contacts trademark. The FTC alleged that these agreements restricted competition in violation of Section 5 of the FTC Act because they “prevent[ed] [1-800 Contacts’] competitors from disseminating ads that would have informed consumers that the same contact lenses were available at a cheaper price from other online retailers,” and reduced “price competition in search advertising auctions.”[3] An Administrative Law Judge (ALJ) upheld the FTC’s case, and the Commission affirmed the ALJ’s decision, classifying the agreements in question as “inherently suspect” under the antitrust laws.[4]

The Second Circuit’s Decision

1-800 Contacts appealed the Commission’s decision to the Second Circuit, and the appeals court reversed. As an initial matter, the court agreed with the FTC that trademark settlements are not categorially immune from antitrust scrutiny.[5] Consistent with FTC v. Actavis,[6] the Second Circuit held that trademark settlements can, under certain circumstances, violate the antitrust laws. But the court rejected the Commission’s characterization of the trademark settlements as “inherently suspect” and its application of a truncated rule of reason analysis.[7] Because trademark settlements have “cognizable procompetitive justifications” and have not “been widely condemned” by courts, the court found that application of the full rule of reason approach was required.[8]

The court found that 1-800 Contacts had shown that its settlements had procompetitive justifications. The court reasoned that the “[t]he protection of [1-800 Contacts’] trademark interests constitutes a valid procompetitive justification,”[9] that “agreements to protect trademark interests are ‘common, and favored, under the law,’” and that courts “should ‘presume’ that trademark settlement agreements are procompetitive.”[10] In response to the FTC’s claim that these procompetitive justifications did not justify the restrictions in the settlements because those benefits could be achieved through a “less restrictive alternative,” the court adopted a very narrow view of that doctrine.  In language deferential to the settling parties, the court held that “what is ‘reasonably necessary’” to achieve the procompetitive benefits of protecting a trademark interest “is likely to be determined by competitors during settlement negotiations.”[11] The court then found that the FTC’s proposed alternative—a “disclosure requirement”—was not shown to be a less restrictive alternative because, among other things, the FTC failed to address the practical difficulties with its proposal, e.g., how the disclosure requirement could be enforced.[12] As a result, the court found that the FTC’s proposed alternative might not as be as effective in promoting the “parties’ ability to protect and enforce their trademarks.”[13] The court, accordingly, found that the FTC failed to show that the settlement agreements violated the antitrust laws and ordered the FTC’s case dismissed.

Practical Implications for Trademark Settlements

The 1-800 Contacts decision has numerous practical implications for parties seeking to settle trademark disputes and otherwise protect their trademark interests. The decision provides some very useful guidance on how companies may settle trademark disputes with minimal antitrust risk, but companies should continue to take care to consider antitrust concerns in crafting such settlements. While the court dismissed the FTC’s case against 1-800 Contacts, it did find that trademark settlements can raise antitrust issues in certain circumstances. Overall, there are several key takeaways from the decision, including:

• The Second Circuit decision includes language that is deferential to the settling parties in trademark disputes. As a result, the FTC and private plaintiffs will face significant hurdles if they attempt to bringing new antitrust cases challenging trademark settlements. Notably, a respondent in an FTC administrative proceeding can appeal an adverse decision in any Circuit in which the respondent does business,[14] which means that the Second Circuit’s decision will effectively set the legal standard for any future FTC administrative enforcement actions.
• While the Second Circuit did not expressly define the situations in which a trademark settlement might raise greater antitrust risk, it did mention an agreement entered “under duress” “between parties with unequal bargaining power” as a potential example of where a trademark settlement might be entitled to lesser deference in an antitrust challenge.[15]
• The court also left open the possibility that the requirement that competitors use negative keywords could be higher risk than agreements not to bid on each other’s trademarks. The court stated that it had “no reason to consider” the issue of whether the requirement to use negative keywords went “beyond any legitimate claim of trademark infringement” because the FTC had not made a finding of anticompetitive effects specific to “this narrow aspect of the settlement agreements.”[16]

• The court stated that the merits of the trademark claims that led to the settlement agreements in the 1-800 Contacts case were “unsettled.”[17] Although the court’s overall holding implies that courts will be reluctant to second guess the merits of a claim that the parties have elected to settle, aggressive antitrust plaintiffs will likely continue to argue that a lower level of deference should apply if the trademark claims are extremely weak.
• The decision’s reasoning also appears to extend to agreements between competitors that do not arise out of pending trademark infringement litigation. While the FTC had argued that one of the agreements was particularly suspect because the parties’ agreement to limit their bidding on trademark terms was not based on an asserted infringement claim, the court found that the FTC had not offered “direct evidence differentiating” that agreement from the others and that the court did not need to do so in its decision because “protecting trademarks is a valid procompetitive justification for the restrictions.”[18]

Given the risk that regulators or private plaintiffs will continue to pursue similar claims, it remains crucial for companies considering settling trademark disputes with restrictions on search advertising to analyze the antitrust risk of such arrangements.

Broader Implications for Other Types of IP Enforcement and Settlements

The decision also has important implications for non-trademark cases. The court found, as noted, that protecting one’s intellectual property rights constitutes a legitimate business interest that can justify restrictions on an allegedly infringing party’s conduct in a settlement agreement. Although the decision emphasizes the unique features of trademarks, its reasoning is likely to apply, at least to some extent, to antitrust claims challenging settlements of other types of IP disputes. For example, we expect that this decision will be cited by parties in antitrust cases based on alleged reverse-payment settlement agreements in the pharmaceutical industry. Similarly, the court’s narrow interpretation of the “less restrictive alternative” doctrine is also likely applicable outside of the trademark context. For that doctrine to apply, the court required the plaintiff to do more than just speculate about potentially less restrictive alternatives: the plaintiff “needs to show more than the mere possibility” of a less restrictive alternative.[19] And the court also stated that not any proposed alternative will do—the proposed alternative must be practical to apply, as well as “substantially less restrictive” than the arrangement challenged.[20]

Finally, the decision in 1-800 Contacts also serves as a reminder that, in an era in which commentators are encouraging more aggressive and novel antitrust enforcement, the federal judiciary remains the ultimate arbiter of federal antitrust policy. Enforcers seeking to expand the scope of U.S. antitrust law must do more than bring novel cases—they must also prove their cases with hard facts in a court of law.

* Gibson Dunn partner Howard S. Hogan served as an expert witness for 1-800 Contacts in this case, and offered the opinion that the settlement agreements at issue were standard trademark settlements, as courts continue to determine the bounds of trademark claims arising from the use of trademarks as search engine keywords.

____________________________

   [1]   — F.3d —, 2021 WL 2385274 (2d Cir. June 11, 2021).

   [2]   Id. at *2-3.

   [3]   Id. at *3.

   [4]   Id.

   [5]   Id. at *4.

   [6]   570 U.S. 136 (2013).

   [7]   1-800 Contacts, 2021 WL 2385274, at *7. The “inherently suspect” framework is also known as the “abbreviated rule of reason analysis” or a “quick-look” approach.  Id. at *6 (quoting Cal. Dental Ass’n v. FTC, 526 U.S. 756, 770 (1999)).

   [8]   Id. at *7.

   [9]   Id. at *9.

  [10]   Id. at *9 (first quoting Clorox, 117 F.3d at 55; and then quoting id. at 60).

  [11]   Id. at *10 (quoting United States v. Brown Univ., 5 F.3d 658, 679 (3d Cir. 1993)).

  [12]   Id. at *11.

  [13]   Id.  The panel also held that the FTC failed to offer “direct” evidence of anticompetitive effects. Id. at *8.

  [14]   15 U.S.C. § 45(c).

  [15]   1-800 Contacts, 2021 WL 2385274, at *10 n.14.

  [16]   Id. at *11 n.17.

  [17]   Id. at *9 n.13.

  [18]   Id. at *9 n.12.

  [19]   Id. at *11 (emphasis added).

  [20]   Id. (quoting Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and Their Application ¶ 1502 (3rd & 4th eds., 2019 Cum. Supp. 2010-2018)).

---

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition, Intellectual Property, Fashion, Retail and Consumer Products, or Media, Entertainment and Technology practice groups, or the authors:

Eric J. Stock – New York (+1 212-351-2301, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Stephen Weissman – Washington, D.C. (+1 202-955-8678, [email protected])
Michael J. Perry – Washington, D.C. (+1 202-887-3558, [email protected])

Please also feel free to contact the following U.S. practice leaders:

Antitrust and Competition Group:
Rachel S. Brass – San Francisco (+1 415-393-8293, [email protected])
Stephen Weissman – Washington, D.C. (+1 202-955-8678, [email protected])

Intellectual Property Group:
Kate Dominguez – New York (+1 212-351-2338, [email protected])
Y. Ernest Hsin – San Francisco (+1 415-393-8224, [email protected])
Josh Krevitt – New York (+1 212-351-4000, [email protected])
Jane M. Love, Ph.D. – New York (+1 212-351-3922, [email protected])

Fashion, Retail and Consumer Products Group:
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])

Media, Entertainment and Technology Group:
Scott A. Edelman – Los Angeles (+1 310-557-8061, [email protected])
Kevin Masuda – Los Angeles (+1 213-229-7872, [email protected])
Benyamin S. Ross – Los Angeles (+1 213-229-7048, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

On June 3, 2021, the United States Court of Appeals for the Second Circuit issued an important decision dismissing a lawsuit by the New York State Department of Financial Services (“DFS”), which was challenging the authority of the federal Office of the Comptroller of the Currency (“OCC”) to grant special purpose national bank (“SPNB”) charters.[1] Such non-depository charters have attracted the attention of financial technology (“fintech”) companies. The decision reversed a holding of the United States District Court for the Southern District of New York that had placed greater power in state regulators’ hands in holding that the OCC lacked such authority because such non-depository institutions are not engaged in the “business of banking.” The Second Circuit’s decision, which was based on threshold standing and ripeness grounds, maintains ambiguity in the federal-state balance with respect to regulation of SPNBs and threatens to narrow DFS’s regulatory and supervisory reach over cutting-edge financial products and services, which the agency has sought to expand in recent years.

DFS Challenges Special Purpose National Bank Charters

The lawsuit centered around the National Bank Act of 1864, which provides for OCC regulation and supervision of federally chartered national banks in their “business of banking.” The statute provides that if “it appears that [an entity applying for a federal banking charter] is lawfully entitled to commence the business of banking,” the Comptroller shall “give to such association a certificate . . . that such association has complied with all the provisions required to be complied with before commencing the business of banking, and that such association is authorized to commence such business.[2] Once a bank receives a federal charter,

It shall have power . . . [t]o exercise . . . all such incidental powers as shall be necessary to carry on the business of banking; by discounting and negotiating promissory notes, drafts, bills of exchange, and other evidences of debt; by receiving deposits; by buying and selling exchange, coin, and bullion; by loaning money on personal security; and by obtaining, issuing, and circulating notes . . . .[3]

In 2003, the OCC amended federal regulations to provide for authority to issue SPNB charters, or charters for a national bank that engages in a limited range of banking activities, “including one of the core banking functions [i.e., paying checks or lending money], but does not take deposits.”[4] In amending these regulations, the OCC thus asserted that it had authority to charter entities that pay checks or lend money, among other activities, but that do not receive deposits. These regulations, however, were largely ignored until then-Comptroller of the Currency Thomas Curry announced in late 2016 that the OCC would consider such charters for fintech firms.[5]

This announcement met vigorous resistance by DFS, New York’s chief financial regulator. According to DFS, the decision to issue federal SPNB charters would lead to a preemption of state law for newly chartered entities and would reduce “critical financial protections” provided in New York, weakening the state’s “regulatory controls on usury, payday loans, and other predatory lending practices.”[6] DFS also claimed it would lose revenue from assessments levied against fintech companies that do not take deposits, because such companies, which are currently governed primarily by state law, could convert to a federal charter.[7]

In 2017, DFS challenged the OCC’s regulatory regime, but that lawsuit was dismissed for lack of standing and ripeness.[8] In 2018, the OCC announced that it would accept applications for SPNB charters under the new regulation.[9]  Soon thereafter, the OCC allegedly  invited “Fintech startup companies to come to [its] office in New York to discuss . . . the new [SPNB] charter.”[10]  Fintech companies are “non-bank companies that leverage recent technological innovations to provide financial services and/or products to customers in new ways,” such as mobile payment services, distributed ledger technology, marketplace lending, and crowdfunding sites.[11] DFS responded to the OCC’s efforts by bringing an action against the OCC in the United States District Court for the Southern District of New York, claiming among other things that the OCC exceeded its authority under the National Bank Act by authorizing itself to grant SPNB charters to institutions that do not accept deposits and that the OCC’s regulation is null and void.[12]

The District Court’s Decision

The District Court set aside the OCC’s decision to accept SPNB charter applications and held that the OCC had exceeded its authority under the National Bank Act. In particular, the District Court found that the term the “business of banking” in the statute unambiguously requires receiving deposits as an aspect of the banking business.[13] In reaching that conclusion, the District Court looked to the statute’s text, framework, and history, as well as the history of federal banking law, the long history of the OCC not asserting charting power over special purpose institutions, and the “dramatic disruption of federal-state relationships in the banking industry” sought by the OCC on “a question of deep economic and political significance.”[14]

Following that ruling, the parties submitted proposed judgments setting aside the OCC’s regulation “with respect to all fintech applicants seeking a national bank charter that do not accept deposits,” but the OCC sought a narrower judgment setting aside the regulation only as to fintech companies that “have a nexus to New York State, i.e., applicants that are chartered in New York or that intend to do business in New York (including through the internet) in a manner that would subject them to regulation by DFS.”[15] The District Court rejected the OCC’s proposal and set aside the regulation regardless of fintech companies’ location nationwide.[16]

The Second Circuit’s Ruling

Last week, the Second Circuit reversed the district court’s judgment and instructed the court to dismiss the case without prejudice. The Court concluded that DFS’s claims were unripe and without standing because DFS failed to allege that the OCC’s decision caused it to suffer an actual or imminent injury.[17] Having determined that the case was not justiciable, the Court did not address the District Court’s holding on the merits that the “business of banking” under the federal banking statute unambiguously requires receipt of deposits.[18]

The Court concluded that DFS lacked standing because its concerns about the effects of preemption were “too speculative,” given that the OCC’s actions would not implicate such concerns until the OCC received an SPNB charter application from or granted such a charter to a non-depository fintech that would otherwise be subject to DFS’s jurisdiction.[19] As the Court explained, there is “currently no non-depository fintech that can claim federal preemption engaging in any practice that may give rise to the regulatory harms that DFS alleges, such as charging interest rates that exceed New York’s statutory cap.”[20] The Court was likewise unpersuaded that DFS faced a “substantial risk” of losing revenue acquired through annual assessments under New York law.[21] The Court explained that DFS has “yet to lose out on any revenue acquired through its assessments . . . because the OCC has not received, let alone approved, an application for an SPNB charter from a non-depository fintech within DFS’s jurisdiction.”[22] The Court declined to “decide the precise point at which DFS’s claims may become justiciable in the future,” whether it be when a non-depository fintech formally applies for an SPNB charter, when the OCC grants such an application, or some other time.[23]

Conclusion

This decision represents a setback for DFS and other state regulators who may perceive the OCC’s assertion of authority over non-depository institutions as an incursion into an area that has traditionally fallen within the states’ ambit. Indeed, as New York’s primary financial regulator, DFS has jurisdiction over approximately 1,500 financial institutions and 1,800 insurance companies, and it supervises approximately $7 trillion in assets across the insurance, banking, and financial services industries.[24]

The OCC’s ability to press forward with fintech companies is of special concern to DFS, which has been actively flexing authority in recent years with respect to contemporary trends in financial services, implementing new initiatives designed to foster innovation in a wide range of services and products, such as cryptocurrencies, while also focusing on consumer protection and bringing fintechs within an expanded regulatory scheme.[25] The future of regulation over these cutting-edge industries, many of which have close connections to New York, could be impacted by the Second Circuit’s ruling.

The effects of the decision, however, should not be overstated. The Court of Appeals made clear that it expressed no opinion on the ultimate issue of whether the OCC has authority to grant national bank charters to non-depository institutions, and it likewise expressed no view on whether the OCC’s amended regulation (if unlawful) must be set aside only as to companies applying within a particular jurisdiction such as New York or more broadly nationwide. These important issues are likely to be resolved through future litigation, and indeed, a similar case is pending in the United States District Court for the District of Columbia.[26] In addition, the new Acting Comptroller of the Currency, Michael Hsu, a longtime member of the supervisory staff of the Federal Reserve Board, has indicated that he intends to take a close look at whether to continue some of the OCC’s initiatives launched under the Trump Administration.[27]

__________________________

   [1]   See Lacewell v. Office of Comptroller of Currency, — F.3d —, 2021 WL 2232109 (2d Cir. June 3, 2021).

   [2]   12 U.S.C. § 27(a) (emphasis added).

   [3]   Id. § 24 (Seventh) (emphasis added).

   [4]   Lacewell, 2021 WL 2232109, at *2 (quoting 12 C.F.R. § 5.20(e)(1)(i)); see Vullo v. Office of Comptroller of Currency, 378 F. Supp. 3d 271, 279 (S.D.N.Y. 2019), rev’d, Lacewell, 2021 WL 2232109.

   [5]   See “Remarks By Thomas J. Curry Comptroller of the Currency Regarding Special Purpose National Bank Charters for Fintech Companies,” Georgetown University Law Center (December 2, 2016), available at https://www.occ.gov/news-issuances/speeches/2016/pub-speech-2016-152.pdf.

   [6]   Lacewell, 2021 WL 2232109, at *8; see Vullo, 378 F. Supp. 3d at 286.

   [7]   Lacewell, 2021 WL 2232109, at *8, *11; see Vullo, 378 F. Supp. 3d at 286.

   [8]   Vullo, 378 F. Supp. 3d at 280.

   [9]   Id. at 279.

  [10]   Lacewell, 2021 WL 2232109, at *4.

  [11]   Vullo, 378 F. Supp. 3d at 378 n.2; see Lacewell, 2021 WL 2232109, at *3.

  [12]   Vullo, 378 F. Supp. 3d at 278, 280.

  [13]   Id. at 292.

  [14]   Id. at 292-98 (emphasis added).

  [15]   Lacewell, 2019 WL 6334895, at *1 (S.D.N.Y. Oct. 21, 2019), rev’d, Lacewell, 2021 WL 2232109.

  [16]   Id. at *2.

  [17]   Id. at *7-13.

  [18]   Id. at *13.

  [19]   Id. at *8-11.

  [20]   Id. at *9.

  [21]   Id. at *11-12.

  [22]   Id. at *12.

  [23]   Id. at *6 n.11.

  [24]   See N.Y. Dep’t of Fin. Servs., About Us, https://www.dfs.ny.gov/our_mission; Vullo, 378 F. Supp. 3d at 278.

  [25]   See, e.g., Mylan L. Denerstein, Akiva Shapiro & Seth M. Rokosky, New York State Dep’t of Fin. Servs. Roundup (2021), https://www.gibsondunn.com/wp-content/uploads/2021/02/NY-Department-of-Financial-Services-Round-Up-February-2021.pdf; Denerstein, Shapiro & Rokosky, Webcast: Recent Developments at the New York State Dep’t of Fin. Servs. (2020), https://www.gibsondunn.com/webcast-recent-developments-at-the-new-york-state-department-of-financial-services/; Denerstein, Shapiro & Rokosky, New York State Dep’t of Fin. Servs. Roundup (2020), https://www.gibsondunn.com/wp-content/uploads/2020/02/NY-Department-of-Financial-Services-Round-Up-February-2020.pdf.

  [26]   See, e.g., Press Release, “Conference of State Banking Supervisors Files New Complaint Against OCC,” December 22, 2020, available at https://www.csbs.org/newsroom/csbs-files-new-complaint-against-occ.

  [27]   See, e.g., Statement of Michael J. Hsu, Acting Comptroller of the Currency, Committee on Financial Services, United States House of Representatives, May 19, 2021 (Hsu Statement).

---

Gibson, Dunn & Crutcher’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, or the authors:

Mylan L. Denerstein – Co-Chair, Public Policy Practice, New York (+1 212-351-3850, [email protected])
Akiva Shapiro – New York (+1 212-351-3830, [email protected])
Seth M. Rokosky – New York (+1 212-351-6389, [email protected])

Please also feel free to contact the following leaders and members of the firm’s Financial Institutions practice group:

Matthew L. Biben – New York (+1 212-351-6300, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, [email protected])
M. Kendall Day – Washington, D.C. (+1 202-955-8220, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

Pearl of Wisdom

The DIFC Court of Appeal in Lahelalahela V Lameezlameez [2020] DIFC CA 007 found that the Riyadh Convention[1] is not a part of DIFC Law, and in any event provides a non-exclusive service regime. To the extent Pearl Petroleum[2] found to the contrary, it was wrongly decided. The DIFC Court can therefore order alternative service or dispense with service in respect of a receiving party domiciled in a Riyadh Convention state. This will come as a great relief to DIFC Court practitioners who have been grappling with Pearl Petroleum and the significant hurdles it created for service of DIFC Court documents in the GCC Region. The Court of Appeal also provided welcome clarity on the implementation of international agreements to which the UAE is a party into DIFC Law, finding that obligations in such agreements are not automatically a part of DIFC Law where they relate to civil and commercial matters. This is an important development with wide-ranging implications for the source and content of DIFC Law, as well as for the enforcement of DIFC-seated arbitrations. Gibson, Dunn & Crutcher, with lead Counsel Tom Montagu-Smith-QC, acted for the successful Claimant at first instance and Respondent on appeal.

Background

The Claimant obtained a monetary award in DIFC-seated arbitration proceedings against the Defendant, and later successfully obtained (ex parte) a DIFC Court order recognising and enforcing the award (the “Enforcement Order”). Pursuant to RDC 43.70 and the terms of the Enforcement Order, the Enforcement Order could not be enforced until after it had been served on the Defendant.

The Defendant company is registered in Erbil, in the Republic of Iraq, which, along with the UAE, is a signatory to the Riyadh Convention. Article 6 of the Riyadh Convention sets out a method of service (“Convention Service”), which applies where the sender and recipient are both resident in a signatory state to the Riyadh Convention (a “Convention State”).[3] Unlike diplomatic service, Convention Service operates directly between a sending court (in this case the DIFC Court) and a receiving court (in this case the local Erbil Court).

The Claimant attempted Convention Service. The local court in Erbil refused to serve the Enforcement Order and stated (wrongly) that the Riyadh Convention did not apply.  The Claimant then obtained (ex parte) an order for alternative service from the DIFC Court (the “Service Order”). Upon being served with the Service Order, the Defendant applied for it to be set aside. The principal argument by the Defendant was that Pearl Petroleum correctly found that the Riyadh Convention, where applicable, is part of DIFC law and provides an exclusive and mandatory service regime, and the DIFC Court does not have the power to order alternative service or dispense with service.

The Claimant argued that Pearl Petroleum was distinguishable, and in any event wrongly decided because the Riyadh Convention is not binding on the DIFC Court. At first instance, H.E. Justice Shamlan Al Sawalehi (“Justice Al Sawalehi”) found for the Claimant on both these grounds. As the first instance decision conflicted with Pearl Petroleum, permission to appeal was granted, and a hearing occurred before the Court of Appeal in February 2021, with the Court of Appeal issuing its decision on 9 May 2021.

Pearl Petroleum

In Pearl Petroleum, the DIFC Court set aside an order for alternative service of a recognition and enforcement order. The alternative service order had been initially granted ex parte on the basis that service under the Riyadh Convention would very likely be stymied by the award-debtor, the Kurdistan Regional Government. The DIFC Court held that, by virtue of Article 5 of UAE Federal Law No. 8 of 2004 (“Article 5”)[4], treaties which form part of the law of the UAE are binding in the DIFC.  Importantly, the Court found that, not only was the Riyadh Convention applicable in the DIFC, but the service regime in Article 6 of the Riyadh Convention was mandatory and exclusive. That is, there was no scope to circumvent the terms of the Riyadh Convention by an order for alternative service or to dispense with service altogether so that the Riyadh Convention was not engaged.

The effect of Pearl Petroleum was that, if the Court of a Convention State refuses or fails to serve a DIFC Court recognition and enforcement order pursuant to the Convention Service regime, the recognition and enforcement order will never become enforceable; similarly draconian implications applied to the service of other court documents. The obvious problem that this gave DIFC Court users was exacerbated by the fact that the Riyadh Convention is of broad application throughout the GCC region.

Justice Al Sawalehi’s Decision

At first instance, Justice Al Sawalehi held that Pearl Petroleum was distinguishable, as, unlike in Pearl Petroleum, service had been attempted but failed in the present case. In the alternative, His Honour found that Pearl Petroleum was wrongly decided and the DIFC Court was not bound to follow the Riyadh Convention at all.

The present case distinguished from Pearl Petroleum

In Pearl Petroleum, the claimant had not actually attempted service in accordance with the Riyadh Convention – instead, alternative service had been sought on the basis that interference with service by the Defendant was highly likely. Justice Al Sawalehi considered this to be a critical distinction and confined the ration in Pearl Petroleum accordingly. That is, Pearl Petroleum, properly interpreted, held that where a document in DIFC Court proceedings is required to be served on a defendant in a Convention State, it must first be attempted to be served by Convention Service, but after this attempt, the Court is empowered to order alternative service or dispense with it altogether.

Pearl Petroleum wrongly decided

Justice Al Sawalehi also found that, even if Pearl Petroleum was not distinguishable, it was in any event wrong on a more fundamental basis – i.e. the Riyadh Convention was not binding in the DIFC at all. There are two ‘avenues’ by which the Riyadh Convention could ‘automatically’[5] apply in the DIFC: (1) Article 5; and (2) Article 3(2) of the UAE Federal Law No. 8 of 2004, which provides that financial Free Zones “shall…be subject to all Federal laws, with the exception of Federal civil and commercial laws” (“Article 3(2)”).

Regarding Article 5, His Honour found that it placed an obligation on “financial free zones”, which meant the DIFC executive (i.e. the Ruler, the President of the DIFC and the DIFC Authority), but not the DIFC Courts. To the contrary, Article 30 of the DIFC Court Law[6] provides a mandatory, exhaustive list of the law that can be applied by the DIFC Court. UAE Federal law is not mentioned. Therefore, the DIFC Court shall not apply UAE Federal law unless either: (1) it is agreed by the parties, or (2) it is incorporated into DIFC domestic law by express enactment. There was no such party agreement, and His Honour found that the Riyadh Convention had not been incorporated into DIFC Law, notwithstanding Article 42(1) of the DIFC Arbitration Law[7] and Article 24(2) of the DIFC Court Law[8]. As such, Article 5 was not binding on the DIFC Court.

His Honour also grappled with the slightly different question of whether the Riyadh Convention applied to the DIFC Court, not by virtue of Article 5, but by virtue of Article 3(2). The Riyadh Convention is not only an international treaty to which the UAE is party (thus potentially triggering Article 5, were it to apply), but it is also incorporated directly into UAE Federal law by way of Federal Decree No. 53 of 1999 (the “Decree”). If the Riyadh Convention (as converted to Federal Law by the Decree) was not a civil or commercial law, it would therefore apply to the DIFC by virtue of Article 3(2). The Defendant argued that the Riyadh Convention was procedural law, not civil or commercial law, and thus applied in the DIFC. Justice Al Sawalehi rejected this, finding that Article 6 fell under the rubric of civil and commercial law in Article 3(2), and was thus precluded from application in the DIFC.

The Appeal

The Defendant appealed, and the hearing occurred in February 2021 before Chief Justice Zaki Azmi, Justice Wayne Martin, and Justice Sir Richard Field. The two[9] key issues on appeal were:

1. Do the terms of the Riyadh Convention form part of DIFC Law such that they must be applied by the DIFC Court?
2. If the answer to (1) is yes, is the service regime in the Riyadh Convention exclusive, such that the DIFC Court cannot either order alternative service or dispense with service?

(1)    Is the Riyadh Convention part of DIFC Law?

The Court of Appeal answered this question in the negative, which was sufficient to dismiss the Appeal. Like the Court of First Instance, the focus of the Court of Appeal was on whether the Riyadh Convention was ‘automatically’ a part of DIFC Law (and therefore binding on the DIFC Court), by virtue of Article 5 and/or Article 3(2).

Article 5

Regarding Article 5, the Court of Appeal found:

(a)    Article 5 imposes obligations upon the “Financial Free Zones”. On the proper construction of Article 5, “Financial Free Zones” does not include the DIFC Courts. This was for the following reasons:

i.	A “Financial Free Zone” is defined by Article 1 to be the corporate body created when a Federal Decree is issued in accordance with Article 2[10] of UAE Federal Law No. 8 of 2004. The DIFC Court is not such a corporate entity[11].  Rather, the combined effect of Federal Law No. 8 of 2004 and Federal Decree No. 35 of 2004 was to create a corporate entity known as the Dubai International Financial Centre. It is this entity that is the subject of Article 5.
ii.	There is an important distinction between the obligation of courts to apply the domestic law of the jurisdiction, and the obligation of States to comply with their international agreements. The Defendant/Appellant’s reliance on Article 5 elided this distinction.
iii.	Article 5 is intended to ensure that the relevant corporate body which is delegated executive power by the State exercises such power in a manner which does not put the State in breach of its international agreements. In other words, Article 5 functions as a constraint on the exercise of executive power; it cannot be taken to import all obligations imposed under all treaties to which the UAE is a party into the domestic law of each Financial Free Zone.
iv.	Indeed, Articles 3 and 7(3)[12] of UAE Federal Law No. 8 of 2004 are the provisions concerned with the laws applicable in Financial Free Zones, not Article 5.
v.	The exercise of judicial authority within a Financial Free Zone is left to be dealt with by laws issued by the relevant Emirate pursuant to Article 7(3). It is impossible to construe the reference in Article 5 to the “Financial Free Zones” to include whatever myriad arrangements might be made with respect to the exercise of judicial authority within the various Emirates within which such Zones might be created.

The crux of the above is that Article 5 does not provide that international agreements to which the UAE is party apply automatically within the DIFC. Subject to Article 3(2) (see below), unless and until a relevant Emirate exercises the powers reserved to it by Article 7(3) to issue legislation implementing international agreements into the domestic law of the relevant Financial Free Zone, such obligations will not form part of that domestic law – in the same way as treaty obligations do not form part of the domestic law of any State unless and until implemented by the State.

However, the Court of Appeal was careful to say that, although the Riyadh Convention was not binding law in the DIFC, the DIFC Court was a UAE Court and thus could invoke the provisions of the Riyadh Convention to facilitate service where it was applicable. In such cases, whether service is validly effected as a matter of DIFC Law will turn upon the question of whether service has taken place in accordance with the rules of the Court.

Article 3(2)

As set out above, Article 3 provides that all Financial Free Zones are subject to all Federal Laws “with the exception of Federal civil and commercial laws”. On the assumption that the Riyadh Convention formed part of the UAE Federal Law, the critical question for the Court of Appeal was whether the Riyadh Convention generally, or Article 6 of the Riyadh Convention specifically, were “civil and commercial laws” and therefore excepted from the operation of Article 3(2). The Court of Appeal found as follows:

1. Article 3(2) is properly construed as applying to the specific rule or obligation which it is contended should be applied within the relevant Zone, rather than as a reference to the instrument in which that rule, law or obligation is located. So the question was not whether the Riyadh Convention is a civil and commercial law, but whether the relevant provisions are (e.g. Article 6).
2. The relevant provisions in the Riyadh Convention relate to service of DIFC Court documents. This is a matter of civil procedure. Pursuant to the case of  IGPL v Standard Chartered Bank[13], matters of civil procedure are matters of civil and commercial law, and thus excepted from the operation of Article 3. This is further supported by the application of Article 6, which is expressly said to relate to “civil, commercial and administrative cases and cases of personal status”.

For these reasons Article 3(2) expressly excludes Article 6 of the Riyadh Convention from application within the DIFC. The Judge in Pearl Petroleum was wrong to conclude otherwise.

(2)     Is the service regime in the Riyadh Convention exclusive?

While strictly unnecessary given the finding that the Riyadh Convention did not apply in the DIFC under either Article 5 or Article 3(2), the Court of Appeal also considered whether the Riyadh Convention specified an exclusive service regime. The Court of Appeal answered this in the negative, finding that:

1. The Riyadh Convention does not state that Convention Service is the exclusive means by which service can be validly effected.
2. Any construction of the Riyadh Convention to that effect would be antithetical to its objects and purpose.
3. The proposition that service by alternative methods may only be permitted after service under the Riyadh Convention had been attempted but failed therefore falls away.

(3)     Can the DIFC Court in any event dispense with service so that the Riyadh Convention is not engaged?

The Riyadh Convention also did not prevent the DIFC Court from dispensing with service. Article 6 applies to documents which are “required to be served or notified”. Determining which documents fall within that category is a matter for the Court in which the proceedings are being conducted. If that Court concludes, in accordance with its own rules, that a document is not required to be served, Article 6 has no application.

Take-away points

To recap, the key points from the Judgment are as follows:

1. Article 5 of Federal Law No. 8 of 2004 does not provide that international agreements to which the UAE is party apply automatically within the DIFC. Subject to Article 3(2), unless and until a relevant Emirate expressly implements the international agreement into the domestic law of the relevant Financial Free Zone, such obligations will not form part of that domestic law. The Riyadh Convention is not therefore part of DIFC Law.
2. In any event, the Riyadh Convention does not provide an exclusive service regime.
3. The DIFC Court can, in an appropriate case, order alternative service or dispense with service in respect of a receiving party domiciled in a Convention State.
4. That said, where a receiving party is domiciled in a Convention State, the Riyadh Convention should be considered a ‘tool in the arsenal’ – it can still be used to effect valid service, provided the DIFC Court Rules are satisfied.

Conclusion

The Court of Appeal’s decision will be welcomed by DIFC Court practitioners and users. It provides welcome clarity to an issue that has dogged practitioners since Pearl Petroleum, and confirms flexibility regarding service-out of DIFC Court documents on parties resident in Convention states. No longer are parties bound to attempt Convention Service, and blocked when Convention Service fails. This reaffirms the DIFC Court’s status as a regional dispute resolution hub that is pro-arbitration and committed to enforcement. Further, and perhaps most importantly, the decision has answered the fundamental question of when and how international agreements to which the UAE is a party become part of DIFC law. This will no doubt be relied on in many cases to come.

For further information or advice regarding the Court of Appeal decision, or service and enforcement more generally, please contact the highly experienced team at Gibson Dunn.

____________________

      [1]     The 1983 Riyadh Arab Agreement for Judicial Cooperation (the “Riyadh Convention”). The Riyadh Convention has state signatories from across the Arab world (including the UAE, Jordan, Bahrain, Tunisia, Egypt, Algeria, Djibouti, Saudi Arabia, Sudan, Syria, Somalia, Iraq, Oman, Palestine, Qatar, Kuwait, Lebanon, Libya, Morocco, Mauritania and Yemen).

      [2]     Pearl Petroleum Company Limited & Others v The Kurdistan Regional Government of Iraq [2017] DIFC ARB 003 (“Pearl Petroleum”).

      [3]     A translation of Article 6 of the Riyadh Convention provides (with alternative wording in square brackets): “Legal and non- legal [Judicial and non-judicial] documents and papers relating [pertaining] to civil, commercial and administrative cases and cases of personal status required to be served or notified to [which are to be published or which are to be transmitted to] persons residing in one of the contracting states shall be sent [dispatched] directly by the authority or the competent legal office [from the judicial body or officer concerned] to the court which the person who is required to be served or notified resides in its jurisdiction area [to the court of the district in which the person to be notified resides].”

      [4]     Article 5 provides: “The Financial Free Zones shall not do anything which may lead to contravention of any international agreements to which the state is or shall be a party”.

      [5]     That is to say, apply without express implementation by Dubai or DIFC Law, or the agreement of the parties.

      [6]     Law No. 10 of 2004. Article 30 provides: “Governing Law (1) In exercising its power and functions, the DIFC Court shall apply: (a) the Judicial Authority Law; (b) DIFC Law or any legislation made under it; (c) the Rules of Court; or (d) such law as is agreed by the parties. (2) The DIFC Court may, in determining a matter or proceeding, consider decisions made in other jurisdictions for the purpose of making its decision”.

      [7]     Article 42(1) provides: “For the avoidance of doubt, where the UAE has entered into an applicable treaty for the mutual enforcement of judgments, orders or awards the DIFC Court shall comply with the terms of such treaty”.

      [8]     Article 24(2) provides: “Where the UAE has entered into an applicable treaty for the mutual enforcement of judgments, orders or awards, the Court of First Instance shall comply with the terms of such treaty”. In his additional reasons for granting permission to appeal, Justice Al Sawalehi found that, Article 24(2) was an express exception to the general rule that UAE treaties do not apply directly within the DIFC. The need for this express exception carried with it a negative implication – i.e. that UAE treaties do not have direct effect within the DIFC absent DIFC legislation enacting the treaty as law. This was consistent with the relationship between UAE treaties and the rest of the UAE. This does not mean that DIFC Courts cannot comply with UAE treaties which have not been expressly incorporated into DIFC Law; it simply means that the effectiveness of proceedings will not come down to compliance or non-compliance with them.  This is similar to the approach of the English Courts with respect to UK treaties.

      [9]     The Court also briefly discussed other issues that had been raised by the Parties, including: (1) whether the DIFC Court was precluded from applying Federal Laws generally, absent agreement of the Parties and (2) whether the New York Convention overrode any inconsistent provisions of the Riyadh Convention.  Ultimately the Court found it was unnecessary to decide these issues given its primary finding that the Riyadh Convention was not a part of DIFC law.

      [10]    Article 2 provides: “A Financial Free zone shall be established by a Federal Decree. It shall have a body corporate and shall be represented by the President of its Board. It and no one else shall be responsible for the obligations arising out of the conduct of its activities. The Cabinet will describe its area and location”.

      [11]    The DIFC Courts are a separate (in effect, subsidiary) corporate body established under the Dubai Law No. 9 of 2004, which was made pursuant to the legislative powers specifically reserved to the Emirate of Dubai by Article 7(3) of Federal Law No. 8 of 2004.

      [12]    Article 7(3) provides: “Subject to the provisions of Article 3, the concerned Emirate may, within the limits of the goals of establishing the Financial Free Zone, issue legislation necessary for the conduct of its activities”.

      [13]    [2015] DIFC CA 004.

---

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, or the following authors in the firm’s Dubai office:

Graham Lovett (+971 (0) 4 318 4620, [email protected])
Michael Stewart (+971 (0) 4 318 4638, [email protected])
Sophia Cafoor-Camps (+971 (0) 4 318 4629, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

Colorado’s Equal Pay for Equal Work Act (EPEW), as well as the accompanying Rules and guidance, took effect on January 1, 2021. Prior to the new year, however, the Rocky Mountain Association of Recruiters (RMAR) sued the Colorado Department of Labor and Employment (CDLE) in the U.S. District Court for the District of Colorado, challenging the constitutionality of the law’s compensation and promotion posting requirements. On May 27, 2021, after previously ordering supplemental briefs on the posting requirements’ burdens on interstate commerce, Judge William J. Martinez denied the RMAR’s request for a preliminary injunction to suspend enforcement of the posting provisions at issue.

Colorado’s Equal Pay for Equal Work Act Posting Requirements

With a stated goal of aiding in achieving pay equity in Colorado, the EPEW has an expansive reach, covering all public and private employers that employ at least one person in Colorado. The law includes extensive compensation and promotion posting requirements, which employers—particularly multi-jurisdictional employers—have struggled with implementing. In fact, the posting provisions have proved so burdensome in practice that some employers have elected to wholly remove some employment opportunities from Colorado rather than navigate compliance difficulties. See https://www.9news.com/article/news/investigations/job-posting-labor-laws/73-7f2ac237-06fe-4353-8318-00a4b52d80bc.

Under the EPEW’s compensation posting requirements, employers are required to “disclose in each posting for each job the hourly or salary compensation, or a range of the hourly or salary compensation, and a general description of all of the benefits and other compensation to be offered to the hired applicant.” C.R.S. § 8-5-201(2) (2021). In addition to postings for jobs in Colorado, the requirement also reaches postings for all remote positions that could be performed in Colorado. 7 CCR 1103-13 (4.3)(B).

Additionally, the EPEW requires employers to “make reasonable efforts to announce, post, or otherwise make known all opportunities for promotion to all current employees on the same calendar day and prior to making a promotion decision.” C.R.S. § 8-5-201(1) (2021). Under the Rules, a “promotional opportunity” is broadly defined as “when an employer has or anticipates a vacancy in an existing or new position that could be considered a promotion for one or more employee(s) in terms of compensation, benefits, status, duties, or access to further advancement.” 7 CCR 1103-13 (4.2.1). Postings are required even if no one in Colorado is qualified for the promotional opportunities. The promotion requirement applies widely and only allows for a few narrow exceptions, such as when employees are unaware they will be separated from their employers.

Background on Rocky Mountain Association of Recruiters v. Moss

In its initial complaint, the RMAR argued that: (1) the EPEW’s posting requirements constitute unlawfully “compelled speech” in violation of the First Amendment; and (2) the requirements violate the Dormant Commerce Clause due to their excessive burden on interstate commerce and their conflict with other states’ statutory schemes. The RMAR requested from the court a declaration that the posting requirements are unconstitutional, as well as a permanent injunction barring the CDLE’s enforcement of the posting provisions. Additionally, the RMAR filed a motion for a preliminary injunction on December 31, 2020, which would prevent the posting provisions’ enforcement until a decision on their legality is reached.

On April 21, 2021, Judge William J. Martinez held a hearing on the RMAR’s motion for preliminary injunction. The court ordered supplemental briefings from the CDLE and RMAR on the burdens that the EPEW posting requirements place on interstate commerce—hinting that the court was potentially amenable to the RMAR’s Dormant Commerce Clause argument. The supplemental briefs were filed on May 6, 2021, and response briefs were filed on May 17, 2021.

For the RMAR’s supplemental brief, the court directed it to identify the two most burdensome aspects of both the compensation and promotion posting requirements. For the compensation posting requirements, the RMAR identified as most burdensome: (1) the requirement to post compensation for remote jobs or other jobs that “could” be performed in Colorado; and (2) the forced disclosure of confidential information and trade secrets. For the most burdensome aspects of the promotion posting requirements, the RMAR identified: (1) the requirement to notify Colorado employees of “promotional opportunities” anywhere in the world and to pause any hiring or promotions until such notice is provided; and (2) the lack of exceptions for trade secret disclosures, confidential searches, and corporate mergers and reorganizations. In its response brief, the CDLE argued that the RMAR’s identified burdens were “simply operational or logistical burdens” on individual firms, which do not rise to cognizable burdens on interstate commerce under the Dormant Commerce Clause.

From the CDLE, the court requested a supplemental brief on why the operational compliance costs incurred by employers do not matter to Dormant Commerce Clause analysis. In its brief, the CDLE argued that the RMAR failed to show that interstate commerce would be unduly burdened, as individual companies’ increased operational or compliance costs do not equate to a harm to the national market. It also argued that, because the EPEW’s effects are felt primarily in Colorado (or equally inside and outside of Colorado), precedent dictates that the court should not engage in Dormant Commerce Clause balancing analysis at all. Finally, the CDLE contended that, even if the court proceeds with a balancing test, the RMAR’s allegations are too broad and general to use as evidence in such a test. In response, the RMAR reiterated that the posting requirements burden interstate commerce by interfering with “a fundamental part of the process of talent acquisition and mobility nationwide (and worldwide)” and that the burdens on its members are representative of the burdens on interstate commerce.

Injunction Holding & Key Takeaways

On Thursday, May 27, 2021, Judge William J. Martinez denied the RMAR’s motion for preliminary injunction, finding that the RMAR failed to demonstrate a substantial likelihood of success on the merits of its Dormant Commerce Clause or First Amendment claims. Notably, the court categorized the RMAR’s request as a disfavored preliminary injunction and applied a heightened standard, with the RMAR bearing a heavier burden to show likelihood of success on the merits of its claims.

For the RMAR’s Dormant Commerce Clause claim, the court found that the RMAR “failed to put forward the necessary evidence regarding the relative magnitude of the local benefits, as compared to the burdens on interstate commerce.” That is, given the record’s lack of specific evidence regarding the EPEW’s harm to interstate commerce, the court could not effectively engage in the necessary balancing test. As such, the RMAR failed to establish a substantial likelihood of success on its Dormant Commerce Clause claim.

For the RMAR’s First Amendment claim, the court found that the EPEW bears a reasonable relationship to a substantial government interest and that, at this stage, the RMAR failed to show that the posting provisions created an undue burden on employers. Specifically, the court noted that, based on testimony and common sense, the posting requirements rationally related to the law’s goal of reducing the wage pay gap. Further, the court found that the requirements do not drown out employers’ individual messages in job postings, because they can be satisfied “in short statements and by disclosing promotion opportunities available to some employees to current Colorado employees.” The court was similarly unpersuaded by the RMAR’s argument that the provisions chill commercial speech, because “employers are still able to recruit candidates with compensation rates for positions of the employers’ choosing.” Thus, the RMAR failed to show a substantial likelihood of success on its First Amendment claim.

It is worth noting that the RMAR’s Dormant Commerce Clause claim failed due to the record’s lack of evidence at this initial, pre-discovery stage of litigation. This leaves the door open for the record to be developed adequately, as the suit proceeds, with the types of specific evidence the court identified as necessary for determining whether the Dormant Commerce Clause claim has merit. (The court seemed less receptive to the First Amendment claim, as its Order tended to focus on the substantive flaws of the RMAR’s arguments.) Thus, while the court denied the RMAR’s motion for preliminary injunction, the RMAR could still ultimately succeed in the suit and, if so, potentially obtain a permanent injunction that would prevent enforcement of the EPEW’s posting provisions. It will be important for employers to continue to comply with the EPEW’s posting requirements in the meantime.

---

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, any member of the firm’s Labor and Employment practice group, or the following authors:

Jessica Brown – Denver (+1 303-298-5944, [email protected])
Marie Zoglo – Denver (+1 303-298-5735, [email protected])

Labor and Employment Group:
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202-955-8242, [email protected])
Katherine V.A. Smith – Co-Chair, Los Angeles (+1 213-229-7107, [email protected])
Rachel S. Brass – San Francisco (+1 415-393-8293, [email protected])
Jessica Brown – Denver (+1 303-298-5944, [email protected])
Catherine A. Conway – Los Angeles (+1 213-229-7822, [email protected])
Jesse A. Cripps – Los Angeles (+1 213-229-7792, [email protected])
Theane Evangelis – Los Angeles (+1 213-229-7726, [email protected])
Gabrielle Levin – New York (+1 212-351-3901, [email protected])
Michele L. Maryott – Orange County (+1 949-451-3945, [email protected])
Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Molly T. Senger – Washington, D.C. (+1 202-955-8571, [email protected])
Greta B. Williams – Washington, D.C. (+1 202-887-3745, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

Background

On May 28, 2021, the Administration released its fiscal year (FY) 2022 Budget, outlining a plan for $6 trillion of federal spending and $4.1 trillion in revenue for FY 2022 alone. Each year, the White House publishes the President’s Budget request for the upcoming fiscal year, which begins on October 1st. The President’s Budget lays out the Administration’s proposals for discretionary spending, revenue and borrowing and typically marks the opening of a dialog with Congress that culminates in appropriations bills and, on a parallel path, tax expenditure and revenue-raising legislation.

Detailed descriptions of the Administration’s legislative tax proposals have historically been provided in a “Greenbook” that includes revenue estimates generated by economists in Treasury’s Office of Tax Policy.[1] With the December 2017 enactment of sweeping changes to the federal tax law in legislation commonly known as the “Tax Cuts and Jobs Act” (the “TCJA”),[2] the prior administration did not publish a separate document laying out new tax legislative proposals. Thus, for the first time since the Obama Administration’s FY 2017 Budget (released in February 2016), the President’s FY 2022 Budget includes a Greenbook with detailed proposals for changes to the federal tax law, including provisions that would modify, expand or add to existing tax expenditures and revenue-raising measures.

Although the Greenbook is only the opening chapter in the FY 2022 budget and appropriations process, the current unified Democratic control of both the White House and of Congress, albeit each House of Congress by small margins, suggests that at least some of its proposals have a significant, although by no means certain, likelihood of moving forward as part of the Appropriations process or in separate pieces of legislation like an infrastructure bill. Most notably, the narrow Democratic majority in the House and the potential use of “reconciliation” procedures in an evenly divided Senate allow Democratic Senators, if they all agree, to pass legislation in Congress without help from Senate Republicans. The prospect of Democrats enacting legislation into law without Republican buy-in provides a new dynamic this year and makes this the most anticipated set of administration legislative tax proposals in recent memory.

The following summaries focus on tax expenditure and revenue-raising proposals in the Greenbook that affect business taxpayers and their owners, as follows:

Part I: Increased Rates for Corporations and Individuals

Part II: Elimination of Certain Significant Benefits

Part III: Sea Changes for International Tax

Part IV: Changes to Prioritize Clean Energy

Part V: Improve Compliance and Tax Administration

PART I: INCREASED RATES FOR CORPORATIONS AND INDIVIDUALS

Corporate Income Tax Rate Raised to 28%

The Greenbook proposes to increase the federal income tax rate on C corporations from 21 percent to 28 percent, effective for taxable years beginning after the end of 2021 (with a phase-in rule for taxpayers that have a non-calendar taxable year).

Recent comments by President Biden caused many to expect a proposed increase to 25 percent, rather than 28 percent, and it remains possible that the Administration will end up agreeing to a smaller corporate rate increase. An increased corporate income tax rate may incentivize corporations to accelerate income into the 2021 calendar year and to defer deductions until a later calendar year. This proposal may also encourage the use of passthrough entities (although taxpayers must also take into account the proposed increase in individual rates). Moreover, the proposed increase would push the corporate rate well above the 23.51 percent average rate for trading partners in the Organisation for Economic Co-Operation and Development (the “OECD”), raising again the long-standing tension between avoiding a “race to the bottom” on rates and strengthening the global tax competitiveness of U.S.-based companies.

It is noteworthy that in proposing an increase in the corporate rate, the Greenbook makes no reference to repealing or modifying the deduction for qualifying business income of certain passthrough entities (e.g., partnerships and S corporations) under Internal Revenue Code (the “Code”) section 199A. That provision was included in the TCJA late in the legislative drafting process in order to create parity between corporations and business operated in passthrough form, such as partnerships, S corporations, and sole proprietorships. Setting the corporate rate at 28 percent (along with the proposed elimination of lower rates on qualified dividends above stated thresholds) may tend to shift the incentive in the opposite direction, although Code section 199A is scheduled to expire in 2025.

Corporate taxpayers with GAAP-based financial statements will have to consider the impact of any rate increase on the values of their deferred tax assets and liabilities.

New 15 Percent Minimum Tax on Book Earnings of Large Corporations

The Greenbook proposes a 15 percent minimum tax on worldwide pre-tax book income for corporations whose book income exceeds $2 billion annually.

This proposal, taken together with the proposal for disallowing interest deductions, would further integrate income tax treatment with financial statement accounting treatment. Historically, these treatments have operated independently, but began to be integrated for limited purposes with the enactment of Code section 451(b) in 2017. The link to financial statement treatment is one of two proposals in the Greenbook (along with the proposed SHIELD provision discussed below) that would significantly expand reliance on third-party accounting standards to determine federal tax liability, a notable shift from the long-standing assumption, recognized by the Supreme Court in Thor Power Tool Co. v. United States, that there are “differing objectives of tax and financial accounting” and the risks and challenges associated with conforming them. It would also re-introduce the complexity of parallel sets of tax rules that Congress sought to eliminate when it repealed the corporate alternative minimum tax as part of the TCJA.

The proposal would be effective for taxable years beginning after December 31, 2021.

Top Marginal Tax Rate for Individuals Raised to 39.6%

Under current law, the top marginal income tax rate for individuals is 37 percent (before accounting for the additional 3.8 percent tax rate on net investment income), but would revert to 39.6 percent (again, before accounting for the additional 3.8 percent tax rate on net investment income) for taxable years beginning on and after January 1, 2026. In 2021, the top marginal rate applies to taxable income that exceeds $628,300 (for married couples filing jointly) or $523,600 (for single filers).

The Greenbook proposes that, beginning in 2022, the new 39.6 percent (before accounting for the additional 3.8 percent tax rate on net investment income) top marginal income tax rate would apply to taxable income that exceeds $509,300 (for married couples filing jointly) or $452,700 (for single filers); the thresholds would be adjusted for inflation in taxable years after 2022. The proposed increase in individual tax rates was not accompanied by a repeal of the limitation on deductibility of state and local taxes.

Tax Certain Capital Gains at Ordinary Income Rates for High Earners

Currently, individual taxpayers are taxed at preferential rates on their long-term capital gains and qualified dividends as compared to ordinary income—the current highest rate for long-term capital gains and qualified dividends is 20 percent (23.8 percent, including the net investment income tax, if applicable).

The Greenbook proposes to tax individuals’ long-term capital gains and qualified dividends at ordinary income tax rates to the extent that the individual’s adjusted gross income exceeds $1 million ($500,000 for married filing separately), indexed for inflation after 2022. For example, an individual with $200,000 of long-term capital gains and $900,000 of wages would have $100,000 of long-term capital gains taxed at ordinary income rates (the $100,000 excess over $1 million).

Other than a brief period of time after passage of the Tax Reform Act of 1986, capital gains have received preferential federal income tax treatment since the 1920s. The Greenbook proposal will add to the long-standing debate on the merits of this preference and undoubtedly cause taxpayers to consider ways in which they can defer or avoid recognition events.The proposal would also remove a historic tax incentive to hold capital assets for one year, possibly resulting in earlier and more common dispositions of assets held for 10 or 11 months.

The proposal would be effective for gain recognized after the date of the announcement (understood to be April 28, 2021, the date when President Biden announced the proposal as part of the American Families Plan). As with other aspects of the Greenbook proposals, the effective date could change during the Budget reconciliation process.

“Deemed” or “Forced” Realization – New Realization Events for Gifts, at Death and for Certain Partnerships and Trusts

Under general tax principles, taxpayers take into account increases and decreases in the value of their assets only at the time of a realization event, such as a sale. Currently, gifts and transfers upon death are not treated as taxable events. This is the case on transfers on death, even though the heir generally takes a “stepped up” fair market value basis in the decedent’s assets upon death, with no income tax due at that time.

Under the Greenbook proposal, donors and decedents would recognize capital gain upon a transfer to a donee or heir, as applicable, based on the asset’s fair market value at the time of transfer. A decedent would be permitted to use capital losses and carry-forwards to offset such capital gains.

The proposal would require the recognition of unrealized appreciation by partnerships, trusts, and other non-corporate entities that are the owners of the property if that property has not been subject to a recognition event in the prior 90 years. Because the look-back period begins January 1, 1940, this aspect of the proposal would not become operational until December 31, 2030. The operational aspects of this proposal – such as which property would be taxed, who would bear the incidence of tax, and the extent of adjustment to basis – are not addressed by the Greenbook.

The proposal also would treat otherwise tax-deferred contributions to, or distributions from, partnerships, trusts, and other non-corporate entities as taxable events. The description of this aspect of the proposal in the Greenbook is startling in its breadth. That is, if taken literally the proposal would upend the bedrock principles in partnership taxation that contributions to and distributions by partnerships generally are tax free. Presumably, the proposal was intended to address indirect donative transfers, and it is hoped that clarification will be forthcoming in short order.

Exclusions would apply to assets transferred to U.S. spouses and charities. Additionally, there would be a $1 million per-person exclusion (generally $2 million per married couple) that would be indexed for inflation. Payment of tax would be deferred in the case of certain family-owned and -operated businesses (which are not defined but would presumably be modeled on the payment extension provisions for estate taxes in Code section 6166) until the interest in the business is sold or the business ceases to be family-owned and -operated. Additionally, the proposal would allow a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death (excluding certain liquid assets and transfers of businesses for which the deferral election is made). This proposal has the potential to create substantial liquidity issues for closely held businesses. As proposed, no change would be made to the exclusion of certain capital gains under Code section 1202.

The proposal generally would be effective beginning January 1, 2022.

Eliminate Gap in Medicare Taxes for High Earners

The current 3.8 percent “net investment income tax” generally applies to passive income and gains recognized by high-income individuals, including trade or business income earned by taxpayers who do not materially participate in the business. The separate 3.8 percent “SECA” tax currently applies to self-employment earnings of high-income taxpayers—both taxes are intended to fund Medicare and are often colloquially referred to as “Medicare” taxes.

Neither form of Medicare tax currently applies to limited partners (many taxpayers believe that certain members of limited liability companies classified as partnerships for federal income tax purposes are “limited partners” for this purpose) and S corporation shareholders (who are subject to Medicare tax solely on “reasonable compensation” paid in an employee capacity) who are treated as materially participating in a trade or business. The Biden Administration likens this gap to a loophole because certain high-income taxpayers’ distributive share of business income may escape Medicare taxation.

The Greenbook proposal would subject all trade or business income of high-income taxpayers (earned income exceeding $400,000) to the 3.8 percent Medicare tax (either through the net investment income tax or the SECA tax) and would apply to taxable years beginning on or after January 1, 2022. The Greenbook bases this change on fair and efficient tax administration. “Different treatment [for owners of different types of passthrough entities] is unfair, inefficient, distorts choice of organizational form, and provides tax planning opportunities for business owners, particularly those with high income, to avoid paying tax.” Notwithstanding that explanation, the proposal goes to some lengths to ensure that it does not impact taxpayers with less than $400,000 in earned income, although it is noteworthy that the proposal is explicit in saying that this threshold would not be indexed for inflation. It is also noteworthy that the exclusion for these lower income taxpayers is linked to earned income rather than “taxable income (from all sources),” which is used elsewhere in the Greenbook as the trigger for proposed denial of capital gain treatment for carried interest.

PART II: ELIMINATION OF CERTAIN SIGNIFICANT BENEFITS

Tax Carried Interests as Ordinary Income

The Greenbook, following in the footsteps of many previously proposed bills, proposes to tax a partner’s share of profits from, and gain from the disposition of, an “investment services partnership interest” as ordinary income, regardless of the character of the income at the partnership level.

Under current law, partnerships are generally able to issue a partnership interest to a service provider who then holds the interest as a capital asset, with the character of the partner’s share of profits from the partnership being determined by reference to the character of the profits in the hands of the partnership. Thus, if the partnership recognizes capital gain, the service provider’s share of such income would generally likewise be capital gain. These equity grants may take the form of a “profits interest,” which is referred to as a “carried interest” in the private equity context, an “incentive allocation” in the hedge fund context, or a “promote” in the real estate context. The TCJA limited the ability to recognize long-term capital gain with respect to these profits interests by enacting Code section 1061, which generally treats gain recognized with respect to certain partnership interests held for less than three years as short-term capital gain.

The Greenbook proposal would eliminate this benefit, but only for partners whose taxable income (from all sources) exceeds $400,000. Partners whose taxable income does not exceed $400,000 would continue to be subject to Code section 1061, which generally treats gain recognized with respect to certain partnership interests or partnership assets held for less than three years as short-term . The “cliff” effect of this proposal would add considerable complexity to the tax law, requiring a parallel set of rules that may apply differently to different members of the same partnership.

The proposal would apply to profits interests held by persons who provide services to a partnership that is an “investment partnership.” A partnership would be an investment partnership if (i) substantially all of its assets are investment-type assets and (ii) more than half of the partnership’s contributed capital is from partners whose partnership interest is an investment (i.e., partners in whose hands the partnership interest is not held in connection with a trade or business). The proposal would not apply to a partnership interest attributable to any capital contributed by the service provider. The proposal includes certain anti-abuse rules intended to prevent the avoidance of the recharacterization rule through the use of compensatory arrangements other than partnership interests.

It appears that the most significant differences between the proposal in the Greenbook and existing law under Code section 1061 would be (i) unlimited time duration (Code section 1061 applies only to recharacterize long-term capital gain recognized with respect to an asset held for three years or less), (ii) treatment of the recharacterized amount as ordinary income rather than short-term capital gain (there is no rate differential, but there could be sourcing and other differences), and (iii) subjecting the income to SECA.

Given that final Treasury regulations under Code section 1061 were released only this year, the proposal to repeal and replace Code section 1061 in certain cases is somewhat surprising, although similar proposals have recently been introduced in Congress. If enacted, this proposal could meaningfully impact the taxation of individuals in the private equity, hedge fund, and real estate industries, and other service providers receiving a profits interest as a form of compensation. It should be noted that if the proposal ending the preferential treatment of long-term capital gain is also enacted, this carried interest proposal would materially affect only profits interests holders with taxable income below $1 million (the threshold in the long-term capital gain proposal).

The provision would be effective for taxable years beginning after December 31, 2021.

Make Permanent Excess Business Loss Limitation of Noncorporate Taxpayers

The TCJA requires that “excess business losses” be carried forward as net operating losses rather than deducted currently. Very generally, an excess business loss is the amount of losses from a business that exceeds the sum of the gains from business activities and a stated threshold ($524,000 for married couples filing jointly and $262,000 for other taxpayers).

Under current law, the excess business loss provision expires in 2027; the Greenbook would make the provision permanent.

Severely Limit Deferral of Gain from Like-Kind Exchanges

Code section 1031 currently provides for non-recognition of gain on exchanges of real property for other like-kind real property (like-kind exchanges). The Greenbook proposes to limit the applicability of Code section 1031 to exchanges that defer gain of less than $500,000 (or $1 million in the case of married individuals filing a joint return) in a taxable year. The proposal does not index the exclusion amounts to inflation, although it does apply those amounts on an annual basis.

This proposal represents a significant change for the real estate, oil and gas, and mineral industries, which together engage in billions of dollars of like-kind exchanges per year. In particular, the proposal could significantly impact the business of REITs, which must distribute at least 90 percent of their taxable income per year and often use Code section 1031 to reduce the amount of income subject to this distribution requirement in order to keep additional cash on hand to complete other real estate purchases. Further, oil and gas “acreage swaps” and mineral interest exchanges could be severely limited. If enacted, the $500,000 / $1 million exclusion included in the proposal could create an incentive to divide property and make partial, tax-deferred dispositions. It could also create an incentive for taxpayers to use tenant-in-common or other pooled structures, like tax partnerships, to facilitate transactions without triggering taxation.

The proposal would be effective for exchanges completed in taxable years beginning after December 31, 2021.

PART III: SEA CHANGES FOR INTERNATIONAL TAX

The TCJA introduced sweeping reform on international tax matters with the goal of incentivizing multinational companies to remain in the United States. Along these lines, not only did the TCJA lower the U.S. corporate income tax rate and provide a 100 percent dividends-received deduction for certain offshore dividends, but it also introduced new obstacles and penalties to discourage so-called inversions and established the global intangible low-tax income (GILTI) and base erosion anti-avoidance regimes to generally provide a minimum level of tax on certain foreign earnings.

The Greenbook, as described in further detail below, proposes to—again—usher in comprehensive changes and unscramble some of the TCJA complexity. Interestingly, several of these proposals are reminiscent of similar proposals made by the OECD. In fact, the Greenbook mentions the OECD four times (compared to zero mentions in the JCT’s Blue Book for the TCJA), suggesting a willingness to find common ground with the OECD on some principles of international taxation.

The proposed changes to the international tax regime come less than four years after passage of the TCJA and inject a new level of uncertainty and instability into U.S.-based companies’ decisions around the global deployment of capital. Moreover, the IRS is just now beginning to audit many of the returns filed for the 2018 tax year, the first year in which TCJA was in full effect. Beyond the front-end planning challenges for taxpayers, enactment of the Greenbook proposals will raise significant administrability issues for the IRS as it works with taxpayers to sort through several interlocking but materially different regimes for taxing cross-border activities.

Revised Global Minimum Tax Regime                 

The Greenbook proposal would increase the effective tax rate of U.S. multinational companies by overhauling the GILTI regime. Specifically, the so-called “QBAI” (or qualified business asset income) exemption would be eliminated, with the result that a U.S. shareholder’s entire net tested income would be subject to tax (i.e., net tested income would no longer be offset by a deemed 10 percent return on certain depreciable tangible property).

The elimination of the QBAI exemption would remove the last fig leaf of the quasi-territorial tax system that was announced with much fanfare in 2017. If enacted, the United States will stake new ground in the international tax arena by requiring U.S. shareholders to pay tax on all earnings in foreign companies, as compared to most countries that tax analogous shareholders only on certain foreign earnings (e.g., corporate earnings from low-tax countries or passive income). Moreover, since all foreign earnings would now be taxed, the Code section 245A dividend-received exemption would become increasingly irrelevant, since the earnings underlying the dividends would generally have been taxed under subpart F or GILTI at the time the foreign corporation earned the income.

It is also worth noting that QBAI is generally tangible property eligible for depreciation, such as buildings or machinery, but QBAI does not include assets that are not depreciable (such as land) nor intangible assets. As a result, the elimination of QBAI may disproportionately affect companies with more tangible assets, rather than companies whose value is primarily intangible assets (like intellectual property). In addition, the cost-benefit analysis of a potential Code section 338(g) election, which regularly arises in cross-border acquisitions, will change given that the step-up in asset basis will no longer produce a tax benefit in the form of QBAI to reduce future GILTI inclusions, though Code section 338(g) elections still have other benefits.

The proposal would also effectively increase the GILTI rate by reducing the Code section 250 deduction from 50 percent to 25 percent. Under current law, U.S. shareholders are entitled to a 50 percent deduction against a 21 percent tax rate, resulting in an effective 10.5 percent GILTI rate. The Greenbook proposal, however, would reduce the deduction to 25 percent. Taken together with the proposed corporate rate increase to 28 percent, this change would result in an effective GILTI rate of 21 percent. Interestingly, the Greenbook’s proposal does not do away with the Code section 250 deduction. Rather, it achieves the 21 percent rate by changing the percentage of the deduction. This approach suggests a willingness to use the relative percentage deduction as a way to reach a compromise on the overall package.

Consistent with the general increase in corporate tax rates, this change to the effective GILTI rate may encourage taxpayers to accelerate gain recognition transactions and/or defer deductions.

In addition, the Greenbook proposes that U.S. shareholders of a controlled foreign corporation (“CFC”) calculate their global minimum tax on a country-by-country basis. In other words, a U.S. shareholder’s global minimum tax inclusion, and tax on such inclusion, would be determined separately for each country in which it or its CFCs operate, rather than permitting taxes paid to higher-taxed jurisdictions to reduce the residual U.S. tax paid on income earned in lower-taxed foreign jurisdictions. This proposed change results in a separate foreign tax credit limitation for each country.

The Greenbook does not suggest any changes to the 80 percent limitation that currently applies to GILTI foreign tax credits. If the 80 percent limitation still exists, GILTI will be exempt from further U.S. tax only if it is subject to foreign taxation at a rate of at least 26.25 percent, since 20 percent (or 5.25) of the foreign tax credit is disallowed under current law.

Finally, this proposal would also repeal the high tax exemption to subpart F income and repeal the cross-reference to that provision in the global minimum tax rules in Code section 951A. This proposal would end the controversy over the Treasury Regulations that provided a high tax exemption for GILTI.

In a proposal that is remarkable for its potential deference to the OECD, these general rules would be adjusted for foreign-parented multinational groups (consistent with the OECD/G20 Inclusive Framework on BEPS project’s Pillar Two proposal (the “Pillar Two”)).

These rules would be effective for taxable years beginning after December 31, 2021.

Expanded Application of Anti-Inversion Rules    

To backstop the changes to the global minimum tax regime and prevent U.S. companies from moving offshore to avoid the global minimum tax, the Greenbook proposes a dramatic expansion of the anti-inversion regime under Code section 7874. Code section 7874 currently applies to the acquisition of a U.S. corporation by a foreign corporation if, after the transaction, the former shareholders of the U.S. corporation own more than 80 percent, by vote or value, of the foreign corporation and certain other conditions are satisfied. In this case, Code section 7874 applies to treat the foreign acquiring corporation as a domestic corporation for U.S. federal income tax purposes, assuming certain other conditions are satisfied. If the portion of the foreign corporation held by former shareholders of the U.S. corporation (the so-called ownership fraction) is between 60 and 80 percent, current law subjects the foreign corporation to the possibility of increased taxation, but does not treat it as a domestic taxpayer.

The Greenbook proposal would replace the current 80-percent threshold with a 50-percent threshold and would eliminate the current 60-percent test entirely. In addition, the proposal would expand the universe of acquisitions treated as inversions (regardless of ownership fraction) to include acquisitions where (1) immediately prior to the acquisition, the fair market value of the domestic entity is greater than the fair market value of the foreign acquiring corporation, (2) after the acquisition, the expanded affiliated group is primarily managed and controlled in the United States, and (3) the expanded affiliated group does not conduct substantial business activities in the country in which the foreign acquiring corporation is created or organized. The proposal would also broaden Code section 7874 in several important ways, by including certain asset acquisitions and stock distributions, picking up U.S. businesses operated by foreign partnerships, and by considering the spinoff of a foreign subsidiary the equivalent of an inversion under certain circumstances.

Code section 7874 is already exceedingly complex and broad in many respects and is thus a frequent trap for the unwary. These proposals, if enacted, will require careful scrutiny by taxpayers and practitioners to avoid dangerous foot faults. Introduction of the management and control and substantial business activities tests, in particular, would add a new level of subjectivity and uncertainty to the threshold question of whether the rules apply.

These rules would be effective for transactions that are completed after the date of enactment of such rules. The lack of an exception for transactions for which there is a binding contract as of the effective date could chill market activity even before passage.

Repeal of Deduction for Foreign-Derived Intangible Income     

The Greenbook proposes the repeal of the deduction currently available to domestic corporations with respect to 37.5 percent of any foreign-derived intangible income for taxable years beginning after December 31, 2021. This proposal was expected, and is framed by the Greenbook as the elimination of an inefficient subsidy to multinational corporations. Additionally, many commentators viewed the existing provision as violating World Trade Organization principles. The increased tax revenue that is estimated to come from repeal would be “used to encourage R&D” (presumably in the United States), although no details are provided on how the $123 billion would be deployed.

Replace BEAT with Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD) Rule

The Greenbook would replace the “base erosion and anti-abuse tax” (“BEAT”) in Code section 59A with a new rule—the Stopping Harmful Inversions and Ending Low-Tax Developments (“SHIELD”) rule—disallowing deductions by domestic corporations with respect to members in their financial reporting group whose income is subject to (or deemed to be subject to) an effective tax rate that is below either the rate agreed to under OECD Pillar Two or the U.S. global minimum tax rate of 21 percent. Disallowance may be complete or partial, depending on whether the payment is made directly to such low-taxed entities.

The rule would apply to financial reporting groups with greater than $500 million in global annual revenues, although the proposal permits the Treasury Department to exempt from SHIELD (i) certain financial reporting groups, if they meet a minimum effective level of tax (on a jurisdiction-by-jurisdiction basis) and (ii) payments to investment funds, pension funds, international organizations, or non-profit entities. It is unclear whether the exemption would extend to investors that rely on the Code section 892 exemption. As discussed above in connection with the proposed minimum tax on book earnings, the link to financial statement reporting would mark another notable shift to reliance on third-party standards for determining U.S. income tax liability.

This proposal could adversely impact entities that have already “inverted,” or foreign-parented entities with domestic subsidiaries (and which conduct significant business in the United States). Foreign-parented entities that have substantial offshore intellectual property held in lower-tax jurisdictions may be particularly affected by this proposal.

The rule would be effective for taxable years beginning after December 31, 2022.

Limit Foreign Tax Credits from Sales of Hybrid Entities

The Greenbook would require that, for purposes of applying the foreign tax credit rules, the source and character of items of certain hybrid entities resulting from either a disposition of an interest in such a hybrid entity or a change in the U.S. tax classification of such entity that is not recognized for foreign tax purposes be determined as if the recognition event were a sale or exchange of stock.

The rule would be effective for transactions occurring after the date of enactment.

Restrict Interest Deductions for Disproportionate Borrowing in the United States

This proposal potentially disallows deductions for interest paid by an entity that is a member of a multinational group that prepares consolidated financial statements. Such an entity’s interest deductions would be disallowed to the extent they exceed an amount determined by reference to the entity’s proportionate share (based on its proportion of group earnings) of the group’s net interest expense as reported on the group’s consolidated financial statement.

Alternatively, if an entity subject to the proposal fails to substantiate its proportionate share of the group’s net interest expense for financial reporting purposes, or an entity so elects, the entity’s interest deduction would be limited to the entity’s interest income plus ten percent of the entity’s adjusted taxable income (as defined under Code section 163(j)).

The proposal would not apply to financial services entities. The proposal also would not apply to groups that would otherwise report less than $5 million of net interest expense, in the aggregate, on one or more U.S. income tax returns for a taxable year.

The proposal would be effective for taxable years beginning after December 31, 2021.

Tax Incentive for Onshoring Jobs

This proposal would create a new general business credit equal to 10 percent of certain expenses paid or incurred in connection with moving a trade or business located outside the United States to the United States to the extent the action results in an increase in U.S. jobs.

The proposal would also reduce tax benefits associated with U.S. companies moving jobs outside of the United States by disallowing deductions for certain expenses paid or incurred in connection with offshoring a U.S. trade or business to the extent the action results in a loss of U.S. jobs.

The proposal would be effective for expenses paid or incurred after the date of enactment.

Expand Taxation of Foreign Fossil Fuel Income

Under current law, certain non-U.S. oil-and-gas-related income effectively is taxed at a lower rate than similar oil-and-gas-related income from activities within the United States. For example, “foreign oil and gas extraction income” is excluded from a controlled foreign corporation’s “gross tested income” and may be repatriated tax free. In addition, taxpayers may claim a credit against U.S. income tax liability for certain levies paid to non-U.S. governments.

The Greenbook proposes scaling back the beneficial tax treatment afforded to non-U.S. oil-and-gas-related income. Specifically, the proposal would require foreign oil-and-gas-extraction income to be included in a CFC’s gross tested income for purposes of GILTI and would limit the situations in which taxpayers can claim a credit for levies paid to non-U.S. governments.

The proposal would be effective for taxable years beginning after December 31, 2021.

PART IV: CHANGES TO PRIORITIZE CLEAN ENERGY

Extension of Tax Credits for Wind, Solar and Other Renewable Generation Facilities

The production tax credit (“PTC”) and investment tax credit (“ITC”) are long-standing renewable energy incentives. The PTC is a production-based incentive, available as power produced from qualifying renewable resources (e.g., wind, solar) is sold to unrelated parties. The ITC is a cost-based incentive, determined as a percentage of eligible basis, that arises when a qualifying renewable energy facility is placed in service. The credits have historically been subject to a complicated patchwork of rules for different resources (e.g., when construction of a facility needs to begin, when the facility must be placed in service, etc.), the qualification rules have changed frequently and often unpredictably, and the credits have been non-refundable. Taken together, these features have presented challenges in the development and financing of renewable energy projects.

The Greenbook proposes a long-term extension of the rules, with the full PTC and ITC both being available for facilities whose construction begins after December 31, 2021 and before January 1, 2027, followed by a predictable, stepped phase-down period. Moreover, unlike the current PTC and ITC, taxpayers would have the option to elect a cash payment in lieu of the tax credits (the so-called “direct pay” option).

If enacted, these proposals would bring greater predictability to project developers and, through the direct pay option, make it meaningfully easier for taxpayers lacking sufficient tax “appetite” to efficiently participate in renewables transactions, spurring additional investment in renewable energy generation facilities. While not described in detail, this “direct pay” option would appear to effectively make the credits refundable, meaning that funding is available irrespective of whether the taxpayer has positive income tax liability. Although this could reduce the incentive to use partnership structures to utilize the credits, it would also add a new level of complexity to their administration and raise concerns from the IRS about the potential for abuse.

The proposal would be effective for taxable years beginning after December 31, 2021.

Expansion of Tax Credits to Stand-Alone Energy Storage and Energy Transmission Assets

Historically, energy storage assets (such as battery storage projects) have been eligible for the ITC only when paired with certain renewable energy resources, and the ITC has been unavailable with respect to energy transmission property. The Greenbook proposes to make certain stand-alone energy storage assets and energy transmission infrastructure assets eligible for the ITC. Moreover, as with the generation facility credit, taxpayers would be eligible to elect a cash payment in lieu of tax credits.

We expect that these proposals to increase the scope of ITC-eligible assets will provide strong incentives for investment in infrastructure designed to make the nation’s electric grid more reliable and resilient.

The proposal would be effective for taxable years beginning after December 31, 2021.

New Tax Credits for Qualifying Advanced Energy Manufacturing

Existing law authorizes a tax credit for the establishment of certain clean energy manufacturing facilities (e.g., facility to manufacture wind or solar equipment), but the amount of the credit is subject to a relatively low cap, which makes the incentive unavailable to certain otherwise-qualifying credit applicants. The Greenbook would expand the availability of the credit to include various new manufacturing facilities (including those focused on energy storage equipment, electric grid modernization equipment, energy conservation technology, and carbon oxide sequestration equipment) and significantly expand the cap, with a material portion of the credit being specifically allocable to projects in coal communities. Again, taxpayers would be eligible to elect a cash payment in lieu of tax credits. Taken together, the proposal intends to spur the production of domestic manufacturing of clean energy property.

The proposal would be effective for taxable years beginning after December 31, 2021.

Eliminate Fossil Fuel Tax Preferences

Current law provides a number of tax incentives meant to encourage oil and gas production. These incentives were targeted for repeal under the Obama Administration’s Greenbook in each year beginning with the 2011 fiscal year. The Biden Administration’s fiscal year 2022 Greenbook picks up where the Obama Administration left off, proposing to repeal a nearly identical set of fossil fuel-related tax incentives. Specifically, the Greenbook proposes repealing: (1) the enhanced oil recovery credit for eligible costs attributable to a qualified enhanced oil recovery project; (2) the credit for oil and gas produced from marginal wells; (3) the expensing of intangible drilling costs; (4) the deduction for costs paid or incurred for any tertiary injectant used as part of a tertiary recovery method; (5) the exception to passive loss limitations provided to working interests in oil and natural gas properties; (6) the use of percentage depletion with respect to oil and gas wells; (7) two-year amortization of independent producers’ geological and geophysical expenditures, instead allowing amortization over the seven-year period used by integrated oil and gas producers; (8) expensing of exploration and development costs; (9) percentage depletion for hard mineral fossil fuels; (10) capital gains treatment for royalties; (11) the exemption from the corporate income tax for publicly traded partnerships with qualifying income and gains from activities relating to fossil fuels; (12) the Oil Spill Liability Trust Fund excise tax exemption for crude oil derived from bitumen and kerogen-rich rock; and (13) accelerated amortization for air pollution control facilities.

If enacted, the repeal of these incentives would make the production of oil and gas costlier by increasing producers’ effective tax rate. That said, some of these incentives, like the intangible drilling cost deduction, predate the Internal Revenue Code itself and have survived numerous political cycles. Efforts to repeal a nearly identical set of incentives proved difficult for the Obama Administration, even where the revenue generated from repeal was projected to be higher during the Obama Administration.

The proposal generally would be effective for taxable years beginning after December 31, 2021, although the repeal of item 11 above (exception for certain publicly traded partnerships) will only become effective for taxable years beginning after December 31, 2026.

Expand and Enhance the Carbon Oxide Sequestration Credit

Current law provides a tax credit for the capture and sequestration of certain types of carbon oxide captured with carbon-capture equipment placed in service at certain qualifying facilities, with the amount of the credit dependent on when and how the carbon oxide is sequestered.

The Greenbook proposes increasing the value of the sequestration credit by (i) $35 dollars per metric ton for carbon oxide that is more difficult to capture, such as carbon oxide from cement production, steelmaking, or hydrogen production, and (ii) $70 per metric ton for direct air carbon capture projects. Further, the “begin construction” date for qualifying facilities eligible for the credit would be extended five years to January 1, 2031. As is the case for the Greenbook’s other clean energy proposals, taxpayers could elect to receive a direct cash payment in lieu of the credits. The enhanced credits, together with the begin construction date extension and the direct pay option, should spur investment in carbon capture facilities and technologies.

The proposal would be effective for taxable years beginning after December 31, 2021.

Other Clean Energy Proposals

• Establish Tax Credits for Heavy- and Medium-Duty Zero Emissions Vehicles
• Provide Tax Incentives for Sustainable Aviation Fuel
• Provide a Production Tax Credit for Low-Carbon Hydrogen
• Extend and Enhance Energy Efficiency and Electrification Incentives
• Provide Disaster Mitigation Tax Credit
• Extend and Enhance the Electric Vehicle Charging Station Credit
• Reinstate Superfund Excise Taxes and Modify Oil Spill Liability Trust Fund Financing

PART V: IMPROVE COMPLIANCE AND TAX ADMINISTRATION

The Administration has been vocal in recent months in calling for an increase in IRS funding to reverse more than a decade of declining budgets and staff attrition, and to address information technology infrastructure challenges, all of which have driven historically low audit rates. On April 9, 2021, the Office of Management and Budget released an outline of the President’s request for fiscal year 2022 discretionary spending that would provide the IRS with $13.2 billion in funding for next year alone, a $1.2 billion or 10.4 percent increase over enacted IRS funding for 2021.[3] This increase would be used in part to improve taxpayer service but a major focus of the increased funding would be on increasing taxpayer compliance with existing law, reducing the “gap” between what is paid over to Treasury in taxes each year and what is actually owed. The most recent official estimates, covering the 2011 – 2013 tax years, are that this “tax gap” is roughly $441 billion annually (reduced by existing enforcement efforts to roughly $ $281 billion), although IRS Commissioner Charles Rettig recently suggested that a more accurate number may be closer to $1 trillion.

While there are some estimates that the IRS can collect $4 in additional tax for every $1 in increased IRS funding, those estimates cover a broad range of enforcement activity and are likely skewed toward low-cost/high-return functions like automated matching of information returns, rather than audits of complex tax returns. And, in the context of those more complex returns, there is considerably more uncertainty around what tax is actually owed, given ambiguities in the underlying law. Moreover, according to the IRS’s own estimates, over time the voluntary compliance rate has remained remarkably constant at just under 85 percent, even during periods of significantly declining budgets and enforcement activity, raising the question as to whether a material increase in IRS funding will translate into the expected increase in compliance.

Introduce Comprehensive Financial Account Reporting to Improve Tax Compliance

Recognizing that increased funding for the IRS alone will not be sufficient to make the necessary dent in the tax gap, the Greenbook includes several proposals that would equip the IRS with better information to address noncompliance with existing tax laws. The premise for these proposals is that third-party reporting can increase voluntary compliance rates from below 50 percent to as high as 95 percent. From that premise, the Administration proposes to create a “comprehensive financial account reporting regime,” that would require financial institutions to report gross transfers into and out of accounts, including accounts owned by the same taxpayer. This proposal is estimated to raise $8.3 billion in FY 2022 alone and, once fully implemented, to raise over $462 billion over the next 10 years. While increased information reporting will undoubtedly improve voluntary compliance, by how much is an open question. The proposed reporting regime falls several steps short of the Form W-2 reporting that ties directly into taxable income and also falls short of most existing Form 1099 reporting, which ties directly into gross income. Rather, like merchant card reporting under Code section 6050W, the comprehensive reporting regime would provide the IRS with information about fund flows that could lead to uncovering unreported taxable income (or encourage taxpayers to more accurately report taxable income to begin with) but will not do so directly. Whether this helps move compliance from under 50 percent to closer to 95 percent will depend on a number of variables, including the extent to which and how quickly financial institutions can implement a new reporting requirement and whether the IRS has the resources in place to effectively utilize the new information through deployment of artificial intelligence and comprehensive audit follow up. Successful implementation of the program will present additional challenges to the extent that, as proposed, it covers crypto assets, where a longer period of time for implementation could be needed, and unique substantive issues around transfers of “property,” as the IRS has characterized cryptocurrency, are likely to be raised. Even with established financial institutions that have deep experience with reporting information to the IRS, implementation of prior information reporting regimes including broker accounts and FATCA have proven far more complicated and burdensome than first expected.

Oversight of Paid Tax Return Preparers

The Greenbook proposes to provide the Secretary with explicit authority to regulate paid tax return preparers. This proposal has been included in several pieces of introduced legislation and was proposed in a number of prior-year Budget requests. In the past it was met with resistance from some in the tax professional community as well as members of Congress who oppose imposing new regulatory requirements on small businesses.

The proposal would be effective for taxable years beginning after December 31, 2021.

Modifications to Partnership Audit Rules

Under the BBA Centralized Partnership Audit Regime signed into law in 2015 and generally effective for tax years beginning in 2018, partners in the “adjustment” year of a partnership’s return are responsible for any tax payment obligation arising from adjustments going back to the “reporting year” return at issue. The BBA generally permits partnerships undergoing audit for certain tax years to make a “push out” election whereby the reporting year partners, and not the adjustment year partnership, become responsible for payments arising from an audit adjustment. If an adjustment reduces, instead of increases, a partner’s tax liability, the partner can use the decrease to offset its tax liability in the current year, but not below zero, with any reduction in excess of its tax liability in the current year being lost. The proposed change would treat the excess as a tax overpayment, potentially allowing a refund. This proposal reflects the Administration’s priority on increased enforcement for flow-through entities.

The proposal would be effective upon enactment.

_________________________

   [1]   The term “Bluebook” has also been used in prior administrations. Greenbook and Bluebook legislative proposals dating back to 1990 are available on the Treasury Department’s website, https://home.treasury.gov/policy-issues/tax-policy/revenue-proposals. The Joint Committee on Taxation (“JCT”) periodically publishes a general explanation of recently enacted tax legislation in a publication that is also known as a “Blue Book.” In December 2018, JCT released a Blue Book that explains the TCJA, which can be found at https://www.jct.gov/publications/2019/jcs-2-19/.

   [2]   TCJA is formally titled “An act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” Pub. L. No. 115-97, 131 Stat. 2045.

   [3]   https://www.whitehouse.gov/wp-content/uploads/2021/04/FY2022-Discretionary-Request.pdf.

---

This alert was prepared by Jennifer Sabin, John-Paul Vojtisek, Dora Arash, Michael D. Bopp, James Chenoweth, Michael J. Desmond, Pamela Lawrence Endreny, Roscoe Jones, Jr., Kathryn Kelly, Brian W. Kniesly, David Sinak, Eric Sloan, Jeffrey M. Trinklein, Edward Wei, Lorna Wilson, Daniel A. Zygielbaum, Michael Cannon, Jennifer Fitzgerald, Evan M. Gusler, Brian Hamano, James Jennings, James Manzione and Collin Metcalf.

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

Jennifer Sabin – New York (+1 212-351-5208, [email protected])
John-Paul Vojtisek – New York (+1 212-351-2320, [email protected])
Dora Arash – Los Angeles (+1 213-229-7134, [email protected])
James Chenoweth – Houston (+1 346-718-6718, [email protected])
Michael J. Desmond – Los Angeles/Washington, D.C. (+1 213-229-7531, [email protected])
Pamela Lawrence Endreny – New York (+1 212-351-2474, [email protected])
Kathryn A. Kelly – New York (+1 212-351-3876, [email protected])
Brian W. Kniesly – New York (+1 212-351-2379, [email protected])
David Sinak – Dallas (+1 214-698-3107, [email protected])
Eric B. Sloan – Co-Chair, New York (+1 212-351-2340, [email protected])
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224 /+1 212-351-2344), [email protected])
Edward S. Wei – New York (+1 212-351-3925, [email protected])
Lorna Wilson – Los Angeles (+1 213-229-7547, [email protected])
Daniel A. Zygielbaum – Washington, D.C. (+1 202-887-3768, [email protected])

Public Policy Group:
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Roscoe Jones, Jr. – Washington, D.C. (+1 202-887-3530, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

Gibson Dunn strongly condemns acts of violence, hatred and bigotry of any kind. In recent weeks, we have seen a disturbing rise of anti-Jewish hate erupt in communities around the world. These attacks rooted in anti-Semitism have no place in society, and we denounce anti-Semitism in any form, and in any context.

It has been a difficult year for many, and we know that many of our colleagues, friends and family members have been impacted by the recent attacks on the Jewish community and are struggling on a very personal level with these heinous acts of bigotry and prejudice. These horrific acts of physical violence in our communities and explicit anti-Semitic messages are deeply disturbing.

If we have learned anything from this past year, it is that we must not be afraid to condemn acts of hatred and violence wherever, and whenever, we see them in our communities. As Elie Wiesel said, “I swore never to be silent whenever human beings endure suffering and humiliation.” Silence is complicity and Gibson Dunn has never been silent. At Gibson Dunn, we have always and will always defend the rule of law, civil liberties, and equal justice for all. Our lawyers have been encouraged to take up that mantle, through pro bono efforts, charitable giving, or otherwise. The firm is proud of our longstanding partnerships with organizations committed to fighting anti-Semitism, including the Anti-Defamation League and the American Jewish Committee, which recently issued a groundbreaking survey on anti-Semitism in America. We are proud of the pro bono work that we have done in collaboration with organizations like Bet Tzedek and so many others, and we commit ourselves to further engaging in these important efforts.

Indeed, we have always prided ourselves on being on the frontlines of all major social justice and human rights issues of the day. Whether fighting for marriage equality; protecting those impacted most directly by the Travel Ban; fighting to reunite families separated at the southern border; standing up for the Dreamers and ultimately saving the DACA program; tackling police reform and criminal justice reform; defending the rights of peaceful protestors demanding racial justice in the wake of the murder of George Floyd; or advocating for victims of anti-Asian hate, we have actively taken a leadership role in righting such inequities. And this has never been more true than over the past year – Gibson Dunn has repeatedly reaffirmed our commitment to fighting hatred, injustice and inequity in our communities – particularly when these acts of hatred are rooted in discrimination against race, religion, color, sexual orientation, or national origin. We continue to stand with our colleagues and will fight prejudice and bigotry as we continue to advocate for tolerance, inclusion and understanding.

Gibson Dunn is committed to doing our part to combat anti-Semitism and hate in all of its forms. We encourage you to read this OpEd published in The American Lawyer from law firm leaders that we are proud to co-sign.

Mass arbitration is a recent phenomenon in which thousands of plaintiffs—often consumers, employees, or independent contractors—bring arbitration demands against a company at the same time. Many mass arbitrations are the product of sophisticated advertising campaigns in which a plaintiffs’ firm uses social media to generate a list of thousands of individual “clients.” Other mass arbitrations arise after a court has enforced a class-action waiver in an arbitration agreement—instead of filing a single arbitration on behalf of the named plaintiff only, the plaintiffs’ firm tries to replicate the failed class action by bringing thousands of arbitrations on behalf of would-be class members.

Mass arbitrations can impose significant, even crippling, costs on companies, particularly in light of the hefty filing fees that many arbitration providers charge. For example, if a company’s filing-fee obligation is $2,000 per arbitration, a mass arbitration of 5,000 individuals could result in the arbitration provider invoicing the company for $10 million in nonrefundable filing fees. Equally large invoices—for case management fees and arbitrators’ fees—can quickly follow.

Because mass-arbitration plaintiffs are often recruited on social media, with little-to-no vetting, a mass arbitration might include hundreds of plaintiffs who never had any relationship or dealings with the company. Nonetheless, it is often difficult to identify and eliminate those frivolous claims before the arbitrations commence, and many arbitration providers insist on the company paying nonrefundable filing fees regardless of whether the claims have merits. A recent California law (SB 707) raises the stakes even further by requiring companies to pay arbitration fees within 30 days, and failure to do so can lead to default judgments and liability for the plaintiffs’ attorneys’ fees.

Many companies, however, have deployed successful strategies for deterring and defending against mass arbitrations, primarily through the careful drafting of their arbitration agreements. Below, we identify a few of the strategies that have been deployed. This list is not exhaustive, not all strategies are right for each company, and mass arbitration tactics are evolving and changing rapidly.

1. Informal dispute resolution clauses. Companies can often reduce mass-arbitration costs by requiring the parties to engage in a mediation or informal dispute resolution conference before either side serves an arbitration demand. Those conferences can often result in the settlement or dismissal of many claims, and also deter the filing of frivolous claims, saving the company costly arbitration filing fees.
2. Require individualized arbitration demands. Plaintiffs’ firms often try to initiate mass arbitrations by sending the company a single arbitration demand and appending a list of their purported clients. This tactic often fails to give companies sufficient information about the claimants bringing the arbitration demands, and also increases companies’ nonrefundable filing fees. To deter this tactic, some companies have required claimants to serve individualized arbitration demands, each of which must clearly identify the claimant, their legal claims, the requested relief, and an express authorization by the claimant to bring the arbitration demand.
3. Cost-splitting provisions. Courts generally permit companies to require consumers, employees or independent contractors to bear some of the costs of arbitration, including the amount it would cost a claimant to file a lawsuit in a local court. Requiring claimants to pay for some arbitration fees can reduce the cost of a mass arbitration and deter the filing of frivolous claims.
4. Fee-shifting for frivolous claims. Companies may also consider inserting clauses in their arbitration agreements that allow the arbitrator to award fees and costs to the prevailing party if the arbitrator finds that the losing party filed a frivolous claim. This can be another useful tool for deterring frivolous mass arbitrations and, at a minimum, it incentivizes plaintiffs’ counsel to vet claimants before bringing claims on their behalf.
5. Offers of judgment. In many jurisdictions, an offer of judgment shifts costs to the plaintiff if they recover less money at trial than the settlement offer. A company may be able to reduce its costs and exposure by making offers of judgment at the outset of a mass arbitration. While most jurisdictions automatically enforce offers of judgment in arbitration, companies may consider including provisions in their arbitration agreements that expressly permit offers of judgment, with cost-shifting.
6. Selecting the arbitration provider. Arbitration providers charge filing fees and other fees that vary widely. Some arbitration providers have dedicated fee schedules and other protocols for mass arbitrations. Companies should research and compare providers’ fee schedules and mass-arbitration protocols before selecting a provider for their arbitration agreement. It is also advisable to include a provision in the arbitration agreement that allows either side to negotiate lower fees with the provider—without such a provision, the provider may be unwilling to enter into such negotiations.
7. Reserve the right to settle claims on a class-wide basis. A company facing a mass arbitration may wish to obtain global peace by entering into a class settlement that extinguishes all claims. No clause in an arbitration agreement should be necessary to allow a company to settle a class action. Indeed, for years, companies have settled class actions despite having arbitration agreements with class-action waivers. However, some plaintiffs’ lawyers have argued that class-action waivers preclude companies from settling a class action. Therefore, in an abundance of caution, companies might consider adding a clause to their arbitration agreements that allows any party to settle claims on a class-wide basis.
8. Establish a protocol for adjudicating a mass arbitration. Some companies have inserted specific protocols in their arbitration agreements to help reduce the cost of a potential mass arbitration. For example, some arbitration agreements state that, in the event more than 100 similar arbitrations are filed at the same time, they will be “batched” into groups of 100, with each batch assigned to a single arbitrator and triggering a single filing fee. In this particular example, the batching protocol could potentially cut the company’s arbitration costs by up to 99%. However, having arbitrators assigned to multiple arbitrations could create additional risk for the company. In addition to batching, there are other mass-arbitration protocols that offer different risk/cost profiles.

Conclusion

Mass arbitrations can create significant cost and risk for a company. Being proactive and drafting an arbitration agreement with an eye toward mass arbitration can help reduce that cost and risk.

---

We will continue to monitor closely and develop new strategies and approaches to mass arbitration. If you have any questions or would like additional information about these or other developments, please reach out to any of your contacts at Gibson Dunn, any member of the firm’s Class Actions practice group, or the author of this alert:

Michael Holecek – Los Angeles (+1 213-220-6285, [email protected])

The following Gibson Dunn attorneys also are available to assist in addressing any questions you may have regarding this alert:

Christopher Chorba – Los Angeles (+1 213-229-7396, [email protected])
Theane Evangelis – Los Angeles (+1 213-229-7726, [email protected])
Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, [email protected])
Dhananjay S. Manthripragada – Los Angeles (+1 213-229-7366, [email protected])

© 2021 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 May 2021, Gibson Dunn attorneys won a landmark case before the General Court of the European Union (case T-561/18, ITD and Danske Fragtmænd v European Commission).

Gibson Dunn represented ITD (a Danish trade association of international companies operating parcel and logistics services) and Danske Fragtmænd (a company operating in this sector in Denmark) in a case concerning state subsidies in the Danish post and courier market. The EU General Court partially annulled a European Commission decision of 28 May 2018 authorising certain aid measures granted by the Danish and Swedish States to Post Danmark, the Danish postal incumbent and former monopolist owned by PostNord AB, a holding company in turn owned by the Danish and Swedish States. In its decision the Commission had rejected claims that a capital injection from Post Danmark’s parent company and a tax exemption in favour of Post Danmark involved unlawful State aid, but the General Court overturned this decision.

With the rapid decline in letter volumes across the EU, ex monopolists in the postal sector have been struggling to remain viable and have become more actively engaged in the booming parcel freight transport market based on e-commerce transactions. The problem is that ex monopolists still receive funding from their owners, i.e., the State, and while that funding may lawfully be granted for providing a universal letter service in remote areas, it is not justified to use it to gain a competitive advantage in markets such as parcel transport. The EU courts have therefore intensified its scrutiny of Member States which transfer funding to their State owned ex monopolists in various sectors, including in the postal sector. While Member States are allowed to invest in their own companies, capital contributions to loss making entities with no prospect of a reasonable return constitute prohibited State aid. Similarly tax exemptions granted selectively to State owned companies are illegal.

Post Danmark, the ex monopolist for letter services in Denmark, has experienced a 80% decline in letter volumes and has been unable to generate a profit even in the parcel transport market. The company has been incurring catastrophic losses for a decade (or more).

On 5 May 2021, the General Court of the European Union annulled the Commission’s finding that a capital injection to Post Danmark of EUR 135 million in 2017 did not involve State aid as well as a finding that a VAT exemption (with an annual value of approx. EUR 37 million) benefitting Post Danmark for at least 10 years did not constitute State aid. The Danish State and PostNord AB (the Danish-Swedish owned parent company of Post Danmark) intervened in the case to support the European Commission while two freight transport companies, Jørgen Jensen Distribution and Dansk Distribution, intervened in support of ITD and Danske Fragtmænd.

This judgment is the latest in a series by EU Courts setting out requirements regarding Member States’ capital injections in loss making State owned companies in the EU. Specifically, the General Court makes clear that State aid granted in the form of capital injections must be capable of producing a reasonable rate of return in order to avoid being classified as prohibited State aid.

Indeed, while the European Commission had concluded that the capital injection of EUR 135 million granted to loss making Post Danmark would make it possible to restore Post Danmark’s viability, the General Court found that the Commission had no basis for coming to this conclusion. There was no evidence that the company could be brought back to profitability nor that it would have prospects of generating a reasonable return. In the same vein, while the Commission had accepted their arguments that Denmark and Sweden were not involved in the capital injection (as it had been contributed by the parent company to Post Danmark) and were merely ‘passive spectators’ to this payment, the General Court held that the Commission cannot just rely on States’ own arguments whilst ignoring conflicting information submitted by the complainants. Instead the Commission must diligently investigate the matter especially in view of the Commission’s obligation to conduct an impartial examination of the complaint.

The judgment also finds that the VAT exemption (with an annual value of approx. EUR 37 million) benefiting Post Danmark, which allowed e-commerce companies not to  charge their customers VAT if they used Post Danmark as their freight company, also benefits Post Danmark and thus involves illegal State aid. The General Court specifically pointed out that this VAT exemption is not covered by the existing permissible VAT exemption covering the provision of Universal Service Obligations based on the VAT Directive 2006/112/EC of 28 November 2006.

As a result of the judgment, the Commission must now reopen the case and will probably be forced to consider that the capital injection of EUR 135 million and the VAT exemption involve incompatible, and therefore unlawful, State aid that must be recovered from Post Danmark. In view of its catastrophic financial situation, this may mean that Post Danmark will  unable to survive, at least in its current form.

---

The following Gibson Dunn lawyers assisted in preparing this client update: Lena Sandberg, Yannis Ioannidis and Pilar Pérez-D’Ocon.

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

Antitrust and Competition Group:

Brussels
Attila Borsos (+32 2 554 72 11, [email protected])
Christian Riis-Madsen (+32 2 554 72 05, [email protected])
Lena Sandberg (+32 2 554 72 60, [email protected])
David Wood (+32 2 554 7210, [email protected])
Alejandro Guerrero (+32 2 554 7218, [email protected])

London
Ali Nikpay (+44 20 7071 4273, [email protected])
Deirdre Taylor (+44 20 7071 4274, [email protected])
Philip Rocher (+44 20 7071 4202, [email protected])
Patrick Doris (+44 20 7071 4276, [email protected])
Charles Falconer (+44 20 7071 4270, [email protected])

Frankfurt
Georg Weidenbach (+49 69 247 411 550, [email protected])

Munich
Michael Walther (+49 89 189 33 180, [email protected])
Kai Gesing (+49 89 189 33 180, [email protected])

Hong Kong
Kelly Austin (+852 2214 3788, [email protected])
Sébastien Evrard (+852 2214 3798, [email protected])

Washington, D.C.
Adam Di Vincenzo (+1 202-887-3704, [email protected])
Scott D. Hammond (+1 202-887-3684, [email protected])
Joseph Kattan (+1 202-955-8239, [email protected])
Kristen C. Limarzi (+1 202-887-3518, [email protected])
Joshua Lipton (+1 202-955-8226, [email protected])
Richard G. Parker (+1 202-955-8503, [email protected])
Michael J. Perry (+1 202-887-3558, [email protected])
Cynthia Richman (+1 202-955-8234, [email protected])
Jeremy Robison (+1 202-955-8518, [email protected])
Stephen Weissman (+1 202-955-8678, [email protected])
Andrew Cline (+1 202-887-3698, [email protected])
Chris Wilson (+1 202-955-8520, [email protected])

New York
Eric J. Stock (+1 212-351-2301, [email protected])
Lawrence J. Zweifach (+1 212-351-2625, [email protected])

Los Angeles
Daniel G. Swanson (+1 213-229-7430, [email protected])
Christopher D. Dusseault (+1 213-229-7855, [email protected])
Samuel G. Liversidge (+1 213-229-7420, [email protected])
Jay P. Srinivasan (+1 213-229-7296, [email protected])
Rod J. Stone (+1 213-229-7256, [email protected])

San Francisco
Rachel S. Brass (+1 415-393-8293, [email protected])
Caeli A. Higney (+1 415-393-8248, [email protected])

Dallas
Veronica S. Lewis (+1 214-698-3320, [email protected])
Mike Raiff (+1 214-698-3350, [email protected])
Brian Robison (+1 214-698-3370, [email protected])
Robert C. Walters (+1 214-698-3114, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

On May 18, 2021, the New York Privacy Act (“NYPA”) passed out of the New York Senate Consumer Protection Committee.[1]  Senator Kevin Thomas previously introduced a version of this bill in the 2019-2020 legislative session, but this is the first time that the bill—or any comprehensive privacy bill in New York—has made it out of committee. In addition to needing the approval of the majority of the full senate, the bill must progress in the New York Assembly before it is enacted. If the NYPA is enacted, it would be the third comprehensive state privacy law in the United States following the California Consumer Privacy Act (as amended by the California Privacy Rights Act) (“CCPA”) and the Virginia Consumer Data Protection Act (“VCDPA”), the latter of which was signed into law earlier this year and goes into effect in January 2023. While the New York Privacy Act shares similarities with its counterparts in California and Virginia, such as prohibiting discrimination against consumers that exercise their rights under the laws, the NYPA is substantially broader.[2] If the NYPA is signed into law, many companies doing business in New York will need to assess their compliance and may need to modify their compliance efforts and collection and use of consumer personal information.

The NYPA’s broad jurisdictional mandate applies to any entity that “conduct[s] business in New York or produce[s] products or services that are targeted to residents of New York,” and that (1) has annual gross revenue of $25 million or more, (2) controls or processes the personal data of at least 100,000 New York consumers, (3) controls or processes the personal data of at least 500,000 individuals nationwide and 10,000 New York consumers, or (4) derives over 50% of gross revenue from the sale of personal data and controls or processes the personal data of at least 25,000 New York consumers.[3] Just like the CCPA and VCDPA do not define  “doing” or “conduct[ing]” business in California or Virginia, the NYPA does not define “conduct[ing] business in New York.” It seems likely that the NYPA will apply to for-profit and business-to-business companies that interact with New York residents, or process personal data of New York residents on a relatively large scale. Like the CCPA, the NYPA would exempt a list of enumerated data types, including data already subject to certain laws and regulations, like the Gramm-Leach-Bliley Act (“GLBA”).[4]

The cornerstone of the NYPA is the creation of an expansive consumer “bill of rights,” which contains similar rights as enacted in California and Virginia, but also goes further to give unprecedented rights to consumers. Similar to the California and Virginia laws, consumer rights under the NYPA include the right to know the categories of personal data collected, and purposes of such categories; the right to access, correct, and delete their personal information; the right to data portability; and anti-discrimination rights.[5] Unlike the California and Virginia laws, which provide consumers with the right to opt out of certain data selling, sharing, and/or processing, under the NYPA data controllers must obtain opt-in consent before processing personal data or “mak[ing] any changes in the processing or processing purpose,” such as using “less protective” methods of collection.[6]

The NYPA would also go further in codifying the concept of a “data fiduciary.” This concept would prevent controllers from using consumers’ personal information in a way that would harm them—that is, in a manner against a consumer’s physical, financial, psychological, or reputational interests. As a data fiduciary, a controller would be required pursuant the NYPA’s duty of loyalty to notify consumers about data processing foreseeably adverse to their interests and prohibit controllers from engaging in “unfair, deceptive, or abusive…practices with respect to obtaining consumer consent.”[7] Complying with the NYPA’s duty of care would require implementing certain practices, such as annual risk assessments and reasonable safeguards to protect personal data.[8] The bill’s consumer focus also extends to authorizing a broad private right of action for violations of any of these consumer rights—unlike the California laws, which provide for a narrow private right of action, and the Virginia law, which provides for no private right of action at all.[9] The Attorney General also has authority to enforce the law. Finally, the Virginia and California laws provide the opportunity to cure violations before enforcement, which is not explicitly provided for in the NYPA.[10]

The NYPA would create an even broader comprehensive privacy regime than its counterparts in Virginia and California. If the NYPA is enacted, it would mandate yet another privacy regime in the United States and pose additional challenges as businesses attempt to navigate this already complex environment. Gibson Dunn is tracking this bill through the end of the legislative session, and will continue to monitor developments in New York and nationwide.

______________________

   [1]   Senate Bill No. 6701.

   [2]   Compare id. § 1103(1)(C) with Cal. Civ. Code § 1798.125 (as amended by California Consumer Privacy Rights and Enforcement Act on November 3, 2020) and Virginia Consumer Data Protection Act, S.B. 1392 § 59.1-574(A)(4).

   [3]   Senate Bill No. 6701 § 1101.

   [4]   Id. § 1101(2).

   [5]   Id. § 1102–1103.

   [6]   Id. § 1102(2).

   [7]   Id. § 1103(1)(A).

   [8]   Id. § 1103(1)(B).

   [9]   Compare id. § 1106 with Cal. Civ. Code § 1798.150 and S.B. 1392 § 59.1-579(C).

  [10]   See, e.g., Cal. Civ. Code § 1798.199.45; S.B. 1392 § 59.1-579(B).

---

This alert was prepared by Alexander H. Southwell, Mylan L. Denerstein, Amanda M. Aycock, Jennifer Katz and Lisa V. Zivkovic.

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 in the firm’s Privacy, Cybersecurity and Data Innovation practice group, or the following authors:

Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, [email protected])
Mylan L. Denerstein – Co-Chair, Public Policy Practice (+1 212-351-3850, [email protected])

Privacy, Cybersecurity and Data Innovation 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])
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])
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, [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])
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, [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])

© 2021 Gibson, Dunn & Crutcher LLP

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

I.  Introduction

Following two major cybersecurity events, President Biden issued a sweeping Executive Order on May 12, 2021,[1] reinforcing his commitment that fighting cyberattacks is “a top priority and essential to national and economic security.” The executive action is the latest of the Administration’s efforts on “prevention, detection, assessment, and remediation of cyber incidents,” coming on the heels of the Colonial Pipeline ransomware attack, and just a few months after the SolarWinds breach.

In brief, reports in December 2020 revealed that hackers accessed the systems of SolarWinds, an IT management software company, and implemented malicious code that enabled the hackers to install malware that was used to spy on SolarWinds and its customers, including several U.S. government agencies and many Fortune 500 companies. And in early May 2021, Colonial Pipeline, an oil pipeline system, was targeted by a criminal cybergroup encrypting its system and demanding a ransom. Although aimed at business technology, the attack caused Colonial Pipeline to shut down operations on a major pipeline serving the Northeast, leading to gas shortages and panic buying.

These two high-profile incidents illustrate the reality that cyberattacks are a growing threat facing both the public and private sectors. The scope and incidence of these attacks has grown steadily year over year, with experts from Cybersecurity Ventures estimating that cybercrime will cost $6 trillion globally in 2021 and continue to grow by 15% annually over the next five years.[2] Cyberattacks can have wide-ranging implications, including theft of sensitive personal data, breach of state and trade secrets, and network and power disruptions, so investment in cybersecurity infrastructure is critical.

In light of these threats, the Order is the latest step in the Biden Administration’s commitment to “disrupt and deter our adversaries from undertaking significant cyberattacks.” President Biden’s appointments have signaled his seriousness in this regard — he has appointed a number of experienced cybersecurity professionals to significant roles, including for the newly-created role of National Cyber Director and a Deputy National Security Advisor for Cyber and Emerging Technology (a role that elevated the subject within the Administration). While the Administration has indicated intentions to push for more comprehensive cybersecurity legislation, in the interim, the Order will have a significant impact on the way that federal government agencies and government contractors approach cybersecurity. The Administration intends the Order to also “encourage private sector companies to follow the Federal Government’s lead,” a strategy that had prior success with the widespread adoption of the National Institute of Standards and Technology’s 2014 voluntary cybersecurity framework.

II.  Key Provisions of the Executive Order

The Order aims to improve the nation’s cybersecurity and protect federal government networks against sophisticated, malicious cyber activity from both nation-state actors and cyber criminals. As many high-profile cyber incidents have shared risk factors and other commonalities, such as similar cybersecurity vulnerabilities and a lack of robust defenses, the Order focuses on measures likely to have an immediate and wide-ranging impact on critical infrastructure systems, such as strengthening federal network protections, promoting information-sharing between the U.S. government and private sector, and enhancing the ability to respond to incidents. While many federal agencies and contractors already maintain and abide by existing agency-specific cybersecurity measures, the Order establishes additional mechanisms and standards to ensure that all information systems used or operated by federal agencies or contractors “meet or exceed” the cybersecurity standards and requirements set forth in the Order.

The Order aims to spur substantial participation and investment from a diverse array of relevant stakeholders in both the public and private sectors. Although the Order’s requirements apply only to federal agencies and contractors, the Order acknowledges the private sector’s integral role in providing and maintaining domestic critical infrastructure. To this end, the Order expressly encourages the private sector — including entities that are not government contractors — to adopt comparable and ambitious measures to minimize future cyber incidents.

The Order contains eight key components and provisions for modernizing the federal government’s defenses and responses to cyberattacks, which are summarized below.

Sec. 2.  Removing Barriers to Sharing Threat Information. 

The Order calls for the review and update of Federal Acquisition Regulation (“FAR”) and Defense Federal Acquisition Regulation Supplement (“DFARS”) requirements to ensure that federal contractors collect, preserve, and share information related to cyber threats and incidents. The anticipated revisions to the FAR and DFARS provisions would also require service providers to collaborate with federal agencies in investigating and responding to incidents or potential incidents. The Order establishes a federal government policy that information and communications technology service providers must promptly report the discovery of cyber incidents to the appropriate federal agencies, and contemplates revisions to the FAR identifying the types of cyber incidents that will trigger such reporting, the types of information to be reported, the time periods within which to report cyber incidents based on a graduated scale of severity, and the types of contractors and service providers to be covered by the proposed language. The Order also contemplates the standardization of agency-specific cybersecurity requirements through the anticipated FAR updates. Furthermore, the Biden Administration has conveyed its expectation that these revised contract terms will spur adoption of the practices by the private sector more broadly.

Sec. 3.  Modernizing Federal Government Cybersecurity.

Recognizing that the cyber threat environment is “dynamic and increasingly sophisticated,” the Order identifies necessary steps for modernizing its approach to cybersecurity and ensuring effective defenses, including: (1) adopting security best practices; (2) advancing toward Zero Trust Architecture; (3) accelerating movement to secure cloud services, including Software as a Service (“SaaS”), Infrastructure as a Service (“IaaS”), and Platform as a Service (“PaaS”); (4) centralizing and streamlining access to cybersecurity data to drive analytics for identifying and managing cybersecurity risks; and (5) investing in both technology and personnel to match these modernization goals.

Tools such as multi-factor authentication and encryption for data at rest and in transit, as well as endpoint detection response, logging, and operating in a zero-trust environment, will be rolled out across federal government networks on a tight timeline. The Order also requires the development of cloud-security technical reference architecture documentation that illustrates recommended approaches to cloud migration and data protection, as well as the development and issuance of a cloud-service governance framework. Notably, the Order also requires modernization of the existing FedRAMP program, a government-wide program that delivers a standard approach to the security assessment, authorization, and continuous monitoring of cloud products and services.

Sec. 4.  Enhancing Software Supply Chain Security.

The Order also seeks to improve the security of commercial software used by the federal government in three ways. First, the Order calls for the creation of baseline guidelines and standards for the security of software used by the federal government based on industry best practices established by the National Institute of Standards and Technology (“NIST”) with input from “the Federal Government, private sector, academia, and other appropriate actors.” Second, the Order seeks to jumpstart the market for secure software by leveraging federal buying power. The Order requires the FAR Council to consider recommendations for contract language requiring software suppliers to comply with, and attest to complying with, the new software standards. Agencies will then be directed to remove and remediate software products that do not meet the amended FAR requirements. Third, the Order directs NIST to develop a cybersecurity “pilot program” labeling initiative to give consumers visibility into the security of the software.

Sec. 5.  Establishing a Cyber Safety Review Board.

The Order establishes a Cyber Safety Review Board composed of both federal officials and representatives from private-sector entities to review and assess threat activity, vulnerabilities, mitigation activities, and agency responses related to “significant” cyber incidents. The Board, which is modeled after the National Transportation Safety Board’s investigations of civil transportation incidents, would convene following significant cyber incidents and provide recommendations for improving cybersecurity and incident response practices.

Sec. 6.  Standardizing the Federal Government’s Playbook for Responding to Cybersecurity Vulnerabilities and Incidents.

As current cybersecurity vulnerability and incident response procedures vary across agencies, the Order calls for standardized response processes to “ensure a more coordinated and centralized cataloging of incidents and tracking of agencies’ progress toward successful responses.” The Order mandates that federal agencies work together in the development of a “standard set of operational procedures (playbook)” that incorporates NIST standards, as well as articulates all phases of an incident response while also building in flexibility. The Administration intends for this playbook to “also provide the private sector with a template for its response efforts.”

Sec. 7.  Improving Detection of Cybersecurity Vulnerabilities and Incidents on Federal Government Networks.

Endpoint detection and response is an emerging technology intended to address the need for continuous monitoring and response to advanced threats. The Order calls for an Endpoint Detection and Response (EDR) initiative to “support proactive detection of cybersecurity incidents within Federal Government infrastructure, active cyber hunting, containment and remediation, and incident response.” Federal adoption of EDR has lagged behind the private sector, which has already begun incorporating it as central component of cybersecurity programs within industry.

Sec. 8.  Improving the Federal Government’s Investigative and Remediation Capabilities.

The Order requires “agencies to establish requirements for logging, log retention, and log management, which shall ensure centralized access and visibility for the highest level security operations center of each agency,” and requires that the FAR Council consider the recommendations for these policies in promulgating the revisions to the FAR described in Section 2 of the Order. Therefore, companies should anticipate changes to contractual requirements to establish logging policies.

Sec. 9.  National Security Systems.

The Order calls for “National Security Systems requirements that are equivalent to or exceed the cybersecurity requirements set forth in this order that are otherwise not applicable to National Security Systems,” which will be reflected in a National Security Memorandum (“NSM”). Generally speaking, a “national security system” is an information system used or operated by an agency or contractor that involves intelligence activities, cryptologic activities, command and control of military forces, equipment integral to a weapon or weapons system, or that is critical to the fulfilment of military or intelligence missions.

III.  Analysis and Takeaways

Among the many takeaways from the Order, the most noteworthy is the expected and intended impact beyond federal agencies and contractors, given the express goal of influencing the broader private sector’s cybersecurity best practices. The Order’s ultimate impact will largely be shaped by the regulations issued in the coming months to comply with these new requirements.

• The Order contemplates an aggressive timeline for these reforms, with deadlines ranging between 45 and 120 days for agencies to begin implementing many of the Order’s key requirements.
• Many of these requirements have already been established as common or best practices in the private sector, but widespread adoption by federal agencies may encourage additional private sector businesses to conform to these standards.
• With the forthcoming guidelines, private companies — regardless of whether they intend to pursue federal contracts — may see a new “best practice” to which its own standards will be compared and evaluated. As a result, the requirements promulgated in response to the Order could impact what amounts to “reasonableness” and the duty of care for civil liability.
• The Order’s recognition of the need for collaboration and cooperation between the federal government and the private sector creates an opportunity for input from private sector stakeholders. Industry should monitor forthcoming rulemakings to implement the Order and consider opportunities to comment.

The legal issues and obligations related to Executive Order 14028, entitled “Improving the Nation’s Cybersecurity,” are likely to shift as federal agencies implement its provisions. We will continue to monitor and advise on developments to stay on the forefront of this rapidly-changing area. We are available to guide companies through these and related issues. Please do not hesitate to contact us with any questions.

____________________

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

[2]   Steve Morgan, Cybercrime To Cost The World $10.5 Trillion Annually By 2025, Cybercrime Magazine (Nov. 13, 2020), https://cybersecurityventures.com/cybercrime-damage-costs-10-trillion-by-2025/.

---

This alert was prepared by Alexander H. Southwell, Eric D. Vandevelde, Ryan T. Bergsieker, Lindsay M. Paulin, Jennifer Katz and Terry Y. Wong.

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 in the firm’s Privacy, Cybersecurity and Data Innovation or Government Contracts practice groups, or the following authors:

Alexander H. Southwell – New York (+1 212-351-3981, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
Lindsay M. Paulin – Washington, D.C. (+1 202-887-3701, [email protected])
Jennifer Katz – New York (+1 212-351-4066, [email protected])

Privacy, Cybersecurity and Data Innovation 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])
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])
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, [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])
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, [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])

Government Contracts Group:
Dhananjay S. Manthripragada – Los Angeles (+1 213-229-7366, [email protected])
John W.F. Chesley – Washington, D.C. (+1 202-887-3788, [email protected])
Joseph D. West – Washington, D.C. (+1 202-955-8658, [email protected])
Lindsay M. Paulin – Washington, D.C. (+1 202-887-3701, [email protected])
Justin Paul Accomando – Washington, D.C. (+1 202-887-3796, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

On April 28, 2021, the U.S. Senate approved a resolution to repeal EPA’s 2020 policy amendments to regulations of upstream and midstream oil and gas operations. Under the 2020 policy amendments, the Trump Administration had declined to regulate oil and gas transmission and storage operations or set methane emission limits under Section 111 of the Clean Air Act’s (“CAA”) New Source Performance Standards (“NSPS”). If the U.S. House of Representatives approves the resolution and it is signed by the President, then the 2020 policy amendments would no longer be in effect, thus restoring key aspects of an earlier rule from the Obama Administration regulating methane from production and processing facilities at upstream oil and gas facilities as well as transmission and storage operations.

Key Takeaways:

• The recent Senate resolution targets the last Administration’s rulemaking declining to regulate methane emissions from production and processing operations at oil and gas facilities. The soon-to-be repealed rule also declined to regulate associated transmission and storage operations.
• Once the House of Representatives passes the same resolution and it is signed into law by President Biden, EPA will be able to quickly commence regulation of methane emissions for this sector as well as volatile organic compounds (“VOC”) and methane emissions for transmission and storage operations.
• Impacted sources in the sector should begin evaluating compliance with the 2016 Obama Administration rules governing methane from production and processing operations as well as transmission and storage operations.
• For production and processing operations, compliance with methane requirements should complement existing VOC compliance programs under NSPS Subpart OOOOa, although additional requirements could attach for operations in areas of ozone nonattainment.
• The 2020 technical amendments to the NSPS Subpart OOOOa program governing production and processing operations remain unaffected.

Detailed Analysis: Beginning in 2012 and again in 2016, the Obama administration promulgated new regulations of the oil and gas industry under the CAA’s NSPS (“2016 NSPS”). Pursuant to the 2016 NSPS, the transmission and storage segment of the oil and gas industry was included in the NSPS regulated source category.[1] This applied the NSPS standards to storage tanks, compressors, equipment leaks, and pneumatic controllers, among other sources in the transmission and storage segment.[2] The 2016 NSPS also added methane emission limits for the same segment.[3]

In 2020, EPA repealed these changes, issuing final policy amendments that removed the transmission and storage segment sources from the NSPS source category.[4] Further, EPA rescinded the separate methane emission limits for the production and processing segments of the source category while retaining limits for VOCs, and EPA also interpreted the CAA to require a “significant contribution finding” for any particular air pollutant before setting performance standards for that pollutant unless EPA addressed the pollutant when first listing or regulating the source category.[5] This latter requirement was significant, among other reasons, because the EPA did not consider methane emissions at the time it initially listed the oil and gas source category in 1979, and would thus require “significant contribution finding” for methane.[6]

In a separate rulemaking also finalized in 2020, EPA made a number of separate technical amendments to the 2016 NSPS.[7] This final rule was not cited in the resolution that passed the Senate.

This week, Congress began the process of reversing course. The Senate passed a resolution, S.J. RES. 14,[8] which disapproved of the EPA’s 2020 policy amendments. The Senate voted by a 52-42 margin, with three Republicans voting in the majority, to repeal the 2020 policy amendments pursuant to its authority under the Congressional Review Act (“CRA”). Pursuant to the CRA, certain agency rules must be reported to Congress and the Government Accountability Office.[9] After receiving the report, Congress is authorized to disapprove of the promulgated rule within 60 session days.[10] Significantly, when certain criteria are met, a joint resolution of disapproval cannot be filibustered in the Senate.[11] Moreover, disapproval carries with it longer term effects: the CRA prohibits a rule in “substantially the same form” as the disapproved rule from being subsequently promulgated (unless so authorized by a subsequent law).

Although the Senate resolution is a significant step towards repeal of the 2020 policy amendments, the 2016 NSPS are not yet back in effect. In order to repeal the 2020 rule and reinstate the 2016 NSPS (subject to the technical changes finalized in 2020 that are unaffected by the CRA resolution), the House of Representatives will also need to pass the same resolution, which it is expected to vote on in the coming weeks.[12] Disapproval renders the 2020 rule “as though such rule had never taken effect.”[13] Questions remain as to whether this repeal will reignite past litigation challenging the 2012 and 2016 NSPS rulemakings.

Affected facilities in the transmission and storage segments of the source category that will soon be subject to the NSPS should prepare for compliance. Furthermore, all facilities in the source category subject to NSPS, including in the production and processing segments, should ensure that they have adequate controls to meet the 2016 NSPS requirements for methane emissions. The practical impact of this reversion is uncertain, particularly given EPA’s findings in 2020 that separate methane limitations for these segments of the industry are redundant because controls used to reduce VOC emissions also reduce methane. Moreover, given the uncertainty created by the CRA’s language that a disapproved rule is rendered not only ineffective moving forward but also “as though such rule had never taken effect,” EPA likely will need to issue guidance to regulated entities in order to explain its expectations for compliance and the timing thereof. EPA likely also will need to promulgate a ministerial rule restoring the applicable regulatory text from the 2016 NSPS in the Code of Federal Regulations.

Litigation over the 2012 and 2016 rulemakings, currently held in abeyance, likely will resume in the wake of this resolution. In addition, EPA will once again be responsible for issuing an existing source rule for this source category. Because EPA rescinded methane limits for the source category, EPA was no longer required to issue emission guidelines to address existing sources. This will change after the CRA resolution is approved.

_____________________

  [1]  EPA Issues Final Policy Amendments to the 2012 and 2016 New Source Performance Standards for the Oil and Natural Gas Industry: Fact Sheet, epa.gov (Aug. 13, 2020), https://www.epa.gov/sites/production/files/2020-08/documents/og_policy_amendments.fact_sheet._final_8.13.2020_.pdf.

  [2]  EPA’s Policy Amendments to the New Source Performance Standards for the Oil and Gas Industry, epa.gov (Aug. 2020), here.

  [3]  Supra note 1.  For additional analysis of the previous standard, see S. Fletcher and D. Schnitzer, “Inside EPA’s Plan for Reducing Methane Emissions,” Law360 (Aug. 20, 2015), available at https://www.gibsondunn.com/wp-content/uploads/documents/publications/Fletcher-Schnitzer-Inside-EPAs-Plan-For-Reducing-Methane-Emissions-Law360-08-20-2015.pdf; “Client Alert: EPA Announces Program Addressing Methane Emissions from Oil and Gas Production,” (Jan. 15, 2015), available at https://www.gibsondunn.com/epa-announces-program-addressing-methane-emissions-from-oil-and-gas-production/

  [4]  Supra note 1.

  [5]  Id.

  [6]  See id.

  [7]  Id.

  [8]  A joint resolution providing for congressional disapproval under chapter 8 of title 5, United States Code, of the rule submitted by the Environmental Protection Agency relating to “Oil and Natural Gas Sector: Emission Standards for New, Reconstructed, and Modified Sources Review”, S.J.Res.14, 117th Cong. (2021).

  [9]  5 U.S.C. §801(a)(1)(A).

[10]  See 5 U.S.C. §802.

[11]  See 5 U.S.C. §802(d).

[12]  Jeff Brady, Senate Votes To Restore Regulations On Climate-Warming Methane Emissions, NPR (Apr. 28, 2021), https://www.npr.org/2021/04/28/991635101/senate-votes-to-restore-regulations-on-climate-warming-methane-emissions.

[13]  5 U.S.C. §801(f).

---

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 Litigation and Mass Tort practice group, or the following authors:

Stacie B. Fletcher – Washington, D.C. (+1 202-887-3627, [email protected])
David Fotouhi – Washington, D.C. (+1 202-955-8502, [email protected])
Mark Tomaier – Orange County, CA (+1 949-451-4034, [email protected])

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

Environmental Litigation and Mass Tort Group:
Stacie B. Fletcher – Washington, D.C. (+1 202-887-3627, [email protected])
Daniel W. Nelson – Washington, D.C. (+1 202-887-3687, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

Join Gibson Dunn panelists Michelle Kirschner and Matthew Nunan for a discussion of:

• Recent FCA criminal prosecutions;
• Lessons for board governance from the Aviva plc Final Notice;
• Update on the Investment Firms Prudential Regime (IFPR) and remuneration;
• Crystal ball gazing

View Slides (PDF)

---

---

Michelle M Kirschner: A partner in the London office. She advises a broad range of financial institutions, including investment managers, integrated investment banks, corporate finance boutiques, private fund managers and private wealth managers at the most senior level.

Matthew Nunan: A partner in the London office. He specializes in financial services regulation and enforcement, investigations and white collar defense.

Martin Coombes: An associate in the London office and a member of the Financial Institutions group. He specialises in advising on UK and EU financial services regulation.  This includes a wide range of financial services and compliance issues including advice on UK and EU regulatory developments, the regulatory aspects of corporate transactions and the on-going compliance obligations of financial services firms.

Chris Hickey: An associate in the London office and a member of the firm’s Financial Institutions group. He advises on a range of UK and EU financial services regulatory matters. This includes the regulatory elements of corporate transactions, regulatory change management and ongoing compliance requirements to which firms are subject.

---

CPD TRAINING/MCLE CREDIT INFORMATION:

Gibson, Dunn & Crutcher LLP is authorized by the Solicitors Regulation Authority to provide in-house CPD training. This program is approved for CPD credit in the amount of 1.0 hour. Regulated by the Solicitors Regulation Authority (Number 324652).

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

This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

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

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