On his first day in office, President Biden signed an Executive Order that directed his administration to focus on addressing climate change, and issued a mandate that certain agencies immediately review a number of agency actions from the previous administration regarding greenhouse gas (GHG) emissions.[1] In keeping with that directive, the National Highway Traffic Safety Administration (NHTSA) and the U.S. Environmental Protection Agency (EPA) have formally announced their intent to reconsider the 2019 Safer Affordable Fuel-Efficient Vehicles Rule Part One: One National Program (SAFE 1),[2] which curtailed California’s ability to establish and enforce more stringent GHG emission standards and a Zero Emission Vehicle (ZEV) sales mandate.[3] These steps are consistent with the Biden administration’s efforts to move swiftly to reexamine—and possibly to revoke—environmental regulations promulgated under the Trump administration, and could serve as a prime example of the shifting regulatory landscape for industries subject to GHG regulations.

Through SAFE 1, EPA withdrew the portions of California’s waiver under Section 209(b)(1) of the Clean Air Act (CAA) that allowed California to establish its own GHG emission standards and establish a mandate for the sale of ZEVs.[4] EPA went on to interpret the CAA as preventing other states from adopting California’s GHG standards, as well.[5] In the same action, NHTSA similarly cut back on California’s independent regulatory powers by concluding that NHTSA’s authority to regulate fuel economy under the Energy Policy and Conservation Act (EPCA) preempted all state and local regulations “related to” fuel economy.[6]

On April 22 and April 23, 2021, respectively, NHTSA and EPA formally announced that they are reconsidering this action, and will be soliciting public comment on the agencies’ separate proposed paths forward.

NHTSA

On April 22, 2021, NHTSA issued a notice of proposed rulemaking that would repeal those portions of SAFE 1 (including the regulatory text and interpretive statements in the preamble) that found California’s GHG and ZEV mandates preempted by EPCA.[7] In particular, NHTSA proposes to conclude that it lacks legislative rulemaking authority to issue a preemption regulation. The notice does not take a position on the substance of EPCA preemption. Rather, NHTSA says merely that it seeks to restore a “clean slate”—i.e., to take no formal agency position on express preemption by EPCA.[8]

The notice goes on to state, however, that even if NHTSA had legislative rulemaking authority, it would nonetheless repeal SAFE 1 because “NHTSA now has significant doubts about the validity of its preemption analysis as applied to the specific state programs discussed in SAFE 1,”[9] including federalism concerns and concerns with the “categorical” manner of the analysis taken in SAFE 1.[10]

NHTSA’s notice of proposed rulemaking includes a comment period of 30 days after publication in the Federal Register, which is expected in the coming days.

EPA

One day after NHTSA issued its notice, EPA announced its parallel action on SAFE 1. In its notice, EPA takes no new positions on the Agency’s authority to withdraw a previously granted waiver or the statutory interpretation of CAA Section 209.[11] Rather, EPA’s notice merely summarizes its past positions and tees up these issues, along with issues raised in administrative petitions, for public comment as part of a reconsideration. The notice states that the Agency now believes that there are “significant issues” with the positions taken in SAFE 1 and that “there is merit in reviewing issues that petitioners have raised” in the reconsideration petitions submitted to EPA.[12] However, the notice does not propose to take any specific alternative interpretation.

Notably, EPA has not initiated a rulemaking proceeding, but rather describes this as an informal adjudication.[13] The Agency also states that for waiver decisions, “EPA traditionally publishes a notice of opportunity for public hearing and comment and then, after the comment period has closed, publishes a notice of its decision in the Federal Register. EPA believes it is appropriate to use the same procedures for reconsidering SAFE 1.”[14]

A virtual public hearing will take place on June 2, 2021, and EPA will accept comments until July 6, 2021.[15]

Conclusion

In announcing the reconsideration of SAFE 1, EPA Administrator Michael Regan stated, “Today, we are delivering on President Biden’s clear direction to tackle the climate crisis by taking a major step forward to restore state leadership and advance EPA’s greenhouse gas pollution reduction goals.”[16] Final agency actions resulting from these reconsiderations are still months away, but EPA’s and NHTSA’s announcements signal the agencies’ continuing focus on GHG emissions and revisiting regulations issued by the previous administration. As executive branch agencies continue to carry out the directives in President Biden’s Executive Orders related to climate change, the landscape for regulated industries will remain in flux.

___________________________

[1]      Exec. Order No. 13990, 86 Fed. Reg. 7037, 7041 (Jan. 25, 2021) (issued Jan. 20, 2021).

[2]      84 Fed. Reg. 51310 (Sept. 27, 2019). The SAFE 1 Rule was challenged in a series of consolidated cases before the U.S. Court of Appeals for the D.C. Circuit, where Gibson Dunn represented a coalition of automotive industry members as Intervenors in support of the rule. See Union of Concerned Scientists v. NHTSA, No. 19-1230 (D.C. Cir.). That matter has been held in abeyance at the request of the United States pending further review of the SAFE 1 rulemaking by EPA and NHTSA.

[3]      Press Release, U.S. Dep’t of Transp., NHTSA, NHTSA Advances Biden-Harris Administration’s Climate & Jobs Goals (Apr. 22, 2021), here; U.S. EPA, Notice of Reconsideration of a Previous Withdrawal of a Waiver for California’s Advanced Clean Car Program (Light-Duty Vehicle Greenhouse Gas Emission Standards and Zero Emission Vehicle Requirements), here.

[4]      84 Fed. Reg. at 51328.

[5]      Id. at 51350.

[6]      Id. at 51313.

[7]      U.S. Dep’t of Transp., NHTSA, Notice of Proposed Rulemaking (prepublication version), Corporate Average Fuel Economy (CAFE) Preemption (Apr. 22, 2021), here.

[8]      Id. at 12.

[9]      Id. at 13.

[10]    Id. at 37.

[11]    U.S. EPA, Notice of Reconsideration (prepublication version), California State Motor Vehicle Pollution Control Standards; Advanced Clean Car Program; Reconsideration of a Previous Withdrawal of a Waiver of Preemption; Opportunity for Public Hearing and Public Comment (Apr. 23, 2021), here.

[12]    Id. at 7.

[13]    Id. at 27.

[14]    Id.

[15]     Id. at 2.

[16]    Press Release, U.S. EPA, EPA Reconsiders Previous Administration’s Withdrawal of California’s Waiver to Enforce Greenhouse Gas Standards for Cars and Light Trucks (Apr. 26, 2021), here.


The following Gibson Dunn lawyers assisted in preparing this client update: Ray Ludwiszewski, Stacie Fletcher, David Fotouhi, Rachel Corley, and Veronica Till Goodson.

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 practice leaders and authors in Washington, D.C.:

Stacie B. Fletcher – Co-Chair (+1 202-887-3627, [email protected])
David Fotouhi (+1 202-955-8502, [email protected])
Raymond B. Ludwiszewski (+1 202-955-8665, [email protected])
Daniel W. Nelson – Co-Chair (+1 202-887-3687, [email protected])
Rachel Levick Corley (+1 202-887-3574, [email protected])
Veronica Till Goodson (+1 202-887-3719, [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.

This April 2021 edition of Gibson Dunn’s Aerospace and Related Technologies Update discusses newsworthy developments, trends, and key decisions from 2020 and early 2021 that are of interest to companies in the aerospace, space, defense, satellite, and drone sectors as well as the financial, technological, and other institutions that support them.

This update addresses the following subjects: (1) commercial unmanned aircraft systems, or drones; (2) recent government contracts decisions involving companies in the aerospace and defense industry; and (3) the commercial space sector.

___________________

TABLE OF CONTENTS

I.  Unmanned Aircraft Systems

A. New Rules Remote ID
B. Flight Over People, Over Vehicles, or at Night
C. Continued Lack of Clarity on Airspace
D. Newsworthy FAA Approvals
E. COVID-19 and Use of Drones

II.  Government Contracts

III.  Space

A. First Private Human Space Launch
B. Noteworthy Space Achievements in Countries Other than the United States
C. Other Noteworthy Space Developments
D. NASA’s Perseverance Rover, Past Updates, and Future Plans
E. Record-Setting Private investment
F. Satellite Internet Constellations
G. Expected Impact of Biden Administration

___________________

I.  Unmanned Aircraft Systems

A.  New Rules Remote ID

On December 28, 2020, the FAA released final rules regarding the Remote Identification of Unmanned Aircraft (“Remote ID”) and operations at night.[1] These rules, published in the Federal Register on January 15, 2021,[2] require that certain unmanned aircraft (“drones”) broadcast their identification and location during operation. The final rules reflect the FAA’s attempt to balance the competing interests in the federal airspace between commercial operators, hobbyists, law enforcement, and the general public.

The FAA received significant feedback on the Remote ID rules following its initial December 31, 2019 Notice of Proposed Rulemaking (“NPRM”), accumulating over 53,000 comments from manufacturers, organizations, state and local governments, and a significant number of individual recreational pilots.[3] In a departure from the original proposal, under the final rule, drones must broadcast the required Remote ID information “using radio frequency spectrum compatible with personal wireless devices” rather than over the internet to a third-party service provider.[4] The FAA received substantial feedback criticizing the original proposal as expensive and requiring additional hardware and a data plan from a wireless carrier, depending on internet connectivity.[5] But with drones now required to broadcast Remote ID information over ranges that can be received by cell phones, members of law enforcement and the general public will be able to receive the broadcasts and determine flight information about drones flying in their vicinity without special receiving technology.[6]

Compliance with Remote ID Rules

The rules create three ways in which operators and manufacturers can comply with the Remote ID rules: (1) a drone containing “Standard Remote ID,” (2) a drone retrofitted with a “broadcast module,” and (3) a drone without Remote ID operating recreationally in specified areas.[7] The rules include an exception for drones weighing less than 0.55 pounds (250 grams), which are not subject to the Remote ID rules if flown recreationally.[8]

Standard Remote ID

The primary form of compliance is “Standard Remote ID.”[9]  Standard Remote ID is built into a drone at the time of manufacturing and tested for compliance via FAA-approved methods. It requires the most robust broadcast, including the location of both the drone and its operator, along with certain flight parameters, a unique ID assigned to the drone and registered by the operator, and an emergency status indication. Additionally, Standard Remote ID drones must be configured to prevent takeoff if the Remote ID equipment is not functional.

Remote ID Broadcast Module

The second form of compliance involves the installation on a drone of a Remote ID “broadcast module.”[10] This allows drones not manufactured with Standard Remote ID, including those currently in use, to comply with the Remote ID rules. The broadcast module’s transmission is similar to Standard Remote ID, except that it broadcasts the takeoff location rather than the location of the operator. Furthermore, drones outfitted with a broadcast module are not required to send an emergency status indication, and need not prevent the drone from taking off if the module is not functional. Unlike Standard Remote ID drones, those fitted with a Remote ID broadcast module are expressly limited to operation within visual line of sight.

Manufacturers should not rely on the Remote ID broadcast module moving forward. Starting eighteen months after the final rule becomes effective, manufacturers must meet the Remote ID standard in their production of drones. Restrictions on operation of noncompliant drones will take effect thirty months after the final rule becomes effective. As of now, the FAA has delayed implementation of the rule until April 21, 2021 as part of the Biden administration’s regulatory freeze.[11]

FAA-Recognized Identification Areas

Lastly, the new rules create FAA-Recognized Identification Areas (“FRIAs”) in which drones can be operated recreationally without complying with the Remote ID rules.[12] FRIAs are fixed locations where drones can be flown safely, thus preserving minimally regulated operations at hobbyist airfields, such as those maintained by the Academy of Model Aeronautics. In a departure from the proposed rules in the NPRM, which limited applicants to community-based organizations, the new rules expanded the list of potential FRIA applicants to include educational institutions.

Addressing Concerns Regarding Improper Use

The commercial drone industry has faced questions and concerns that drones will be operated in an unprofessional manner or used by malicious individuals to obtain data for nefarious purposes.[13] Law enforcement and government agencies have also shared concerns related to illegal operations, such as interference with manned aircraft.[14] The Remote ID rules will help address those concerns by allowing these organizations to identify the drone owner or determine if the drone is not equipped with Remote ID and not legally operating. Addressing these concerns will minimize some of the resistance the industry has faced. Further, Remote ID helps lay a foundation for an ecosystem in which tens of thousands of drones operate autonomously beyond visual line of sight on a daily basis. Although the current rules may be modified and more technology-developed, transmitting basic identification and location information will be a pillar of future large-scale autonomous operations. These rules are an important early step on the path to an integrated regime for regulating a rapidly growing body of unmanned aeronautical operations.

B.  Flight Over People, Over Vehicles, or at Night

On December 28, 2020, the FAA released final rules impacting drone operations over people, over moving vehicles, or at night.[15] Prior to the new rules, Part 107 of the FAA regulations required commercial drone operators to receive a waiver in order to fly over people, over moving vehicles, or at night. In early 2019, the FAA and the Department of Transportation shared an NPRM, proposing alterations to Part 107 to make the operation of small unmanned aircraft over people or at night legal, under certain circumstances, without a waiver. On January 15, 2021, the final rule was published in the Federal Register.[16] The rule is scheduled to take effect on April 21, 2021.[17]

Drone Operations Over People

The new law permits commercial drone operations over people under certain conditions based on four categories of drones operating under Part 107. Category One, Two, and Four drones must be compliant with Remote ID rules discussed above to have sustained flight over open-air assemblies, but Category Three drones may never operate over open-air assemblies.

Category One is the most lenient category, consisting of drones that are both under 0.55 pounds (250 grams) and lack any exposed rotating parts that would cause lacerations.[18] Due to the weight restrictions, the drones in this Category will most likely initially be limited to photography and videography drones, but these restrictions may result in innovation of new lightweight sensors for expanded operations within Category One.

Categories Two and Three cover drones greater than 0.55 pounds and less than 55 pounds.[19] These categories allow drones to be flown over people only if the manufacturer has proven that a resulting injury to a person would be under a specified severity threshold. Category Two aircraft will need to demonstrate a certain injury threshold, and Category Three aircraft will have a higher injury threshold with additional operating limitations. Category Three drones can only operate over people (1) in a restricted access site in which all individuals on the ground have notice, or (2) without maintaining any sustained flight over people unless they are participating in the operations or protected by a structure.[20]

The new rules also created a fourth category that was not included under the proposed rules, but clarifies that specific drones for which the FAA has issued an airworthiness certificate under Part 21 can conduct operations over people unless prohibited under its operating limitations.[21]

Drone Operations Over Moving Vehicles

Although the proposed rule did not allow operations over moving vehicles, the final rule does allow such operations under two circumstances: (1) if in a restricted access site and the people in the vehicle are on notice, or (2) when the drone does not maintain sustained flight over moving vehicles.[22] This addition is a welcome change for all drone operators who no longer have to cancel, delay, or change an operation due to an unexpected vehicle or nearby traffic.

Drone Operations at Night

The rule also allows operations at night under two conditions: (1) the remote pilot in command must complete an updated initial knowledge test or online recurrent training, and (2) the drone must have proper anti-collision lighting that is visible for at least three statute miles.[23] Operators will be pleased with this change because it removes the need for nighttime waivers and delays associated with obtaining such waivers.

Looking Ahead

The Part 107 changes are steps in the right direction for increased commercial use of drones. Operating over people, moving vehicles, and at night expands the applications and timing of operations available to commercial operators. The additions to the proposed rules, such as permitting operations over moving vehicles, are an indication that the FAA is listening to the drone community and working to advance this industry.

C.  Continued Lack of Clarity on Airspace

While new rules for Remote ID and operations over people, over moving vehicles, and at night are helpful to move the industry forward, they do not address the most challenging legal issue that remains for the commercial drone industry: control of low-altitude airspace. It remains unclear as to how much, if any, airspace is owned by private landowners and whether states and municipalities have any jurisdiction over low-altitude airspace. Furthermore, a legislative solution on this issue is increasingly improbable, and it will instead likely be decided by the courts years in the future.

In a nutshell, the confusion regarding low-altitude operations stems from the FAA’s claim that it controls the airspace “from the ground up” and that the claim that it does not control all the airspace below 400 feet is a “myth.”[24] However, many local governments and property owners do not agree with the FAA’s interpretation.  While the FAA has jurisdiction over “navigable airspace,” many assert that the boundary of where that airspace ends and begins is far from clear.[25]

To date, this boundary has not been directly addressed by a court in the context of drones. The closest that federal courts have come to addressing this issue was in July 2016 when U.S. District Judge Jeffrey Meyer, of the District of Connecticut, questioned the FAA’s position: “[T]he FAA believes it has regulatory sovereignty over every cubic inch of outdoor air in the United States . . . . [T]hat ambition may be difficult to reconcile with the terms of the FAA’s statute that refer to ‘navigable airspace.’”[26] The dicta raised the question of where the FAA’s authority begins, but noted that the “case does not yet require an answer to that question.”[27] In time a case will require such an answer.

The legal uncertainty surrounding low-altitude operations remains one of the most significant barriers to large-scale commercial operations, and it is likely to be one of the most important issues for the industry for years to come.

D.  Newsworthy FAA Approvals

This past year saw several groundbreaking approvals of new uses for unmanned aircraft systems, specifically in operations beyond the visual line of sight and in the agricultural context. The industry also saw progress in setting airworthiness standards.

Beyond the Visual Line-of-Sight Approvals

Perhaps the most well-known approval occurred in August 2020, when, according to public filings, the FAA approved Amazon’s use of a fleet of Prime Air delivery drones, allowing the company to expand its unmanned package delivery operations.[28] The FAA issued this authorization under Part 135 of its Unmanned Aircraft Systems regulations, which govern the use of drones beyond the visual line of sight (“BVLOS”) of the operator.[29] Although the Prime Air fleet is not yet fully scaled, this authorization enables the company to soon be able to deliver packages weighing five pounds or less in areas with relatively low population density.[30]

Further expanding the boundaries of BVLOS drone use, the FAA gave its first-ever approval of a company’s use of automated drones without a human operator on site earlier this year.[31] In January 2021, the FAA authorized American Robotics, a Boston-based drone systems developer that specializes in operating in rugged environments, to begin such automated operations.[32] Obtaining this approval required a four-year testing program in which the company ran up to ten automated drone flights per day.[33] While only beginning to be fully understood, the automated use of drones without the need for on-site human personnel could have enormous ramifications for the agricultural, energy, and infrastructure industries.[34]

Agricultural Use Approvals

The agricultural industry may experience additional aerospace innovation after the FAA approved the Iowa-based startup Rantizo’s use of drone swarms to spray crops.[35] The company received approval in July 2020 to operate three-drone swarms, which move in concert with one another with the help of one drone operator and one visual observer.[36] The approval will allow the company to cover between 40 and 60 acres of farmland per hour.[37]

Rantizo was not the only company to receive approval to operate drone swarms. In October 2020, the company DroneSeed obtained FAA approval to use five-drone swarms of heavy-lift drones beyond the visual line of sight for reforestation efforts in Arizona, California, Colorado, Montana, New Mexico, and Nevada.[38] Each of the company’s drones can carry up to a 57-pound payload, and reports suggest that the company may focus its reforestation efforts on areas ravaged by wildfires.[39]

Creation of Airworthiness Standards

Lastly, in September 2020, the FAA opened for public comment its first-ever set of type-certification airworthiness standards relating to drones, with the goal of streamlining the certification of certain classes of drones.[40] Whereas the FAA has airworthiness standards in place for most types of manned aircraft, allowing companies seeking approval of such vehicles to avoid a cumbersome, case-by-case process, no such process previously existed for drones. The creation of a standard airworthiness certificate for drones as a class of aircraft could significantly shorten the drone approval process, potentially accelerating innovation in the aerospace industry.

E.  COVID-19 and Use of Drones

As discussed in last year’s update, many expected the global COVID-19 pandemic to usher in a new era of drone applications. In the early months of the pandemic, governments began using drones in novel ways: spraying disinfectant across large areas, developing disease detection mechanisms, and even enforcing social distancing requirements. Though these initial reports of drone usage in the age of COVID-19 dealt mostly with disease control efforts, corporations soon shifted their focus to the socially distant environment, turning to drones to facilitate deliveries to consumers and medical providers alike and provide services in a safer way.

Consumer Deliveries

For years, corporations have been hoping to facilitate deliveries via drone, and the pandemic amplified consumer interest. With more and more people looking to avoid crowds and stay at home, demand for drone delivery of consumer goods increased, and many companies deployed their technology to facilitate deliveries via drone.

Wing (Alphabet’s drone delivery company) launched a pilot program in October 2019, partnering with several local retailers to deliver certain products to people in Christiansburg, Virginia.[41] Since the pandemic, it has expanded its program by adding new products and new retailers, and deliveries have more than doubled.[42]

In North Dakota, Flytrex, an airborne delivery service company, launched a program allowing customers to order from a selection of 200 Walmart items.[43] The two companies recently introduced a partnership in North Dakota for grocery deliveries.[44] The company also delivers snacks to golfers at King’s Walk course in North Dakota.[45]

In addition to consumer goods, food delivery via drone has also increased since the pandemic. In fact, Flytrex has begun testing drone delivery of food and drink items in North Carolina.[46] And in Alabama, the company Deuce Drone has partnered with some restaurants for drone doorstep delivery.[47]

As discussed above, in August 2020, Amazon received FAA approval under Part 135 of FAA regulations to “safely and efficiently deliver packages to customers.”[48] This allows Amazon to transport property on small drones “beyond the visual line of sight.”[49] Amazon, which began testing drones in 2013, is continuing to test the technology and has not yet deployed drones at scale.[50]

Medical Supplies Deliveries

Drones also delivered medical supplies in 2020. In May, Zipline, a company that has been using drones to deliver blood in Rwanda since 2016, began delivering medical supplies and personal protective equipment via drones to a medical center in North Carolina.[51]

In November 2020, Wal-Mart received approval to deliver COVID-19 test kits to El Paso, Texas residents.[52] A few months later, Nevada-based Flirtey announced: “that it has successfully conducted multiple deliveries of at-home COVID-19 test kits in Northern Nevada during the initial phase of its test program.”[53] Drone delivery of COVID-19 test kits is more efficient and more convenient, and it reduces exposure risks.[54]

Remote Service Providers

Beyond deliveries, the pandemic also drove up demand for remote services as companies adapted to social distancing guidelines that made providing in-person services more difficult. Since the pandemic started, flights by construction-related companies are up 70%.[55] DroneDeploy, a startup that “has a program that analyzes drone footage of farmers’ fields and helps make recommendations about when to apply pesticides” has reported that these agriculture flights have tripled during the first several months of the pandemic.[56] The company also reported significant increases in flights using its energy app, which helps solar panel installers calculate where best to place the panels.[57]

Lasting Impact?

Though there has certainly been an expansion of drone services in the U.S., this expansion is not widespread. Many of the examples discussed above are limited to small geographic areas and it is still unclear when mass adoption will occur. While the pandemic appears to have pushed forward the adoption of drone delivery and service programs, it is unclear if that mentality will change after societies are no longer quarantined at home. Will there be as much of a demand for drone deliveries and services once there is no longer a pandemic-driven crisis?

Despite these uncertainties, many are optimistic about the future of drone deliveries. Technologies are improving, and most of the elements needed for the widespread adoption of drones are already available in the market.[58]

 II.  Government Contracts

In this update, we summarize select recent government contracts decisions that involve companies in the aerospace and defense industry, as well as decisions that may be of interest to them, from the tribunals that hear government contracts disputes. These cases address a wide range of issues with which government contractors in the aerospace and defense industry should be familiar.

DFARS 252.227-7103(f) Does Not Prohibit Markings On Noncommercial Technical Data That Restrict Third-Party Rights

In The Boeing Co. v. Sec’y of the Air Force, 983 F.3d 1321 (Fed. Cir. 2020), the Federal Circuit considered whether Defense Federal Acquisition Regulation Supplement 252.227-7103(f) (“DFARS 252.227-7103(f)”) applies to legends that restrict only the rights of third parties but do not restrict the rights of the Government. Boeing applied a legend to its technical data that stated, “NON-U.S. GOVERNMENT ENTITIES MAY USE AND DISCLOSE ONLY AS PERMITTED IN WRITING BY BOEING OR THE U.S. GOVERNMENT.” The Government rejected Boeing’s data deliverables because the legend allegedly did not conform to DFARS 252.227‑7103(f), which stated that the contractor could “only assert restrictions on the Government’s rights,” and specified the legends authorized under the contract. The Armed Services Board of Contract Appeals’ (“ASBCA”) decisions below found in favor of the Government. On appeal, Boeing argued that its legend conformed to the requirements of DFARS 252.227-7103(f) because the clause is applicable only to legends that assert restrictions on the Government’s rights, and is silent on legends that assert restrictions on the rights of third parties. The Federal Circuit agreed with Boeing that DFARS 252.227-7103(f) applies only to legends that assert restrictions to the Government’s rights in the data, and is silent on legends that restrict the rights of third parties. The Federal Circuit remanded the decision to the ASBCA to decide whether, as a matter of fact, Boeing’s legend asserted rights that restricted the Government’s rights in the data on which the legend was included.

ASBCA Declines To Decide Whether Fly America Act Applies To Indirect Costs

In Lockheed Martin Corp., ASBCA No. 62377 (Jan. 7, 2021), the ASBCA did not reach the question of whether the Fly America Act, 49 U.S.C.A. § 40118, as implemented by Federal Acquisition Regulation 52.247-63, Preference for U.S.-Flag Air Carriers, applies to a contractor’s indirect costs because there was no “live dispute” between the parties. FAR 52.247-63, “requires that all . . .Government contractors and subcontractors use U.S.-flag air carriers for U.S. Government-financed international air transportation of personnel (and their personal effects) or property, to the extent that service by those carriers is available.” It further requires that “[i]f available, the Contractor, in performing work under this contract, shall use U.S.-flag carriers for international air transportation of personnel (and their personal effects) or property.”

In 1997, Lockheed Martin Corporation and the Government entered into a memorandum of understanding (“MOU”) that the Fly America Act applied only to direct costs. However, in 2019, the corporate administrative contracting officer (“CACO”) withdrew the MOU on the purported basis that the MOU had misinterpreted FAR 52.247-63, and issued a final decision asserting the interpretation that FAR 52.247-63 applies to indirect costs. The ASBCA did not address the merits of the issue, finding that because Lockheed had not changed its practices as a result of the Government’s withdrawal of the MOU or the CACO’s final decision, there was no evidence that there was a live dispute to decide.

ASBCA Clarifies Types Of Activities That Are Not Unallowable Costs Under The FAR

In Raytheon Co. & Raytheon Missile Sys., ASBCA Nos. 59435 et al., (Feb. 1, 2021), the ASBCA issued a lengthy decision on the allowability of various types of costs incurred by Raytheon Company and its business segment Raytheon Missile Systems (“Raytheon”). The ASBCA sustained all but $18,109 of Raytheon’s appeals of the Government’s $11.8 million claims. The types of costs addressed in the decision include costs for Raytheon’s Government relations group, costs for Raytheon’s corporate development group, and airfare costs.

Government Relations Costs. In 2007 and 2008, Raytheon included Government relations group costs as indirect costs in its incurred cost submissions, but withdrew a portion of those costs as unallowable lobbying costs in accordance with FAR 31.205-22, Lobbying and political activity costs, which requires that contractors “maintain adequate records to demonstrate that the certification of costs as being allowable or unallowable…pursuant to this subsection complies with the requirements of this subsection.” The Government disagreed with Raytheon’s practice and disallowed 100 percent of the costs incurred by Raytheon’s Government relations group as expressly unallowable costs.

The ASBCA held that the Government had the burden to prove that the costs were expressly unallowable and that there was no basis to shift the burden to the contractor. The ASBCA further held that the Government did not meet its burden of proving that any of the Government relations costs included in Raytheon’s incurred costs submissions were unallowable, and that Raytheon’s method of removing unallowable lobbying costs was proper based on its disclosed accounting practice.

Corporate Development Costs. Raytheon included a portion of corporate development group costs as indirect costs in its incurred cost submission in 2007 and 2008, but withdrew a portion of the costs as unallowable organizational costs under FAR 32.205-27, Organization Costs. Raytheon implemented a “bright line” rule for its employees to determine the difference between costs for allowable activities under FAR 31.205-12, Economic Planning Costs, and FAR 31.205-38, Selling costs, and costs for unallowable activities under FAR 31.205-27. The Board found Raytheon’s corporate development employees kept track of their time in accordance with the bright line rule, that the allowable costs for the corporate development group were supported by documentation and credible witness testimony, and that the Defense Contract Management Agency (“DCMA”) did not meet its burden of proving that the corporate development costs were unallowable organization costs under FAR 31.205-27.

Airfare Costs. With respect to airfare costs, the ASBCA addressed two distinct issues: (1) whether the pre-Jan. 11, 2010 version of FAR 31.205-46(b) required Raytheon to take into account its corporate discounts in determining its allowable airfare; and (2) whether Raytheon’s policy of allowing business class travel for trans-oceanic flights in excess of 10 hours was reasonable and consistent with FAR 31.205-46(b). Prior to Jan. 11, 2010, FAR 31.205-46(b) stated:

Airfare costs in excess of the lowest customary standard, coach, or equivalent airfare offered during normal business hours are unallowable except when such accommodations require circuitous routing, require travel during unreasonable hours, excessively prolong travel, result in increased cost that would offset transportation savings, are not reasonably adequate for the physical or medical needs of the traveler, or are not reasonably available to meet mission requirements. However, in order for airfare costs in excess of the above standard airfare to be allowable, the applicable condition(s) set forth in this paragraph must be documented and justified.

(Emphasis added.) Effective Jan. 11, 2010, FAR 31.205-46(b) was amended to read: “Airfare costs in excess of the lowest priced airfare available to the contractor during normal business hours are unallowable except …” (emphasis added).

The ASBCA concluded that prior to Jan. 11, 2010, contractors were not required to factor in any negotiated corporate discounts when determining the allowable amounts of airfare costs. The ASBCA also held that Raytheon’s travel policy “documented and justified premium airfare,” as required by FAR 31.205-46(b), and that there is no requirement that premium airfare be “documented and justified” on an individual, flight-by-flight basis. Moreover, the ASBCA held that the CO acted within the scope of his authority when he determined that Raytheon’s travel policy complied with FAR 31.205-46(b), and that his determination was binding on DCMA.

ASBCA Rules That Government Shares Liability for Contractor’s Underfunded Pension Plan

In Appeal of Northrop Grumman Corp., ASBCA No. 61775  (Oct. 7, 2020), the ASBCA found that Northrop Grumman (“NG”)’s valuation of a nonqualified defined benefits pension plan adopted in 2003 and frozen in 2014 was compliant with the Cost Accounting Standards despite the Government’s objections to the company’s valuation methodology. During the plan’s existence, NG allocated its costs to numerous government contracts, all of which included FAR 52.215-15, Pension Adjustments and Asset Reversions; FAR 52.230-2, Cost Accounting Standards; and FAR 52.233-1, Disputes.

When the plan was frozen, NG calculated that the plan’s liabilities exceeded its market value and requested that the Government pay its pro rata share to NG to “true-up” the plan under CAS 413. The Government argued, inter alia, that NG’s reduction to its calculation of investment income to account for taxes on such income was non-compliant with CAS 412. Although the Board disagreed with NG’s approach of reducing its investment rate of return by the marginal tax rate, the Board found that roughly the same outcome would have been achieved had NG accounted for taxes as an administrative expense. Because FAR 30.602(c)(1) provides that the Government should make no adjustment to the contract when there is no material cost difference due to the alleged CAS violation, the Board sustained NG’s appeal and remanded to the parties to calculate the amount due and owing from the Government to NG.

Contractor’s REAs Were Not Contract Disputes Act (“CDA”) Claims Subject to the CDA Statute of Limitations 

In Appeal of BAE Sys. Ordnance Sys., Inc., ASBCA No. 62416 (Feb. 10, 2021), the Board considered whether BAE’s requests for equitable adjustment (“REAs”) constituted claims in light of the Federal Circuit’s recent decision in Hejran Hejrat Co. Ltd v. United States Army Corps of Engineers, 930 F.3d 1354 (Fed. Cir. 2019). In Hejran Hejrat, the Federal Circuit ruled that, under certain circumstances, an REA can actually constitute an implicit request for a final decision.

BAE submitted three REAs seeking reimbursement for state-issued fines it received as a result of environmental conditions at the plant. The contracting officer (“CO”) replied that he would “entertain reimbursement” of a portion of the state fines, but later issued a “final determination” rejecting the REAs entirely.  Subsequently, BAE submitted a CDA claim to which the Government failed to respond. BAE appealed the deemed denial of its claim to the Board. The Army then moved to dismiss the appeal asserting that BAE’s challenge to the CO’s decision was untimely because the REAs were, in fact, CDA claims, and the CO’s final determination upon them was thus a CO’s Final Decision. In denying the government’s motion to dismiss the appeal for lack of jurisdiction as outside of the CDA’s statute of limitations, the Board found that “BAE did all that it could to keep its REAs from falling within the realm of being also considered CDA claims by carefully avoiding making a request — explicit or implicit — for a [contracting officer]’s final decision.” Therefore, the Board found that BAE’s claims were timely filed and denied the government’s motion to dismiss.

III.  Space

A.  First Private Human Space Launch

On November 15, 2020, the launch of SpaceX’s Resilience marked the first “NASA-certified commercial human spacecraft system.”[59] The mission is the first of six crewed missions NASA and SpaceX plan to fly as part of the Commercial Crew Program, a program designed to provide “safe, reliable, and cost-effective transportation to and from the International Space System from the United States.”[60] The crew is comprised of four members, including three NASA astronauts and one member of the Japan Aerospace Exploration Agency.[61]

Resilience autonomously docked at the International Space Station on November 16, 2020 for a sixth-month stay, making it the longest space mission launched from the United States. During the mission, the crew is conducting various science and research investigations, including a “study using chips with tissue that mimics the structure and function of human organs to understand the role of microgravity on human health and diseases.”[62] The crew will also conduct various space walks, encounter several uncrewed spacecraft, and welcome crews from the Russian Soyuz vehicle and the next SpaceX Crew Dragon.[63] At the end of the mission, Resilience will autonomously undock and return to Earth.

B.  Noteworthy Space Achievements in Countries Other than the United States

Countries and private companies are racing to the Moon, Mars, and even asteroids. This space race involves countries that are both newcomers to space and those that seek a return to the unknown.

China

Chang’e-5’s Lunar Exploration Mission

Following the Chang’e-4’s successful lunar exploration mission in 2019,[64] China reached the Moon again in 2020. On November 23, 2020, Chang’e-5 lifted off from Wenchang Space Launch Center on Hainan Island, China and went into the Moon’s orbit on November 28, 2020.[65] The descender craft separated from the orbiter on November 29, 2020 and landed on the Mons Rümker region of Oceanus Procellarum on December 1, 2020.[66] Once on the Moon’s surface, the lander system used a scoop and drill to dig up lunar samples.[67]  After collection and storage, Chang’e-5 made its return to Earth on December 16, 2020, landing in the Siziwang Banner grassland of the autonomous region of Inner Mongolia in northern China.[68] The successful mission retrieved about 1,731 g (61.1 oz.) of lunar samples.[69]  Chang’e-5 was China’s first successful lunar sample return mission,[70] and the first in the world in over four decades since the Soviet Union’s Luna-24 in 1976.[71]

The Chang’e-5 venture demonstrates China’s increasing capability in space, and is part of a broader effort under the Chinese National Space Administration Chang’e Lunar Exploration Program.[72] The Chang’e-6, expected to launch in 2023, will be China’s next lunar sample-return mission.[73]

Tianwen-1 Reaches Mars’s Orbit

China’s first independent interplanetary mission is well underway with the launch of the Tianwen-1 spacecraft on July 23, 2020.[74] After a 202-day, 295-million-mile journey through space, it arrived in orbit around Mars on February 10, 2021.[75] The first phase of Tianwen-1’s mission is to circle Mars’s orbit and map the planet’s morphology and geology, while allowing the orbiter to find a secure landing zone.[76]

About three months after arrival into orbit, in May 2021, the craft’s lander is expected to detach from its orbiter and descend onto Mars’s surface in a region known as Utopia Planitia.[77] Once on the surface, the lander will unveil a rover carrying a panoramic camera.[78] The solar-powered rover will also investigate surface soil characteristics for potential water-ice distribution with a ground-penetrating radar.[79] Tianwen-1 comes on the heels of several successful lunar missions for China’s space program.[80]

China’s Ambitious Plans for a Space Station

China has ambitious plans for a new space station.[81] Tianhe, the station’s core module, is expected to launch sometime in 2021.[82] The module is 59 feet (18 meters) long, weighs about 24 tons (22 metric tons), and will provide living space and life support for astronauts and house the outpost’s power and propulsion elements.[83] Tianhe’s launch will be one of eleven total liftoffs that will be required to build the space station, which China wants to finish by the end of 2022.[84]

China’s iSpace Fails to Reach Orbit During Second Attempt

China’s iSpace, also known as Beijing Interstellar Glory Space Technology Ltd. (a different company than the Japanese lunar startup ispace) was the first Chinese private company to reach orbit when it successfully launched its Hyperbola-1 rocket on July 25, 2019.[85] On February 1, 2021, iSpace’s four-stage Hyperbola-1 rocket failed to reach orbit during its second attempt to go to space.[86]

Despite its failed launch, iSpace is a prominent name in the Chinese private space industry, having raised $173 million in Series B funding for the Hyperbola rocket line. The company has indicated plans for a potential IPO and is in the midst of creating its Hyberbola-2 rocket.[87] Other private Chinese companies, including Galactic Energy, One Space, and Deep Blue Aerospace, are planning launches later this year.[88]

Japan

Hayabusa2’s Samples From Asteroid Ryugu

After spending over a year collecting and storing samples on a near-Earth asteroid named Ryugu,[89] Japan’s Hayabusa2 spacecraft started its journey back towards Earth in November 2019.[90] It completed its yearlong journey to return the asteroid samples back to Earth on December 5, 2020.[91] The return capsule landed in South Australia, carrying with it samples from the asteroid’s surface and interior.[92] From the samples, scientists hope to learn more about the composition of Ryugu’s minerals, as well as the origin and evolution of the solar system.[93]

Hayabusa2 was originally launched in 2014,[94] and its mission is far from over.[95] The Hayabusa2’s main craft separated from the return capsule just two days before the delivery of Ryugu’s samples was complete and retreated back to work on an extended mission.[96] Hayabusa2’s extended mission will feature visits to two more asteroids, one in 2026 and another in 2031.[97]

Japanese Startup Is Targeting the Moon in 2021

A Japanese startup, ispace (a different company than China’s iSpace), is targeting the Moon.[98] On August 22, 2020, company representatives stated ispace intends to go to the lunar surface on a stationary lander in 2021.[99] The company is also planning a second mission in 2023, in which it will deploy a rover for surface exploration.[100] These two missions will ride as secondary payloads on SpaceX Falcon 9 rockets, and together make up ispace’s Hakuto-Reboot program.[101]

United Arab Emirates

Hope Arrives on Mars

On February 9, 2021, the UAE’s Hope orbiter entered into Mars’s orbit,[102] making the UAE the fifth country to visit the Red Planet (China became the sixth the next day with its Tianwen-1 mission),[103] and the first Arab nation in history to do so.[104] Hope will take up a near-equatorial orbit as it observes the planet’s atmosphere, weather, and climate systems.[105] Hope also aims to study the leakage of hydrogen and oxygen into space, which scientists suspect is a contributing factor to Mars missing the once-abundant water that previously occupied its surface.[106]

Russia

Expected Launch of Luna-25 in October 2021

After a nearly half-century hiatus for its space program,[107] Russia is gearing up for a launch to the Moon.[108] Russia’s Luna-25 spacecraft will be the first Russian or Soviet Moon mission since 1976,[109] and will mark the reactivation of Russia’s Moon exploration program.[110] The Luna-25 lander will include scientific instruments to research the composition and structure around the Moon’s south pole.[111]  Luna-25 is expected to launch in October 2021.[112]

Looking Ahead

As more countries join the space race, the global community benefits from all of research, technology, and discoveries resulting from outer space exploration. With upcoming missions to the Moon, Mars, and the development of a space station, the upcoming year is sure to result in tremendous advancement in our understanding of space.

C. Other Noteworthy Space Developments

The last year featured a number of developments in space technology, including from SpaceX, which became the first private company to launch astronauts to space, made progress on its Starship design, and launched a public beta program of its Starlink satellite internet service.

Crewed Flights

On May 30, 2020, SpaceX became the first private company to launch astronauts into orbit.[113] The mission marked the first launch of NASA astronauts from the U.S. since the space shuttles were retired in 2011.[114] The Falcon 9 Rocket carried a Crew Dragon capsule, an upgraded version of SpaceX’s Dragon capsule, which has been used to carry cargo to the space station.[115] While on board, the astronauts, tested all of the systems and verified that they performed as designed.[116] The astronauts arrived at the International Space Station on May 31, 2020,[117] and returned safely to Earth on August 2, 2020.[118]

Just five and a half months later, SpaceX sent astronauts to space again.  As discussed above, on November 15, 2020, NASA’s SpaceX Crew-1 mission lifted off—the first of six crewed missions NASA and SpaceX plan to fly as part of the Commercial Crew Program, a program designed to provide safe, reliable, and cost-effective transportation between the ISS and the U.S.[119] The mission marked many firsts, including “the first flight of the NASA-certified commercial system designed for crew transportation.”[120] In contrast to the May launch, the Crew-1 mission transported four astronauts (three NASA astronauts and one from the Japan Aerospace Exploration Agency) to the International Space Station for a six-month science mission.[121] The crew arrived safely on November 16, and will eventually reboard Crew Dragon for transport back to Earth.[122]

Starship SN Flights

Following the successful launch of its first astronaut mission in May, SpaceX shifted gears to focus on the Starship, the rocket designed to launch cargo and up to 100 passengers at a time on missions to the Moon and Mars.[123] CEO Elon Musk acknowledged that the rocket has many milestones to reach before people can fly in it.[124]

After multiple launches of several starship prototypes failed, on August 4, 2020, SpaceX flew the Starship SN5 test vehicle for the first time ever.[125] Though the SN5 was only in the air for about 40 seconds, the short hop allowed SpaceX to gather valuable data necessary to analyze and smooth out the launch process.[126]

Just several weeks later, SpaceX launched SN6, which rose to nearly 500 feet above the ground before touching down near the launchpad.[127] Similar to the SN5 launch, the launch of the SN6 prototype was used to help SpaceX understand the technologies needed for a fully reusable launch system for deep space missions.[128]

On December 9, 2020, SpaceX launched Starship SN8 to 40,000 feet above its facility in Boca Chica, Texas.[129] After completing several objectives, including testing its aerodynamics and flipping to prepare for landing, the rocket exploded on impact as it attempted to land.[130] SpaceX declared the launch a success; despite the fiery landing, the nearly seven-minute flight provided helpful information to improve the probability of success in the future.[131]

Other Updates

SpaceX launched many satellites into orbit in 2020. Throughout the year, SpaceX launched satellites for the U.S. Space Force[132] and foreign militaries.[133] SpaceX also began to launch satellites for its Starlink mega-constellation, an infrastructure project designed to provide global broadband coverage to people in rural and remote areas.[134] As of January 29, 2021, SpaceX had deployed 1,023 satellites over the course of 18 launches.[135] In October, SpaceX began a public beta program of the Starlink satellite internet service in the northern U.S., Canada, and the U.K.[136] By February 2021, the Starlink satellite internet service had over 10,000 users.[137]

SpaceX had a monumental fundraising year. In May, SpaceX raised more than $346 million.[138] In August, the company reported its largest single fundraising round to date: $1.9 billion in new funding.[139] SpaceX also sold an additional $165 million in common stock.[140] In December, SpaceX began discussing another funding round with investors. This round will likely value the company at a minimum of $60 billion and possibly as high as $92 billion.[141]

D.  NASA’s Perseverance Rover, Past Updates, and Future Plans

Two of NASA’s biggest accomplishments this year were the successful landing of the Perseverance Rover on Mars and the publication of the Artemis Plan, a document that outlines NASA’s intention to return a human to the Moon.

Perseverance Rover

On February 18, 2021, NASA’s Perseverance Rover landed safely in an area known as Jezero Crater on Mars.[142] Perseverance’s mission is to search for signs of ancient life and collect samples of rock and regolith for a return to Earth.[143] The Perseverance Rover will examine Martian dirt and rock with a variety of sophisticated scientific gear, including an instrument called SuperCam, which will zap rocks with a laser and gauge the composition of the resulting vapor.[144] The Rover will also utilize its drill and long robotic arm to collect samples and seal them into special tubes, and these samples will be brought back to Earth, perhaps as early as 2031.[145] Once returned, these samples will be analyzed and studied by scientists for decades to come.[146]

Artemis Plan

The United States is pushing forward on its plans to return to the Moon, with NASA publishing its comprehensive Artemis Plan in September 2020.[147] Under the Artemis Plan, the United States plans to send the next man and first woman to the Moon by 2024, and establish a sustained human presence on the Moon by 2028.[148] However, Congress is only providing $850 million for work on the Human Landing System to support NASA’s Artemis mission, well short of the requested $3.37 billion on the project.[149] This shortfall is the biggest risk to the ambitious goals and timing of the Artemis Plan.[150]

The Artemis I Mission

Artemis I is set to be the first mission under the Artemis Plan, and it is currently scheduled for launch on November 2021.[151] It will be an uncrewed mission from NASA’s Kennedy Space Station in Florida.[152] This mission will allow NASA to test its powerful new Space Launch System and Orion spacecraft.[153]

Commercial Lunar Payload Services

Under the Artemis Plan, NASA established the Commercial Lunar Payload Services initiative (“CLPS”) to partner with the U.S. commercial space industry to introduce new lander technologies and deliver payloads to the surface of the Moon.[154] As of February 2021, NASA had 14 companies on contract through CLPS to bid on delivery science experiments and technology demonstrations to the lunar surface.[155] Most recently, NASA awarded Firefly Aerospace of Cedar, Texas approximately $93.3 million to deliver a suite of ten science investigations and technology demonstrations to the Moon in 2023.[156]

Lunar Orbital Platform Gateway

The Lunar Orbital Platform Gateway is instrumental to NASA’s goal of sustaining a human presence on the Moon.[157] The Gateway will be a station orbiting the Moon that will serve as a holding area for astronaut expeditions and science investigations, as well as a port for deep space transportations.[158] NASA has selected SpaceX to provide launch services for the first two Gateway modules, the Power and Propulsion Element (“PPE”) and Habitation and Logistics Outpost (“HALO”), which are targeted to launch together no earlier than May 2024.[159]

Human Landing System

NASA’s Human Landing System Program (“HLS”) is tasked with developing a lander that will haul two astronauts to the Moon in 2024, and then safely return them to lunar orbit before their trip back to Earth.[160] Three companies have been selected to begin development work for the HLS: Blue Origin (of Kent, Washington), Dynetics, a Leidos company (of Huntsville, Alabama), and SpaceX (of Hawthorne, CA).[161]  HLS is also charged with developing a sustainable, long-term presence on and around the Moon.[162]

E.  Record-Setting Private investment

Over the past several years, there has been increased interest in investing in pure aerospace companies, and more recently, space and space-satellite-based companies have become the focus of special-purpose acquisition companies (“SPACs”).[163] Numerous milestones are driving the rise of space stocks traded on exchanges. For example, companies such as Virgin Galactic have been developing, and are on the cusp of starting, a commercial space tourism service; AstraSpace is entering the public market through a blank-check merger with Holicity; and Momentus is going public via Stable Road Capital, among others.[164] In addition to the above, exchange traded funds (“ETF”) have been rising in popularity as well.

To further illustrate the above, one only has to look to ETFs such as Procure Space ETF, a space-related fund launched in 2019, which has holdings in various space stocks.[165] In January, Cathie Wood’s Ark Investment Management announced in a filing that it was looking to start the ARK Space Exploration ETF.[166] This ETF would focus on exposure to “companies involved in space-related businesses like reusable rockets, satellites, drones, and other orbital and sub-orbital aircrafts.”[167]

In terms of SPACs, the aerospace industry has shown a significant amount of growth. SPACs are among the trendiest, high-growth investment opportunities in the finance world at the moment.[168]A SPAC raises money through an IPO to acquire an existing operating company. In the past, we have seen successful SPACs such as when Virgin Galactic merged with Social Capital Hedosophia, or when Momentus Space merged with Stable Road Acquisition Corp.[169] Another company considering a merger with a SPAC is Kraus Hamdani Aerospace, whose aircraft can “safely carry satellite payloads within the stratosphere, providing a lower cost alternative to satellites with zero carbon footprint[.]”[170]  It appears that SPACs can provide a beneficial pathway for aerospace companies to obtain important access to capital.

There are other companies to watch for as well in the near term. Firefly Aerospace is a “small launch vehicle developer” that is increasingly nearing its first orbital launch attempt, and it is looking to raise $350 million to “scale up production and work on a new, larger vehicle.”[171] This is after Relativity Space, a similar launch vehicle developer, raised $500 million in November of 2020.[172]

In viewing the industry, it seems clear that the rise in space and space-related development is leading to more and more opportunities for small to large companies to expand into the public markets in order to raise the capital necessary to further expand these companies’ operations. Moreover, with the similar rise in ETFs and SPACs, access to equity in space companies, which may have been limited to a select few in years prior, is now more available to the general public than ever before. As such, the space industry market should be one to follow and watch for in the coming years.

F.  Satellite Internet Constellations

The space industry, which includes the consumer broadband sector, saw record private investment in 2020.[173] One area of investment was in the continued development of satellite constellations that provide internet access across the globe. These new technologies offer great business potential and provide internet access to underserved remote populations. In fact, federal agencies are encouraging more private investment in the space economy, including internet satellite constellations.[174]

In December 2020, the FCC awarded $9.2 billion in funding to bidders as part of the Phase I Auction from its Rural Digital Opportunity Fund (“Fund”). The Fund, established in 2019 with $20 billion in funding, is to be used for providing internet access to the millions of Americans without internet access, particularly in rural and remote areas.[175] The funding is estimated to provide high-speed broadband internet service to 5.22 million users[176]— Former FCC Chairman Ajit Pai described it as the “single largest step ever taken to bridge the digital divide.”[177] According to Pai, the awards would bring “welcome news to millions of unconnected rural Americans who for too long have been on the wrong side of the digital divide. They now stand to gain access to high-speed, high-quality broadband service.”[178]

On January 19, 2021, over 150 members of Congress wrote a letter urging the FCC “to thoroughly vet the winning bidders to ensure that they are capable” and to “consider opportunities for public input on the applications.”[179] Among other requirements, winning bidders must deliver financial statements, coverage maps, and certify to the FCC that their network is able to deliver “to at least 95% of the required number of locations in each relevant state.”[180]

Multiple companies developing satellite constellations that provide internet access from low earth orbit are creating many opportunities, but these projects have also led to some concern. The U.S. National Oceanic and Atmospheric Administration projected that the number of active satellites in orbit could increase by 50% or more in 2021.[181] The injection of more satellites into low earth orbit increases the risk of collisions between man-made objects, which could create orbital debris that itself might collide with other space objects, thus resulting in greater accumulations of “space junk.”[182] According to Morgan Stanley, some government agencies now struggle to track this orbital debris, creating potential demand for private companies to track and maintain this potentially catastrophic threat.[183]

The rapidly developing breakthroughs in satellite broadband internet access will bridge the gap in the digital divide, and be the driving force in a projected trillion-dollar industry. Morgan Stanley projects that the global space economy could generate more than $1 trillion in revenue by 2040, with satellite broadband accounting for 50-70% of the projected growth.[184]

G.  Expected Impact of Biden Administration

The inauguration of President Biden on January 20, 2020 signaled the beginning of significant changes to policies of the Trump administration in many key areas, but thus far President Trump’s space-related policies have generally proven a uniquely bipartisan area of continuity during this latest transition of power.

Having inherited a global pandemic, among other issues, President Biden’s first priorities have primarily been more terrestrial in focus, and insight into future policy decisions generally have to be gleaned from statements made on the campaign trail. However, the administration’s early remarks regarding Trump-era ventures like the Space Force and NASA’s Project Artemis have given those with their eyes turned skyward reasons for optimism, which has only been bolstered by President Biden’s symbolic decoration of the Oval Office with a moon rock collected during the Apollo 17 mission of 1972.[185]

Space Force

On December 20, 2019, President Trump signed the National Defense Authorization Act for Fiscal Year 2020 (“NDAA”) establishing the United States Space Force as the sixth branch of the United States military, and the first new military service in more than 70 years.[186] Its duties are to “(1) protect the interests of the United States in space; (2) deter aggression in, from, and to space; and (3) conduct space operations.”[187] Since its establishment, about 2,400 service members have officially transferred into the Space Force service, with plans to grow to 6,400 active-duty troops and add a reserve component in 2021.[188]

Despite earlier speculation to the contrary, White House spokeswoman Jen Psaki recently affirmed that the Space Force “absolutely has full support of the Biden administration.”[189] In response, the Chief of Space Operations Gen. John Raymond emphasized that the White House’s unambiguous statement of support for the Space Force makes it “really clear that this is not a political issue, it’s an issue of national security.”[190] That same sentiment is also reflected in Congress among bipartisan lawmakers who view the new branch as integral to ensuring the military puts enough focus on space to counter China and Russia.[191] Although President Biden has not yet publicly detailed his plans for the future of the Space Force, it does appear to be here to stay.

Space Exploration

In early February 2021, the White House also announced support for Project Artemis, NASA’s effort to return astronauts to the lunar surface. President Biden’s endorsement of the Artemis program means it will become the first major deep space human exploration effort with funding to survive a change in presidents since Apollo, after several fitful efforts to send astronauts back to the moon and beyond ultimately went nowhere.[192]

The Trump administration embraced exploration and directed NASA to speed up its moon campaign, directing it to land another man, and the first woman, on the lunar surface by 2024, but the time frame of this goal appears to be stifled by budgetary constraints, safety concerns, and other matters of national priority like COVID-19 relief.[193] For example, NASA requested a total of $25.2 billion for FY2021, a 12 percent increase over FY2020, in order to pay for Artemis. Although Congress had been steadily adding money to NASA’s budget for several prior years, in this case it provided less, $23.3 billion, suggesting there are limits to what it will allocate.[194]

Additionally, speculation remains that the Biden administration may instead prioritize NASA missions focused on increasing earth-observation capabilities, rather than space exploration. Lori Garver, the NASA deputy administrator during the Obama administration, was a key speaker at the SpaceVision 2020 convention on November 7 and 8, 2020. She noted, “[m]anaging the Earth’s ability to sustain human life and biodiversity will likely, in my view, dominate a civil space agenda for a Biden-Harris administration.”[195] However, eleven Democratic senators have already sent a letter to President Biden urging greater funding for Project Artemis, stressing that other NASA programs should not be cannibalized to pay for it.[196] As such, the first explicit insight into President Biden’s support for human spaceflight, and the timeline at which it can proceed, will likely be the FY2022 budget request that the President will send to Congress in the coming months.

Nevertheless, space exploration remains an overwhelmingly popular and bipartisan goal among Americans. Polls taken last year showed, for example, that 80% of Americans believed space travel supports scientific discovery; 78% had a favorable impression of NASA; 73% said NASA contributes to pride and patriotism; and 71% said NASA is not just a desirable agency, but a necessary one.[197] Such uniquely bipartisan support in this area cannot go unnoticed by the administration. Indeed, it appears that even if delayed for now, the question of landing another man or woman on the moon—or beyond—is a matter of when, not if, for the Biden Administration.

________________________

   [1]   Press Release – U.S. Department of Transportation Issues Two Much-Anticipated Drone Rules to Advance Safety and Innovation in the United States, Fed. Aviation Admin. (Dec. 28, 2020), available at https://www.faa.gov/news/press_releases/news_story.cfm?newsId=25541.

   [2]   Fed. Aviation Admin., Final Rule on Remote Identification of Unmanned Aircraft (Jan. 15, 2021), available at https://www.federalregister.gov/documents/2021/01/15/2020-28948/remote-identification-of-unmanned-aircraft.

   [3]   Id. at 4396.

   [4]   Id. at 4507­–08.

   [5]   Id. at 4406.

   [6]   See id. at 4428.

   [7]   Id. at 4391.

   [8]   Id. at 4447.

   [9]   Id. at 4507.

   [10]   Id. at 4507–08.

   [11]   Fed. Aviation Admin., Operation of Small Unmanned Aircraft Systems Over People; Delay; Withdrawal; Correction (Mar. 10, 2021), available at https://public-inspection.federalregister.gov/2021-04881.pdf.

   [12]   Fed. Aviation Admin., supra note 2 at 4511–12.

   [13]   See James Roger, The dark side of our drone future, The Bulletin (Oct. 4, 2019), available at https://thebulletin.org/2019/10/the-dark-side-of-our-drone-future/.

   [14]   See Office of the Attorney General, Guidance Regarding Department Activities to Protect Certain Facilities or Assets from Unmanned Aircraft and Unmanned Aircraft Systems (Apr. 13, 2020), available at https://www.justice.gov/archives/ag/page/file/1268401/download.

   [15]     Fed. Aviation Admin., Operations Over People General Overview (Jan. 4, 2021), available at https://www.faa.gov/uas/commercial_operators/operations_over_people/.

   [16]   Operation of Small Unmanned Aircraft Systems Over People, 86 Fed. Reg. 4,314 – 4,387 (14 CFR 11, 21, 43, 107) (Jan. 15, 2021), available at https://www.federalregister.gov/documents/2021/01/15/2020-28947/operation-of-small-unmanned-aircraft-systems-over-people.

   [17]   Fed. Aviation Admin., Operation of Small Unmanned Aircraft Systems Over People; Delay; Withdrawal; Correction (Mar. 10, 2021), available at https://public-inspection.federalregister.gov/2021-04881.pdf.

   [18]   Id. at 4315

   [19]   Id. at 4315-16

   [20]   Id.

   [21]   Id. 4316-17

   [22]   Fed. Aviation Admin., Executive Summary Final Rule on Operation of Small Unmanned Aircraft Systems Over People (Dec. 28, 2020), available at https://www.faa.gov/news/media/attachments/OOP_Executive_Summary.pdf.

   [23]   Id.

   [24]   Fed. Aviation Admin., Busting Myths about the FAA and Unmanned Aircraft (Mar. 7, 2014), available at https://www.faa.gov/news/updates/?newsId=76240.

   [25]   49 U.S.C. § 40103(b)(1); 49 U.S.C. § 40102(32); 14 C.F.R. § 91.119(b)(c).

   [26]   Huerta v. Haughwout, No. 3:16-cv-358, Dkt. No. 30 (D. Conn. July 18, 2016).

   [27]   Id.

   [28]   Annie Palmer, Amazon wins FAA approval for Prime Air drone delivery fleet, CNBC (Aug. 31, 2020), available at https://www.cnbc.com/2020/08/31/amazon-prime-now-drone-delivery-fleet-gets-faa-approval.html.

   [29]   Id.

   [30]   Id.

   [31]   Flying robots get FAA approval in first for drone sector, ZDNet (Jan. 20, 2021), available at https://www.zdnet.com/article/flying-robots-get-faa-approval-in-first-for-drone-sector/.

   [32]   Id.

   [33]   Id.

   [34]   Id.

   [35]   Rantizo receives FAA approval to operate drone swarms, Clay and Milk (July 7, 2020), available at https://clayandmilk.com/2020/07/07/rantizo-receives-faa-approval-to-operate-drone-swarms/.

   [36]   Id.

   [37]   Id.

   [38]   DroneSeed is first in U.S. to receive approval from FAA for post-wildfire reforestation in California and five other states, PR Newswire (Oct. 6, 2020), available at https://www.prnewswire.com/news-releases/droneseed-is-first-in-us-to-receive-approval-from-faa-for-post-wildfire-reforestation-in-california-and-five-other-states-301146779.html.

   [39]   Id.

   [40]   Fed. Aviation Admin., Notice of Proposed Rulemaking on Type Certification of Certain Unmanned Aircraft Systems (Sept. 18, 2020), available at https://www.federalregister.gov/documents/2020/09/18/2020-17882/type-certification-of-certain-unmanned-aircraft-systems.

   [41]   Alan Levin, Alphabet’s Drone Delivery Service in Virginia Sees Surge During Pandemic, Transport Topics (Apr. 8, 2020), available at https://www.ttnews.com/articles/alphabets-drone-delivery-service-virginia-sees-surge-during-pandemic.

   [42]   Id.

   [43]   Aaron Pressman, Drone industry flies higher as COVID-19 fuels demand for remote services, Fortune (July 13, 2020), available at https://fortune.com/2020/07/13/coronavirus-drones-dji-wing-flytrex-covid-19-pandemic/.

   [44]   Id.

   [45]   Ryan Duffy, A Q&A with Flytrex CEO and Cofounder Yariv Bash, Emerging Tech Brew (Feb. 22, 2021), available at https://www.morningbrew.com/emerging-tech/stories/2021/02/22/qa-flytrex-ceo-cofounder-yariv-bash.

   [46]   Brian Straight, If drones can deliver Starbucks, what’s taking so long for packages?, Modern Shipper (Feb. 15, 2021), available at https://www.freightwaves.com/news/if-drones-can-deliver-starbucks-whats-taking-so-long-for-packages.

   [47]   Tyler Fingert, The future of doorstep delivery being tested in Mobile; Drones could soon deliver orders in minutes, Fox 10 News (Aug. 5, 2020), available at https://www.fox10tv.com/news/mobile_county/the-future-of-doorstep-delivery-being-tested-in-mobile-drones-could-soon-deliver-orders-in/article_93138836-d786-11ea-872e-536e9c4176b9.html.

   [48]   Palmer, supra note 28.

   [49]   Id.

   [50]   Id.

   [51]   John Porter, Zipline’s drones are delivering medical supplies and PPE in North Carolina, The Verge (May 27, 2020), available at https://www.theverge.com/2020/5/27/21270351/zipline-drones-novant-health-medical-center-hospital-supplies-ppe.

   [52]   Walmart using drones to deliver Covid-19 test kits to El Paso homes, ABC-7 KVIA (Nov. 16, 2020), available at https://kvia.com/news/business-technology/2020/11/16/walmart-to-start-using-drones-to-delivery-covid-19-test-kits-to-homes-in-el-paso/.

   [53]   Kaleb Roedel, Flirtey successfully conducts drone deliveries of COVID test kits, Nevada Appeal (Feb. 19, 2021), available at https://www.nevadaappeal.com/news/2021/feb/22/flirtey-successfully-conducts-drone-deliveries-cov/.

   [54]   Id.

   [55]   Aaron Pressman, Drone industry flies higher as COVID-19 fuels demand for remote services, Fortune (July 13, 2020), available at https://fortune.com/2020/07/13/coronavirus-drones-dji-wing-flytrex-covid-19-pandemic/.

   [56]   Id.

   [57]   Id.

   [58]   Bijan Khosravi, How The Global Pandemic Became An Inflection Point for Drones, Forbes (Dec. 6, 2020), available at https://www.forbes.com/sites/bijankhosravi/2020/12/06/how-the-global-pandemic-became-an-inflection-point-for-drones/?sh=1fa1ddb01870.

   [59]   NASA’s SpaceX Crew-1 Astronauts Headed to International Space Station, NASA (Nov. 15, 2020), available at https://www.nasa.gov/press-release/nasa-s-spacex-crew-1-astronauts-headed-to-international-space-station.

   [60]   Id.

   [61]   Id.

   [62]   Id.

   [63]   Id.

   [64]   See Adam Mann, China’s Chang’e Program: Missions to the Moon, Space.com (Feb. 1, 2019), available at https://www.space.com/43199-chang-e-program.html.

   [65]   NASA Space Science Data Coordinated Archive, Chang’e 5, NASA, available at https://nssdc.gsfc.nasa.gov/nmc/spacecraft/display.action?id=2020-087A.

   [66]   Id.

   [67]   Jonathan Amos, China’s Chang’e-5 mission returns Moon samples, BBC (Dec. 16, 2020), available at https://www.bbc.com/news/science-environment-55323176.

   [68]   Id.

   [69]   NASA, supra note 65.

   [70]   Adam Mann, China’s Chang’e 5 mission: Sampling the lunar surface, Space.com (Dec. 10, 2020), available at https://www.space.com/change-5-mission.html.

   [71]   Id.

   [72]   See Mann, supra note 64.

   [73]   Dr. David R. Williams, Future Chinese Lunar Missions, NASA (Dec. 21, 2020), available at https://nssdc.gsfc.nasa.gov/planetary/lunar/cnsa_moon_future.html.

   [74]   Andrew Jones, China’s Tianwen-1Mars probe captures epic video of Red Planet during orbital arrival, Space.com (Feb. 12, 2021), available at https://www.space.com/tianwen-1.html.

   [75]   Id.

   [76]   Vicky Stein, Tianwen-1: China’s first Mars mission, Space.com (Feb. 8, 2021), available at https://www.space.com/tianwen-1.html.

   [77]   Id.

   [78]   Jones, supra note 74.

   [79]   Id.

   [80]   See Mann, supra note 64.

   [81]   See Mike Wall, China plans to launch core module of space station this year, Space.com (Jan. 7, 2021), available at https://www.space.com/china-space-station-core-module-launch-spring-2021.

   [82]   Id.

   [83]   Id.

   [84]   Id.

   [85]   Elizabeth Howell, China’s ispace fails to reach orbit in 2nd launch attempt, Space.com (Feb. 4, 2021), available at https://www.space.com/chinese-startup-ispace-rocket-launch-failure.

   [86]   Id.

   [87]   Id.

   [88]   Id.

   [89]   Smriti Mallapaty, Asteroid dust recovered from Japan’s daring Hayabusa2 mission, Nature.com (Dec. 15, 2020), available at https://www.nature.com/articles/d41586-020-03451-6.

   [90]   Meghan Bartels, Samples of asteroid Ryugu arrive in Japan after successful Hayabusa2 capsule landing, Space.com (Dec. 8, 2020), available at https://www.space.com/hayabusa2-asteroid-ryugu-samples-arrive-in-japan.

   [91]   Id.

   [92]   Id.

   [93]   Mallapaty, supra note 89.

   [94]   Bartels, supra note 90.

   [95]   See Doris E. Urrutia, Japan’s asteroid sample-return spacecraft Hayabusa2 gets extended mission, Space.com (Sept. 30, 2020), available at https://www.space.com/japan-asteroid-mission-hayabusa2-extended.

   [96]   Bartels, supra note 90.

   [97]   Urrutia, supra note 95.

   [98]   Mike Wall, Japanese Company ispace Now Targeting 2021 Moon Landing for 1st Mission, Space.com (Aug. 23, 2019), available at https://www.space.com/japan-ispace-first-moon-mission-2021.html.

   [99]   Id.

   [100]   Id.

   [101]   Id.

   [102]   Jonathan Amos, UAE Hope mission returns first image of Mars, BBC (Feb. 14, 2021), available at https://www.bbc.com/news/science-environment-56060890.

   [103]   Meghan Bartels, Behold! See the 1st Mars closeup from UAE’s Hope orbiter (photo), Space.com (Feb. 16, 2021), available at https://www.space.com/uae-hope-mars-spacecraft-first-close-photo.

   [104]   Natasha Turak and Dan Murphy, United Arab Emirates becomes first Arab country to reach Mars, CNBC (Feb. 10, 2021), available at https://www.cnbc.com/2021/02/09/mars-probe-uae-attempts-to-become-first-arab-country-to-reach-mars-with-hope-probe.html.

   [105]   Jonathan Amos, Hope probe: UAE launches historic first mission to Mars, BBC (July 19, 2020), available at https://www.bbc.com/news/science-environment-53394737.

   [106]   Id.

   [107]   Leonard David, Luna-25 Lander Renew Russian Moon Rush, Scientific American (Aug. 27, 2020), available at https://www.scientificamerican.com/article/luna-25-lander-renews-russian-moon-rush/.

   [108]   Id.

   [109]   Leonard David, Russia gearing up to launch moon mission in 2021, Space.com (Aug. 7, 2020), available at https://www.space.com/russia-moon-mission-luna-25.html.

   [110]   Id.

   [111]   Id.

   [112]   Id.

   [113]   Kenneth Chang et al., SpaceX Launch: Highlights from NASA Astronauts’ Trip to Orbit, The New York Times (May 30, 2020), available at https://www.nytimes.com/2020/05/30/science/spacex-launch-nasa.html.

   [114]   Id.

   [115]   Id.

   [116]   Id.

   [117]   Meghan Bartels, Space X’s 1st Crew Dragon with astronauts docks at space station in historic rendezvous, Space.com (May 31, 2020), available at https://www.space.com/spacex-crew-dragon-demo-2-docking-success.html.

   [118]   Mike Wall, SpaceX Crew Dragon makes historic 1st splashdown to return NASA astronauts home, Space.com (Aug. 2, 2020), available at https://www.space.com/spacex-crew-dragon-demo-2-splashdown.html.

   [119]   NASA’s SpaceX Crew-1 Astronauts Headed to International Space Station, NASA (Nov. 15, 2020), available at https://www.nasa.gov/press-release/nasa-s-spacex-crew-1-astronauts-headed-to-international-space-station.

   [120]      Id.

   [121]   Id.

   [122]   Id.

   [123]   Michael Sheetz, SpaceX launches and lands another Starship prototype, the second flight test in under a month, CNBC (Sep. 3, 2020), available at https://www.cnbc.com/2020/09/03/spacex-launches-and-lands-starship-sn6-prototype-in-flight-test.html.

   [124]   Id.

   [125]   Mike Wall, SpaceX’s Starship SN5 prototype soars on 1st test flight! ‘Mars is looking real,’ Elon Musk says, Space.com (Aug. 5, 2020), available at https://www.space.com/spacex-starship-sn5-prototype-1st-test-flight.html.

   [126]   Id.

   [127]   Sheetz, supra note 123.

   [128]   Tariq Malik, SpaceX launches Starship SN6 prototype test flight on heels of Starlink mission, Space.com (Sep. 3, 2020), available at https://www.space.com/spacex-starship-sn6-first-test-flight.html.

   [129]   Michael Sheetz, SpaceX’s prototype Starship rocket reaches highest altitude yet but lands explosively on return attempt, CNBC (Dec. 9, 2020), available at https://www.cnbc.com/2020/12/09/spacex-starship-rocket-sn8-explodes-after-high-altitude-test-flight-.html.

   [130]   Id.

   [131]   Id.

   [132]   Amy Thompson, SpaceX launches advanced GPS satellite for US Space Force, sticks rocket landing, Space.com (June 30, 2020), available at https://www.space.com/spacex-space-force-gps-3-sv03-launch-success.html.

   [133]   Amy Thompson, SpaceX launches South Korea’s 1st military satellite, nails rocket landing at sea, Space.com (July 20, 2020), available at https://www.space.com/spacex-launches-south-korean-military-satellite-anasis-2-lands-rocket.html.

   [134]   Amy Thompson, SpaceX launches 60 Starlink internet satellites, sticks rocket landing, Space.com (Sep. 3, 2020), available at https://www.space.com/spacex-starlink-11-satellites-launch-september-2020.html

   [135]   Michael Sheetz, SpaceX looks to build next-generation Starlink internet satellites after launching 1,000 so far, CNBC (Jan. 29, 2021), available at https://www.cnbc.com/2021/01/28/spacex-plans-next-generation-starlink-satellites-with-1000-launched.html.

   [136]   Id.

   [137]   Michael Sheetz, SpaceX says its Starlink satellite internet service now has over 10,000 users, CNBC (Feb. 4, 2021), available at https://www.cnbc.com/2021/02/04/spacex-starlink-satellite-internet-service-has-over-10000-users.html?recirc=taboolainternal.

   [138]   Samantha Mathewson, SpaceX raises $1.9 billion in latest funding round: report, Space.com (Aug. 21, 2020), available at https://www.space.com/spacex-raises-1.9-billion-funding-round.html.

   [139]   Id.

   [140]   Id.

   [141]   Reuters, Wire Service Content, SpaceX Valuation to Hit at Least $60 Billion in New Funding Round – Business Insider, U.S. News (Jan. 28, 2021), available at https://www.usnews.com/news/technology/articles/2021-01-28/spacex-finalizing-new-funding-round-at-minimum-valuation-of-60-bln-business-insider.

   [142]   Mike Wall, Touchdown! NASA’s Perseverance rover lands on Mars to begin hunt for signs of ancient life, Space.com (Feb. 18, 2021), available at https://www.space.com/perseverance-mars-rover-landing-success.

   [143]   Id.

   [144]   Id.

   [145]   Id.

   [146]   Id.

   [147]   See NASA, The Artemis Plan (2020), available at https://www.nasa.gov/sites/default/files/atoms/files/artemis_plan-20200921.pdf.

   [148]   Thalia Patrinos, Artemis Moon Program Advances – The Story So Far, NASA (Oct. 7, 2019), available at https://www.nasa.gov/artemis-moon-program-advances.

   [149]   Id.

   [150]   See Elizabeth Howell, NASA receives $23.3 billion for 2021 fiscal year in Congress’ omnibus spending bill: report, Space.com (Dec. 22, 2020), available at https://www.space.com/nasa-2021-budget-congress-omnibus-spending-bill.

   [151]   Lia Rovira and Deborah Byrd, NASA’s moon program – Artemis – boosted at White House press briefing, EarthSky (Feb. 6, 2021), available at https://earthsky.org/space/what-is-nasas-artemis-program-moon.

   [152]   Id.

   [153]   Id.

   [154]   Commercial Lunar Payload Services, NASA (Feb. 9, 2021), available at https://www.nasa.gov/content/commercial-lunar-payload-services-overview.

   [155]   Id.

   [156]   Sean Potter, NASA Selects Firefly Aerospace for Artemis Commercial Moon Delivery in 2023, NASA (Feb. 4, 2021), available at https://www.nasa.gov/press-release/nasa-selects-firefly-aerospace-for-artemis-commercial-moon-delivery-in-2023.

   [157]   See Adam Mann, NASA’s Artemis Program, NASA (July 3, 2019), available at https://www.space.com/artemis-program.html.

   [158]   Kelli Mars, Gateway, NASA (Feb. 11, 2021), available at https://www.nasa.gov/gateway.

   [159]   Sean Potter, NASA Awards Contract to Launch Initial Elements for Lunar Outpost, NASA (Feb. 10, 2021), available at https://www.nasa.gov/press-release/nasa-awards-contract-to-launch-initial-elements-for-lunar-outpost.

   [160]   Leonard David, NASA’s 2024 Moon Goal: Q&A with Human Landing System Chief Lisa Watson-Morgan, NASA (Oct. 7, 2019), available at https://www.space.com/nasa-2024-moon-human-landing-system-chief-interview.html.

   [161]   Sean Potter, NASA Names Companies to Develop Human Landers for Artemis Moon Mission, NASA (Jan. 4, 2021), available at https://www.nasa.gov/press-release/nasa-names-companies-to-develop-human-landers-for-artemis-moon-missions.

   [162]   See Mike Wall, NASA picks SpaceX, Dynetics and Blue Origin-led team to develop Artemis moon landers, Space.com (Apr. 30, 2020), available at https://www.space.com/nasa-artemis-moon-landers-spacex-blue-origin-dynetics-selection.html.

   [163]   Gillian Rich, First Space Stock of its Kind Faces SpaceX Threat, Crowded Field, Investors.com (Feb. 2, 2021), available at https://www.investors.com/news/space-stocks-astra-space-to-go-public-but-faces-spacex-threat-crowded-field/.

   [164]   Gillian Rich, You Can’t Buy SpaceX Yet But These Space Stocks Are Up For Grabs, Investors.com (Mar. 25, 2021), available at https://www.investors.com/news/space-stocks-upstart-space-companies-moon-mars/.

   [165]   Id.

   [166]   ARK ETF Trust, Registration Statement Under The Securities Act of 1933 Amendment No. 31, Securities and Exchange Commission (Jan. 13, 2021), available at https://www.sec.gov/Archives/edgar/data/0001579982/000110465921003837/tm212832d1_485apos.htm.

   [167]   Ark Invest, Space Exploration, Ark-Invest.com (2021), available at https://ark-invest.com/strategy/space-exploration/.

   [168]    Mike Bellin, Alan Jones, and Eric Watson, How special purpose acquisition companies (SPACs) work, PWC (accessed Apr. 2, 2021), available at https://www.pwc.com/us/en/services/audit-assurance/accounting-advisory/spac-merger.html.

   [169]   Rich, supra note 164.

   [170]   Melissa Rowley, How SPACs Are Changing The Investment Landscape For Space Exploration And Beyond, Forbes (Feb. 9, 2021), available at https://www.forbes.com/sites/melissarowley/2021/02/09/how-spacs-are-changing-the-investment-landscape-for-space-exploration-and-beyond/?sh=5a2ba29435c4.

   [171]   Rich, supra note 164.

   [172]   Id.

   [173]   5 Key Themes in the New Space Economy, Morgan Stanley (Feb. 4, 2021), available at  https://www.morganstanley.com/ideas/space-economy-themes-2021.

   [174]   Id.

   [175]   Michael Sheetz and Magdalena Petrova, Why in the Next Decade Companies Will Launch Thousands More Satellites Than in all of History, CNBC (Dec. 15, 2019), available at https://www.cnbc.com/2019/12/14/spacex-oneweb-and-amazon-to-launch-thousands-more-satellites-in-2020s.html; Federal Communications Commission, 2020 BROADBAND DEPLOYMENT, 5 FCC Rcd 8986 (11) (Apr. 20, 2020), available at https://docs.fcc.gov/public/attachments/FCC-20-50A1.pdf.

   [176]   David Shepardson, FCC Awards $9.2 Billion to Deploy Broadband to 5.2 Million U.S. Homes, Businesses U.S. (2020), available at https://www.reuters.com/article/us-usa-internet-fcc/fcc-awards-9-2-billion-to-deploy-broadband-to-5-2-million-u-s-homes-businesses-idUSKBN28H2V1.

   [177]   Christopher Davenport, FCC Announces Billions of Dollars in Awards to Provide Rural Areas with Broadband Access, Washington Post (Dec. 7, 2020), available at https://www.washingtonpost.com/technology/2020/12/07/fcc-digital-divide-spacex-broadband/.

   [178]   Id.

   [179]   Ryan Tracy, Elon Musk’s SpaceX Riles Its Rivals for Broadband Subsidies, The Wall Street Journal (Jan. 31 2021), available at www.wsj.com/articles/elon-musks-spacex-riles-its-rivals-for-broadband-subsidies-11612108801.

   [180]   Public Notice: Rural Digital Opportunity Fund Phase I Auction (Auction 904) Closes; Winning Bidders Announced; FCC Form 683 Due January 29, 2021, Federal Communications Commission (Dec. 7, 2020), available at https://docs.fcc.gov/public/attachments/DA-20-1422A1.pdf.

   [181]  Morgan Stanley, supra note 173.

   [182]   The Economist, It’s time to tidy up space, The Economist (Jan. 16, 2021), available at https://www.economist.com/leaders/2021/01/14/its-time-to-tidy-up-space.

   [183]  Morgan Stanley, supra note 173.

   [184]  Space: Investing in the Final Frontier | Morgan Stanley, Morgan Stanley (July 24, 2020), available at https://www.morganstanley.com/ideas/investing-in-space.

   [185]  Jeffrey Kluger, The Biden Presidency Could Fundamentally Change the U.S. Space Program, Time (Jan. 29, 2021), available at https://time.com/5933447/biden-space-nasa/.

   [186]  Sec’y of the Air Force Public Affairs, With the Stroke of a Pen, U.S. Space Force Becomes a Reality (Dec. 20, 2019), available at https://www.spaceforce.mil/News/Article/2046055/with-the-stroke-of-a-pen-us-space-force-becomes-a-reality.

   [187]  National Defense Authorization Act for Fiscal Year 2020, S. 1790, 116th Cong. § 952 b(4) (as passed by Senate, June 27, 2019), available at https://www.congress.gov/116/bills/s1790/BILLS-116s1790enr.pdf‌.

   [188]   Rebecca Kheel, Space Force Expected To Live On Past Trump Era, The Hill (Dec. 19, 2021), available at https://thehill.com/policy/technology/530936-space-force-expected-to-live-on-past-trump-era.

   [189]   Reuters, Biden Decides to Stick with Space Force as Branch of U.S. Military, Reuters (Feb. 3, 2021), available at https://www.reuters.com/article/us-usa-biden-spaceforce/biden-decides-to-stick-with-space-force-as-branch-of-u-s-military-idUSKBN2A32Z6.

   [190]   Sandra Erwin, Raymond: Space Force ‘Not a Political Issue’, Space News (Mar. 3, 2021), available at https://spacenews.com/raymond-space-force-not-a-political-issue/.

   [191]   Kheel, supra note 199.

   [192]  Christian Davenport, The Biden Administration Has Set Out To Dismantle Trump’s Legacy, Except In One Area: Space, The Washington Post (Mar. 2, 2021), available at https://www.washingtonpost.com/technology/2021/03/02/biden-space-artemis-moon-trump/.

   [193]   Marcia Smith, Biden Administration “Certainly” Supports Artemis Program, Space Policy Online (Feb. 4, 2021), available at https://spacepolicyonline.com/news/biden-administration-certainly-supports-artemis-program/.

   [194]   Id.

   [195]   Lia Rovira, How Will the U.S. Space Program Fare Under Joe Biden?, EarthSky, (Jan. 10, 2021), available at https://earthsky.org/human-world/how-will-the-u-s-space-program-fare-under-joe-biden.

   [196]   Smith, supra note 204.

   [197]   Kluger, supra note 196.


The following Gibson Dunn lawyers assisted in preparing this client update: Dhananjay Manthripragda, Jared Greenberg, Lindsay Paulin, Sarah Ediger, Macey Olave, Andrew Blythe, Jacob Rierson, Sarah Scharf, Casper Yen, Alayna Monroe, Zak Baron, and Christopher Wang.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding the issues discussed above. Please contact the Gibson Dunn lawyer with whom you usually work, any of the following in the Aerospace and Related Technologies practice group:

Los Angeles
William J. Peters (+1 213-229-7515, [email protected])
David A. Battaglia (+1 213-229-7380, [email protected])
Perlette M. Jura (+1 213-229-7121, [email protected])
Dhananjay S. Manthripragada (+1 213-229-7366, [email protected])

Denver
Jared Greenberg (+1 303-298-5707, [email protected])

Washington, D.C.
Lindsay M. Paulin (+1 202-887-3701, [email protected])
Christopher T. Timura (+1 202-887-3690, [email protected])

New York
David M. Wilf – Chair (+1 212-351-4027, [email protected])

London
Mitri J. Najjar (+44 (0)20 7071 4262, [email protected])

Paris
Ahmed Baladi (+33 (0)1 56 43 13 00, [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.

Each month, Gibson Dunn’s Media, Entertainment and Technology Practice Group highlights notable developments and rulings that may impact future litigation in this area. This month we focus on the increasingly popular digital asset known as non-fungible tokens or “NFTs” and related issues in the entertainment space and beyond.

Issue: Non-Fungible Tokens (NFTs)

Summary: NFTs have gone mainstream in what some have called a new “gold rush.” An NFT sold for almost $70 million at a Christie’s auction last month, NFTs of basketball video highlights have generated hundreds of millions of dollars in sales on the NBA Top Shot platform, and NFTs even were the subject of a skit on a recent episode of Saturday Night Live. Some consider them a fad or a bubble, citing the almost $600,000 sale of an image of an animated flying cat with a pop-tart body that anyone can download from the internet for free. But in one form or another, NFTs are here to stay. Even if the market matures and interest wanes in some unconventional pieces of digital art, NFTs will continue to offer a significant potential revenue stream for artists and entities in the film and television, music, and online gaming industries, among many others. We highlight below some of the emerging legal and policy issues related to NFTs, which include intellectual property law, profit participation issues, securities law, and even climate change.

What do the music group Megadeth, former University of Iowa basketball player Luka Garza, and New York City track and field center The Armory have in common?  In the span of 24 hours earlier this month, each of them entered the rapidly expanding NFT market. They joined a number of artists and entertainers who have led the charge in selling NFTs. As film studios and other entities with large content libraries consider following suit, they will need to consider a number of deeply rooted legal issues against a relatively new technological backdrop.

I. Background

There are widely varied understandings of NFTs and related issues concerning tokens and blockchain technology. While many of our readers are familiar with these terms, a brief introduction is helpful to frame the issues that follow.

A. What are NFTs and What is the Blockchain?

An NFT, or “non-fungible token,” is a unique unit of data stored on a public ledger of transactions called a blockchain. The unique data could represent an image, an electronic deed to a piece of property, or a digital ticket for a particular seat at a sporting event. In contrast to these “non-fungible” tokens, cryptocurrencies such as Bitcoin and Ether—just like U.S. dollars, British pounds and other “fiat” government-issued currencies—are fungible; one penny in your pocket has the same intrinsic value as the penny under your couch cushion.

Today, NFTs generally reside on the Ethereum blockchain, which also supports, among other things, the cryptocurrency Ether—the second largest cryptocurrency in terms of market capitalization and volume after Bitcoin. While other blockchains can have their own versions of NFTs, right now Ethereum is the most widely used (though NBA Top Shot uses the Flow blockchain).

But what is a blockchain? As noted above, it is an electronic database or ledger showing a history of transactions. Each transaction is represented by an entry into the electronic ledger and multiple ledger entries are ordered in data batches known as “blocks” to await verification on the network. New blocks are added after the current block reaches its data limit.  The blocks are connected using cryptography: each block contains a “hash” (a sort of coded electronic signature linking it to the previous block), which is how the blockchain gets its name.

A key feature of the Ethereum blockchain that distinguishes it from a database one might have at a business or law firm is that the blockchain is decentralized across a community of servers. Data is not stored in any one location or managed by any particular body. Rather, it exists on multiple computers simultaneously, with network participants holding identical copies of the ledger reflecting the encrypted transactions.

That is why blockchains are touted as both verifiable and secure.  It is similar to the tracking details showing each step in a package’s journey from the shipper to its final delivery destination. Unlike the tracking details provided by a shipping company, however, on the blockchain no one person can alter that record to change the encrypted data without the network’s users noticing and rejecting the fraudulent version. And if any one computer system fails, there are duplicate images of the tracking details on the blockchain ledger available on other computers around the world.

B. What Do You Get When You Buy An NFT?

While an NFT is unique, it is important to keep in mind what that unique digital item actually is.  In most cases the NFT is a digital identifier recording ownership, not—to borrow an example from the above—the actual image of the pop-tart cat. What amounts to your “receipt” is reflected in the blockchain, but the image file itself resides elsewhere.

This has to do with blockchain storage limitations and costs. The digital image itself theoretically can be stored in metadata on the blockchain, but in the vast majority of cases it is hosted on a regular website or the decentralized InterPlanetary File System (IPFS). The identifier is logged on the blockchain, but if the image is taken down from its non-blockchain location—say, because it violates someone’s copyright—the NFT could end up being a unique digital path to a closed door (even if there may be seemingly identical “copies” of the digital asset elsewhere). The immutable purchase record would remain on the blockchain, but the original image might not be viewable.

Almost uniformly, the NFT transfer conveys an interest in a licensed copy while copyright ownership of the underlying image or song is not transferred. The NFT may be in a limited edition and it may have some additional perceived value because it is officially authorized by the copyright holder or originated from the address of the copyright holder. But while the underlying copyright can be transferred when the NFT is sold or licensed, typically it isn’t. The terms and conditions of an NFT platform may reveal the limits of what actually is being transferred and how it might be used.

Under NBA Top Shot’s terms, for example, the purchaser who obtains a license to a “Moment” cannot use it for a commercial purpose, modify it, or use the image alongside anything the NBA considers offensive or hateful. An NFT platform that controls the image file is able to remove that file from its platform.

* * *

Monetization strategies for NFTs are constantly evolving, so one cannot generalize and say that all NFTs fall in one legal bucket or another. An NFT can be fair use of a copyright or it can violate it. An NFT likewise could be a simple collectible or it may be offered in such a way to convert it into a security subject to myriad regulations and disclosure requirements. It depends on the NFT.  But as the market evolves, complicated questions will need to be answered by NFT creators, platforms, and, potentially, courts.

II. Intellectual Property

Any NFT platform must be particularly focused on the intellectual property rights underlying the NFTs stored, sold, or licensed on the platform. A single NFT may include various copyrightable elements, including a video clip and any accompanying music. Whereas the platform may be able to invoke a statutory liability protection with respect to some potential claims—like defamation—certain intellectual property claims are not precluded.

Specifically, Section 230 of the Communications Decency Act of 1996 shields certain online service providers from liability for hosting content that someone else created.  In particular, Section 230(c)(1) states that “No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.”

To the extent Section 230 applies to a particular NFT platform, the law’s broad protection still has carve-outs. Among other things, it does not apply to “any law pertaining to intellectual property.” Courts have different interpretations of the scope of Section 230’s reference to “intellectual property.” In Perfect 10 v. CCBill, 488 F.3d 1102 (9th Cir. 2007), the Ninth Circuit ruled that Section 230 permitted claims under federal intellectual property laws but preempted state intellectual property claims alleging a violation of the plaintiff’s right of publicity. In Atlantic Recording Corp. v. Project Playlist, Inc., 603 F. Supp. 2d 690 (S.D.N.Y. 2009), a Southern District of New York court reached the opposite conclusion, holding that the “intellectual property” carve-out extended beyond intellectual property claims under federal law to include state-law claims.

Whether or not an NFT platform would be subject to potential liability for violating someone’s state-law right in her or his name and likeness, federal intellectual property law still would apply.  And offering an NFT that potentially infringes a copyright could result in liability for the platform if, for example, it does not take the necessary steps under the Digital Millennium Copyright Act. That risk is heightened for some platforms given how easy it is to tokenize someone else’s work. Speculators can turn any digital image into an NFT that they can then try to sell, even if the original creator does not agree to that use or even know about it.

Studios and other intellectual property rights holders will need to be especially vigilant in protecting their intellectual property—and NFT platforms likewise will need to promptly remove content if a copyright owner notifies it of an infringement—as the market for small pieces of content expands.

III. Profit Participations

Especially in the current NFT environment, it is not difficult to imagine the potential value of tokenized iconic moments from movies and television. Of course, there would be a number of contractual issues for a rightsholder to navigate, which would vary from deal to deal.  Valuable clips might come from movies dating back long before the advent of NFTs, the internet, or even computers. The relevant agreements certainly would not address NFTs, but even analogous provisions might be difficult to identify. Agreements may refer to “clips,” for example, but typically a clip is used to promote the full program or film rather than to be monetized on its own.

Depending on what it depicts, an NFT might not be a “clip” at all.  Again using NBA Top Shot as an example, a “Moment” is not just a short video excerpt showing a pass or dunk; it is a package of on-court video, still photographs, digital artwork, and game information. Contracts would need to be analyzed to determine if the NFT should be categorized as a clip, a derivative production, merchandising, promotional material, or something else, with potential consequences on the calculation of gross receipts and any corresponding rights to profit participations or Guild royalties.

Exclusivity provisions in film or television licenses to third parties might bar or limit a studio from “minting” an NFT from a work in its library. Other considerations might also limit a rightsholder’s willingness to enter the NFT space. With vast libraries of well-known and high‑quality content, however, studios are better positioned than most to take advantage of the increased interest and marketability of discrete portions of a film or program.

IV. Securities Law

Particularly in light of the SEC’s increased focus on cryptocurrencies, including its recent lawsuit accusing Ripple Labs Inc. and two of its executives of engaging in an unregistered “digital asset securities offering,” anyone involved in marketing an NFT should give careful consideration to whether the NFT is a security under U.S. law.

This should be of particular concern to the celebrities marketing their own NFTs. Several years ago, in response to celebrity endorsements for cryptocurrency Initial Coin Offerings (ICOs), the SEC warned that “[a]ny celebrity or other individual who promotes a virtual token or coin that is a security must disclose the nature, scope, and amount of compensation received in exchange for the promotion.”[1] A failure to do so would be “a violation of the anti-touting provisions of the federal securities laws.”[2] The same principle would apply to NFTs, with the key question being whether an NFT is a security. This issue has significant bearing on the NFT platform as well. If an NFT is a security, the offeror must follow securities law disclosure requirements and restrictions on who may invest.

The term “security” in U.S. securities laws includes an “investment contract” as well as other instruments like stocks and bonds. Both the SEC and federal courts often use the “investment contract” analysis to determine whether unique instruments, such as digital assets, are securities subject to federal securities laws.

To determine whether a digital asset has the characteristics of an investment contract, courts apply a test derived from the U.S. Supreme Court’s decision in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Under that Howey test, federal securities laws apply where

  1. there is an investment of money or some other consideration,
  2. in a common enterprise,
  3. with a reasonable expectation of profits,
  4. to be derived from the efforts of others.

Again, it would depend on the NFT, but transactions that resemble a fan buying a collectible likely would not be securities under this test. The notion that an NFT is non-fungible also makes it less likely to be a security.

Nevertheless, the NFT market is a creative one. Many NFTs, for example, are configured through the “smart contracts”—which are essentially computer programs—to automatically pay out royalties to the digital artwork’s original creator with every future sale of the NFT on that platform; the artist could package those royalty rights for sale to potential investors.

NFT issuers also can sell fractional interests in NFTs or groups of NFTs. As prices for some NFTs climb into the stratosphere, this approach becomes more appealing to potential buyers who want a piece of the NFT but are unwilling or unable to pay for the whole thing. According to recent statements by SEC Commissioner Hester Peirce, however, doing so increases the likelihood that the NFT would be deemed a security under the Howey test.[3] That likelihood grows where the NFT issuer or a third party claim to be able to help increase the NFT’s value.

V. Climate Change

A major issue that has arisen related to NFTs— and cryptocurrency generally—is their believed effect on the environment. Articles abound comparing the energy consumption of the Ethereum blockchain to entire countries. An analysis by Cambridge University asserts that what it calls the “Bitcoin network” uses more energy than Argentina.[4] NFTs thus have proven somewhat controversial, with one online marketplace for digital artists dropping its plans to launch an NFT platform after backlash that included an artist labeling NFTs an “ecological nightmare pyramid scheme.”[5]

Some contend that these ecological concerns are exaggerated and misleading, noting that NFTs themselves do not cause carbon emissions. As one platform wrote in a recent blog post, “Ethereum has a fixed energy consumption at a given point of time.”[6] The carbon footprint of the Ethereum blockchain would be the same if people minted more NFTs or stopped minting them altogether. But even the post acknowledges that “[i]t is true that Ethereum is energy intensive.”[7]

The crypto energy consumption issue relates to how blockchain technology currently operates. To validate a transaction—and engender trust in a system that is not backed by any central bank or other government authority—the blockchain network relies on a method called “Proof of Work.” The hashing function described above that allows the blocks to be chained together requires complex mathematical equations that only powerful computers can solve. “Miners” must solve these equations to add a new block to the chain. As incentive to solve the mathematical puzzles, the miner receives a reward of new tokens or transaction fees.

The energy costs to complete the hash functions under the Proof of Work model can be high, with miners using entire data centers to compete to solve the puzzles first and garner the reward. To mitigate any environmental effects, mining sites may increasingly rely on renewable energy and “stranded” energy, which is surplus energy created, for example, by excess power that some hyrdroelectric dams around the world generate during rainy seasons.

Another option, at least for the Ethereum blockchain, is moving to a “Proof of Stake” model. Rather than relying on miners using significant amounts of electricity in a race to solve an equation the fastest, the Proof of Stake model involves validators of transactions who are assigned randomly via an algorithm. These validators also have to commit some of their own cryptocurrency, giving them a “stake” in keeping the blockchain accurate.

Reports indicate that Ethereum may move to the Proof of Stake model as soon as this year.[8] Doing so would decrease energy consumption associated with NFTs, allow more transactions per second than in the Proof of Work model, and seemingly remove (or at least mitigate) an apparent drag on the willingness of some to embrace NFTs.

At the same time, one recent article noted what a crypto-mining finance company executive called the “‘inherent security issue of using the native tokens of a blockchain to decide the future of those tokens or the blockchain.’”[9] If the value of the tokens fall, the value of a validator’s stake falls along with it. The validator then has less to lose if they decide to propose an incorrect transaction or otherwise misbehave.

VI. Conclusion

NFTs present significant opportunities for content creators and owners, but they also present novel legal and policy issues across a wide range of areas as the technology continues to evolve. Beyond those listed here, areas of potential concern include Commodities/Derivatives, Tax, Data Privacy, and Cross-Border Transactions. Understanding the potential complications of moving into the NFT space is a necessity in anticipation of the regulatory scrutiny and litigation that often follow similar explosions of interest and investment.

_______________________

[1] https://www.sec.gov/news/public-statement/statement-potentially-unlawful-promotion-icos (Nov. 1, 2017).

[2] Id.

[3] https://cointelegraph.com/news/sec-s-crypto-mom-warns-selling-fractionalized-nfts-could-break-the-law (Mar. 26, 2021).

[4] https://www.bbc.com/news/technology-56012952 (Feb. 10, 2021).

[5] https://www.theverge.com/2021/3/15/22328203/nft-cryptoart-ethereum-blockchain-climate-change (Mar. 15, 2021).

[6] https://medium.com/superrare/no-cryptoartists-arent-harming-the-planet-43182f72fc61 (Mar. 2, 2021).

[7] Id.

[8] https://www.coindesk.com/ethereum-proof-of-stake-sooner-than-you-think (Mar. 17, 2021).

[9] https://cryptonews.com/exclusives/proof-of-disagreement-bitcoin-s-work-vs-ethereum-s-planned-s-9788.htm (Apr. 3, 2021).

 

The following Gibson Dunn lawyers assisted in the preparation of this client update: Michael Dore and Jeffrey Steiner.

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 the following leaders and members of the firm’s Media, Entertainment & Technology Practice Group:

Scott A. Edelman – Co-Chair, Media, Entertainment & Technology Practice, Los Angeles (+1 310-557-8061, [email protected])
Kevin Masuda – Co-Chair, Media, Entertainment & Technology Practice, Los Angeles (+1 213-229-7872, [email protected])
Orin Snyder – Co-Chair, Media, Entertainment & Technology Practice, New York (+1 212-351-2400, [email protected])
Brian C. Ascher – New York (+1 212-351-3989, [email protected])
Michael H. Dore – Los Angeles (+1 213-229-7652, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Ilissa Samplin – Los Angeles (+1 213-229-7354, [email protected])
Nathaniel L. Bach – Los Angeles (+1 213-229-7241,[email protected])

Please also feel free to contact the following members of the firm’s Digital Currencies and Blockchain Technology team:

Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [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])
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, [email protected])
Judith Alison Lee – Washington, D.C. (+1 202-887-3591, [email protected])
Alexander H. Southwell – New York (+1 212-351-3981, [email protected])
S. Ashlie Beringer – Palo Alto (+1 650-849-5327, [email protected])
Michael H. Dore – Los Angeles (+1 213-229-7652, [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 15, 2021, the United States announced a significant expansion of sanctions on Russia, including new restrictions on the ability of U.S. financial institutions to deal in Russian sovereign debt and the designation of more than 40 individuals and entities for supporting the Kremlin’s malign activities abroad.  As part of a sprawling package of measures, the Biden administration imposed sectoral sanctions on some of Russia’s most economically consequential institutions—including the country’s central bank, finance ministry, and sovereign wealth fund.  The administration also blacklisted an array of individuals and entities implicated in Russia’s annexation of Crimea, foreign election interference, and the SolarWinds cyberattack.  Most of the sanctions authorities included in newly issued Executive Order (“E.O.”) 14024 were already in force across a range of earlier Executive Orders and actions promulgated to respond to Russia’s initial incursion into Crimea in 2014, Moscow’s malicious cyber activities, election interference, chemical weapons attacks, and human rights abuses.  This new initiative, however, suggests that the Biden administration is prepared to move aggressively to deter Moscow from further engaging in destabilizing activities.  Moreover, we assess that this new initiative by the Biden administration is designed, at least in part, to elicit multilateral support, principally from the United Kingdom and the European Union.  Whether Washington’s transatlantic allies take up the call (London is apparently poised to follow soon) and whether these measures ultimately change Russia’s behavior remains to be seen.  In the meantime, the already frosty relationship between the West and Moscow appears likely to further deteriorate, which could have significant repercussions for multinational companies active in both jurisdictions.

Executive Order 14024

E.O. 14024 authorizes blocking sanctions against, among others, (1) persons determined to operate in certain sectors of the Russian economy; (2) those determined to be responsible for or complicit in certain activities on behalf of the Russian Government such as malicious cyber activities, foreign election interference, and transnational corruption; (3) Russian Government officials; and (4) Russian Government political subdivisions, agencies, and instrumentalities.  As noted above, many of these bases for designation already exist under earlier Executive Orders.  The duplication of these authorities suggests that the Biden administration may be looking both to put its own stamp on U.S. sanctions policy and to have a single, consolidated sanctions tool that it can use to target the full range of Russian malign behavior.  E.O. 14024 also expands upon some of those earlier authorities, for example, by authorizing the imposition of sanctions against the spouse and adult children of individuals sanctioned pursuant to the new E.O.  This is a somewhat uncommon provision apparently designed to prevent sanctions evasion by those who may seek to shift assets to close relatives—a strategy that the United States has seen in its implementation and enforcement of Russian sanctions, especially with respect to oligarchs.

Restrictions on Russian Sovereign Debt

While the 46 individual and entity designations (discussed more fully below) are potentially impactful on the specific parties targeted, the most systemically important component of E.O. 14024 comes in the form of a new Directive issued by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”).  Such directives have in the past only been issued in the context of sectoral sanctions imposed against Russia.  This latest Directive prohibits U.S. financial institutions, as of June 14, 2021, from either (1) participating in the primary market for “new” ruble and non-ruble denominated bonds issued by the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation (Russia’s principal sovereign wealth fund), or the Ministry of Finance of the Russian Federation, or (2) lending ruble or non-ruble denominated funds to those three entities.  Modeled on earlier sectoral sanctions targeting major actors in Russia’s financial services, energy, defense, and oil sectors, the new Directive prohibits U.S. financial institutions from engaging only in certain narrow categories of transactions involving the targeted entities.  Absent some other prohibition, U.S. banks may continue engaging in all other lawful dealings with the named entities.  This reflects the delicate balance that President Biden and earlier administrations have attempted to strike by imposing meaningful consequences on large, globally significant actors without at the same time roiling global markets or imposing unpalatable collateral consequences on U.S. allies.  Notably, the Biden administration stopped far short of more draconian measures such as blacklisting Russia’s sovereign wealth fund, or the Russian Government itself (as the Trump administration did in Venezuela).

The sectoral sanctions on Russia’s central bank, sovereign wealth fund, and finance ministry are further circumscribed in several key respects.  First, they do not become effective until 60 days after the issuance of the Directive.  Second, they are one of the rare instances in which OFAC’s Fifty Percent Rule does not apply, meaning that the Directive’s restrictions extend only to bonds issued by, and loans made to, the three named Russian Government entities and not to any other entities in which they may own a direct or indirect majority interest.  Third, the Directive also does not prohibit U.S. financial institutions from participating in the secondary market for Russian sovereign bonds—a potentially wide loophole under which U.S. banks may continue to purchase such debt, just not directly from the three targeted entities.  This is a loophole that could be significantly closed if the United Kingdom and European Union adopted similar measures—further supporting our assessment that the administration designed these restrictions in part to be imposed alongside similar restrictions promulgated by London and Brussels.

Particularly in light of existing restrictions on U.S. banks’ ability to participate in the primary market for non-ruble denominated Russian sovereign bonds, and from lending non-ruble denominated funds to the Russian sovereign, the Directive’s main significance is that it will make it more difficult for the Russian Government, starting on June 14, 2021, to borrow new funds in local currency.  From a policy perspective, the Directive therefore appears calculated to further restrict potential sources of financing for the Russian state—in effect, penalizing the Kremlin by driving up its borrowing costs.  Such a seemingly narrow expansion of restricted activities also leaves room to further strengthen measures if the Kremlin’s malign activities continue.

Sanctions Targeting Russia’s Other Troubling Activities

In addition to imposing restrictions on Russian sovereign debt, the Biden administration also designated dozens of individuals and entities to OFAC’s Specially Designated Nationals and Blocked Persons (“SDN”) List for their involvement in Russia’s destabilizing operations abroad.  As a result of these designations, U.S. persons are generally prohibited from engaging in transactions involving the targeted individuals and entities and any property and interests in property of the targeted persons that come within U.S. jurisdiction are frozen.  Underscoring the scope of the Biden administration’s concerns, these sanctions designations target an accumulation of Russian activities during the preceding months, including efforts to cement Russian control of the Crimea region of Ukraine, foreign election interference, and the SolarWinds cyberattack.

Among those targeted were eight individuals and entities involved in Russia’s annexation of Crimea.  In particular, OFAC designated various persons involved in constructing the Kerch Strait Bridge, which connects the Crimean peninsula by rail to the Russian mainland.  These designations also targeted Russian and local government officials for attempting to exercise control over Crimea, as well as a detention facility in the Crimean city of Simferopol that has been implicated in human rights abuses.  Through these actions—which come amid reports of Russian troops massing on the eastern Ukrainian border—the United States appears to be signaling its continuing commitment to the territorial integrity of Ukraine.

In a second batch of designations, OFAC added a further 32 individuals and entities to the SDN List for attempting to influence democratic elections in the United States and Africa at the behest of the Russian state.  Notably, these designations include a network of Russian intelligence-linked websites that allegedly engaged in a campaign of disinformation and election interference.  OFAC also targeted associates and enablers of Yevgeniy Prigozhin, the principal financial backer of the Russia-based Internet Research Agency, as well as the Russian political consultant Konstantin Kilimnik.  This set of sanctions targets not only Russian actors engaged in disinformation on behalf of the Russian government, but also those that facilitate this harmful behavior—adding a new layer of accountability to the extensive disinformation-related sanctions put in place over the last five years.

Finally, the Biden administration announced a long-awaited group of designations targeting six companies in the Russian technology sector in response to last year’s high-profile SolarWinds cyberattack on government and private networks—which the United States for the first time definitively attributed to Russia’s intelligence services.  These technology companies, which were the first to be designated pursuant to E.O. 14024, were targeted because they are funded and operated by the Russian Ministry of Defense and allegedly helped research and develop malicious cyber operations for Russia’s three main intelligence agencies.

Taken together, these actions targeting a broad spectrum of disruptive activities beyond Russia’s borders mark a significant escalation of U.S. pressure on Moscow.  U.S. Secretary of the Treasury Janet Yellen in a statement described the measures as “the start of a new U.S. campaign against Russian malign behavior,” implying that additional designations may be on the horizon.  For example, a fresh round of sanctions could soon be announced if further harm were to come to the jailed Russian dissident Alexey Navalny.

Next Steps Between Washington and Moscow

This week’s wide-ranging sanctions on Moscow suggest that President Biden is likely to continue using sanctions and other instruments of economic coercion to deter and impose costs on the Kremlin.  As for what this latest development means for foreign investors and multinational companies, the answer depends in part on how Russia ultimately responds.  By reportedly holding out the possibility of a U.S.-Russia summit in a recent call with Russia’s President Vladimir Putin, as well as refraining from imposing more biting sanctions, President Biden appears to have left open the possibility of limited retaliation by Russia and an eventual de-escalation of tensions between Washington and Moscow.  The Kremlin’s public response so far has been muted, including the expulsion of a handful of U.S. diplomats and the imposition of sanctions against eight senior U.S. officials.  However, if Russia were to respond more forcefully—such as by launching an incursion further into Ukraine or through renewed cyberattacks against the United States and allied nations—the imposition of more severe sanctions barring U.S. persons from participating in the secondary market for Russian bonds or the designation of a major enterprise in the country’s energy sector could occur.  At a minimum, the sanctions announced this past week are likely to further increase the risks, and the yield, associated with new issuance of Russian sovereign debt—marking the beginning of a new chapter in U.S. Government efforts to change the Russian Government’s behavior, or at least impose significant costs if the Kremlin refuses to alter course.


The following Gibson Dunn lawyers assisted in preparing this client update: Scott Toussaint, Judith Alison Lee, Adam Smith, Stephanie Connor, Christopher Timura and Laura Cole.

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

United States:
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, [email protected])
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, [email protected])
Jose W. Fernandez – New York (+1 212-351-2376, [email protected])
Nicola T. Hanna – Los Angeles (+1 213-229-7269, [email protected])
Marcellus A. McRae – Los Angeles (+1 213-229-7675, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [email protected])
Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, [email protected])
Laura R. Cole – Washington, D.C. (+1 202-887-3787, [email protected])
R.L. Pratt – Washington, D.C. (+1 202-887-3785, [email protected])
Samantha Sewall – Washington, D.C. (+1 202-887-3509, [email protected])
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, [email protected])
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, [email protected])
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, [email protected])

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

Europe:
Attila Borsos – Brussels (+32 2 554 72 10, [email protected])
Nicolas Autet – Paris (+33 1 56 43 13 00, [email protected])
Susy Bullock – London (+44 (0)20 7071 4283, [email protected])
Patrick Doris – London (+44 (0)207 071 4276, [email protected])
Sacha Harber-Kelly – London (+44 20 7071 4205, [email protected])
Penny Madden – London (+44 (0)20 7071 4226, [email protected])
Steve Melrose – London (+44 (0)20 7071 4219, [email protected])
Matt Aleksic – London (+44 (0)20 7071 4042, [email protected])
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])

© 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.

Protecting First Amendment rights has long been a hallmark of Gibson Dunn’s practice. In particular, we have vigilantly defended freedom of the press and its indispensable role in a healthy democracy. On this episode of the podcast, Ted Boutrous and Ted Olson discuss some of the most important and interesting First Amendment cases they’ve worked on.

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.

On April 6, 2021, New York Governor Andrew Cuomo signed into law Senate Bill 297B/Assembly Bill 164B (the “New York LIBOR Legislation”), the long anticipated New York State legislation addressing the cessation of U.S. Dollar (“USD”) LIBOR.[1]  The New York LIBOR Legislation generally tracks the legislation proposed by the Alternative Reference Rates Committee (“ARRC”).[2] It provides a statutory remedy for so-called “tough legacy contracts,” i.e., contracts that reference USD LIBOR as a benchmark interest rate but do not include effective fallback provisions in the event USD LIBOR is no longer published or is no longer representative, and that will remain in existence beyond June 30, 2023 in the case of the overnight, 1 month, 3 month, 6 month and 12 month tenors, or beyond December 31, 2021 in the case of the 1 week and 2 month tenors.[3]

Under the new law, if a contract governed by New York law (1) references USD LIBOR as a benchmark interest rate and (2) does not contain benchmark fallback provisions, or contains benchmark fallback provisions that would cause the benchmark rate to fall back to a rate that would continue to be based on USD LIBOR, then on the date USD LIBOR permanently ceases to be published, or is announced to no longer be representative, USD LIBOR will be deemed by operation of law to be replaced by the “recommended benchmark replacement.” The New York LIBOR Legislation provides that the “recommended benchmark replacement” shall be based on the Secured Overnight Financing Rate (“SOFR”) and shall have been selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or the ARRC for the applicable type of contract, security or instrument. The recommended benchmark replacement will include any applicable spread adjustment[4] and any conforming changes selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or the ARRC.

The New York LIBOR Legislation also establishes a safe harbor from liability for the selection and use of a recommended benchmark replacement and further provides that a party to a contract shall be prohibited from declaring a breach or refusing to perform as a result of another party’s selection or use of a recommended benchmark replacement.

It should be noted that the New York LIBOR Legislation does not affect contracts governed by jurisdictions other than New York, and that the parties to a contract governed by New York law remain free to agree to a fallback rate that is not based on USD LIBOR or SOFR; the new law does not override a fallback to a non-USD LIBOR based rate (e.g., the Prime rate) agreed to by the parties to a contract. Although this legislation provides crucial safeguards, it should not be viewed as a substitute for amending legacy USD LIBOR contracts where possible. Rather, it should be viewed as a backstop in the event that counterparties are unwilling or unable to agree to adequate fallback language prior to the cessation date or date of non-representativeness.

The ARRC, the Federal Reserve Board and several industry associations and groups have expressed their strong support for the new law.[5]

__________________

   [1]   See https://www.nysenate.gov/legislation/bills/2021/S297.

   [2]   See https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/libor-legislation-with-technical-amendments.

   [3]   We note that certain contracts, such as derivatives entered into under International Swaps and Derivatives Association (ISDA) standard documentation, provide for linear interpolation of the 1 week and 2 month USD LIBOR tenors until USD LIBOR ceases to exist for all tenors on June 30, 2023. The New York LIBOR Legislation provides that if the first fallback in a contract is linear interpolation, then, for the 1 week or 2 month tenor USD LIBOR contracts, the parties to the contract would continue to use linear interpolation for the period between December 31, 2021 and June 30, 2023. See the definition of “LIBOR Discontinuance Event” and “LIBOR Replacement Date” in the New York LIBOR Legislation.

   [4]   Note that the ICE Benchmark Administration Limited and the UK Financial Conduct Authority formally announced LIBOR cessation and non-representative dates for USD LIBOR on March 5, 2021. These announcements fixed the spread adjustment contemplated under certain industry-standard documents. See Gibson Dunn’s Client Alert: The End Is Near: LIBOR Cessation Dates Formally Announced, available at https://www.gibsondunn.com/the-end-is-near-libor-cessation-dates-formally-announced/.

   [5]   See “ARRC Welcomes Passage of LIBOR Legislation by the New York State Legislature,” ARRC (March 24, 2021, available at https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/20210324-arrc-press-release-passage-of-libor-legislation; see also, Randall Quarles, Keynote Address at the “The SOFR Symposium: The Final Year,” an event hosted by the Alternative Reference Rates Committee, New York, New York (March 22, 2021), available at https://www.federalreserve.gov/newsevents/speech/quarles20210322a.htm.


Gibson Dunn’s lawyers are available to answer questions about the LIBOR transition in general and these developments in particular. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Capital Markets, Derivatives, Financial Institutions, Global Finance or Tax practice groups, or the following authors of this client alert:

Andrew L. Fabens – New York (+1 212-351-4034, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
John J. McDonnell – New York (+1 212-351-4004, [email protected])

Please also feel free to contact the following practice leaders and members:

Capital Markets Group:
Andrew L. Fabens – New York (+1 212-351-4034, [email protected])
Hillary H. Holmes – Houston (+1 346-718-6602, [email protected])
Stewart L. McDowell – San Francisco (+1 415-393-8322, [email protected])
Peter W. Wardle – Los Angeles (+1 213-229-7242, [email protected])

Derivatives Group:
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
Darius Mehraban – New York (+1 212-351-2428, [email protected])
Erica N. Cushing – Denver (+1 303-298-5711, [email protected])

Financial Institutions Group:
Matthew L. Biben – New York (+1 212-351-6300, [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])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, [email protected])

Global Finance Group:
Aaron F. Adams – New York (+1 212 351 2494, [email protected])
Linda L. Curtis – Los Angeles (+1 213 229 7582, [email protected])
Ben Myers – London (+44 (0) 20 7071 4277, [email protected])
Michael Nicklin – Hong Kong (+852 2214 3809, [email protected])
Jamie Thomas – Singapore (+65 6507 3609, [email protected])

Tax Group:
Sandy Bhogal – London (+44 (0) 20 7071 4266, [email protected])
Benjamin Fryer – London (+44 (0) 20 7071 4232, [email protected])
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224/+1 212-351-2344), [email protected])
Bridget English – London (+44 (0) 20 7071 4228, [email protected])
Alex Marcellesi – New York (+1 212-351-6222, [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.

This edition of Gibson Dunn’s Federal Circuit Update summarizes key petitions for certiorari in cases originating in the Federal Circuit, addresses the Federal Circuit’s announcement that Judge Wallach will be taking senior status and the court’s updated Rules of Practice, and discusses recent Federal Circuit decisions concerning issue preclusion, Section 101, appellate procedure for PTAB appeals, and the latest mandamus petitions on motions to transfer from the Western District of Texas.

Federal Circuit News

Supreme Court:

Today, the Court decided Google LLC v. Oracle America, Inc. (U.S. No. 18-956).  In a 6-2 decision, the Court held that because Google “reimplemented” a user interface, “taking only what was needed to allow users to put their accrued talents to work in a new and transformative program,” Google’s copying of the Java API was a fair use of that material as a matter of law.  The Court did not decide the question whether the Copyright Act protects software interfaces.  “Given the rapidly changing technological, economic, and business-related circumstances,” the Court explained, “[the Court] should not answer more than is necessary to resolve the parties’ dispute.”  The Court therefore assumed, “purely for argument’s sake,” that the Java interface is protected by copyright.

This month, the Supreme Court did not add any new cases originating at the Federal Circuit.  As we summarized in our January and February updates, the Court has two such cases pending: United States v. Arthrex, Inc. (U.S. Nos. 19-1434, 19-1452, 19-1458); and Minerva Surgical Inc. v. Hologic Inc. (U.S. No. 20-440).

The Court will hear argument on the doctrine of assignor estoppel on Wednesday, April 21, 2021, in Minerva v. Hologic.

Noteworthy Petitions for a Writ of Certiorari:

There are three new potentially impactful certiorari petitions that are currently before the Supreme Court:

Ono Pharmaceutical v. Dana-Farber Cancer Institute (U.S. No. 20-1258):  “Whether the Federal Circuit erred in adopting a bright-line rule that the novelty and non-obviousness of an invention over alleged contributions that were already in the prior art are ‘not probative’ of whether those alleged contributions were significant to conception.”

Warsaw Orthopedic v. Sasso (U.S. No. 20-1284):  “Whether a federal court with exclusive jurisdiction over a claim may abstain in favor of a state court with no jurisdiction over that claim.”

Sandoz v. Immunex (U.S. No. 20-1110):  “May the patent owner avoid the rule against double patenting by buying all of the substantial rights to a second, later-expiring patent for essentially the same invention, so long as the seller retains nominal ownership and a theoretical secondary right to sue for infringement?”

The petitions in American Axle & Manufacturing, Inc. v. Neapco Holdings LLC (U.S. No. 20-891) and Ariosa Diagnostics, Inc. v. Illumina, Inc. (U.S. No. 20-892) are still pending.

After requesting a response, the Court denied Argentum’s petition in Argentum Pharmaceuticals LLC v. Novartis Pharmaceuticals Corporation (U.S. No. 20-779).  Gibson Dunn partners Mark Perry and Jane Love were counsel for Novartis.

Other Federal Circuit News:

Judge Wallach to Retire.  On March 16, 2021, the Federal Circuit announced that Judge Evan J. Wallach will retire from active service and assume senior status, effective May 31, 2021.  Judge Wallach served on the Federal Circuit for nearly 10 years and, prior to that, served on the U.S. Court of International Trade for 16 years.  Judge Wallach’s full biography is available on the court’s website.  On March 30, President Biden announced his intent to nominate Tiffany Cunningham for the empty seat.  Ms. Cunningham has been a partner in the Patent Litigation practice of Perkins Coie LLP since 2014, and serves on the 17-member Executive Committee of the firm.  She began her legal career as a law clerk to Judge Dyk.

Federal Circuit Practice Update

Updated Federal Circuit Rules.  Pursuant to the court’s December 9, 2020 public notice, the court has published an updated edition of the Federal Circuit Rules.  This edition incorporates the emergency amendment to Federal Circuit Rule 15(f) brought about by the court’s en banc decision in NOVA v. Secretary of Veterans Affairs (Fed. Cir. No. 20‑1321).

Upcoming Oral Argument Calendar

The list of upcoming arguments at the Federal Circuit are available on the court’s website.

Live streaming audio is available on the Federal Circuit’s new YouTube channel.  Connection information is posted on the court’s website.

Case of Interest:

New Vision Gaming & Development, Inc. v. SG Gaming, Inc. (Fed. Cir. No. 20‑1399):  This case concerns “[w]hether the unusual structure for instituting and funding AIA post-grant reviews violates the Due Process Clause in view of Tumey v. Ohio, 273 U.S. 510 (1927), and its progeny, which establish ‘structural bias’ as a violation of due process.”  It attracted an amicus brief from US Inventor in support of appellant, which argues that the administrative patent judges’ compensation and performance rating system affects their decision making.  Panel M will hear argument in New Vision Gaming on April 9, 2021, at 10:00 AM Eastern.

Key Case Summaries (March 2021)

SynQor, Inc. v. Vicor Corp. (Fed. Cir. No. 19-1704):  In an inter partes reexamination (“IPR”), the Patent Trial and Appeal Board (“PTAB”) found several claims of SynQor’s patent unpatentable over the prior art.  SynQor appealed, arguing that common law preclusion arising from a prior reexamination involving two related patents collaterally estopped the Board from finding a motivation to combine.

The Federal Circuit panel majority (Hughes, J., joined by Clevenger, J.) vacated and remanded, holding that common law issue preclusion can apply to IPRs.  Analyzing the statutory scheme, the majority determined that Congress did not intend to prevent application of common law estoppel.  Instead, the estoppel provisions of 35 U.S.C. §§ 315(c), 317(b) were more robust than common law collateral estoppel and fully consistent with allowing common law estoppel.  The majority also determined that IPRs satisfied the traditional elements of issue preclusion.  The majority explained that unlike an ex parte reexamination, Congress provided the third-party reexamination requestor the opportunity to fully participate in inter partes proceedings.  The majority also determined that inter partes reexaminations contained sufficient procedural elements necessary to invoke issue preclusion.  In an IPR, a party has the opportunity to respond to the other party’s evidence, challenge an expert’s credibility and submit its own expert opinions.  Thus, the majority found that the lack of cross-examination did not prevent common law issue preclusion from applying to IPRs.

Judge Dyk dissented, arguing that common law issue preclusion should not apply to inter partes reexaminations because of the lack of compulsory process and cross-examination.

In Re: Board of Trustees of the Leland Stanford Junior University (Fed. Cir. No. 20-1012):  The PTAB affirmed the examiner’s final rejection of Stanford’s claims directed to determining haplotype phase, on the basis that the claims were ineligible.  The process of haplotype phasing involves determining from which parent an allele was inherited.  The PTAB held that the claims were directed to “receiving and analyzing information,” which are “mental processes within the abstract idea category,” and that the claims lacked an inventive concept.

The Federal Circuit (Reyna, J., joined by Prost, C.J. and Lourie, J.) affirmed.  At step one, the court held that the claims were directed to the abstract idea of “mathematically calculating alleles’ haplotype phase.”  At step two, it held that the claims lacked an inventive concept, noting that the claims recited no steps that “practically apply the claimed mathematical algorithm.”  The court held that, instead, the claims merely stored the haplotype phase information, which could not transform the abstract idea into patent-eligible subject matter.  It further held that the dependent claims recited limitations amounting to no more than an instruction to apply that abstract idea.

Mylan Laboratories v. Janssen Pharmaceutica (Fed. Cir. No. 20-1071):  Mylan petitioned for IPR of Janssen’s patent.  Janssen opposed institution on the grounds that instituting the IPR would be an inefficient use of the PTAB’s resources because of two co-pending district court actions: one against Mylan and a second against Teva Pharmaceuticals that was set to go to trial soon after the institution decision.  The Board applied its six-factor standard articulated in Fintiv and denied institution.  Mylan appealed and requested mandamus relief; arguing that denying IPR based on litigation with a third party undermined Mylan’s constitutional and other due process rights, and that application of the six-factor standard violated congressional intent.

The Federal Circuit (Moore, J., joined by Newman, J. and Stoll, J.) granted Janssen’s motion to dismiss the appeal and denied Mylan’s petition for a writ of mandamus.  The court dismissed Mylan’s direct appeal and reiterated that the court lacks jurisdiction over appeals from decisions denying institution because Section 314(d) specifically makes institution decisions “nonappealable.”  The court noted that “judicial review [of institution decisions] is available in extraordinary circumstances by petition for mandamus,” even though “the mandamus standard will be especially difficult to satisfy” when challenging a decision denying institution of an IPR.  Indeed, the court noted that “it is difficult to imagine a mandamus petition that challenges a denial of institution and identifies a clear and indisputable right to relief.”  Considering the merits of Mylan’s petition, the court explained that “there is no reviewability of the Director’s exercise of his discretion to deny institution except for colorable constitutional claims,” which Mylan had failed to present.

Uniloc 2017 v. Facebook (Fed. Cir. No. 19-1688):  Uniloc appealed from a PTAB ruling that the petitioners were not estopped from challenging the claims and that the patents at issue were invalid as obvious.  Facebook filed two IPR petitions and then joined an IPR petition that had been previously filed by Apple, which challenged only a subset of the claims in the Facebook petitions.  LG then joined Facebook’s two petitions, but not Apple’s.  After instituting trial on Facebook’s two IPR petitions, the PTAB issued it final written decision in the Apple IPR, upholding the validity of Apple’s claims.  The PTAB determined that, as of the final written decision on the Apple IPR, Facebook was estopped from challenging the overlapping claims in its own IPR petitions under § 315 (e)(1).  LG, however, was not estopped from challenging the overlapping claims.

The Federal Circuit (Chen, J., joined by Lourie, J. and Wallach, J.) affirmed.  The panel first determined that it had jurisdiction to review the challenge because the final written decision in the Apple IPR did not issue until after the institution of trial on the Facebook petitions.  Next, the panel held that LG was not a real-party-at-interest or privy of Facebook because there was no evidence of any sort of preexisting, established relationship that indicates coordination related to the Apple IPR.  According to the panel, moreover, Facebook was not estopped from addressing the non-overlapping claims (even the claim that depended from an overlapping claim) because § 315 (e)(1) specifically applies to claims in a patent.  The panel then addressed the PTAB’s obviousness determination regarding the challenged claims and affirmed the Board’s obviousness findings as supported by substantial evidence.

In Re TracFone Wireless (Fed. Cir. No. 21-118): Precis Group sued TracFone in the Western District of Texas, alleging that venue was proper because TracFone has a store in San Antonio.  TracFone moved to transfer on the grounds that venue was inconvenient, as well as improper because it no longer has a branded store in the district.  For several months, the district court (Judge Albright) did not decide the motion, and instead kept the case moving towards trial.  After eight months, TracFone petitioned the Federal Circuit for a writ of mandamus.

In its decision granting mandamus, the Federal Circuit (Reyna, J., joined by Chen, J. and Hughes, J.) ordered Judge Albright to “issue its ruling on the motion to transfer within 30 days from the issuance of this order, and to provide a reasoned basis for its ruling that is capable of meaningful appellate review.”  It also ordered that all proceedings in the case be stayed until further notice.  Notably, the court explained “that any familiarity that [the district court] has gained with the underlying litigation due to the progress of the case since the filing of the complaint is irrelevant when considering the transfer motion and should not color its decision.”  Judge Albright denied the motion to transfer the day after the mandamus decision issued.

The Federal Circuit has recently denied two other petitions for mandamus involving cases before Judge Albright.  In In re Adtran, Inc. (Fed. Cir. No. 21-115), the court denied a petition for mandamus directing Judge Albright to stay all deadlines unrelated to venue pending a decision on transfer.  In In re True Chemical Solutions (Fed. Cir. No. 21-131), the court denied a petition for mandamus reversing Judge Albright’s grant of a motion for intra-division transfer.  Notably, Judge Albright now oversees 20% of new US patent cases (link).


Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Federal Circuit.  Please contact the Gibson Dunn lawyer with whom you usually work or the authors of this alert:

Blaine H. Evanson – Orange County (+1 949-451-3805, [email protected])
Jessica A. Hudak – Orange County (+1 949-451-3837, [email protected])

Please also feel free to contact any of the following practice group co-chairs or any member of the firm’s Appellate and Constitutional Law or Intellectual Property practice groups:

Appellate and Constitutional Law Group:
Allyson N. Ho – Dallas (+1 214-698-3233, [email protected])
Mark A. Perry – Washington, D.C. (+1 202-887-3667, [email protected])

Intellectual Property Group:
Wayne Barsky – Los Angeles (+1 310-552-8500, [email protected])
Josh Krevitt – New York (+1 212-351-4000, [email protected])
Mark Reiter – Dallas (+1 214-698-3100, [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 26 March 2021, the European Commission (the “Commission”) published guidance on the circumstances under which it is likely to accept requests from national competition authorities within the EU to investigate mergers that do not meet the EU or even national jurisdictional tests (the “Guidance”).[1] The Guidance concerns the application of the referral mechanism under Article 22 of the EU Merger Regulation, a hitherto relatively little-used provision.[2]  The Guidance firmly cements the Commission’s change in policy towards deals in the pharma and digital sectors, in particular with respect  to so-called “killer acquisitions”, designed to address an apparent enforcement gap in these sectors.[3] The effect of the Guidance is likely to increase significantly the jurisdictional reach of the Commission, and may go so far as to lead to a de facto notification process in the absence of sufficient turnover to meet mandatory filing requirements.

1.  A radical shift in the Commission’s approach

In a speech to the IBA in September 2020,[4] Commissioner Vestager (in charge of EU competition law enforcement) looked back on 30 years of EU merger control, including whether it is still right that the EU turnover-based thresholds for filings are the appropriate way to identify “mergers that matter for competition”. She noted that “these days, a company’s turnover doesn’t always reflect its importance in the market. In some industries, like the digital and pharmaceutical industries, competition in the future can strongly depend on new products or services that don’t yet have much in the way of sales”. In that speech, Vestager ruled out lowering the EUMR thresholds to capture such deals (as this would disproportionately capture a lot of irrelevant deals) and signalled that a change in approach to the Article 22 referral process “could be an excellent way to see the mergers that matter at a European scale”.

The Article 22 referral mechanism allows one or more Member States to ask the Commission to review a concentration that does not meet the EU thresholds but that (a) affects trade between Member States and (b) threatens to significantly affect competition within the territory of the Member State or States making the request. Until now, the Commission’s practice has been to discourage Article 22 referrals from Member States that did not have the power to review a deal under their own national merger control rules. This meant that deals that did not trigger national merger control in at least one Member State were not, in practice, referred for Commission review.

Vestager therefore stated that the Commission planned to “start accepting referrals from national competition authorities of mergers that are worth reviewing at the EU level – whether or not those authorities had the power to review the case themselves”.

The Guidance published on 26 March gives effect to this plan and sets out how the Commission foresees this new jurisdictional approach working.

2.  What deals are likely to be caught by this new approach

The Commission can accept referrals with respect to any deal, regardless of whether national filings might be required or not, provided that it meets the two formal conditions noted above. The Guidance makes is clear that these are low thresholds:

  • An effect on trade between Member States requires no more than “some discernible influence on the pattern of trade between Member States”, whether direct or indirect, actual or potential. The Guidance highlights that customers located in different Member States, cross-border sales/availability, collection of data across borders or the commercialisation of R&D efforts in more than on Member State would all meet this requirement.
  • Threatening to significantly affect competition within the territory of the Member State requires no more than a demonstration that “based on a preliminary analysis, there is a real risk” of such an effect. Here, the Guidance notes that this could include circumstances such as the “ elimination of a recent or future entrant, making entry/expansion more difficult, or the ability and incentive to leverage a strong market position from one market to another.

Further, given the Commission’s approach to date with respect to Article 22 referrals, in practice, we would not expect the Commission to take a restrictive approach to whether these conditions are met, particularly in cases where the Commission invites a national competition authority to make a referral request.

It is clear that the Commission’s focus is not on all deals involving new entrants, but primarily on the pharma and digital sectors where “services regularly launch with the aim of building up a significant user base and/or commercially valuable data inventories, before seeking to monetise the business” and where “there have been transactions involving innovative companies conducting research & development projects and with strong competitive potential, even if these companies have not yet finalised, let alone exploited commercially, the results of their innovation activities”.[5]

The Guidance also specifies that the Commission is most likely to exercise its discretion to investigate where the deal that has been referred to it is one in which the “turnover of at least one of the undertakings concerned does not reflect its actual or future competitive potential”. This may occur where the value of the consideration received by the seller is particularly high compared to the current turnover of the target. It may also occur where one party:

  • is a start-up or recent entrant with significant competitive potential that has yet to develop or implement a business model generating significant revenues (or is still in the initial phase of implementing such business model);
  • is an important innovator or is conducting potentially important research;
  • is an actual or potential important competitive force;
  • has access to competitively significant assets (such as for instance raw materials, infrastructure, data or intellectual property rights); and/or
  • provides products or services that are key inputs/components for other industries.

As the above, non-exhaustive list, shows, this new approach has the potential to catch almost any deal involving a new pharma or digital start-up, innovative company or company exploring new market areas. It would also clearly catch so-called “killer acquisitions” of small companies with high potential future value.

3.  How will the process work?

The Article 22 mechanism requires a Member State that wishes to make a referral to send a reasoned request to the Commission within 15 working days from when the concentration is made known to it.[6] The Commission then informs the other Member States and they have a further 15 working days to join the request if they so wish. After the expiry of this period, the Commission must decide within 10 working days if it accepts the referral request. Upon receipt of a referral request from a Member State, the Commission must inform the parties of the request. Once the parties are informed of this, the suspension obligation under the EU Merger Regulation applies and the transaction cannot be closed unless it has already been implemented.

Importantly, whilst the European merger control system is a pre-closing suspensory one and companies are used to assessing the need to factor in a Commission investigation prior to completion, the Guidance specifies that referrals can be made post-completion provided they are within a suitably short period. In this respect, the Guidance states that a period of six months is likely to be an appropriate period, although this may be longer if the deal is not made public on completion or if there is a sufficiently large potential for competition concerns or detrimental effect on consumers.

4.  What does this mean for deals?

The new approach has the potential to significantly reduce legal certainty for companies engaged in M&A activity in these sectors and to increase the procedural burdens on parties.

By moving the possibility of an EU-level review away from turnover-based thresholds, towards a more qualitative assessment of potential effects, and allowing for investigations to be opened post-completion, the Commission’s change in approach means that the EU system now mirrors that of the UK (with its broad “share of supply” test and post-completion review process) for deals that do not meet the EU merger review thresholds. The level of uncertainty that the UK’s system has meant for deals in these sectors in light of recent CMA decisions (see client alert on Roche/Spark) will now be felt at wider, EU-level.

Additionally, there is little likelihood that the Commission would refrain from using its new approach to referrals extensively.  The Guidance states that the Commission will engage actively with Member States to “identify concentrations that may constitute potential candidates for a referral” and encourages third-parties to contact either the Commission or the Member States to inform them of potential referral cases. Additionally, the Commission has, at the same time as it issued the Guidance, consulted on changes to the “simplified procedure” process to allow for easy/fast review of cases that do not raise competition concerns. The implication is that the Commission is “clearing the decks” to allow it to focus on these more interesting digital and pharma deals. We can therefore expect the Commission to actively seek out deals that might warrant an EU-level review and to secure their referral by one or more Member States.

For companies active in the pharma and digital sectors, their M&A planning will need to include not just an assessment of the relevant thresholds and filing requirements across EU Member States, but a more general assessment of the potential for an EU referral.

With the possibility that a Commission investigation could be initiated months after completion, with the attendant substantive risks, companies may find that it is advisable (at least in some circumstances) to proactively engage with the Commission to provide the information necessary to determine whether a deal is a good candidate for referral. Indeed, this type of de facto voluntary notification is expressly provided for in the Guidance.[7]

Companies’ M&A planning process will also need to factor in the potential impact on deal timing of this new approach. As section 3 above shows, the time period involved before the parties will even know if a deal is being investigated, not to mention the time involved for the actual Commission investigation, is significant.

___________________

[1]      Commission Guidance on the application of the referral mechanism set out in Article 22 of the Merger Regulation to certain categories of cases, C(2021) 1959 final, available at: https://ec.europa.eu/competition/consultations/2021_merger_control/guidance_article_22_referrals.pdf.

[2]      In the last 30 years, Article 22 referral requests by Member States  have been made only 41 times: See https://ec.europa.eu/competition/mergers/statistics.pdf (statistics to end February 2021).

[3]      In announcing the Guidance, together with the results of the Commission’s evaluation of the procedural and jurisdictional aspects of EU merger control, Executive Vice-President Margrethe Vestager, in charge of competition policy, said: “A number of transactions involving companies with low turnover, but high competitive potential in the internal market are not reviewed by either the Commission or the Member States. A more frequent use of the existing tool of referrals under Article 22 of the Merger Regulation can help us capture concentrations which may have a significant impact on competition in the internal market”.

[4]      Available at: https://ec.europa.eu/commission/commissioners/2019-2024/vestager/announcements/future-eu-merger-control_en.

[5]      See Guidance, paragraph 9.

[6]      This means being in receipt of sufficient information to make a preliminary assessment as to the existence of the criteria relevant for the assessment of the referral. It is unlikely that a newspaper article or press release would qualify as providing sufficient information for the national competition authorities to make an assessment. In practice, national competition authorities can be expected to request information from the parties about deals that have attracted their (or the Commission’s) attention and the 15-day period will start running upon receipt of the parties response to their information request.

[7]      Guidance, paragraph 24.


The following Gibson Dunn lawyers prepared this client alert: Deirdre Taylor, Attila Borsos, Christian Riis-Madsen, and Ali Nikpay.

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.

The New York State Legislature appears set to enact into law a new tax on debt financing for commercial real estate transactions involving “mezzanine debt and preferred equity investments”[1] located solely in New York City, as part of the 2021-2022 budget.

Although similar bills have failed previously, the current bills appear likely to become law.  The proposed law, reflected in both Senate Bill S2509B Pt. SS and the State Assembly Bill A03009B Pt. VV, would require mezzanine debt and preferred equity investments to be recorded and taxed in the same way that mortgages are currently.  However, the bill’s text leaves a number of important questions open to interpretation, including: whether the bill applies to debt and investments outside the real estate context; whether it would have any practical impact on preferred equity investments; and whether it will be applied retroactively.

The bill is also open to a variety of potential legal challenges, outlined below.

A 2.8% Tax on “Mezzanine Debt or Preferred Equity Investment[s]” Used to Finance Real Estate in New York City

Under the bill, a lender who finances a property subject to a mortgage in New York City[2] must also record “any mezzanine debt or preferred equity investment related to the real property upon which the mortgage instrument is filed.”[3]  And just as with recording a mortgage, the recording of the mezzanine debt or preferred equity would be associated with a tax.  The tax would be levied at the same rate and in the same manner as the tax “on the recording of a mortgage instrument financing statement.”[4]  Currently, the mortgage recordation tax in New York City on commercial properties is 2.8% of the principal debt.  Thus, borrowers from lenders whose interests are in the form of mezzanine debt or preferred equity also would have to pay an additional 2.8% tax against the amount of debt funded under these instruments.  All revenue collected from these new taxes would be remitted to the “New York City housing authority.”[5]

If a lender holding mezzanine debt or preferred equity fails to record the debt or equity under the new law, or to pay the associated tax, she would lose any “remedy otherwise available” under Article 9 of the Uniform Commercial Code.[6]  Remedies under the UCC are the usual route for owners of a debt secured by equity interests in a legal entity to foreclose on such equity collateral in the event of default.

A Lack of Clarity

Many of the details of this new mezzanine debt tax remain unclear due to ambiguities in the bill’s text.

Breadth and scope.  The bill is drafted to apply to mezzanine debt or preferred equity investment “related to … real property” and secured debt “in relation to real property.”[7]  However, the bill does not define when debt qualifies as “related to” or “in relation to” real property.  As such, the new law could be read to cover, and tax, any secured loan made to an operating company that happens to own an indirect interest in a New York City property.  Such a broad scope would have profound implications for corporate debt transactions far beyond the world of real estate debt financing. For example, a credit line to an operating company secured by an equity pledge in all of its assets, a small portion of which may include New York real estate, may be subject to taxation under this bill. Among its ambiguities, the bill does not include any allocation of debt that is secured by equity interests in New York City real estate and other assets.  Further, it has become customary for mortgage lenders on New York real estate—and in other jurisdictions where there is a lengthy time period to complete a mortgage foreclosure—to require a pledge of equity interests in the mortgage borrower as additional collateral for the loan. It is unclear whether the additional pledge of equity would require payment of a second tax on the same loan where mortgage recording taxes have already been paid.

Retroactivity.  Relatedly, the bill is unclear as to whether it seeks to require a lender to pay the recordation tax for mezzanine debt or preferred equity already financed, or whether the tax would only apply to such loan instruments that come about after the bill is enacted into law.  However, given the well-established presumption against retroactive legislation, this same lack of clarity makes it likely that a court would construe the bill not to impose a retroactive tax.[8]

Enforceability for preferred equity.  As mentioned above, a lender holding mezzanine debt or preferred equity who fails to record would lose remedies otherwise available under Article 9 of the UCC.[9]  However, lenders who hold preferred equity investments typically do not pursue UCC remedies in the first place.  Rather, because the debt is structured as equity in a joint venture, defaults are treated as breaches of partnership contracts and remedies are governed by partnership and contract law.  Thus, it is not clear if the bill would have a practical impact in these cases.

Potential Legal Challenges

As drafted, the bill may be vulnerable to legal challenge on multiple grounds.  Notably, any challenge would likely need to be brought in New York State court, not federal court.  Under the federal Tax Injunction Act, federal courts may not enjoin “the assessment, levy or collection of any tax under State law” where a remedy is available in the courts of the State.[10]

Vagueness. To the extent that the scope of the bill is materially unclear, as discussed above, it may be open to challenge as unconstitutionally vague, in violation of due process.  A statute is unconstitutionally vague when “it fails to give fair notice to the ordinary citizen that the prohibited conduct is illegal, [and] it lacks minimal legislative guidelines, thereby permitting arbitrary enforcement[.]”[11]  If expert industry actors are unable to discern which kinds of transactions and investments are subject to the new tax, and different interpretations could include or exclude entire fields of debt transaction, then the bill could likely be said to “fail to give fair notice” and create opportunities for “arbitrary enforcement.”

Retroactivity. If the bill is construed to apply retroactively, it may be subject to challenge under constitutional prohibitions against laws that “impair rights a party possessed when he acted” or which “impose[s] new duties with respect to transactions already completed.”[12]

Contracts Clause.  Relatedly, the Contracts Clause of the United States Constitution prohibits any State from “pass[ing] any . . . Law impairing the Obligations of Contracts.”[13]  To the extent one reads the bill as weakening a remedy a lender may otherwise have under a preexisting contract, the bill’s new recordation-and-tax hurdle is arguably unconstitutional.  With that said, the United States Supreme Court has severely limited the reach of the Contracts Clause.[14]

Tax on intangibles.  Under the New York Constitution, Art. 16, § 3, “[i]ntangible personal property shall not be taxed ad valorem nor shall any excise tax be levied solely because of the ownership or possession thereof[.]”  The mortgage tax, on which the new bill is based, has been held not to violate this provision because it as “a tax upon the privilege of recording a mortgage,” and not a tax on any property itself.[15]  However, the new tax is arguably distinguishable from, and not defensible under, this rationale.  First, the recording of mezzanine debt and preferred equity investments would be a requirement, not a privilege, under the new bill[16]; and second, the privileges associated with recording mezzanine debt and preferred equity would be far fewer and less significant than those associated with recording a mortgage.  On the other hand, the new bill arguably mandates recording only when a mortgage is also recorded; and it arguably would grant UCC Article 9 remedies as a new privilege associated with recording mezzanine debt and preferred equity investment.

Conclusion

Should this bill pass into law—as it seems likely to—the costs associated with financing commercial real estate transactions in New York City would increase substantially.  However, the bill’s ambiguity in certain key respects leaves open important areas for interpretation and potential legal dispute and challenge.

____________________

[1]  N.Y. State S. B. S2509B (2021), Pt. SS, § 1; N.Y. State Assemb. B. A03009B (2021), Pt. VV, § 1.

[2] See NYS Senate Bill S2509B, Pt. SS, §§ 1.1, 5.2 (2021) (“Within a city having a population of one million or more . . .”).  New York City is the only city in the State of New York with a large enough population for this to apply.

[3] Id. at § 1.1.

[4] Id. at §§ 5.1–5.3, 5.6

[5] Id. at § 7.

[6] Id. § 1.4, 5.4.

[7] Id. §§ 1.4, 5.4.

[8] See St. Clair Nation v. City of New York, 14 N.Y.3d 452, 456–57 (2010) (“It is well settled under New York law that retroactive operation of legislation is not favored by courts and statutes will not be given such construction unless the language expressly or by necessary implication requires it” (internal quotation marks omitted)).

[9] Id. at §§ 1.4, 5.4.

[10] 28 U.S.C. § 1341.

[11] People v. Bright, 71 N.Y.2d 376, 379 (N.Y. 1988).

[12] Regina Metro. Co., LLC v. New York State Div. of Hous. & Cmty. Renewal, 35 N.Y.3d 332, 365 (2020) (quoting Landgraf v. USI Film Prods., 411 U.S. 244, 278-80 (1994)).

[13] U.S. Const., Art. I, § 10, cl. 1.

[14] See, e.g., Sveen v. Melin, 138 S. Ct. 1815, 1821 (2018).

[15] S.S. Silberblatt, Inc. v. Tax Comm’n, 5 N.Y.2d 635, 640 (N.Y. 1959); see also Franklin Soc. for Home Bldg. & Sav. v. Bennett, 282 N.Y. 79, 86 (N.Y. 1939).

[16] Compare N.Y. RPP 291 (“A conveyance of real property… may be recorded”) with Section 1.1 (“any mezzanine debt or preferred equity investment … shall also be recorded”).


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 Real Estate Practice Group, or the following authors in New York:

Andrew J. Dady (+1 212-351-2411, [email protected])
Brian W. Kniesly (+1 212-351-2379, [email protected])
Andrew A. Lance (+1 212-351-3871, [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.

With the California Privacy Rights and Enforcement Act (“CPRA”) almost two years out from its effective date of January 1, 2023, the California Consumer Privacy Act (“CCPA”) remains in effect—but remains a moving target for businesses seeking to comply. On March 15, 2021, the California Office of Administrative Law (“OAL”) approved additional regulations relating to the right to opt out of sale of personal information; these changes are effective immediately. Even as these changes to the CCPA took effect, California has begun preparing for enforcement of the CPRA: on March 17, 2021, California announced the appointment of the inaugural five-member board for the California Privacy Protection Agency (“CPPA”), which is empowered to draft regulations supporting to CPRA, and to enforce the CPRA after it becomes effective.

Highlights of the New CCPA Regulations

Among the notable provisions in the new CCPA regulations are the following:

  • New “Do Not Sell My Personal Information” Icon (§ 999.306(f)). This new regulation permits (but does not require) businesses that sell personal information (defined under the CCPA as the disclosure of personal information to a third party “for monetary or other valuable consideration”[1]) to provide consumers with the ability to opt-out of the sale of their personal information by clicking the icon below. The icon, however, cannot replace the requirement to post the notice of the right to opt-out and the “Do Not Sell My Personal Information” link at the bottom of the business’s homepage.[2] Earlier drafts of the CCPA regulations contained examples of similar icons that businesses could use, but they were omitted from the final version of the regulations issued in August 2020.

  • Offline Opt-Out Notices Explained (§ 999.306(b)(3)). The new regulations explicitly require offline businesses to inform consumers in an offline context of their right to opt-out and offer an offline method to exercise such right, but the requirements are more flexible than that those that apply to online platforms.[3] The regulations include the following examples for accomplishing this offline notice requirement.
    • Notify consumers of their right to opt-out on the paper forms that collect the personal information.[4]
    • Post signage in the area where the personal information is collected directing consumers where to find opt-out information online.[5]
    • Inform consumers from whom personal information is collected over the phone during the call of their opt-out right.[6]
  • Mechanisms to Submit Opt-Out Requests Clarified (§ 999.306(h)). This new regulation provides that methods to submit opt-out requests should be “easy to execute and shall require minimal steps.”[7] Businesses are explicitly prohibited from using a method “that is designed with the purpose or has the substantial effect of subverting or impairing a consumer’s choice to opt-out.” The regulations include the following examples:

    • The opt-out process cannot require more steps than the process to opt-in to the sale of personal information after having previously opted out or use confusing language, including double negatives (i.e., “Don’t Not Sell My Personal Information”).[8]
    • Businesses cannot require consumers to scroll through a privacy policy (or similar document) to locate the mechanism for submitting a request after clicking on the “Do Not Sell My Personal Information” link. Businesses also generally cannot require consumers to click through or listen to reasons why they should not opt-out before confirming their request.
    • Consumers cannot be required to provide personal information that is not necessary to implement the request (which is in addition to the August 2020 regulations’ prohibition against requiring consumers to provide additional personal information not previously collected by the business).
  • Verifying Authorized Agents to Exercise Consumer Requests (§ 999.326(a)). The CCPA creates a mechanism by which an authorized agent may submit personal information-related requests on behalf of a consumer, provided the agent is registered with the Secretary of State to conduct business in California. The March 2021 regulations amended Section 999.326 to provide that businesses may require the authorized agent to provide proof that the consumer gave the agent permission to submit a request to know or delete the personal information about the consumer collected by the business. However, the new regulations do not affect a business’s ability to require consumers to verify their own identity directly with the business or confirm that they provided the authorized agent permission to submit the request.[9]

California Privacy Protection Agency Members Announced

The CPRA established the CPPA, which is “vested with full administrative power, authority, and jurisdiction to implement and enforce [along with the Attorney General]” the CPRA (Section 1798.199.10(a)).[10] The Agency will consist of five members, appointed by the Governor (who appoints the Chair and one other member), the Attorney General, the Senate Rules Committee, and the Speaker of the Assembly (each of whom appoints one member).

This week, Governor Gavin Newsom, Attorney General Xavier Becerra, Senate President pro Tempore Toni Atkins, and Assembly Speaker Anthony Rendon announced their choices for the members of the California Privacy Protection Agency. Their choices span across academia, private practice, and nonprofits. Newsom appointed Jennifer M. Urban, Clinical Professor of Law and Director of Policy Initiatives for the Samuelson Law, Technology, and Public Policy Clinic at the University of California, Berkeley School of Law, as Chair of the state agency. Newsom designated John Christopher Thompson, Senior Vice President of Government Relations at LA 2028. Becerra appointed Angela Sierra, who recently served as Chief Assistant Attorney General of the Public Rights Division. Atkins appointed Lydia de la Torre, professor at Santa Clara University Law School, where she has taught privacy law and co-directed the Santa Clara Law Privacy Certificate Program. Rendon appointed Vinhcent Le, Technology Equity attorney at the Greenlining Institute, focusing on consumer privacy, closing the digital divide, and preventing algorithmic bias.

These members are tasked with—among other things—drafting CPRA regulations by July 2022, and enforcing the CPRA when it takes effect in January 2023.

We will continue to monitor the development of the CCPA, the CPRA, and other notable state privacy laws and regulations.

_______________________

   [1]   Cal Civ. Code § 1798.140(t)(1).

   [2]   Cal Civ. Code § 1798.135.

   [3]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.306(b)(3).

   [4]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.306(b)(3)(a).

   [5]   Id.

   [6]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.306(b)(3)(b).

   [7]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.306(h).

   [8]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.306(h)(a).

   [9]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.326(a)(1)-(2).

  [10]   For more information on the CPPA, please refer to our previous alert: https://www.gibsondunn.com/potential-impact-of-the-upcoming-voter-initiative-the-california-privacy-rights-act/.


This alert was prepared by Alexander Southwell, Ashlie Beringer, Ryan Bergsieker, Cassandra Gaedt-Sheckter, Jeremy Smith, and Lisa Zivkovic

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

United States
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, [email protected])
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])
Matthew Benjamin – New York (+1 212-351-4079, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [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.

When Ted Olson argued Bush v Gore before the Supreme Court, it was one of the most important and historic moments in recent legal history. On this episode of “The Two Teds,” Olson and Ted Boutrous take a deep dive and explain what it took to manage the sprawling legal team and prepare for arguments. They also tackle the most recent election and draw parallels – and differences – between the 2020 and 2000 elections.

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.

On March 15, 2021, the U.S. Environmental Protection Agency (“EPA”) issued a final rule that requires electric generating units (“EGUs,” i.e., power plants) in 12 states to reduce ozone season nitrogen oxides (“NOx”) emissions. This final rule, issued pursuant to a court-ordered deadline, is the first significant regulatory action finalized by the Biden EPA.

Background. In 2008, EPA set new National Ambient Air Quality Standards (“NAAQS”) for ozone (the “2008 ozone NAAQS”).[1] This action triggered a requirement for states to submit State Implementation Plans (“SIPs”) to EPA addressing, in part, obligations under the Good Neighbor Provision of the Clean Air Act, pursuant to which SIPs must:

contain adequate provisions . . . prohibiting . . . any source or other type of emissions activity within the State from emitting any air pollutant in amounts which will . . . contribute significantly to nonattainment in, or interfere with maintenance by, any other State with respect to any [NAAQS].[2]

The Good Neighbor Provision effectively “requires upwind States to eliminate their significant contributions to air quality problems in downwind States.”[3] In general, states with non-attainment areas classified as Moderate or higher must submit SIPs to EPA to bring those areas into attainment according to the statutory schedule.[4] Under the 2008 ozone NAAQS, downwind states were required to comply with the NAAQS by July 20, 2018 (for areas in Moderate non-attainment) and by July 20, 2015 (for areas in Marginal non-attainment).[5]

Section 110(c)(1) of the Clean Air Act requires EPA to promulgate a Federal Implementation Plan (“FIP”) within two years after EPA: (1) finds that a state has failed to make a required SIP submission, (2) finds an SIP submission to be incomplete, or (3) disapproves an SIP submission.[6]

In 2011, EPA promulgated the Cross-State Air Pollution Rule (“CSAPR”), identifying emissions in 28 states that significantly affected the ability of downwind states to comply with 1997 and 2008 ozone NAAQS and the 2006 NAAQS for PM2.5, and limiting these emissions by setting sulfur oxide (“SOx”) and annual and seasonal NOx “budgets.” EPA then promulgated FIPs for each of the 28 states covered by CSAPR that required EGUs in the covered states to participate in regional trading programs to achieve the necessary emission reductions.[7]

In 2016, EPA promulgated an update to CSAPR to revise seasonal ozone NOx emissions budgets for 22 states (the “CSAPR Update”).[8] The CSAPR Update implemented the budgets through FIPs requiring sources to participate in a revised CSAPR NOx ozone season trading program beginning with the 2017 ozone season, but did not require the upwind states to eliminate their significant contributions to downwind non-attainment by any specific date.[9] The CSAPR Update also did not address emissions from non-EGUs.[10] In 2018, EPA promulgated the CSAPR “Close-Out,” which determined that no further reductions in NOx emissions were required with respect to the 2008 ozone NAAQS for 20 of the states covered by the CSAPR Update.[11]

A host of environmental groups and states challenged the CSAPR Update in the D.C. Circuit, alleging that the rule either over-controlled or under-controlled upwind emissions.[12] The court upheld the CSAPR Update in most respects; however, the court rejected EPA’s argument that Clean Air Act Sections 110(a)(2)(D)(i) and 111, 42 U.S.C. §§ 7410(a)(2)(D)(i) & 7511, when read together, do not require Good Neighbor emissions reductions by a particular deadline.[13] The court held that because the rule did not require upwind states to eliminate their significant contributions to downwind ozone by the deadlines for downwind states to comply with the 2008 ozone NAAQS (or by any date at all), the CSAPR Update was inconsistent with the requirements of the Clean Air Act.[14] The court remanded the CSAPR Update to EPA without vacatur.[15] Shortly thereafter, a different panel of the D.C. Circuit vacated the CSAPR Close-Out because it “rest[ed] on an interpretation of the Good Neighbor Provision now rejected.”[16]

Following these D.C. Circuit decisions, certain downwind states filed suit against EPA in the Southern District of New York on the basis that, due to remand of the CSAPR Update and the vacatur of the Close-Out Rule, EPA had failed to perform its statutory duty to promulgate FIPs for upwind states addressing the Good Neighbor obligations for the 2008 ozone NAAQs.[17] The court agreed with the states and directed EPA to issue a final rule regarding the required FIPs by March 15, 2021.[18]

October 2020 Proposed Rule. On October 30, 2020, EPA published a proposed rule in response to these cases—the Revised Cross-State Air Pollution Rule Update for the 2008 Ozone NAAQS (the “Revised CSAPR Update Proposed Rule”).[19] The key elements of the proposed rule are:

  • A finding that the projected 2021 emissions from 9 upwind states do not significantly contribute to non-attainment or maintenance problems in downwind states and that the CSAPR Update FIPs for these states fully addressed the Good Neighbor obligations of these states.
  • A determination not to impose further obligations (i.e., budget reductions) on these 9 states.
  • A finding that the projected 2021 emissions for 12 upwind states significantly contribute to non-attainment or maintenance problems in downwind states.
  • Promulgation of new or amended FIPs to revise state NOx emission budgets reflecting additional emissions reductions from EGUs.
  • No limits on ozone season NOx emissions from non-EGU sources.

Some commenters to the Revised CSAPR Update Proposed Rule have asserted that the Proposed Rule over-controls upwind emissions and requires reductions in an unreasonably short amount of time, while other commenters asserted that the Proposed Rule under-controls upwind emissions and should require emissions reductions from non-EGU sources.

Final Rule and Key Takeaways. Consistent with the deadline set by the Southern District of New York, on March 15, 2021, EPA issued its final rule (the “Revised CSAPR Update”).[20] The final rule closely tracks the October proposal. The key elements of the final rule are:

  • A finding that further ozone season NOx emissions reductions to address Good Neighbor obligations as to the 2008 ozone NAAQS are necessary for 12 of the 21 states for which the CSAPR Update was found to be only a partial remedy. As such, EPA promulgated new or revised FIPs for these states that include new EGU NOx ozone season emissions budgets, with implementation of these emissions budgets beginning with the 2021 ozone season. These states are: Illinois, Indiana, Kentucky, Louisiana, Maryland, Michigan, New Jersey, New York, Ohio, Pennsylvania, Virginia, and West Virginia.[21]
  • A determination that it is feasible for EGUs to comply with the enhanced stringency of the budgets and there is sufficient time before the effective date of the rule to prepare to meet these budgets by either undertaking emissions control measures (other than installation of state-of-the-art combustion controls, which take effect for the 2022 ozone season) or through a new Trading Program.[22]
  • Implementation of new state-level, ozone season emissions budgets through a new CSAPR NOx Ozone Season Group 3 Trading Program comprising these 12 states.  As part of establishing the Group 3 Program, EPA is permitting the creation of a limited initial bank of allowances by converting allowances banked in 2017–2020 under the existing Group 2 Trading Program at a conversion ratio of 8:1 (and certain additional conversions at a ratio of 18:1).[23]
  • A conclusion that the final rule resolves the interstate transport obligations of 21 states under the Good Neighbor Provision for the 2008 ozone NAAQS.[24]
  • A conclusion that limits on ozone season NOx emissions from non-EGU sources are not required to eliminate significant contribution to non-attainment or interference with maintenance in downwind states under the 2008 ozone NAAQS.[25]

The Revised CSAPR Update is likely EPA’s first use of a revised approach to calculate the social cost of carbon in a final regulatory action.  According to EPA, climate benefits of the rule were based on the reductions in CO2 emissions and calculated using four different estimates of the social cost of carbon: model average at 2.5 percent, 3 percent, and 5 percent discount rates, and 95th percentile at a 3 percent discount rate.[26]

Looking to the future, the Revised CSPAR Update did not address any state’s obligations under the 2015 ozone NAAQS, which set lower primary and secondary standards for ground-level ozone.[27] EPA noted in the Revised CSAPR Update that it is working separately to address Good Neighbor obligations under the 2015 ozone NAAQS, “including consideration of any necessary control requirements for EGU and non-EGU sources.”[28] As environmental groups continue to push for emissions reductions from non-EGU sources, and as EPA continues to consider this issue (including whether emissions reductions become available at a comparable cost threshold to that of EGUs), it is possible that future rulemakings will seek to implement more stringent emissions reductions or emissions reductions from non-EGUs. Litigation challenging the Revised CSAPR Update in the D.C. Circuit appears likely, including the potential for motions seeking a stay of the rule pending judicial review based on the requirement for affected facilities to begin compliance with the more stringent emissions budgets when the rule becomes effective 60 days after publication.[29]

_____________________

   [1]   National Ambient Air Quality Standards for Ozone, 73 Fed. Reg. 16436 (Mar. 27, 2008).

   [2]   42 U.S.C. § 7410(a)(2)(D)(i)(I). EPA has historically referred to SIP submissions made for the purpose of satisfying the applicable requirements of CAA sections 110(a)(1) and 110(a)(2), 42 U.S.C. § 7410(a)(1)–(2), as “infrastructure SIP” submissions.

   [3]   Wisconsin v. Envtl. Prot. Agency, 938 F.3d 303, 309 (D.C. Cir. 2019).

   [4]   42 U.S.C. § 7511a.

   [5]   Wisconsin, 938 F.3d at 313.

   [6]   42 U.S.C. § 7410(c).

   [7]   Federal Implementation Plans: Interstate Transport of Fine Particulate Matter and Ozone and Correction of SIP Approvals, 76 Fed. Reg. 48208 (Aug. 8, 2011).

   [8]   Cross-State Air Pollution Rule Update for the 2008 Ozone NAAQS, 81 Fed. Reg. 74504 (Oct. 26, 2016).

   [9]   Id. at 74504.

  [10]   Id. at 74542.

  [11]   Determination Regarding Good Neighbor Obligations for the 2008 Ozone National Ambient Air Quality Standard, 83 Fed. Reg. 65878, 65921 (Dec. 21, 2018).

  [12]   Wisconsin, 938 F.3d at 303.

  [13]   Id. at 312–15.

  [14]   Id. at 313.

  [15]   Id. at 336.

  [16]   New York v. Envtl. Prot. Agency, 781 F. App’x 4, 7 (D.C. Cir. 2019) (per curiam).

  [17]   New Jersey v. Wheeler, 475 F. Supp. 3d 308, 319 (S.D.N.Y. 2020).

  [18]   Id. at 334.

  [19]   Revised Cross-State Air Pollution Rule Update for the 2008 Ozone NAAQS, 85 Fed. Reg. 68964 (proposed Oct. 30, 2020).

  [20]   Revised Cross-State Air Pollution Rule Update for the 2008 Ozone NAAQS (March 15, 2021) (“Revised CSAPR Update”), prepublication version available at https://www.epa.gov/csapr/final-rule-revised-cross-state-air-pollution-rule-update.

  [21]   Id. at 13.

  [22]   Id. at 14.

  [23]   Id. at 14, 24-25.

  [24]   Id. at 9.

  [25]   Id. at 21.

  [26]   Id. at 26-27.

  [27]   National Ambient Air Quality Standards for Ozone, 80 Fed. Reg. 65292 (Oct. 26, 2015).

  [28]   Revised CSAPR Update at 40.

  [29]   See id. at 14.


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 in Washington, D.C.:

David Fotouhi (+1 202-955-8502, [email protected])
Mia Donnelly (+1 202-887-3617, [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])

Energy, Regulation and Litigation Group:
William S. Scherman – Washington, D.C. (+1 202-887-3510, [email protected])

Power and Renewables Group:
Peter J. Hanlon – New York (+1 212-351-2425, [email protected])
Nicholas H. Politan, Jr. – New York (+1 212-351-2616, [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 5, 2021, regulators and industry groups provided market participants with much anticipated clarity by announcing the dates for the cessation of publication of, and non-representativeness of, various settings of the London Interbank Offered Rate (“LIBOR”)[1] which will allow market participants to identify the date that their financial instruments and commercial agreements that reference LIBOR will transition to an alternative reference rate (e.g., a risk free rate).

The March 5th announcement is not only critical in providing certainty for the financial markets regarding timing for the replacement of LIBOR, but the announcement will also fix the spread adjustment contemplated under certain industry-standard documents as of March 5, 2021—thereby providing greater clarity around the economic impact of the transition from LIBOR to a risk free rate, like the Standard Overnight Financing Rate (“SOFR”) or the Sterling Overnight Index Average (“SONIA”).

LIBOR Announcement

The ICE Benchmark Administration Limited (“IBA”), the authorized administrator of LIBOR, published on March 5, 2021 a feedback statement on its consultation regarding its intention to cease the publication of LIBOR (the “IBA Feedback Statement”).[2]  The IBA Feedback Statement comes in response to the consultation published by IBA on December 4, 2020 (the “Consultation”)[3] and confirmed IBA’s intention to cease the publication of:

  • EUR, CHF, JPY and GBP LIBOR for all tenors after December 31, 2021;
  • one week and two month USD LIBOR after December 31, 2021; and
  • all other USD LIBOR tenors (e.g., overnight, one month, three month, six month and twelve month) after June 30, 2023.

Concurrent with the publication of the IBA Feedback Statement, the UK Financial Conduct Authority (the “FCA”) announced the future cessation or loss of representativeness of the 35 LIBOR settings published in five currencies (the “FCA Announcement”) from the above mentioned dates.[4]

Summary of FCA Announcement and IBA Feedback Statement:

Last Date of Publication or Representativeness is December 31, 2021:

Currency

Tenors

Spread Adjustment Fixing Date

Result

EUR LIBOR

All Tenors (Overnight, 1 Week, 1, 2, 3, 6 and 12 Months)

March 5, 2021

Permanent Cessation.

CHF LIBOR

All Tenors (Spot Next, 1 Week, 1, 2, 3, 6 and 12 Months)

March 5, 2021

Permanent Cessation.

JPY LIBOR

Spot Next, 1 Week, 2 Month and 12 Month

March 5, 2021

Permanent Cessation.

JPY LIBOR

1 Month, 3 Month and 6 Month

March 5, 2021

Non-Representative.  “Synthetic” rate possible for one additional year.

GBP LIBOR

Overnight, 1 Week, 2 Month and 12 Month

March 5, 2021

Permanent Cessation.

GBP LIBOR

1 Month, 3 Month and 6 Month

March 5, 2021

Non-Representative.  “Synthetic” rate possible for a “further period” after end-2021.

USD LIBOR

1 Week and 2 Month

March 5, 2021

Permanent Cessation

Last Date of Publication or Representativeness is June 30, 2023:

Currency

Tenors

Spread Adjustment Fixing Date

Result

USD LIBOR

Overnight and 12 Month

March 5, 2021

Permanent Cessation.

USD LIBOR

1 Month, 3 Month and 6 Month

March 5, 2021

Non-Representative.  “Synthetic” rate possible for a “further period” after end-June 2023.

The FCA Announcement and the IBA Feedback Statement are critical as they make clear the dates on which certain LIBOR settings will cease to exist or become non-representative (as described in more detail above), and they will serve as a “trigger event” for the fallback provisions in industry standard or recommended documentation, including those fallback provisions recommended by the Alternative Reference Rates Committee (“ARRC”) with respect to USD LIBOR and the fallback provisions in the International Swaps and Derivatives Association (“ISDA”) documentation.[5]

The FCA Announcement drew attention in markets around the globe.  For example, the Asia Pacific Loan Market Association (“APLMA”) issued a statement on March 8, 2021 in which it clarified the APLMA’s understanding of the FCA Announcement: The APLMA stated that the FCA Announcement indicates that the most widely used USD LIBOR settings in Asia, such as 1, 3 and 6 Month USD LIBOR, will continue to be published until June 30, 2023 and will continue to be representative until that date.  The APLMA also confirmed that based on undertakings received from the panel banks, the FCA does not expect that any LIBOR settings will become unrepresentative before the relevant dates set out above.

ISDA Index Cessation Event Announcement

Relatedly, shortly after the publication of the IBA Feedback Statement and the FCA Announcement, ISDA announced that these statements constitute an “Index Cessation Event” under the IBOR Fallbacks Supplement (Supplement Number 70 to the 2006 ISDA Definitions) and the ISDA 2020 IBOR Fallbacks Protocol, which in turn triggers a “Spread Adjustment Fixing Date” under the Bloomberg IBOR Fallback Rate Adjustments Rule Book for all LIBOR settings on March 5, 2021.[6]  The ARRC has stated[7] that its recommended spread adjustments for fallback language in non-consumer cash products referencing USD LIBOR (e.g., business loans, floating rate notes, securitizations) will be the same as the spread adjustments applicable to fallbacks in ISDA’s documentation for USD LIBOR.[8]  For further information on why a spread adjustment is necessary, see our previous alert from May 2020.[9]

This ISDA announcement provides market participants holding legacy contracts with greater clarity regarding the economic impact of the transition from LIBOR to risk free rates; however, even though the spread adjustment is now fixed, a value transfer is nonetheless expected to occur as a result of transition.  This is because the spread adjustment looks backwards to the median difference between the risk free rate and LIBOR over the previous five years, which is unlikely to be equivalent to what the net present value of the relevant instrument would have been at the time of transition, had LIBOR not been discontinued / ceased to be representative.  For example, in the case of USD LIBOR, when all tenors cease to be published or are deemed non-representative (at the end of December 2021 or June 2023, as the case may be) fallbacks for swaps will shift to SOFR, plus the spread adjustment that has now been fixed as of March 5, 2021. The fallback replacement rate of SOFR plus the spread adjustment that was fixed over two years prior is unlikely to match what would, absent transition, have been the net present value of such swap on the applicable LIBOR end date, thereby ultimately resulting in a value transfer to one party. However, the extent to which such value transfer will impact a particular financial instrument on the relevant LIBOR end date is unclear, as markets have been pricing in, and will continue to price in, the expected transition when valuing legacy instruments referencing LIBOR.

Potential “Synthetic” LIBOR for Limited Use

The IBA Feedback Statement explains that in the absence of sufficient bank panel support and without the intervention of the FCA to compel continued panel bank contributions to LIBOR, IBA is required to cease publication of the various LIBORs after the dates described above.[10]  Importantly, the IBA Feedback Statement and the FCA Announcement note that the UK government has published draft legislation (in proposed amendments to the UK Benchmarks Regulation set out in the Financial Services Bill 2019-21)[11] proposing to grant the FCA the power to require IBA to continue publishing certain LIBOR settings for certain limited (yet to be finalized) purposes, using a changed methodology known as a “synthetic” basis.

Specifically, the FCA has advised IBA that “it has no intention of using its proposed new powers to require IBA to continue publication of any EUR or CHF LIBOR settings, or the Overnight/Spot Next, 1 Week, 2 Month and 12 Month LIBOR settings in any other currency beyond the intended cessation dates for such settings.”  However, for the nine remaining LIBOR benchmark settings, the FCA has advised IBA that it will consult on using its proposed new powers to require IBA to continue publishing, on a synthetic basis, 1 Month, 3 Month and 6 Month GBP and JPY LIBOR (for certain limited periods of time) and will continue to consider the case for the “synthetic” publication of 1 Month, 3 Month and 6 Month USD LIBOR.  On March 5, 2021, the FCA also published statements of policy regarding some of the proposed new powers that the UK government is considering granting to the FCA.  These statements of policy include more detail on why the FCA is making these distinctions (e.g., to reduce disruption and resolve recognized issues around certain “tough legacy” contracts) and explain the intended methodology for the publication of the identified LIBORs on a synthetic basis (i.e., a forward looking term rate version of the relevant risk free rate, plus a fixed spread adjustment calculated over the same period, and in the same way as the spread adjustment implemented in the IBOR Fallbacks Supplement and the 2020 IBOR Fallbacks Protocol published by ISDA).[12]

If the FCA is granted the power to, and decides to require IBA to continue the publication of any LIBOR setting on a “synthetic” basis, the FCA Announcement makes clear that the synthetic LIBOR settings will no longer be deemed “representative of the underlying market and economic reality the setting is intended to measure”[13] (notwithstanding that the FCA may be able to compel the publication of a “synthetic” LIBOR rate for one or more of the 1 Month, 3 Month or 6 Month tenors for JPY LIBOR, GBP LIBOR and/or USD LIBOR beyond the set cessation date).

Notably, if the UK government decides to grant the FCA the power to, and the FCA decides to compel IBA to publish “synthetic” LIBOR for certain settings, the intent would be to assist only holders of certain categories of legacy contracts that have no or inappropriate alternatives and cannot practically be renegotiated or amended (so called “tough legacy” contracts, such as notes which may require up to 90% or 100% noteholder consent to amend the relevant terms of the note).[14]  As such, the powers are intended to be of limited use, and regulators have consistently stressed the need for market participants to actively transaction their legacy contracts.  For example, under the proposals in the UK Financial Services Bill, UK regulated firms would be prohibited from using such “synthetic” LIBOR settings in regulated financial instruments.  The FCA plans to consult on the “tough legacy” contracts that will be permitted to use “synthetic” LIBOR in the second quarter of this year.

Conclusion

The announcements on March 5th bring us one step closer to the cessation of LIBOR. The announcements are likely to offer market participants much needed clarity regarding the timing, and economics, of the transition of LIBOR to alternative reference rates. They also provide a reminder to, and increase pressure on, market participants to actively transition their financial instruments and commercial agreements that reference LIBOR to risk free rates.

______________________

   [1]   LIBOR is the index interest rate for tens of millions of contracts worth hundreds of trillions of dollars, ranging from complex derivatives to residential mortgages to bilateral and syndicated business loans to commercial agreements.

   [2]   ICE LIBOR® Feedback Statement on Consultation on Potential Cessation (March 5, 2021), available here.

   [3]   ICE LIBOR® Consultation on Potential Cessation (December 2020), available here.

   [4]   “FCA announcement on future cessation and loss of representativeness of the LIBOR benchmarks,” Financial Conduct Authority (March 5, 2021), available here.

   [5]   We note that although the FCA Announcement and IBA Feedback Statement would constitute ”trigger events” under ARRC standard fallback language (e.g., a “Benchmark Transition Event”) and under ISDA standard fallback language (e.g., an “Index Cessation Event”), such financial instruments would continue to reference LIBOR until the date that LIBOR ceases to be published or is deemed non-representative (i.e., after December 31, 2021 or after June 30, 2023).  In other words, the date on which LIBOR changes to a risk free rate and the “trigger event” will likely be two distinct events as a result of the announcement.

   [6]   See Future Cessation and Non-Representativeness Guidance on FCA announcement on future cessation and loss of representativeness of the LIBOR benchmarks, ISDA (March 5, 2021), available here; see also IBOR Fallbacks, Technical Notice – Spread Fixing Event for LIBOR, Bloomberg, available here.

   [7]   See “ARRC Commends Decisions Outlining the Definitive Endgame for LIBOR,” Alternative Reference Rates Committee (March 5, 2021), available here; “ARRC Announces Further Details Regarding Its Recommendation of Spread Adjustments for Cash Products,” Alternative Reference Rates Committee (June 30, 2020), available here.

   [8]   The ARRC followed ISDA’s announcement stating that the IBA Feedback Statement and the FCA Announcement constitute a “Benchmark Transition Event” with respect to all USD LIBOR settings pursuant to the ARRC’s recommended fallbacks for new issuances of LIBOR floating rate notes, securitizations, syndicated business loans and bilateral business loans.  See “ARRC Confirms a “Benchmark Transition Event” has occurred under ARRC Fallback Language,” ARRC (March 8, 2021), available here.

   [9]   See Tax implications of benchmark reform: UK tax authority weighs in, Gibson Dunn (May 2020) available here.

  [10]   IBA received 55 responses to the Consultation which are summarized in the IBA Feedback Statement.  IBA notes that it shared and discussed the feedback received on the Consultation with the FCA.

  [11]   The text and status of the Financial Services Bill 2019-21 are available here.

  [12]   See “Proposed amendments to the Benchmarks Regulation,” Policy Statement, FCA (March 5, 2021) available here.

  [13]   FCA Announcement at footnote 3.

  [14]   See “Paper on the identification of Tough Legacy issues,” The Working Group on Sterling Risk-Free Reference Rates (May 2020), available here.


The following Gibson Dunn lawyers assisted in preparing this client update: Linda Curtis, Arthur Long, Jeffrey Steiner, Jamie Thomas, Bridget English, and Erica Cushing.

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, the authors, or any of the following practice group leaders and members:

Capital Markets Group:
Andrew L. Fabens – New York (+1 212-351-4034, [email protected])
Hillary H. Holmes – Houston (+1 346-718-6602, [email protected])
Stewart L. McDowell – San Francisco (+1 415-393-8322, [email protected])
Peter W. Wardle – Los Angeles (+1 213-229-7242, [email protected])

Derivatives Group:
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
Darius Mehraban – New York (+1 212-351-2428, [email protected])
Erica N. Cushing – Denver (+1 303-298-5711, [email protected])

Financial Institutions Group:
Matthew L. Biben – New York (+1 212-351-6300, [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])
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])

Global Finance Group:
Aaron F. Adams – New York (+1 212 351 2494, [email protected])
Linda L. Curtis – Los Angeles (+1 213 229 7582, [email protected])
Ben Myers – London (+44 (0) 20 7071 4277, [email protected])
Michael Nicklin – Hong Kong (+852 2214 3809, [email protected])
Jamie Thomas – Singapore (+65 6507 3609, [email protected])

Tax Group:
Sandy Bhogal – London (+44 (0) 20 7071 4266, [email protected])
Benjamin Fryer – London (+44 (0) 20 7071 4232, [email protected])
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224/+1 212-351-2344), [email protected])
Bridget English – London (+44 (0) 20 7071 4228, [email protected])
Alex Marcellesi – New York (+1 212-351-6222, [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.

Happy New Year of the Ox! Despite the COVID-19 pandemic, China’s antitrust enforcement remained robust in 2020. On the merger front, the State Administration for Market Regulation (“SAMR”) unconditionally approved more than 99 percent of the 458 deals reviewed and only imposed conditions in four transactions. SAMR also issued a flurry of new guidelines in the antitrust space that provide more guidance on its enforcement priorities and its interpretation of the law.

2021 could be a pivotal year as the Chinese government is considering changes to the PRC Anti-Monopoly Law (“AML”), including increased fines for failure to notify transactions. There are also a number of guidelines that have been published for comments in 2020 and could be adopted in 2021. Finally, SAMR seems intent on vigorously enforcing the AML in the internet space, which could lead to landmark decisions in 2021.

1.  Legislative / Regulatory Developments

2020 saw an active year in the consolidation of often overlapping regulations – a legacy from the tri-agency era – and the introduction of new regulations and guidelines. Most notably, apart from the draft amendments to the Anti-Monopoly Law on January 2, 2020, which we have covered in our Antitrust in China – 2019 Year in Review,[1] SAMR introduced new guidelines addressing competition issues relating to, among other subjects, the automobile industry, the platform economy, intellectual property rights, leniency, and commitments. A summary of these new guidelines is set forth below. In addition, SAMR published several draft guidelines for consultation, including the Guidelines on Companies’ Anti-Monopoly Compliance Abroad and the Anti-Monopoly Guidelines in the Area of Active Pharmaceutical Ingredients.

Automobile Sector: In the past decade, SAMR (and its predecessors) has undertaken significant enforcement actions against car manufacturers and distributors. Drawing from the various agencies’ law enforcement experience, SAMR issued the (long-awaited) Anti-Monopoly Guidelines for the Automobile Sector (“Automobile Guidelines”)[2] on September 18, 2020.

While acknowledging that the automobile manufacturing market as a whole is competitive, the Automobile Guidelines nevertheless provide important provisions with regard to abuses of a dominant position in aftermarket parts and services. In particular, the Automobile Guidelines note that automobile manufacturers that do not hold a dominant market position in manufacturing could nevertheless be held to be in a dominant position in aftermarkets, which include the production and supply of aftermarket spare parts and the availability of technical repair information, equipment, and tools.

The Automobile Guidelines also provide guidance with regard to resale price maintenance (“RPM”). While noting that RPM should be prohibited, the Automobile Guidelines specify several circumstances in which RPM may be exempted from the prohibition. For example, an automobile manufacturer may directly conduct price negotiations and agree on a purchase price with a customer if the distributor is merely an intermediary who plays only a supporting role limited to invoice issuance, delivery of vehicle, and receipt of payment.

Finally, under the Automobile Guidelines, car manufacturers with a market share of less than 30 percent are permitted to impose certain vertical restrictions on distributors. For example, a qualifying manufacturer may generally impose restrictions to prevent a distributor from making any active sales to customers outside of that distributor’s allocated territory.

Platform Economy Sector: SAMR issued Anti-Monopoly Guidelines for the Platform Economy Sector on February 7, 2021 (“Platform Guidelines”).[3] This follows a string of actions taken by the Chinese government to regulate the internet platform sector, most notably its suspension of the initial public offering by Ant Group.

Recognizing that there are difficulties in applying traditional antitrust enforcement approaches to the platform economy sector, the Platform Guidelines provide tailored and specific guidance regarding, among other areas, concentrations of undertakings, monopoly agreements, and abuses of dominance. For example, the Platform Guidelines acknowledge the complexity of the platform economy and that a market would not necessarily be defined by reference to an undertaking’s basic services. As a result, SAMR will take into account the possible network effects in determining if the platform is a distinct market or one that involves multiple related markets.

Moreover, the Platform Guidelines set out types of agreements that may constitute monopoly agreements, some of which go beyond the traditional written or verbal agreements or meeting of minds. Significantly, the Platform Guidelines provide that the use of technical methods, data, and algorithms may constitute horizontal or vertical monopoly agreements. Similarly, a most favored nation clause may constitute a vertical monopoly agreement. The Platform Guidelines also prohibit hub-and-spoke agreements, recognizing that competitors may reach a hub-and-spoke agreement through either a vertical relationship with the platform operator or the organization and coordination of the platform operator.

In addition, the Platform Guidelines provide that if a platform is considered an “essential facility,” the platform operator must not, without any justification, refuse to deal with operators who want to use it. In determining whether a platform constitutes an essential facility, SAMR may consider the substitutability of other platforms, the existence of a potential alternative, the feasibility of developing a competitive platform, the degree of dependence of the operators on the platform, and the possible impact of an open platform on the platform operator.

Finally, on merger control, the Platform Guidelines provide that transactions involving Variable Interest Entities (“VIEs”) must obtain merger clearance if the transaction meets the notification thresholds. This puts an end to the uncertainty surrounding transactions involving VIEs, which by and large were never notified. This announcement was expected given that in July 2020,[4] SAMR for the first time accepted the filing of and later unconditionally approved a transaction involving a VIE structure. The Platform Guidelines also reiterate that SAMR has the discretion to investigate sub-threshold transactions, especially if (1) the transactions involve a start-up or an emerging platform; (2) the undertaking has a low turnover because it operates a business model involving the provision of free-of-charge or low pricing services; or (3) the relevant market is highly concentrated.

Intellectual Property Rights: On September 18, 2020, SAMR published the Anti-Monopoly Guidelines in the Field of Intellectual Property Rights (“IP Guidelines”),[5] which provide clearer guidance on the interplay between the AML and intellectual property rights, and set out a framework for competition analysis and factors that SAMR will take into account when carrying out competition analysis on matters relating to intellectual property rights.

At the outset, the IP Guidelines acknowledge that an undertaking’s exercise of intellectual property rights will not violate the AML unless the undertaking’s conduct or the underlying transaction is anti-competitive. The IP Guidelines address a number of intellectual property-related agreements that could be considered anti-competitive, including joint research and development pacts, cross-licensing, grant-backs, no-challenge clauses, and standard-setting activities. Under the IP Guidelines, in carrying out a competition analysis, SAMR will consider, among other factors, the content, degree, and implementation of the restrictions. The IP Guidelines also provide safe harbor rules: where an undertaking involved in a horizontal monopoly agreement has a market share not exceeding 20 percent or where an undertaking involved in a vertical monopoly agreement has a market share not exceeding 30 percent, it may be presumed that the agreement does not have the effect of eliminating or restricting competition. As a result, SAMR will not take any enforcement action unless there is evidence showing the contrary. However, the safe harbor rules do not apply to hard-core conduct such as price fixing or resale price maintenance.

On abuse of dominance, the IP Guidelines acknowledge that just because an undertaking is an intellectual property right holder does not mean that it has a dominant market position. Rather, whether an intellectual property right holder has dominance in the relevant market will depend on the considerations set out in Article 18 of the AML, such as its market shares and the competitive status of the relevant market, as well as three additional factors set out in the IP Guidelines: (1) the possibility and cost of a transaction counterparty switching to an alternative technology or product; (2) the degree of dependence of the downstream markets on the goods provided by the use of the intellectual property rights; and (3) the capacity of a transaction counterparty to constrain the intellectual property right holder. The IP Guidelines further set out five types of conduct that would amount to an abuse: (1) licensing of intellectual property rights at an unfairly high price; (2) refusal to license intellectual property rights; (3) intellectual property-related bundling; (4) unreasonable transaction conditions relating to intellectual property; and (5) discriminatory treatment relating to intellectual property.

Finally, the IP Guidelines note that a filing obligation could be triggered where an undertaking acquires control or decisive influence over another undertaking by reason of a transfer or sole licensing of intellectual property rights. When determining whether a transaction would trigger the filing obligation, SAMR will consider whether the intellectual property constitutes a stand-alone business, whether the intellectual property independently generated calculable turnover in the previous financial year, and the form and duration of the intellectual property license.

Leniency and Commitments: In September and October 2020, SAMR formalized its leniency and commitment regime through the publication of the finalized version of two relevant guidelines: (a) the Guidelines for the Application of Leniency Program in Horizontal Monopoly Agreement Cases (“Leniency Guidelines”)[6] and (b) the Guidelines on Undertakings’ Commitments in Anti-Monopoly Cases (“Commitments Guidelines”).[7] The two Guidelines aim to encourage cooperation of market players to self-report breaches in exchange for immunity from or mitigation of penalties; and to offer commitments to cease anti-competitive conduct in exchange for the suspension or termination of an investigation.

The Leniency Guidelines introduce a new marker system that allows a leniency applicant to hold their place in the leniency queue while perfecting their application. The first applicant may receive up to a 100 percent reduction of fines. However, cartel leaders and undertakings that are found to have coerced others to participate in the cartel are not eligible for full immunity. The second and third applicants may receive up to a 50 and 30 percent reduction of fines, respectively. While the Leniency Guidelines allow for up to three applicants to receive leniency benefits, they also provide that SAMR may grant a reduction of no more than 20 percent to subsequent applicants in complex cases. Moreover, leniency applicants must, among other conditions, admit liability in order to secure the leniency benefits.

The Commitments Guidelines set out a mechanism under which parties under investigation may enter into voluntary commitments to terminate the alleged anti-monopoly conduct and mitigate or eliminate its consequences, in exchange for SAMR suspending and closing the investigation without a finding of breach. Under the Commitments Guidelines, parties are encouraged to discuss commitments with SAMR at any time during the investigation up to the point of SAMR’s issuance of a penalty notice. Moreover, commitments are not available in cartel investigations.

2.  Merger Control

In 2020, SAMR reviewed a total of 458 concentrations, which represents only a slight increase from 2019 despite disruptions caused by the COVID-19 pandemic. Out of the 458 concentrations, 454 were approved unconditionally and four were approved subject to conditions. SAMR did not prohibit any transactions in 2020.[8]

SAMR on average took approximately 14 days to complete its review of cases under the simplified procedure, less than in 2019. On the other hand, SAMR took eight to 12 months (and on average 9.5 months) to complete its review of conditionally approved cases. SAMR asked the parties in two out of the four conditionally approved cases to withdraw and refile their applications, whilst completing its review within the review period for the other two cases.

2.1  Conditional Approval Decisions

We highlight below the decisions in which SAMR imposed or removed remedies. Save for Danaher/GE BioPharma, which required structural remedies, SAMR imposed behavioral remedies in all the other conditionally approved cases.

SAMR continued its focus on the technology sector as two out of the four cases which involve conditional approval concern the semiconductor industry. In these two cases, conditions were imposed despite that regulators in other jurisdictions (such as in the EU and in the U.S.) approved the transactions without conditions. It is also noteworthy that three out of the four conditionally approved cases involve the imposition of remedies requiring the merged entitles to comply with fair, reasonable and non-discriminatory (FRAND) terms.

Danaher / GE BioPharma:[9] On February 28, 2020, SAMR approved the acquisition by Danaher of GE BioPharma’s life science business, with conditions imposed in the form of structural remedies. SAMR required Danaher to divest a number of its business segments. A notable feature of this matter is the continuous role that research and development has featured in SAMR’s merger analysis. Danaher had a product in the pipeline that could potentially compete with GE BioPharma and SAMR was concerned that Danaher would, post-transaction, have less incentive to invest in research and development. SAMR imposed a condition that Danaher must provide to the purchaser of its divested businesses research and development resources for this product and remain involved in this product for a period of two years after the deal completes. Danaher must report annually to SAMR.

Infineon / Cypress:[10] On April 8, 2020, SAMR conditionally approved the proposed acquisition of Cypress Semiconductor (a U.S. semiconductor design and manufacturing company) by Infineon Technologies (a German semiconductor supplier). Pursuant to the conditions imposed by SAMR: (i) there must be no tie-in sales or imposition of unreasonable trading terms, (ii) there has to be a guarantee of separate supply of any all-in-one/integrated products (should it become possible to integrate products into a single product) as well as the stand-alone products to Chinese customers, (iii) to ensure interoperability, the products sold to Chinese customers should comply with the commonly accepted industry standards for interface and (iv) the supply of products has to be in compliance with FRAND terms.

Nvidia / Mellanox:[11] On April 16, 2020, SAMR conditionally approved the acquisition by Nvidia (a U.S. supplier of graphics processing units) of Mellanox (an Israeli supplier of semiconductor-based network interconnect products). The conditions imposed included that: (i) there must be no tie-in sales or imposition of unreasonable conditions, and it is prohibited to restrict customers from purchasing stand-alone products or otherwise discriminate against these customers, (ii) the provision of products has to comply with FRAND terms, (iii) interoperability has to be ensured between the relevant products and other third-party products, (iv) there must be open source commitment regarding the software offered and (v) protective measures have to be adopted for confidential information made available by third-party manufacturers.

ZF Friedrichshafen / WABCO:[12] On May 15, 2020, SAMR conditionally approved the acquisition of WABCO (a U.S. supplier of systems for commercial vehicles) by ZF Friedrichshafen (a German supplier of vehicle components and systems). Three conditions were imposed, namely that: (i) there has to be a continuous supply of products under terms no less favorable than the existing terms, (ii) the provision of products has to comply with FRAND terms and (iii) Chinese customers have to be provided with the opportunity to develop products in accordance with FRAND principles.

Corun / PEVE: On April 24, 2020, SAMR waived the remedies imposed back in 2014 in respect of the joint venture concerning Corun, PEVE, Sinogy, and a car manufacturer. The remedies were waived on the basis that there had been material changes in the competitive dynamics of the markets in aspects such as the applicable regulations for the automotive industry, the advancement of technology in respect of lithium batteries and the parties’ decreasing market share.

2.2  Enforcement Against Non-Notified Transactions

In 2020, SAMR published 13 decisions relating to failures to notify transactions, less than in  2018 or 2019. These cases, on average, took 250 days to investigate.

A notable development in this area is that on December 14, 2020, SAMR announced that it has fined three companies in the internet space for completing transactions involving variable interest entity, or VIE, structures without prior notification. In very simple terms, VIE refers to a business structure in which an investor has a controlling interest (but not a majority of voting rights) via contractual arrangements.

These fines confirm that SAMR takes the failure to notify mergers (especially those involving online platforms and/or concerning VIE) seriously. If and when the fines for failures to file are increased, enforcement actions in this space are likely to be more robust and visible.

3.  Non-Merger Enforcement

The trend of delegation of enforcement to local antitrust agencies continued from 2019, during which local antitrust regulators were responsible for 15 out of 16 enforcement decisions published in that year. In 2020, SAMR published 22 enforcement decisions (including two decisions to terminate an investigation) involving conduct such as horizontal monopolistic agreements, price fixing and abuse of market dominance. Out of these 22 enforcement decisions, only one was investigated and penalized by SAMR (at the central level).

Enforcement actions were focused on sectors having an impact on the livelihood of the general public, including pharmaceuticals, automobiles, and utilities:

Pharmaceutical Industry: Pharmaceutical companies were penalized in two enforcement decisions, both concerning abusive conduct in the active pharmaceutical ingredient markets. In particular, the investigation by SAMR of three pharmaceutical companies, Shandong Kanghui Medicine (“Kanghui”), Weifang Puyunhui Pharmaceutical (“Puyunhui”), and Weifang Taiyangshen Pharmaceutical (“Taiyangshen”) for abuse of collective dominance, resulted in record monetary penalty against domestic firms under the AML. SAMR found that the three companies collectively abused their market dominance by selling injectable calcium gluconate at unfairly high prices and imposing unreasonable trading terms on downstream manufacturers. SAMR imposed on Kanghui the maximum penalty rate, being 10 percent of its 2018 sales amount; and imposed on Puyanhui and Yaiyangshen 9 percent and 7 percent of their respective 2018 sales amounts. The total monetary penalty imposed on the three companies was RMB 204.5 million (~USD 31.6 million, and all of their illegal gains in the aggregate amount of RMB 121 million (~USD 18.7 million) were confiscated.[13]

Automobile Industry: The automobile industry accounted for four enforcement decisions in 2020 involving price fixing, market partitioning and abusing a dominant position. Importantly, in one of the enforcement decisions, one of the 11 second-hand vehicle dealers involved in the case, Pingluo County Zhongli Second-hand Vehicle Trading, was not subject to any penalty by reason that it provided important evidence to the Ningxia Administration for Market Regulation. The other offenders in the case received a fine equivalent to 4 percent of their 2018 sales amount, in addition to a confiscation of their illegal gains.[14]

Utilities Sector/Energy: Six enforcement decisions concerned actions taken by local antitrust agencies against utility companies for anti-competitive conduct including exclusive dealing and market partitioning. SAMR continues to take into account the level of cooperation exhibited by an undertaking when imposing penalties in administrative actions. For example, in a case involving an agreement partitioning the market of sale of bottled liquefied gas, one of the two undertakings concerned was exempted from penalty in view of its cooperation during the investigation, including the proactive provision of key evidence to the enforcement agency.[15] The other undertaking was fined with an amount equivalent to 3 percent of its sales in 2018, i.e. around RMB 1.76 million (~USD 272,290).

Similarly, the importance of cooperation is highlighted in the Jiangsu Administration for Market Regulation’s (“Jiangsu AMR”) decision to terminate an investigation against Yancheng Xin’ao Fuel Gas (“Yancheng Xin’ao”) for suspected abuse of dominance. The investigation, which began in 2015, was suspended in 2019 in light of the cooperation of Yancheng Xin’ao in the investigation process and the remedial measures proposed and implemented by it. Upon the applications made by Yancheng Xin’ao and having taken into account the implementation of the remedial measures, Jiangsu AMR decided in July 2020 to terminate the investigation.[16]

Finally, the Qinghai Administration for Market Regulation (“Qinghai AMR”) imposed a monetary penalty in the amount of RMB 700,000 (~USD 108,300) on Qinghai Minhe Chuanzhong Petroleum and Natural Gas (“Qinghai Minhe”) for obstructing the investigation by concealing and destroying evidence. In addition, Qinghai AMR took into account the serious nature and the duration of the breaches, and imposed a hefty fine equivalent to 9 percent of its 2017 sales amount on Qinghai Minhe.[17]

4.  Civil Litigation

There continues to be an increasing number of private antitrust litigation covering a wide range of topics and industries. For example, according to the 2020 annual report of China’s Intellectual Property Tribunal, which hears appeals from specialized intellectual property courts, the antitrust cases handled by the tribunal involved various subject matters, including information and communication technologies, pharmaceuticals, power supply, construction, and security products.

Among antitrust cases before the Chinese courts in 2020, of particular interest to the antitrust community is the increasing number of claims against tech companies and development in private litigation following an antitrust regulator’s adverse administrative decision against an undertaking, as summarized below.

4.1  Tech Companies Targeted

Tech companies continue to be the target of private antitrust litigation in 2020, though none of the claimants succeeded in any of the claims against these tech giants. For example, the appeal brought by Huaduo against a leading Chinese internet technology company alleging abuse of market dominance by the latter in relation to a well-known online game at the Higher People’s Court of Guangdong Province was dismissed in May 2020 on the basis that the defendant did not have the market dominance in the relevant market.

It is anticipated that the trend of growing private antitrust litigation against tech companies will continue in 2021. A claim filed by an individual surnamed Wang against Meituan for alleged abuse of dominance by removing Alipay as a payment option was reportedly accepted by the Beijing Intellectual Property Court in late December 2020.[18]

In addition, ByteDance’s Douyin, a video-sharing social network platform, has filed a claim against a Chinese multinational technology conglomerate for alleged monopolistic behavior by blocking users’ sharing of Douyin content on its instant sharing messaging apps. It was also reported that Zhang Zhengxin, who withdrew his claim in January 2020 after the trial against the same conglomerate for abuse of market by disenabling direct sharing of links to Taobao or Douyin through one of its instant sharing messaging apps, indicated earlier this year that he was in the process of filing a claim against the conglomerate afresh on the basis of some evidence he has recently obtained.

4.2  Follow-on Litigation

In 2020, Chinese courts published two decisions in private follow-on litigation after an enforcement action is taken by an antitrust regulator.

In the first case, the Higher People’s Court of Shanghai Municipality (“Shanghai Higher People’s Court”) dismissed Hanyang Guangming’s claim against and Hankook Tire. The court indicated that while materials in an administrative action carried out by an antitrust regulator may be adopted as evidence in court, courts need not admit materials that are irrelevant to the dispute in the private litigation.[19] The claimant argued that the administrative decision by the Shanghai Municipal Price Bureau in 2016 to penalize Hankook Tire found that the latter reached and implemented resale price maintenance agreements, and that this administrative decision could be used as the basis to prove facts in the private litigation. The claimant also argued that the lower court erred in coming to a conclusion that contradicted the Shanghai Municipal Price Bureau’s administrative decision. The Shanghai Higher People’s Court disagreed with the claimant, and upheld the lower court’s determination that the actions of Hankook Tire did not constitute resale price maintenance agreements as prohibited by the AML. This case demonstrates that courts do not always follow determinations made by an antitrust regulator, rendering it less predictable and more difficult for claimants to succeed in private follow-on litigation.

On the other hand, the court in the second private follow-on litigation came to the same conclusion as the antitrust enforcement agency against the defendant. In this case, the defendant, Jiacheng Concrete, received an administrative penalty from the Shaanxi Administration for Market Regulation (“Shaanxi AMR”) for its monopolistic conduct. In reliance on the administrative decision by the Shaanxi AMR against Jiacheng Concrete, the Higher People’s Court of Shaanxi Province ruled in favor of the claimant in the absence of any contrary evidence, despite the fact that the administration decision was not subject to any review or appeal.[20]

_____________________

   [1]   Gibson Dunn, “Antitrust in China – 2019 Year in Review” (released on February 10, 2020), available at https://www.gibsondunn.com/antitrust-in-china-2019-year-in-review/. The amendments are still under discussion.

   [2]   SAMR, “Anti-Monopoly Guidelines for the Automobile Sector” (关于汽车业的反垄断指南) (released on September 18, 2020), available at http://gkml.samr.gov.cn/nsjg/fldj/202009/t20200918_321860.html.

   [3]   SAMR, “Anti-Monopoly Guidelines for the Platform Economy Sector” (关于平台经济领域的反垄断指南) (released on February 7, 2021), available at http://gkml.samr.gov.cn/nsjg/fldj/202102/t20210207_325967.html.

   [4]   The Establishment of a Joint Venture between Shanghai Mingcha Zhegang Management Consulting Co., Ltd. and Huansheng Information Technology (Shanghai) Co., Ltd, see announcement concerning the filing in April 2020 at http://www.samr.gov.cn/fldj/ajgs/jzjyajgs/202004/t20200420_314431.html and announcement concerning the unconditional approval in July 2020 at http://www.samr.gov.cn/fldj/ajgs/wtjjzajgs/202007/t20200722_320099.html.

   [5]   SAMR, “Anti-Monopoly Guidelines in the Field of Intellectual Property Rights” (关于知识产权领域的反垄断指南) (released on September 18, 2020), available at http://gkml.samr.gov.cn/nsjg/fldj/202009/t20200918_321857.html.

   [6]   SAMR, “Guidelines for the Application of Leniency Program in Horizontal Monopoly Agreement Cases” (横向垄断协议案件宽大制度适用指南) (released on September 18, 2020), available at http://gkml.samr.gov.cn/nsjg/fldj/202009/t20200918_321856.html.

   [7]   SAMR, “Guidelines on Undertakings’ Commitments in Anti-Monopoly Cases” (反垄断案件经营者承诺指南) (released on October 30, 2020), available at http://gkml.samr.gov.cn/nsjg/xwxcs/202010/t20201030_322782.html.

   [8]   SAMR, “Announcements of Unconditionally Approved Cases on Undertaking Concentrations” (无条件批准经营者集中案件公示), available at http://www.samr.gov.cn/fldj/ajgs/wtjjzajgs/.

   [9]   SAMR, “Announcement of SAMR’s Antimonopoly Review Decision to Conditionally Approve the Acquisition of the BioPharma Business of the General Electric Company by Danaher Corporation” (市场监管总局关于附加限制性条件批准丹纳赫公司收购通用电气医疗生命科学生物制药业务案反垄断审查决定的公告) (released on February 28, 2020), available at, http://www.samr.gov.cn/fldj/tzgg/ftjpz/202002/t20200228_312297.html.

  [10]   SAMR, “Announcement of SAMR’s Antimonopoly Review Decision to Conditionally Approve Infineon Technologies AG’s Share Acquisition of Cypress Semiconductor Corp.” (市场监管总局关于附加限制性条件批准英飞凌科技公司收购赛普拉斯半导体公司股权案反垄断审查决定的公告) (released on April 8, 2020), available at http://www.samr.gov.cn/fldj/tzgg/ftjpz/202004/t20200408_313950.html.

  [11]   SAMR, “Announcement of SAMR’s Antimonopoly Review Decision to Conditionally Approve Nvidia Corporation’s Share Acquisition of Mellanox Technologies, Ltd.” (市场监管总局关于附加限制性条件批准英伟达公司收购迈络思科技有限公司股权案反垄断审查决定的公告) (released April 16, 2020), available at http://www.samr.gov.cn/fldj/tzgg/ftjpz/202004/t20200416_314327.html.

  [12]   SAMR, “Announcement of SAMR’s Antimonopoly Review Decision to Conditionally Approve ZF Friedrichshafen AG’s Share Acquisition of WABCO Holding Inc.” (市场监管总局关于附加限制性条件批准采埃孚股份公司收购威伯科控股公司股权案反垄断审查决定的公告) (released on May 15, 2020), available at http://www.samr.gov.cn/fldj/tzgg/ftjpz/202005/t20200515_315255.html.

  [13]   SAMR, “Announcement of SAMR of the Decision to Penalize concerning Monopoly involving Calcium Gluconate Pharmaceutical Ingredients” (市场监管总局发布葡萄糖酸钙原料药垄断案行政处罚决定书) (released April 14, 2020), available at http://www.samr.gov.cn/fldj/tzgg/xzcf/202004/t20200414_314227.html.

  [14]   SAMR, “Announcement of SAMR of the Decision concerning the Monopoly Agreement of 11 Second-hand Vehicles Dealers in Ningxia Shizuishan Shi” (市场监管总局发布宁夏石嘴山市11家二手车交易市场经营者垄断协议案的处理决定) (released on October 22, 2020), available at http://www.samr.gov.cn/fldj/tzgg/xzcf/202010/t20201022_322556.html.

  [15]   SAMR, “Announcement of SAMR of the Decision to Penalize Huan Fuel Gas LLC and Huaihua Railway Economic and Technological Development Co. Ltd for Concluding and Implementing Monopoly Agreement” (市场监管总局发布湖南中民燃气有限公司与怀化铁路经济技术开发有限公司达成并实施垄断协议案行政处罚决定) (released on July 2, 2020), available at http://www.samr.gov.cn/fldj/tzgg/xzcf/202007/t20200702_319339.html.

  [16]   SAMR, “Announcement of SAMR of the Decision to Terminate Investigation against Yancheng Xin’ao Fuel Gas Ltd” (市场监管总局发布盐城新奥燃气有限公司垄断案终止调查决定书) (released on July 24, 2020), available at http://www.samr.gov.cn/fldj/tzgg/xzcf/202007/t20200724_320227.html.

  [17]  SAMR, “Announcement of SAMR of the Decision to Penalize Qinghai Minhe Chuanzhong Petroleum and Natural Gas Co., Ltd. for Abusing Market Dominance” (市场监管总局发布青海省民和川中石油天然气有限责任公司滥用市场支配地位案行政处罚决定书) (released on May 19, 2020), available at http://www.samr.gov.cn/fldj/tzgg/xzcf/202005/t20200519_315357.html.

  [18]   China Daily, Meituan in the antitrust dock (December 31, 2020), available at https://www.chinadaily.com.cn/a/202012/31/WS5fed065ca31024ad0ba9fab1.html.

  [19]   Wuhan Hanyang Guangming Trading Company Limited v Shanghai Hankook Tire Sales Company Limited (Higher People’s Court of Shanghai Municipality, July 30, 2020), available here.

  [20]   Yanan Jiacheng Concrete Company Limited v Fujian Sanjian Engineering Company Limited (Higher People’s Court of Shanghai Municipality, August 13, 2020), available here.

 

The following Gibson Dunn lawyers assisted in the preparation of this client update: Sébastien Evrard, Bonnie Tong, Rebecca Ho and Celine Leung.

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

Sébastien Evrard (+852 2214 3798, [email protected])
Kelly Austin (+852 2214 3788, [email protected])
Bonnie Tong (+852 2214 3762, [email protected])
Rebecca Ho (+852 2214 3824, [email protected])
Celine Leung (+852 2214 3823, [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 February 26, 2021, the Board of Governors of the Federal Reserve System (Federal Reserve) issued a Supervision and Regulation letter[1] containing its final supervisory guidance (Effectiveness Guidance) on the effectiveness of a banking institution’s board of directors.  The Guidance applies to bank holding companies and savings-and-loan holding companies with total consolidated assets of $100 billion or more, with the exception of intermediate holding companies of foreign banking organizations (IHCs).  A separate Supervision and Regulation letter issued the same day revised twelve prior Supervision and Regulation letters touching on the subject and made nine additional prior Supervision and Regulation letters inactive.[2]

In keeping with recent banking agency views on supervisory “guidance” generally,[3] the Effectiveness Guidance, in its final form, is less prescriptive than in the Federal Reserve’s 2017 proposal (Effectiveness Proposal).[4]  The Federal Reserve states that the Effectiveness Guidance thus reflects the Federal Reserve’s “observ[ations] over time” regarding the attributes of effective boards of directors and seeks to eschew “standardized” expectations.  This said, the Federal Reserve also declares that “[a]s the board effectiveness guidance builds on the principles set forth in the large financial institution ratings framework, the Federal Reserve intends to use the board effectiveness guidance in informing its assessment of the governance and controls at all firms subject to the large financial institution rating system.”[5]

As a result, it is reasonable to conclude that these new principles of board effectiveness, although stated in guidance form, will become an important standard for determining whether, in Federal Reserve assessments, a board of directors of a large financial institution is meeting regulatory expectations with respect to the firm’s governance.

Federal Reserve’s Key Principles of an Effective Board

The Effectiveness Guidance sets forth five principles that it deems important for a board of directors to be effective.  These are:

  • Setting a Clear, Aligned and Consistent Direction Regarding Firm Strategy and Risk Appetite
  • Directing Senior Management Regarding the Board’s Information Needs
  • Overseeing and Hold Senior Management Accountable
  • Supporting the Independence and Stature of Independent Risk Management and Internal Audit
  • Maintaining a Capable Board Composition and Governance Structure

A. Setting a Clear, Aligned and Consistent Direction Regarding Firm Strategy and Risk Appetite

The Effectiveness Guidance emphasizes the importance of the alignment of a firm’s strategy to its risk appetite.  The Federal Reserve defines “risk appetite” as “the aggregate level and types of risk the board and senior management are willing to assume to achieve the firm’s strategic business objectives, consistent with applicable capital, liquidity, and other requirements and constraints.”  Overseeing such an alignment is a critical board function.

The takeaway on this attribute is that risk management should be an integral part of a firm’s business strategy – the Federal Reserve believes that a business strategy untethered to effective risk management is not a good practice.  This point may be seen in the Federal Reserve’s description of appropriately “clear” business strategies:  such strategies help to “establish and maintain an effective risk management structure, appropriate processes for each . . . risk management function, and an effective risk management and control function.”  So too, when discussing entering into new business lines, the Effectiveness Guidance states that a “clear strategy explains how conducting the business would be consistent with the firm’s risk appetite and changes that would need to be made to the firm’s risk management program and controls.”

An effective board of directors, therefore, regularly evaluates the development of a firm’s business so that risk management keeps up with business goals.  This is in addition to required board reviews of capital planning, recovery and resolution planning, audit plans, enterprise-wide risk management policies, liquidity risk management, compliance risk management, and compensation programs.

B. Directing Senior Management Regarding the Board’s Information Needs

In the aftermath of the Financial Crisis, as board oversight became subject to greater regulatory scrutiny, the information provided to regulated institutions’ boards increased substantially.  The Effectiveness Guidance notes as an attribute of effective boards that such boards direct senior management to provide sufficient, high-quality information in order to make well-informed decisions, including on “potential risks.”

The Effectiveness Guidance does not, however, stop with management reports.  It notes that effective directors actively seek out information in other ways – through special board sessions, outreach to the firm’s chief executive officer and his or her direct reports, and, interestingly, discussions with “Federal Reserve senior supervisors.”

The Effectiveness Guidance also notes that directors of an effective board, “particularly the lead independent director or independent board chair or committee chairs,” take an active role in setting board and committee agendas.  Here again, the concern with risk is paramount:  the Federal Reserve gives as an example if the topic is growth into a new business, “an effective board typically discusses the firm’s risk management and control capabilities that reflect the views of the independent risk management and internal audit function.”

C. Overseeing and Holding Senior Management Accountable

In the Federal Reserve’s view, an effective board of directors is not limited in the ways in which it holds senior management accountable.  There must be sufficient time in board meetings for candid discussion and debate and the hearing of diverse views – particularly around risk.  The Effectiveness Guidance indicates that incomplete information, and identified weaknesses, are to be thoroughly challenged before management recommendations can be approved.  It also indicates that for effective boards, the following areas demand “robust inquiry”:

  • drivers, indicators and trends related to current and emerging risks;
  • adherence to the board-approved strategy and risk appetite by business lines; and
  • material or persistent deficiencies in risk management or control practices.

The Federal Reserve further states that an effective board reviews reports of internal and external complaints, including “whistleblower” reports.

Another key to appropriate management oversight is sufficiently empowered independent directors.  For example, the Federal Reserve notes that where a firm has an executive chair of the board of directors, an effective board may give a lead independent director the power to call board meetings with or without the chair present as a means of counteracting management influence.

For the Federal Reserve, effective boards also carefully consider senior management compensation, including the degree to which management “promot[es] compliance with laws and regulations, including those related to consumer protection.”  Performance objectives include nonfinancial objectives for both business line executives (including the chief executive officer) and the chief risk officer and chief audit executive; in the case of the latter two executives, only nonfinancial objectives are considered.

Once again, risk concerns are paramount to the Federal Reserve:  “[p]erformance management and compensation systems, when combined with business strategies, discourage risk-taking inconsistent with the firm’s strategy and safety and soundness, including compliance with laws, regulations and internal standards, and promote the firm’s risk management goals.”  The Effectiveness Guidance also notes that depending on the size, complexity, and nature of the firm, formalized board succession planning can go beyond planning for the firm’s chief executive officer and include the chief risk officer and chief audit executive, “given the independence of those positions and the control function each serves.”  This is an area where the Effectiveness Guidance reflects supervisory experience that goes beyond legal constraints such as the New York Stock Exchange Rules and their CEO-only requirement.

D. Supporting the Independence and Stature of Independent Risk Management and Internal Audit

The Effectiveness Guidance also describes the attributes of effective risk committees and effective audit committees.  The Federal Reserve states that an effective audit committee engages in “robust inquiry” into, among other things:

  • the causes and consequences of material or persistent breaches of the firm’s risk appetite and risk limits;
  • the timeliness of remediation of material or persistent internal audit and supervisory findings; and
  • the appropriateness of the annual audit plan.

In the Federal Reserve’s view, an effective audit committee also meets directly with the chief audit executive, supports internal audit’s budget, staffing and internal controls, and reviews the status of actions recommended by internal and external auditors to remediate material or persistent deficiencies.

As for an effective risk committee, the Effectiveness Guidance states that it too engages in robust inquiry about the above subjects and further:

  • communicates directly with the chief risk officer on material risk management issues;
  • oversees the appropriateness of independent risk management’s budget, staffing, and internal control systems;
  • coordinates with the compliance function;
  • provides independent risk management with direct and unrestricted access to the risk committee; and
  • after reviewing the risk management framework relative to the firm’s structure, risk profile, complexity, activities and size, effects changes that align with the firm’s strategy and risk appetite.

Finally, the Federal Reserve indicates that an effective board of directors steps in when internal audit and independent risk management are unduly influenced by business lines, and if the views of internal audit and independent risk management are not taken into account when management decisions are made.

E. Maintaining a Capable Board Composition and Governance Structure

The final attribute of an effective board is maintaining a capable composition and governance structure – including “a process to identify and select potential director nominees with a mix of skills, knowledge, experience and perspectives.”  In an addition from the Effectiveness Proposal, the final Guidance states explicitly that a diverse pool of nominees “includ[es] women and minorities.”  Other aspects that support an effective governance structure are appropriate committees and management-to-committee reporting lines.  Finally, an effective board engages in evaluating on an ongoing basis its own strengths and weaknesses, including the performance of board committees, and, specifically, the audit and risk committees.

Conclusion

For those who have followed developments in bank governance, the Effectiveness Guidance does not contain many surprises.  The Federal Reserve’s view – which holds true with respect to its approach to senior management as well – is that the constraints imposed by general corporate law and stock exchange requirements do not necessarily appropriately balance business goals with prudent risk taking, and therefore other checks on the profit making function are necessary to further safety and soundness.  Although a firm’s independent risk management and internal audit are helpful in this regard, those functions need continual reinforcement from a well-informed board and well-informed board committees that keep all forms of risk at the forefront of their consideration and robustly challenge management.

As a result, although firms subject to the Effectiveness Guidance may be judged somewhat particularly given their size and risk profile in supervisory assessments, those firms should not take individualized examination consideration to mean that they should ignore the principles that the Federal Reserve has articulated.  Indeed, to the extent that particular policies and practices at a covered firm do not take into account and reflect these principles, a firm may wish to consider the reasons for taking a different approach and determine whether its current practices achieve the Federal Reserve’s overall goal of effectively overseeing risk.

____________________

   [1]   Federal Reserve, SR Letter 21-3/CA 21-1: Supervisory Guidance on Board of Directors’ Effectiveness (February 26, 2021), available at https://www.federalreserve.gov/supervisionreg/srletters/SR2103.htm.

   [2]   Federal Reserve, SR Letter 21-4/CA 21-2: Inactive or Revised SR Letters Related to the Federal Reserve’s Supervisory Expectations for a Firm’s Boards of Directors (February 26, 2021).  The purpose of the revisions was to align statements made about boards of directors with the Effectiveness Guidance.  The letters rendered inactive were generally described as providing outdated guidance on their subjects.

   [3]   See, e.g., Joint Press Release, “Agencies propose regulation on the role of supervisory guidance” (October 29, 2020).

   [4]   Federal Reserve, “Proposed Guidance on Supervisory Expectation for Board of Directors,” 82 Federal Register 37,219 (August 9, 2017).

   [5]   Such “large financial institutions” include the firms subject to the Effectiveness Guidance, as well as greater than $50 billion asset IHCs.


The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long and Elizabeth Ising.

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, the authors, or any of the following members of the firm’s Financial Institutions or Securities Regulation and Corporate Governance practice groups:

Financial Institutions Group:
Matthew L. Biben – New York (+1 212-351-6300, [email protected])
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [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])
Mylan L. Denerstein – New York (+1 212-351- 3850, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])
Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, [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.

The California Supreme Court’s February 25, 2021 opinion in Donohue v. AMN Services, LLC is the most significant decision construing an employer’s duty to provide and record meal periods in nearly a decade. California employers may wish to assess their meal period policies and practices, including relating to the recordation of meal periods, in light of the Court’s guidance in Donohue.

Donohue reaffirmed the key holding of Brinker Restaurant Corp. v. Superior Court, 53 Cal. 4th 1004 (2012), as the Court once again made clear that employers need not force employees to take full meal periods, so long as such meal periods are provided. But at the same time, the Court held that whenever timekeeping records show that an employee failed to take a compliant meal period, a rebuttable presumption arises under which it is presumed that the employer failed to provide a proper meal period. This means that employers will have the burden to prove they provided compliant meal periods for any shifts in which timekeeping records show that a meal period was short, late, or not recorded at all.

After Donohue, employers seeking to minimize potential litigation may wish to consider, among other options, ensuring that they have robust timekeeping systems that track the amount of time employees spend taking meal periods and automatically prompt employees to confirm they voluntarily chose to take a short or late meal period, or to skip the meal period entirely.

Donohue’s Key Holdings

  • Reaffirming the core teachings of Brinker, the Court in Donohue explained that “[a]n employer is liable [for failing to provide meal periods] only if it does not provide an employee with the opportunity to take a compliant meal period,” that an “employer is not liable if the employee chooses to take a short or delayed meal period or no meal period at all,” that an “employer is not required to police meal periods to make sure no work is performed,” and that “the employer’s duty is to ensure that it provides the employee with bona fide relief from duty and that this is accurately reflected in the employer’s time records.” Donohue slip op. at 27–28.
  • With respect to recordation of meal periods, the Court held that “employers cannot engage in the practice of rounding time punches—that is, adjusting the hours that an employee has actually worked to the nearest preset time increment.” Id. at 1.
  • The Court expressly did not address the use of time rounding policies outside the context of meal periods, but suggested that “the practical advantages of rounding polices may diminish further” as “technology continues to evolve” and “technological advances may help employers to track time more precisely.” Id. at 19, 21.
  • The Court adopted the rebuttable presumption discussed by Justice Werdegar in her concurring opinion in Brinker. Under this presumption, “[i]f an employer’s records show no meal period for a given shift over five hours, a rebuttable presumption arises that the employee was not relieved of duty and no meal period was provided.” Id. at 21–22.
  • The Court further explained that this presumption applies not only to records showing “missed meal periods” but also when records show “short and delayed meal periods.” Id. at 24. And “the presumption goes to the question of liability and applies at the summary judgment stage, not just at the class certification stage.” Id.
  • Significantly, “[a]pplying the presumption does not mean that time records showing missed, short, or delayed meal periods result in ‘automatic liability’ for employers.” Id. at 26. To the contrary, employers “can rebut the presumption by presenting evidence that employees were compensated for noncompliant meal periods or that they had in fact been provided compliant meal periods during which they chose to work.” Id. at 26–27.
  • And the Court specifically held that “[e]mployers may use a timekeeping system like” the electronic timekeeping system used by the employer in Donohue—which “included a dropdown menu for employees to indicate whether they were provided a compliant meal period but chose to work” and “triggered premium pay for any missed, short, or delayed meal periods”—without rounding time punches for meal periods. Id. at 28.

Key Takeaways

Donohue makes clear that even where an employer’s records are imperfect, there is no automatic liability. Rather, employers may rebut the presumption that they did not provide compliant meal periods with evidence showing employees were provided proper meal periods. But to avoid unnecessary litigation, among other options, employers might consider adopting timekeeping systems that adequately track meal periods and do not engage in any rounding of time employees spend taking meal periods.

Employers may also want to consider, as one option, implementing timekeeping systems that can flag when meal periods are recorded as short, late, or missed, and create a follow-up process to determine and document whether employees voluntarily chose not to take a full meal period. In fact, the California Supreme Court indicated that the electronic timekeeping system used by the employer in Donohue, which “included a dropdown menu for employees to indicate whether they were provided a compliant meal period but chose to work, and the system triggered premium pay for any missed, short, or delayed meal periods due to the employer’s noncompliance,” would suffice under the law so long “as the system does not round time punches.” Donohue slip op. at 28.

Finally, while Donohue did not address rounding policies outside the context of meal periods, the Court suggested that technological advances may render such policies obsolete. Given that observation, employers may wish to explore recording work time to the minute without any rounding.


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:

Catherine A. Conway – Co-Chair, Los Angeles (+1 213-229-7822, [email protected])
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202-955-8242, [email protected])
Michele L. Maryott – Orange County (+1 949-451-3945, [email protected])
Jesse A. Cripps – Los Angeles (+1 213-229-7792, [email protected])
Katherine V.A. Smith – Los Angeles (+1 213-229-7107, [email protected])
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, [email protected])
Tiffany Phan – Los Angeles (+1 213-229-7522, [email protected])
Emily Sauer – Los Angeles (+1 213-229-7704, [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 February 18, 2021, the U.S. Office of Foreign Assets Control (OFAC), an agency of the Treasury Department that administers and enforces U.S. economic and trade sanctions, issued an enforcement release of a settlement agreement with BitPay, Inc. (BitPay) for apparent violations relating to Bitpay’s payment processing solution that allows merchants to accept digital currency as payment for goods and services.[1]  OFAC found that BitPay allowed users apparently located in sanctioned countries and areas to transact with merchants in the United States and elsewhere using the BitPay platform, even though BitPay had Internet Protocol (IP) address data for those users.  The users in sanctioned countries were not BitPay’s direct customers, but rather its customer’s customers (in this case the merchants’ customers).

The BitPay action follows an OFAC December 30, 2020 enforcement release of a settlement agreement with BitGo, Inc. (BitGo), also for apparent violations related to digital currency transactions.[2]  BitGo offers, among other services, non-custodial secure digital wallet management services, and OFAC found that BitGo failed to prevent users located in the Crimea region of Ukraine, Cuba, Iran, Sudan and Syria from using these services.  OFAC determined that BitGo had reason to know the location of these users based on IP address data associated with the devices used to log into its platform.

This Alert discusses these developments.

I. OFAC’s Enforcement Against BitGo

BitGo, which was founded in 2013 and is headquartered in Palo Alto, California, is self-described as “the leader in digital asset financial services, providing institutional investors with liquidity, custody, and security solutions.”[3]  As OFAC explained in its enforcement release, the company agreed to remit $98,830 to settle potential civil liability related to 183 apparent violations of multiple sanctions programs.  OFAC specifically claimed that between 2015 and 2019, deficiencies in BitGo’s sanctions compliance procedures led to BitGo’s failing to prevent individuals located in the Crimea region of Ukraine, Cuba, Iran, Sudan, and Syria from using BitGo’s non-custodial secure digital wallet management service despite having reason to know that these individuals were located in sanctioned jurisdictions.  Reason to know was based on BitGo’s having IP address data associated with the devices that these individuals used to log in to the BitGo platform.  According to OFAC, BitGo processed 183 digital currency transactions on behalf of these individuals, totaling $9,127.79.

According to the OFAC release, prior to April 2018, BitGo had allowed individual users of its digital wallet management services to open an account by providing only a name and email address.  In April 2018, BitGo supplemented this practice by requiring new users to verify the country in which they were located, with BitGo generally relying on the user’s attestation regarding his or her location rather than performing additional verification or diligence on the user’s location.  In January 2020, however, BitGo discovered the apparent violations of multiple sanctions compliance programs.  It thereupon implemented a new OFAC Sanctions Compliance Policy and undertook significant remedial measures.  This new policy included appointing a Chief Compliance Officer, blocking IP addresses for sanctioned jurisdictions, and keeping all financial records and documentation related to sanctions compliance efforts.

II. OFAC’s Enforcement Against BitPay

BitPay, which was founded in 2011 and is headquartered in Atlanta, Georgia, provides digital asset management and payment services that enable consumers “to turn digital assets into dollars for spending at tens of thousands of businesses.”[4]  As OFAC explained in its enforcement release, BitPay agreed to remit $507,375 to settle potential civil liability related to 2,102 apparent violations of multiple sanctions programs.  OFAC specifically claimed that between 2013 and 2018, deficiencies in BitPay’s sanctions compliance procedures led to BitPay’s allowing individuals who appear to have been located in the Crimea region of Ukraine, Cuba, North Korea, Iran, Sudan, and Syria to transact with merchants in the United States and elsewhere using digital currency on BitPay’s platform despite BitPay having location data, including IP addresses, about those individuals prior to effecting the transactions.

BitPay allegedly “received digital currency payments on behalf of its merchant customers from those merchants’ buyers who were located in sanctioned jurisdictions, converted the digital currency to fiat currency, and then relayed that currency to its merchants.”  According to OFAC, BitPay processed 2,102 such transactions totaling $128,582.61.  Although BitPay had (i) screened its direct customers (i.e., its merchant customers) against OFAC’s List of Specially Designated Nationals and Blocked Persons and (ii) conducted due diligence on the merchants to ensure they were not located in sanctioned jurisdictions, BitPay failed to screen location data that it obtained about its merchants’ buyers—BitPay had begun receiving buyers’ IP address data in November 2017, and prior to that received information that included buyers’ addresses and phone numbers.  BitPay had implemented sanctions compliance controls as early as 2013, including conducting due diligence and sanctions screening on its merchants, and formalized its sanctions compliance program in 2014.  However, following its apparent violations, BitPay supplemented its program with the following:

  • Blocking IP addresses that appear to originate in Cuba, Iran, North Korea, and Syria from connecting to the BitPay website or from viewing any instructions on how to make payment;
  • Checking physical and email addresses of merchants’ buyers when provided by the merchants to prevent completion of an invoice from the merchant if BitPay identifies a sanctioned jurisdiction address or email top-level domain; and
  • Launching “BitPay ID,” a new customer identification tool that is mandatory for merchants’ buyers who wish to pay a BitPay invoice equal to or above $3,000. As part of BitPay ID, the merchant’s customer must provide an email address, proof of identification/photo ID, and a selfie photo.

III. Conclusion

The major takeaway from these two enforcement cases is that OFAC expects digital asset companies to use IP address data or other location data—even for their customers’ customers—to screen that location information as part of their OFAC compliance function.  OFAC will undoubtedly be considering whether a company has screened such information in assessing whether to impose a penalty.  More guidance on OFAC’s perspective on the essential components of a sanctions compliance program is available in A Framework for OFAC Compliance Commitments, which OFAC published in May 2019.  In addition, we anticipate ongoing scrutiny by OFAC of digital asset companies, given that key Treasury Department policymakers continue to express concerns about digital assets being used to avoid economic sanctions and anti-money laundering compliance.[5]

_____________________

   [1]   OFAC Enters Into $507,375 Settlement with BitPay, Inc. for Apparent Violations of Multiple Sanctions Programs Related to Digital Currency Transactions (Feb. 18, 2021), available at https://home.treasury.gov/system/files/126/20210218_bp.pdf.

   [2]   OFAC Enters Into $98,830 Settlement with BitGo, Inc. for Apparent Violations of Multiple Sanctions Programs Related to Digital Currency Transactions (Dec. 30, 2020), available at https://home.treasury.gov/system/files/126/20201230_bitgo.pdf.

   [3]   See BitGo Announces $16 Billion in Assets Under Custody (December 21, 2020), available at https://www.bitgo.com/newsroom/press-releases/bitgo-announces-16-billion-in-assets-under-custody.

   [4]   See For a Limited Time BitPay and Simplex Partner to Offer Zero Fees on Crypto Purchases for All of Europe (EEA) (February 15, 2021), available at https://www.businesswire.com/news/home/20210215005244/en/For-a-Limited-Time-BitPay-and-Simplex-Partner-to-Offer-Zero-Fees-on-Crypto-Purchases-for-All-of-Europe-EEA.

   [5]   U.S. Treasury Department Holds Financial Sector Innovation Policy Roundtable (February 10, 2021), available at https://home.treasury.gov/news/press-releases/jy0023.


The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long, Judith Alison Lee, Jeffrey Steiner and Rama Douglas.

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, the authors, or any of the following members of the firm’s Financial Institutions, Derivatives, or International Trade practice groups:

Financial Institutions and Derivatives Groups:
Matthew L. Biben – New York (+1 212-351-6300, [email protected])
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [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])
Mylan L. Denerstein – New York (+1 212-351- 3850, [email protected])
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])

International Trade Group:
Judith Alison Lee – Washington, D.C. (+1 202-887-3591, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [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.

Now that the first 100 days of the Biden Administration are in full swing, its financial regulatory priorities are becoming clearer. In this Client Alert, we discuss where we expect the Administration to focus, with respect to the banking, fintech, and derivatives sectors.

We believe these to be the principal takeaways:

  • The Administration’s whole-of-government emphasis on climate change issues should inform the regulatory agencies’ agendas far more than in the past.
  • The Administration’s focus on racial justice will likely lead to increased enforcement activities, particularly by the Consumer Financial Protection Bureau (CFPB), as well as to a reexamination of the Office of the Comptroller of the Currency’s (OCC) recently revised Community Reinvestment Act (CRA) regulations.
  • President Biden’s choices to head the OCC, Securities and Exchange Commission (SEC), and Commodity Futures Trading Commission (CFTC) will have significant input into the regulation of digital assets and fintech, with certain Trump-era regulations likely being subject to reexamination.
  • The CFPB can be expected to return to Obama Administration priorities and enforcement activity, with large financial institutions the likely targets.
  • The CFTC is likely to increase its aggressive enforcement in the derivatives and commodities markets, as well as maintain a keen focus on climate-related risks in those markets.
  • At the federal legislative level, Representative Maxine Waters (D-CA) and Senator Sherrod Brown (D-OH), both committee chairs, will likely focus on pandemic relief, inequity in housing, consumer protection, and climate change; in addition, cannabis banking legislation may finally be advanced.
  • In the immediate future, Congress is focused on the market volatility brought to light by the GameStop short squeeze, including a House Financial Services Committee hearing currently scheduled for February 18th with high-level executives of Robinhood, Citadel, Reddit, and Melvin Capital testifying. The House Financial Services Committee and Senate Banking Committee are also likely to consider legislation to ensure more market stability and possibly regulate order-flow payments.

A. Overarching Administration Priorities: Combatting Climate Change and Advancing Racial Justice

1. Climate Change

Climate change will be a new priority for the financial regulators. At her confirmation hearing, Treasury Secretary Janet Yellen called climate change an “existential threat” and stated that she plans to create a special unit, led by a senior official, to examine the risks that climate change poses to the financial system.[1] It is therefore reasonable to expect that the Financial Stability Oversight Council (FSOC), which Secretary Yellen chairs, will investigate climate-related risks. In December 2020, Senator Dianne Feinstein (D-CA) introduced the Addressing Climate Financial Risk Act, which among other things would establish a permanent FSOC committee to advise the FSOC in producing a report on how to improve the ability of the financial regulatory system to identify and mitigate climate risk.[2] Although Senator Feinstein’s bill will have to be reintroduced this year in the new Congress, Senator Feinstein has called on Secretary Yellen to implement key provisions of the bill via executive action.[3]

In a September 2020 report, titled “Managing Climate Risk in the U.S. Financial System” (the “Report”), the CFTC’s Climate-Related Market Risk Subcommittee of the Market Risk Advisory Committee recommended that the FSOC incorporate climate-related financial risks into its existing oversight function.[4] The Report makes the following policy recommendations:

  • Congress should establish a price on carbon through legislation; this would be the single most important step to manage climate risk and drive an appropriate allocation of capital.
  • Financial regulators should actively promote, and in some cases require, better understanding, quantification, disclosure, and management of climate-related risks by financial institutions and other market participants.
  • Financial regulators should undertake and assist financial institutions to undertake their own pilot climate-risks stress testing.
  • International collaboration and harmonization should be sought, and indeed, are critical for success in this area.

The Federal Reserve too has started to focus on climate issues. It created a Supervision Climate Committee, a system-wide group meant to build out the Federal Reserve’s capacity to understand the potential implications of climate change for financial institutions, infrastructure, and the markets.[5] In addition, the Federal Reserve is continuing its engagement with the Basel Committee on Banking Supervision’s Task Force on Climate-Related Financial Risks to develop recommendations for effective supervisory practices to mitigate climate-related financial risks, and has started to incorporate climate analysis into its Financial Stability Report and Supervision and Regulation Report.[6] And in December, the Federal Reserve became a full member of the Network for Greening the Financial System, a group of central banks and supervisors working to define and promote green finance best practices.[7] In addition, just this month, a paper published by the Federal Reserve Bank of San Francisco noted that the Federal Reserve has begun incorporating the impacts of global warming into its regulations, including by using climate stress tests and climate scenario analysis to measure banks’ vulnerability to climate-related losses.[8]

2. Advancing Racial Justice

The financial regulatory agency most likely to take the lead on racial justice issues is the CFPB. Acting CFPB Director Dave Uejio recently wrote that, in addition to pandemic-related relief, racial equity was his top priority, and that fair lending enforcement would be a major part of this focus.[9] On February 4th, Acting Director Uejio stated that he was asking the CFPB’s Division of Research, Markets, and Regulations to

  • prepare an analysis on housing insecurity, including mortgage foreclosures, mobile home repossessions, and landlord-tenant evictions;
  • prepare an analysis of the most pressing consumer finance barriers to racial equity to inform research and rulemaking priorities;
  • explicitly include in policy proposals the racial equity impact of the policy intervention;
  • resume data collections paused at the beginning of the pandemic, including HMDA quarterly reporting and the CARD Act data collection, as well as the previously completed 1071 data collection and the ongoing PACE data collection;
  • focus the mortgage servicing rulemaking on pandemic response to avert, to the extent possible, a foreclosure crisis when the COVID-19 forbearances end in March and April; and
  • explore options for preserving the status quo with respect to Qualified Mortgage and debt collection rules.[10]

Through such actions, the Biden CFPB would join in the efforts of certain states that have made strides in fair lending regulation, passing legislation to regulate more strictly student loan servicers[11] and to mandate small business truth-in-lending disclosures.[12] One should also expect the CFPB to investigate algorithmic models used in credit underwriting as to whether those models disparately impact minority borrowers.

The CRA will be another focus. In May 2020, under Acting Comptroller Brooks, the OCC finalized a substantial change to its CRA regulations, which community groups severely criticized.[13]   The Federal Reserve and Federal Deposit Insurance Corporation declined to join the OCC’s action, and in October 2020, the Federal Reserve published an Advanced Notice of Proposed Rulemaking to solicit input regarding modernizing its CRA regulatory and supervisory framework, taking a different approach from the OCC’s.[14] We expect that a Biden-appointed Comptroller of the Currency is likely to revisit Acting Comptroller Brooks’ revisions.

B. Other Expected Priorities

1. Digital Assets and Cryptocurrencies

How President Biden staffs the heads of three regulatory agencies – the SEC, OCC and CFTC – may have significant effects on the regulation of digital assets and cryptocurrencies.[15] Gary Gensler, nominated to head the SEC and the former Chair of the CFTC, is now a Senior Faculty Advisor to the Digital Currency Initiative at MIT’s Sloan School of Management, where he teaches classes on blockchain technology and digital currencies.[16] Michael Barr, a Treasury official in both the Clinton and Obama Administrations, has been identified as a leading candidate to head the OCC; Mr. Barr has served as an advisor to Ripple, on Lending Club’s board, and on the fintech advisory council for the Bill and Melinda Gates Foundation.[17] And Chris Brummer, a Georgetown Law professor who was twice nominated as a CFTC Commissioner in the Obama Administration, has been mentioned as a potential CFTC Chair; when at Georgetown Law, he founded DC Fintech Week.[18]

Each of these agencies will have important digital asset and cryptocurrency issues on its agenda. Just at the end of the Trump Administration, the SEC brought an enforcement action against Ripple Labs Inc. and two of its executives on the grounds that the sale of Ripple’s digital asset, XRP, was an unregistered securities offering under the federal securities laws.[19] A Gensler-led SEC will need to decide whether to continue this action, whether to provide guidance on which digital tokens are securities, and whether digital asset exchanges have to register as national securities exchanges or alternative trading systems.[20] Although Mr. Gensler has espoused openness to helping digital assets and cryptocurrencies reach their “real potential in the world of finance,” even if doing so requires “tailor[ing] some of th[e] rules and regulations” to their ecosystem, he has also taken the view that “100 to 200” exchanges “are basically operating outside of U.S. law.”[21]

A second issue that the Gensler-led SEC will need to address is custody. During the Trump Administration, the SEC issued a statement and requested comments regarding the application of the Customer Protection Rule (Rule 15c3-3) to cryptocurrencies and other digital assets. Similar to a safe-harbor provision, the statement essentially maps a path for specialized broker-dealers to operate for five years without fear of an enforcement action in this area where they maintain physical possession or control of digital asset securities.[22] With the request for comment, however, the SEC suggests that it is looking to establish permanent rules in this area.

At the end of the Trump Administration, the OCC moved to the forefront of cryptocurrency regulation by approving the charter conversion application of Anchorage Trust Company.[23] A second charter conversion application was approved just last week, for Protego Trust Company.[24] Whether the OCC will continue to stake out this leadership position under a new Comptroller is therefore a significant question. On these issues, the fact that there has been controversy about who the new Comptroller will in fact be – progressives have been pushing President Biden to name Professor Mehrsa Baradaran, in part because of her skepticism about fintech, rather than Michael Barr – makes it more difficult to offer definitive predictions.

The CFTC, moreover, remains an important regulator in the area. It has jurisdiction over futures and other derivatives contracts on cryptocurrencies, which continue to be developed, and it also has jurisdiction over manipulation in the spot markets for cryptocurrencies that are not securities (e.g., bitcoin and ether) if such manipulation affects a CFTC-regulated futures market. Given the recent significant volatility and meteoric rise in prices in Bitcoin and other cryptocurrencies, the CFTC’s aggressiveness in exercising its legal authority in these areas could have substantial effects.

2. Fintech: The OCC and Trump Administration Rulemakings

Before leaving government service, Trump Acting Comptroller of the Currency Brian Brooks oversaw several important actions of particular relevance to fintech companies.

The first relates to the so-called “Special Purpose National Bank Charter” for financial technology companies, which was first announced by Obama Administration Comptroller of the Currency Thomas Curry in late 2016.[25] The New York State Department of Financial Services (NYDFS) reacted to this development by suing the OCC, arguing that the OCC did not have the authority under the National Bank Act to grant such charters. A district judge in the United States District Court for the Southern District of New York agreed with NYDFS,[26] and this case is on appeal to the Second Circuit Court of Appeals.[27] In November 2020, the OCC accepted a charter application by the fintech Figure Technologies, Inc. and was shortly thereafter sued again – this time by the Conference of State Bank Supervisors Inc. (CSBS) in federal district court in Washington, DC.[28] The new Comptroller will have to determine whether to press ahead with – and defend in court – the “Special Purpose National Bank” and other non-traditional charters.

The other significant actions taken by the OCC under Acting Comptroller Brooks were two rules passed in response to the 2015 Second Circuit decision, Madden v. Midland Funding LLC.[29] Madden limited the application of National Bank Act preemption of state usury laws in the case of nonbanks that purchase debt originated by a national bank.[30] For many fintechs and other nonbank lenders that partner with loan-originating banks, the Madden decision increased uncertainty as to whether nonbanks become subject to state interest rate caps upon purchasing a loan that, at the time of origination, was not subject to the same requirements. In 2020, the OCC issued the “valid-when-made” rule, which took the position that “interest permissible before [a loan] transfer continues to be permissible after the transfer,”[31] and the “true lender” rule, which stated that a national bank is the “true lender” for a loan if the national bank is either named as such on the loan documents or funds the loan.[32]

As in the case of the “Special Purpose National Bank” charter, certain states challenged the rules in federal court.[33] The states argued that the OCC exceeded its statutory authority in issuing the rules and also focused on the rules’ effects on the states’ authority to regulate interest rates and enforce consumer protection laws more broadly, claiming that the rules are “contrary to Congressional actions to rein in the OCC’s ability to preempt state consumer protection laws.”[34] Briefing is underway on cross-motions for summary judgment regarding the “valid-when-made” rule, and a hearing is calendared for mid-March.[35] With the proceedings regarding the true lender rule only a few months behind, these two cases may provide early indications about the new Comptroller’s priorities.

3. An Invigorated CFPB

Rohit Chopra, President Biden’s appointee for the CFPB Director, served in the Obama Administration as the CFPB’s expert on the student loan industry; he also served as a Democratic FTC Commissioner during the Trump Presidency. If confirmed, his appointment suggests that the CFPB will become a more active enforcement agency, as was the case in the Obama Administration. Mr. Chopra’s public statements while FTC Commissioner have encompassed the following important themes: (i) a focus of enforcement efforts on larger firms rather than small businesses; (ii) targeting firms that facilitate and profit from the largest frauds; (iii) shifting from one-off enforcement actions to systemic enforcement efforts; (iv) making greater use of rulemaking, including by codifying enforcement policy; and (v) co-operating with state attorneys general in the enforcement process.[36] The CFPB may also be expected – like the OCC as described above – to revisit certain Trump-era rulemakings, such as its rulemakings on payday lending, qualified mortgages, and debt collection.

4. Shifting Priorities and Continuing Enforcement at the CFTC

Like the SEC, the CFTC will become a majority-Democratic Commission. It is possible that a new CFTC may seek to revisit some of the rules that were finalized on party-line votes under the Trump Administration. For example, in July 2020, the CFTC approved, by a 3-2 party line vote, a final rule addressing cross-border application of the swap dealer and major swap participant registration requirements.[37] In dissent, Commissioner Rostin Behnam criticized the final rule as “refusing to appropriately retain jurisdiction . . . over transactions that are arranged, negotiated or executed in the United States by non-U.S. [swap dealers].”[38] Commissioner Dan Berkovitz critiqued the final rule for “par[ing] back . . . extraterritorial application” of the Commodity Exchange Act (CEA) and setting “a weak and vague standard” for substituted compliance under a “comparable” regulatory regime.[39] Although Professor Brummer, a contender to lead the CFTC, has written extensively about the role of supervisory cooperation and coordination among international regulators,[40] he has also emphasized that the U.S. should “lead by example” and first “commit to the highest standards” before partnering with regulators abroad “who are like-minded,” indicating that he too would support a stronger cross-border rule.[41]

A changed CFTC is likely to result in increased enforcement and collaboration between the CFTC and other agencies, like the Department of Justice. For instance, in October 2020, the DOJ and the CFTC brought related actions against BitMEX based on allegations that BitMEX illegally operated a cryptocurrency derivatives trading platform and violated the anti-money laundering provisions of the Bank Secrecy Act.[42] In December 2020, the CFTC announced a settlement with Vitol, Inc., marking the CFTC’s first public action coming out of its initiative to pursue violations of the CEA involving foreign corruption.[43] The CFTC worked with the Department of Justice and the United States Attorney’s Office for the Eastern District of New York, which announced a Deferred Prosecution Agreement with Vitol the same day.

C. Congressional Priorities

With a Democratic majority in both houses of Congress, legislative priorities will be shaped by the two relevant Committee chairs, Maxine Waters (D-CA) and Sherrod Brown (D-OH).

In December 2020, Representative Waters sent President Biden a public letter with recommendations on areas where she thinks immediate action should be taken.[44] These include:

  • Promoting stable and affordable housing;
  • Increasing CFPB enforcement of consumer financial protection laws;
  • Restoring and enhancing regulatory safeguards on the financial system, including reversing rules that eased prudential requirements for large banks and strengthening the capital regulatory framework;
  • Addressing discriminatory lending issues; and
  • Focusing on climate risks, particularly in the insurance sector.

The hearings scheduled by the House Financial Services Committee also provide insight into what issues the committee believes are the most pressing, including the need for additional pandemic relief, particularly for small and minority-owned businesses, climate change, and lending discrimination. Given recent events, the Committee has also scheduled hearings on the recent market volatility involving GameStop and domestic terrorist financing.[45]

In the Senate, Sherrod Brown (D-OH), the chairman of the Senate Banking Committee, is likely to take a more aggressive stance toward the financial services industry than his predecessor, Senator Mike Crapo (R-ID). Senator Brown is known as one of Congress’s fiercest critics of Wall Street, and plans to reorient the focus of the Banking Committee on addressing the fallout of the pandemic and climate change, and strengthening regulations.[46] Senator Brown’s focus in the immediate future is extending protections from eviction, and affordable housing and housing access will continue to be a priority for the committee.[47] Senator Brown is also keen on a public-banking option and caps on interests rates for payday loans, and has said he intends to investigate the relationship among stock prices, executive compensation, and workers’ wages.[48]

A final area of potential legislative action is cannabis banking. In Congress, the SAFE Banking Act, a bill that would enable banks to offer financial services to legitimate marijuana- and hemp-related businesses, could be re-introduced.   Because cannabis remains classified as a Schedule I controlled substance, most financial institutions refrain from providing services to legal cannabis businesses out of fear of adverse regulatory and supervisory action and federal forfeiture based on racketeering or trafficking charges. The SAFE Banking Act would prohibit such regulatory actions and shield banks from liability premised solely on the provision of financial services to a marijuana- or hemp-related business. The SAFE Banking Act passed the House with bipartisan support in 2019, and was originally included in the Heroes Act, passed by the House in May 2020 in response to the COVID-19 pandemic.   However, the bill was dropped from the COVID relief measures ultimately enacted in December 2020, and the bill has not come up for a vote yet in the Senate despite some bipartisan support.

______________________

   [1]   Zachary Warmbrodt, Yellen vows to set up Treasury team to focus on climate, in victory for advocates, Politico (Jan. 19, 2021), https://www.politico.com/news/2021/01/19/yellen-treasury-department-climate-change-460408.

   [2]   Senator Dianne Feinstein, Press Releases, Feinstein Introduces Bill to Minimize Climate Change Risk in Financial System (Dec. 17, 2020), https://www.feinstein.senate.gov/public/index.cfm/press-releases?ID=27A04819-E44D-435C-AB06-FBC9D6051EB2.

   [3]   Senator Dianne Feinstein, Press Releases, Feinstein to Secretary Yellen: Use Financial System to Mitigate Climate Change Risk (Jan. 28, 2021), https://www.feinstein.senate.gov/public/index.cfm/press-releases?id=F494CF21-B927-404B-876A-CF80D3231985.

   [4]   U.S. Commodity Futures Trading Commission Climate-Related Market Risk Subcommittee, Managing Climate Risk in the U.S. Financial System (2020), available at https://www.cftc.gov/sites/default/files/2020-09/
9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20
Risk%20-%20Managing%20Climate%20Risk%20in%20
the%20U.S.%20Financial%20System%20for%20posting.pdf
.

   [5]   Fed. Reserve Bank of N.Y., Press Release, Kevin Stiroh to Step Down as Head of New York Fed Supervision to Assume New System Leadership Role at Board of Governors on Climate (Jan. 25, 2021), https://www.newyorkfed.org/newsevents/news/aboutthefed/2021/20210125.

   [6]   Lael Brainerd, Strengthening the Financial System to Meet the Challenge of Climate Change (Dec. 18, 2020), available at https://www.federalreserve.gov/newsevents/speech/brainard20201218a.htm.

   [7]   See Central Banks and Supervisors Network for Greening the Financial System, https://www.ngfs.net/en.

   [8] Glenn D. Rudebusch, FRBSF Economic Letter, Climate Change Is a Source of Financial Risk, Fed. Reserve Bank of S.F. (Feb. 8, 2021), https://www.frbsf.org/economic-research/publications/economic-letter/2021/february/climate-change-is-source-of-financial-risk/.

   [9]   Dave Uejio, The Bureau is taking much-needed action to protect consumers, particularly the most economically vulnerable (Jan. 28, 2021), https://www.consumerfinance.gov/about-us/blog/the-bureau-is-taking-much-needed-action-to-protect-consumers-particularly-the-most-economically-vulnerable/.

[10]   Dave Uejio, The Bureau is working hard to address housing insecurity, promote racial equity, and protect small businesses’ access to credit (February 4, 2021), https://www.consumerfinance.gov/about-us/blog/the-bureau-is-working-hard-to-address-housing-insecurity-promote-racial-equity-and-protect-small-businesses-access-to-credit/.

[11]   See, e.g., Jeremy Sairsingh, State Regulation of Student Loan Servicing Continues to Evolve, Am. Bar Assoc. (July 13, 2020), https://www.americanbar.org/groups/business_law/
publications/committee_newsletters/consumer/2020/202007/state-regulation/
.

[12]   See, e.g., Dafina Williams, Policies to Require Transparency in Small Business Lending Gain Momentum, Opportunity Fin. Network (Oct. 14, 2020), https://ofn.org/articles/policies-require-transparency-small-business-lending-gain-momentum.

[13]   See, e.g., Nat’l Cmty. Reinvestment Coal., et al., Joint Statement on CRA Rule Changes from OCC (May 21, 2020), https://ncrc.org/joint-statement-on-cra-rule-changes-from-occ/.

[14]   Community Reinvestment Act, 12 C.F.R. 228 (proposed Oct. 19, 2020).

[15]   Ephrat Livni, What’s Next for Crypto Regulation, N.Y. Times (Jan. 30, 2021), https://www.nytimes.com/2021/01/30/business/dealbook/crypto-regulation-blockchain.html.

[16]   See Gary Gensler Faculty Advisor Profile, available at https://dci.mit.edu/team.

[17]   John Adams, Biden’s OCC expected to chart new course for fintechs, crypto, AML, Am. Banker (Jan. 27, 2021), https://www.americanbanker.com/news/bidens-occ-expected-to-chart-new-course-for-fintechs-crypto-aml.

[18]   See About DC Fintech Week, available at https://www.dcfintechweek.org/; Chris Brummer, Faculty Profile, https://www.law.georgetown.edu/faculty/chris-brummer/.

[19]   Complaint, SEC v. Ripple Labs, Inc., No. 1:20-cv-10832 (S.D.N.Y. Dec. 22, 2020).

[20]   Although the SEC brought its first enforcement action for operating an unregistered exchange in 2018, and has brought at least one other such action, these matters have not been as significant as the Ripple action. See SEC, Press Release, SEC Charges EtherDelta Founder with Operating an Unregistered Exchange (Nov. 8, 2018), https://www.sec.gov/news/press-release/2018-258; SEC, Press Release, SEC Charges Dallas Company and its Founders with Defrauding Investors in Unregistered Offering and Operating Unregistered Digital Asset Exchange (Aug. 29, 2019), https://www.sec.gov/news/press-release/2019-164. For additional discussion of crypto securities registration cases, see our bi-annual Securities Enforcement updates, available here.

[21]   Annalieae Milano, Everything Ex-CFTC Chair Gary Gensler Said About Cryptos Being Securities, Coindesk (Apr. 24, 2018), https://www.coindesk.com/ex-cftc-chair-gary-gensler-on-tokens-securities-and-the-sec.

[22]   SEC, Press Release, SEC Issues Statement and Requests Comment Regarding the Custody of Digital Asset Securities by Special Purpose Broker-Dealers (Dec. 23, 2020), https://www.sec.gov/news/press-release/2020-340.

[23]   OCC, News Release 2021-6, OCC Conditionally Approves Conversion of anchorage Digital Bank (Jan. 13, 2021), https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-6.html.

[24]   OCC, News Release 2021-19, OCC Conditionally Approves Conversion of Protego Trust Bank (Feb. 5, 2021), https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-19.html.

[25]   OCC, Exploring Special Purpose National Bank Charters for Fintech Companies (Dec. 2016), https://www.occ.gov/publications-and-resources/publications/banker-education/files/pub-special-purpose-nat-bank-charters-fintech.pdf.

[26]   Vullo v. Office of Comptroller of Currency, 378 F. Supp. 3d 271, 292 (S.D.N.Y. 2019) (finding that “the term ‘business of banking,’ as used in the [National Bank Act], unambiguously requires receiving deposits as an aspect of the business”); Lacewell v. Office of the Comptroller of the Currency, 2019 WL 6334895, at * 1–2 (S.D.N.Y. Oct. 21, 2019) (prohibiting the OCC from issuing charter to non-depository fintech applicants).

[27]   See Lacewell v. Office of the Comptroller of the Currency, No. 19-4271 (2d Cir. Dec. 16, 2020), ECF No. 108.

[28]   Complaint at ¶¶ 1, 3, Conference of State Bank Supervisors v. Office of the Comptroller of the Currency, No. 20-cv-3797 (D.D.C. Dec. 22, 2020).

[29]   See generally Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015).

[30]   Id. at 250–51.

[31]   Permissible Interest on Loans That Are Sold, Assigned, or Otherwise Transferred, 85 Fed. Reg. 33,530 (June 2, 2020) (to be codified at 12 CFR Parts 7 and 160).

[32]   National Banks and Federal Savings Associations as Lenders, 85 FR 68742 (Oct. 30, 2020) (to be codified at 12 CFR Part 7).

[33]   See Sylvan Lane, Seven states sue regulator over ‘true lender’ rule on interest rates, The Hill (Jan. 5, 2021), https://thehill.com/policy/finance/532759-seven-states-sue-regulator-over-true-lender-rule-on-interest-rates?rl=1.

[34]   Complaint at ¶¶ 11–12, People of the State of New York v. Office of the Comptroller of the Currency, No. 21-cv-00057 (S.D.N.Y Jan. 5, 2021) (challenging “true lender” rule); accord Complaint at ¶¶ 7–9, People of the State of California v. Office of the Comptroller of the Currency, No. 20-cv-05200 (N.D. Cal., July 29, 2020) (challenging valid-when-made rule).

[35]   Order Granting As Modified Joint Stipulation, No. 20-cv-05200 (N.D. Cal. Oct. 5, 2020) (setting briefing schedule).

[36]   See https://www.ftc.gov/about-ftc/biographies/rohit-chopra/speeches-articles-testimonies.

[37]   CFTC, Press Release, CFTC Approves Final Cross-Border Swaps Rule and an Exempt SEF Amendment Order at July 23 Open Meeting (July 23, 2020), https://www.cftc.gov/PressRoom/PressReleases/8211-20.

[38]   Public Statement, Dissenting Statement of Commissioner Rostin Behnam Regarding the Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to SDs and MSPs – Final Rule (July 23, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement072320

[39]   Public Statement, Dissenting Statement of Commissioner Dan M. Berkovitz on the Final Rule for Cross-Border Swap Activity of Swap Dealers and Major Swap Participants (July 23, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement072320 (quoting Kadhim Shubber, US regulator investigates oil fund disclosures, Fin. Times (July 15, 2020), available at https://www.ft.com/content/1e689137-2d1f-4393-a18f-fe0da02141cc.)

[40]   See, e.g., Limiting the Extraterritorial Impact of Title VII of the Dodd-Frank Act: Before the House Financial Services Committee, 112th Cong. (2012) (Written Testimony of Chris Brummer, Professor of Law, Georgetown University Law Center), https://financialservices.house.gov/uploadedfiles/hhrg-112-ba-wstate-cbrummer-20120208.pdf.

[41]   Nominations of Christopher James Brummer and Brian D. Quintenz to be Commissioners of the Commodity Futures Trading Commission: Hearing before the Committee on Agriculture, Nutrition, and Forestry, 114th Cong. (2016) (testimony by Christopher James Brummer, Nominee), https://www.congress.gov/114/chrg/shrg23593/CHRG-114shrg23593.htm.

[42]   CFTC, Press Release, CFTC Charges BitMEX Owners with Illegally Operating a Cryptocurrency Derivatives Trading Platform and Anti-Money Laundering Violations (Oct. 1, 2020), https://www.cftc.gov/PressRoom/PressReleases/8270-20.

[43]   Gibson Dunn, What the CFTC’s Settlement with Vitol Inc. Portends about Enforcement Trends (Jan. 20, 2021) https://www.gibsondunn.com/what-the-cftcs-settlement-with-vitol-inc-portends-about-enforcement-trends/; see also CFTC, Press Release, CFTC Orders Vitol Inc. to Pay $95.7 Million for Corruption-Based Fraud and Attempted Manipulation (Dec. 3, 2020), https://www.cftc.gov/PressRoom/PressReleases/8326-20.

[44]   Letter from Rep. Maxine Waters, Chairwoman, U.S. House of Representatives Committee on Financial Services, to President-elect Joseph Biden (Dec. 4, 2020), available at https://financialservices.house.gov/uploadedfiles/120420_cmw_ltr_to_biden.pdf.

[45]   U.S. House Comm. On Fin. Servs., Press Releases, Waters Announces February Hearing Schedule (Feb. 1, 2021), https://financialservices.house.gov/news/documentsingle.aspx?DocumentID=407103.

[46]   See, e.g., Zachary Warmbrodt, Wall Street scourge Sherrod Brown to get ‘gigantic megaphone’ as Senate Banking chair, Politico (Jan. 11, 2021), https://www.politico.com/news/2021/01/11/sherrod-brown-senate-banking-chair-457692.

[47]   Sylvan Lane, Brown puts housing, eviction protections at top of Banking panel agenda, The Hill (Jan. 12, 2021), https://thehill.com/policy/finance/533911-brown-puts-housing-eviction-protections-at-top-of-banking-panel-agenda.

[48]   Emily Flitter, Next Senate Banking Chairman Sets Lowe-Income and Climate Priorities, N.Y. Times (Jan. 12, 2021), https://www.nytimes.com/2021/01/12/business/banking-environment-housing-democrats-sherrod-brown.html.


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 in the firm’s Financial Institutions or Derivatives practice groups, or the following authors:

Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
Roscoe Jones, Jr. – Washington, D.C. (+1 202-887-3530, [email protected])
Rachel N. Jackson – New York (+1 212-351-6260, [email protected])
Amalia Reiss – Washington, D.C. (+1 202-955-8281, [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.

With the emergence of COVID-19, 2020 was a year of significant and unprecedented change in daily life and the economy. In particular, 2020 was a busy year for Employee Retirement Income Security Act (“ERISA”) lawsuits—across industries—implicating employers’ retirement and healthcare plans. Not only were there significant decisions on a number of key issues impacting these lawsuits, but COVID-19 also triggered new and different legal exposure for plan sponsors and administrators. Recognizing the importance of this area of law to its clients, in 2020, Gibson Dunn launched an ERISA Disputes Practice Area, bringing together the Firm’s deep knowledge base and significant experience from across a variety of its award-winning practice groups, including: Executive Compensation & Employee Benefits, Class Actions, Labor & Employment, Securities Litigation, FDA & Health Care, and Appellate & Constitutional Law.

This 2020 year-end update summarizes key legal opinions and provides helpful analysis to assist plan sponsors and administrators navigating this unprecedented time.

Section I highlights four notable opinions from the United States Supreme Court addressing ERISA’s statute-of-limitations, Article III standing, and ERISA preemption. The Court also remanded a case to the Second Circuit concerning the pleading standard for alleging a breach of the duty of prudence under ERISA on the basis of a failure to act on insider information.

Section II provides a summary of hot topics in ERISA class-action litigation, including notable developments in fiduciary breach litigation and a growing trend of COBRA notice litigation.

Section III addresses evolving procedural issues, including the standard of review of benefits claim decisions, and an emerging circuit split on the arbitrability of claims brought on behalf of plans.

Section IV offers an overview of key issues in health plan litigation, including trends in behavioral health and residential treatment coverage disputes, and updates on assignments and anti-assignment clauses.

I.   Significant Activity in the Supreme Court

2020 saw a significant rise in ERISA cases reaching the United States Supreme Court. In fact, the Court decided four ERISA cases in 2020, which is more than the Court has decided in any other year of the statute’s 45-year existence. These decisions provide helpful guidance to litigants on important topics in ERISA litigation. In Intel Corp. Investment Policy Committee v. Sulyma, 140 S. Ct. 768 (2020), the Court resolved a circuit conflict regarding when employers and plan fiduciaries can invoke the three-year statute of limitations period under Section 413(2) for an alleged breach of fiduciary duty. In Thole v. U.S. Bank N.A., 140 S. Ct. 1615 (2020), addressing fiduciary breach claims against a defined-benefit pension plan, the Court clarified when participants in an ERISA plan have Article III standing to sue for statutory violations. In Rutledge v. Pharmaceutical Care Management Ass’n, 141 S. Ct. 474 (2020), the Court again addressed the scope of ERISA preemption, particularly with respect to state regulations of health care and prescription drug costs, as well as state regulations of intermediaries. Finally, in Retirement Plans Committee of IBM v. Jander, 140 S. Ct. 592 (2020), the Supreme Court was expected to address whether the “more harm than good” pleading standard from Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 430 (2014), can be satisfied by generalized allegations that the harm resulting from the inevitable disclosure of an alleged fraud generally increases over time, but instead, in a per curiam decision, declined to rule on the merits and remanded the case to the Second Circuit.

A.   Intel Corp. Investment Policy Committee, et al. v. Sulyma Addresses Statute of Limitations

In Intel Corp. Investment Policy Committee, et al. v. Sulyma, 140 S. Ct. 768 (2020), the Supreme Court addressed the circumstances in which employers and plan fiduciaries can invoke ERISA’s three-year statute of limitations for an alleged breach of fiduciary duty, unanimously holding that in order to trigger the three-year limitations period, an employee must have become “aware of” the plan information and that a fiduciary’s disclosure of plan information alone does not meet the “actual knowledge” requirement.

The plaintiff, a former employee of Intel, sued Intel’s investment committee, administrative committee and finance committee (collectively, “Intel”), alleging that his retirement plans improperly overinvested in alternative investments. Id. at 774. Under Section 413(1) of the Employment Retirement Income Security Act of 1974 (ERISA), breach of fiduciary duty claims may be brought within six years of the breach or violation. However, Section 413(2) of ERISA shortens the limitations period to “three years after the earliest date on which the plaintiff had actual knowledge of the breach or violation.” 29 U.S.C. § 1113(2). Plaintiff filed suit within six years of the alleged breaches but more than three years after petitioners had disclosed their investment decisions to him. Sulyma, 140 S. Ct. at 774. While Intel provided records showing that the plaintiff had received numerous disclosures explaining the extent to which his retirement plans were invested in alternative assets, the plaintiff testified in a deposition that he didn’t remember reviewing the disclosures and also stated in a declaration that he was unaware that his account was invested in alternative investments. Id. at 775.

The Court unanimously affirmed the Ninth Circuit’s decision holding that a plaintiff does not necessarily have “actual knowledge” based on receipt alone of information if he did not read it. Id. at 779. While the disclosure of information to plaintiff is “no doubt relevant in judging whether he gained knowledge of that information,” to meet § 1113(2)’s “actual knowledge” requirement, the plaintiff must have become aware of that information. Id. at 777. The Court emphasized that its decision does not foreclose any of the “usual ways” to prove actual knowledge at any stage in litigation—including through proof of willful blindness—and that the decision will not prevent defendants from using circumstantial evidence to show actual knowledge. Id. at 779.

Gibson Dunn submitted an amicus brief on behalf of the National Association of Manufacturers, the American Benefits Counsel, the ERISA Industry Committee, and the American Retirement Association in support of petitioner: Intel Corp. Investment Policy Committee.

As we discussed in our Appellate Update on the Sulyma decision, we expect the Court’s holding to lead to an uptick in lawsuits against employers and plan fiduciaries, based on allegations that the three-year limitations period is inapplicable because they did not read or cannot recall reading plan documents.

B.   Thole v. U.S. Bank N.A. Addresses Article III Standing

As we reported in our Appellate Update, in June of last year, the Supreme Court held that participants in a fully funded defined-benefit pension plan lacked Article III standing to sue under ERISA for breach of fiduciary duties because they had no “concrete stake in the lawsuit.” Thole v. U.S. Bank N.A., 140 S. Ct. 1615, 1619 (2020). The plaintiffs in Thole alleged that the plan fiduciaries “violated ERISA’s duties of loyalty and prudence by poorly investing the assets of the plan,” resulting in a loss of $750 million. Id. at 1618. Defendants moved to dismiss for lack of standing, which the district court granted. Id. at 1619. The Eighth Circuit “affirmed on the ground that the plaintiffs lack[ed] statutory standing [under ERISA].” Id.

The Supreme Court, in a 5-4 decision authored by Justice Kavanaugh, affirmed on the ground that plaintiffs lacked Article III standing. Id. The Court explained that “[t]here is no ERISA exception to Article III” and that the plaintiffs lacked standing “for a simple, commonsense reason: They have received all of their vested pension benefits so far, and they are legally entitled to receive the same monthly payments for the rest of their lives.” Id. at 1622. Accordingly, the Court reasoned that the plaintiffs did not have a “concrete stake in the lawsuit” as “[w]inning or losing [the] suit would not change the plaintiffs’ monthly pension benefits.” Id.

In so ruling, the Court rejected each of the four theories plaintiffs raised to demonstrate their standing. Id. at 1619–21. First, the Court rejected plaintiffs’ argument, based on trust-law principles, that they have an equitable or property interest in the plan. Id. at 1619–20. The Court reasoned that “a defined-benefit plan is more in the nature of a contract” than a trust as “[t]he plan participants’ benefits are fixed and will not change, regardless of how well or poorly the plan is managed.” Id. at 1620. Second, the Court held that plaintiffs lacked standing to sue “as representatives of the plan itself” because they had not been “legally or contractually appointed to represent the plan.” Id. Third, the Court found that even though ERISA affords all participants “a general cause of action to sue” it does not “affect the Article III standing analysis.” Id. Fourth, and finally, the Court rejected plaintiffs’ argument that defined-benefit plans will not be “meaningfully regulate[d]” if plan participants lack standing to sue as employers have “strong incentives” to manage plans and the Department of Labor can “enforce ERISA’s fiduciary obligations.” Id. at 1621.

In a concurring opinion, Justice Thomas, joined by Justice Gorsuch, objected to the Court’s “practice of using the common law of trusts as the ‘starting point’ for interpreting ERISA” and recommended that the Court “reconsider our reliance on loose analogies in both our standing and ERISA jurisprudence.” Id. at 1623. The concurrence called for the Court to return to a “simpler framework” for standing, and one in which the party must show injury to private rights. Justice Thomas stated there was no such injury in Thole because the private rights the petitioners alleged were violated did not belong to them; they belonged to the plan, and petitioners had no legal or equitable ownership interest in the plan assets. Id.

The Supreme Court’s decision in Thole is welcome news to plan sponsors, fiduciaries, and administrators, all of whom can now rely on this decision to argue that participants of ERISA plans cannot sue for breach of fiduciary duty unless they have a “concrete stake in the lawsuit,” such as a failure by the plan to make required benefits payments. Id. at 1619. In addition, Thole—and in particular Justice Kavanaugh’s forceful statement that “[t]here is no ERISA exception to Article III”—provides strong support for application of Article III requirements and jurisprudence to cases brought under ERISA.

More litigation is ahead on these issues. For instance, a split among district courts has developed on the question of whether participants in defined-contribution plans have standing to bring claims challenging investments in which they did not personally invest. Compare Cryer v. Franklin Templeton Res., Inc., 2017 WL 4023149, at *4 (N.D. Cal. July 26, 2017) (holding plaintiff had standing to sue for funds “in which he did not invest” because “the lawsuit seeks to restore value to and is therefore brought on behalf of the [p]lan”); McDonald v. Edward D. Jones & Co., L.P., 2017 WL 372101, at *2 (E.D. Mo. Jan. 26, 2017) (finding that “a plan participant may seek recovery for the plan even where the participant did not personally invest in every one of the funds that caused an injury to the plan”), with Wilcox v. Georgetown Univ., 2019 WL 132281, at *9–10 (D.D.C. Jan. 8, 2019) (finding that plaintiffs did not have standing to challenge options in which they did not invest); Marshall v. Northrop Grumman Corp., 2017 WL 2930839, at *8 (C.D. Cal. Jan. 30, 2017) (holding that plan participants lacked standing because they failed to allege that they invested in the particular fund). Since the Supreme Court made clear that injuries to the plan do not necessarily confer standing to the plan participants, Thole may support the argument that plaintiffs lack standing to bring suit when they did not personally invest in a challenged plan investment option. It remains to be seen whether, going forward, the courts adopt this interpretation of Thole to set limits on Article III standing in defined-contribution plan suits.

C.   Rutledge v. Pharmaceutical Care Management Association Narrows ERISA Preemption

On December 10, 2020, the Supreme Court issued an 8-0 decision (Justice Barrett did not participate) in Rutledge v. Pharmaceutical Care Management Association holding that ERISA did not preempt an Arkansas statute regulating the rates at which pharmacy benefit managers reimburse pharmacies for prescription drug costs. Justice Sotomayor, who authored the opinion on behalf of the unanimous Court, relied on “[t]he logic of” the Court’s previous decision in New York State Conference of Blue Cross & Blue Shield Plans v. Travelers Ins. Co., 514 U.S. 645 (1995), to conclude that the Arkansas law “is merely a form of cost regulation . . . [that] applies equally to all PBMs and pharmacies in Arkansas,” and therefore is not subject to ERISA preemption because it did not have an impermissible connection with or reference to ERISA. 141 S. Ct. 474, 481 (2020). Rutledge is likely to be viewed by regulators as supporting state authority to regulate health care costs without running afoul of ERISA preemption. (Gibson Dunn’s Appellate Update discussing this case can be found here). Gibson Dunn submitted an amicus brief on behalf of the U.S. Chamber of Commerce in support of the Pharmaceutical Care Management Association.

In Rutledge, the Court ruled that “ERISA is . . . primarily concerned with pre-empting laws that require providers to structure benefit plans in particular ways,” which include those that require “payment of specific benefits,” those that bind “plan administrators to specific rules for determining beneficiary status,” and those where “acute, albeit indirect, economic effects of the state law force an ERISA plan to adopt a certain scheme of substantive coverage.” Id. at 480. The Court found that the need for regulatory uniformity—in particular, cost uniformity—is not absolute, and that it does not alone justify application of ERISA preemption: “[N]ot every state law that affects an ERISA plan or causes some disuniformity in plan administration has an impermissible connection with an ERISA plan,” which the Court noted is “especially so if a law merely affects costs.” Id. The following sentence from the Court’s opinion encapsulates its holding: “ERISA does not pre-empt state rate regulations that merely increase costs or alter incentives for ERISA plans without forcing plans to adopt any particular scheme of substantive coverage.” Id.

The Rutledge decision will impact future litigation regarding the scope of ERISA preemption. In particular, state regulators likely will rely on this decision in seeking to insulate state laws concerning prescription drug prices and pharmacy benefit managers from preemption. The reach of Rutledge, however, likely will be tested even beyond this immediate context, because state regulators can be expected also to defend other state laws and regulations on the basis that they merely impact health care costs and lack the necessary connection with ERISA plans under Rutledge. States may also attempt to enact new statutes and issue regulations of those health care intermediaries and other service providers to covered plans.

ERISA preemption will continue to be a hot area this year with the Ninth Circuit Court of Appeals hearing argument in Howard Jarvis Taxpayers Association v. CA Secure Choice Retirement Savings Program later this month, for example. In that case, the Ninth Circuit will evaluate whether ERISA preempts California’s state-run auto-IRA program, which transfers portions of a person’s paycheck into a retirement account.

D.   Retirement Plans Committee of IBM v. Jander Remands Questions About Dudenhoeffer Pleading Standard to Second Circuit

As we discussed in a recent Securities Litigation Update, in Retirement Plans Committee of IBM v. Jander, 140 S. Ct. 592, 594 (2020), the Supreme Court was slated to address whether the “more harm than good” pleading standard from Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 430 (2014), “can be satisfied by generalized allegations that the harm of an inevitable disclosure of an alleged fraud generally increases over time.” In Dudenhoeffer, the Court held that, in order to state a claim for breach of the duty of prudence under ERISA on the basis of a failure to act on insider information, a complaint must plausibly allege an alternative action that the fiduciaries could have taken that would not have violated securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it. 573 U.S. at 428.

In Jander, plaintiffs, IBM employees who participated in an employee stock ownership plan (ESOP) sponsored by IBM, sued IBM’s retirement plan fiduciary committee for breach of fiduciary duty, alleged that IBM misrepresented the value of its microelectronics division, thereby artificially inflating the value of company stock, and caused a drop in the stock price upon selling the microelectronics division. Jander v. Ret. Plans Comm. of IBM, 272 F. Supp. 3d 444, 446–47 (S.D.N.Y. 2017). Plaintiffs’ claims were dismissed by the district court on the basis that the complaint lacked context-specific allegations as to why a prudent fiduciary couldn’t have concluded that plaintiff’s hypothetical alternatives were more likely to do more harm than good, failing to satisfy the Dudenhoeffer pleading standard. Id. at 449–54.

The Second Circuit reversed, holding that plaintiffs had pled a plausible claim for violation of ERISA’s duty of prudence based on (1) the fiduciaries’ knowledge that the stock was inflated through accounting violations; (2) their power to disclose these accounting violations; and (3) their failure to promptly disclose the true value of the microelectronics division. Jander v. Ret. Plans Comm. of IBM, 910 F.3d 620, 628–31 (2d Cir. 2018). Ultimately, the Second Circuit held that if the fiduciaries knew that disclosure of the insider information was inevitable, then delaying this disclosure would cause more harm than good to the ESOP. Id. at 630.

In a per curiam decision issued on January 14, 2020, the Supreme Court declined to rule on the merits in Jander, and vacated and remanded the case for the Second Circuit to address two unresolved issues raised by the parties: (1) whether ERISA ever imposes a duty on a fiduciary for an ESOP to act on inside information, and (2) whether ERISA requires disclosures that are not otherwise required by the securities laws. 140 S. Ct. at 594–95. Justice Kagan (joined by Justice Ginsburg) and Justice Gorsuch issued concurring opinions, articulating differing views on how these questions should be resolved on remand. See id. at 595–96 (Kagan, J. concurring); id. at 596–97 (Gorsuch, J. concurring). On remand, the Second Circuit reinstated its original opinion, again reversing the district court’s decision. Jander v. Ret. Plans Comm. of IBM, 962 F.3d 85, 86 (2d Cir. 2020) (per curiam).

While not purporting to break new ground, the Court nevertheless noted two things. First, the Court explained that the Dudenhoeffer “more harm than good” standard is the correct standard to apply to ESOP fiduciaries. See 140 S. Ct. at 594. Second, the Court made clear that ERISA’s fiduciary duty of prudence does not require fiduciaries to act in a way that violates securities laws. See id. However, the opinion leaves unresolved whether there may be circumstances in which ESOP fiduciaries are required to act on the basis of inside information to benefit an ESOP, and whether the Dudenhoeffer standard requires ESOP fiduciaries to disclose information that is not required by federal securities laws. See id. at 594–95.

In recent cases following Jander, at least one district court has concluded that the Second Circuit’s decision should be classified as an outlier because “the overwhelming majority of circuit courts to consider an imprudence claim based on inside information post-Dudenhoeffer [have] rejected the argument that public disclosure of negative information is a plausible alternative.” Burke v. Boeing Co., No. 19-cv-2203, 2020 WL 6681338, at *5 (N.D. Ill. Nov. 12, 2020). Given this circuit split, plaintiffs may be more likely to target the Second Circuit for stock-drop and similar suits. However, in a recent decision from the Second Circuit, the court affirmed dismissal of an imprudence claim brought by a plaintiff who argued that two alternative actions—earlier disclosure and closure of the fund to additional investment—were “on par with those found sufficient in Jander.” Varga v. Gen Elec. Co., No. 20-1144, — F. App’x —-, 2021 WL 391602, at *2 (Feb. 4, 2021). The court found plaintiff’s allegations insufficient, conclusory, and not consistent with those in Jander, concluding that she had “failed to adequately plead alternative actions that the fiduciaries could have taken.” Id. at *2–3. Thus, while Jander remains good law in the Second Circuit, the Varga decision suggests that courts will still look closely at plaintiffs’ allegations of plausible alternative actions in the context of motions to dismiss.

II.   Class Actions Continued To Be a Significant Focus of ERISA Litigation in 2020

The year 2020 was again a busy period in ERISA class-action litigation, particularly fiduciary-breach litigation. While large plans continue to be the primary targets of these lawsuits, plaintiffs are also targeting smaller plans—and some cases attempting to aggregate these claims by suing administrators or service providers to multiple plans. We discuss below two important circuit splits in the field of ERISA fiduciary-breach class actions, and also an emerging area of litigation concerning the required contents of COBRA notices.

A.   Hot Topics in ERISA Fiduciary Breach Litigation

We continued to see significant activity in ERISA fiduciary-breach litigation in 2020, including on issues concerning (1) whether plaintiffs can state a fiduciary-breach claim based on offering a particular mix of investment options in a plan, and (2) whether single-stock funds are per-se imprudent under ERISA. We also may see changes regarding the rules governing whether investing in environmental, social, and corporate governance (“ESG”) funds could constitute a fiduciary breach under ERISA.

As to the first issue, the Seventh, Third, and Eighth Circuits have all recently addressed whether plaintiffs can state a fiduciary-breach claim by alleging that a plan offered certain underperforming investment options, as well as other unobjectionable options. In Divane v. Northwestern University, 953 F.3d 980 (7th Cir. 2020), the Seventh Circuit held that plaintiffs failed to allege a fiduciary breach by claiming that defendants provided investment options that were “too numerous, too expensive, or underperforming,” when the defendant also offered low-cost index funds, among other options that the plaintiffs found unobjectionable. Id. at 991–92. A few months after the Seventh Circuit’s decision in Divane, the Eighth Circuit appeared to adopt a more plaintiff-friendly interpretation by holding that plaintiffs could state a claim by alleging that “fees were too high” and that the defendants “should have negotiated a better deal.” Davis v. Wash. Univ. of St. Louis, 960 F.3d 478, 483 (8th Cir. 2020); see also Sweda v. Univ. of Pennsylvania, 923 F.3d 320, 330 (3d Cir. 2019) (stating that “a meaningful mix and range of investment options” does not necessarily “insulate[] plan fiduciaries from liability for breach of fiduciary duty”). These holdings may suggest to plaintiffs that the Third and Eighth Circuits will be more receptive to these types of claims, prompting an increase in fee-suit litigation in those jurisdictions.

Additionally, a circuit split may have recently developed concerning whether single-stock funds are per se imprudent plan offerings under ERISA. In May 2020, the Fifth Circuit affirmed the dismissal of a putative fiduciary breach class action in Schweitzer v. Investment Committee of Phillips 66 Savings Plan, 960 F.3d 190 (5th Cir. 2020). The court held that defendants satisfied their fiduciary duties to diversify and to act prudently because they provided plan participants with an array of investment options that “enable[d] participants to create diversified portfolios.” Id. at 196–98. Accordingly, the Fifth Circuit in Schweitzer rejected plaintiffs’ claim that “a single-stock fund is imprudent per se.” Id. at 197–98. But only a few months later, the Fourth Circuit held the opposite, concluding that defendants breached their fiduciary duty when offering a single-stock fund. Stegemann v. Gannett Co., 970 F.3d 465, 468 (4th Cir. 2020). The Fourth Circuit rejected the argument that “diversification must be judged at the plan level rather than the fund level,” holding that “each available fund on a menu must be prudently diversified.” Id. at 476–77 (emphasis added). In dissent, Judge Niemeyer argued that “the majority merge[d] the duties of diversification and prudence,” and, in effect, made it impossible for an employer to “ever prudently offer a single-stock, non-employer fund.” Id. at 484, 488. No other court has yet adopted the Fourth Circuit’s standard. Defendants in Stegemann filed a petition for a writ of certiorari, and on January 4, 2021, the Supreme Court called for a response from plaintiffs, indicating that the Justices may be interested in hearing the case.

Last, in the final year of the Trump administration, the Department of Labor (“DOL”) proposed and adopted a new rule that ERISA fiduciaries must make investment decisions “based solely on pecuniary factors”; and an investment intended “to promote non-pecuniary objectives” at the expense of sacrificing returns or taking on additional risk would constitute a breach of the fiduciary’s duty. Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 72,846, 72,851, 72,848 (Nov. 13, 2020). Though the final version of the rule does not explicitly reference ESG funds, the DOL’s press release announcing the rule expressly stated that the rule’s purpose was to provide further guidance “in light of recent trends involving [ESG] investing.” U.S. Dep’t of Labor, U.S. Department of Labor Announces Final Rule to Protect Americans’ Retirement Investments (Oct. 30, 2020), https://www.dol.gov/newsroom/releases/ebsa/ebsa20201030. The new rule took effect on January 12, 2021, 85 Fed. Reg. at 72,885, and there have not yet been any cases addressing when and whether investment in an ESG fund could constitute a fiduciary breach. Notably, the new rule appears to conflict with many of the Biden administration’s stated environmental goals, and the DOL rule may be a target for reversal by the new administration.[1]

The year 2020 also saw a rise in COBRA notice litigation. The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) allows employees and their dependents the opportunity to continue to participate in their employer’s group health plan when coverage would otherwise be lost due to a termination of employment or other “qualifying event[s].” 29 U.S.C. § 1163. And plan administrators are required to provide notice to employees informing them of their right to elect COBRA coverage. 29 C.F.R. § 2590.606-4. COBRA mandates that the notice include specific information and be “written in a manner calculated to be understood by the average plan participant.” Id. § 2590.606-4(b)(4). Plaintiffs have filed numerous class actions against employers alleging technical violations in the language of the notices, seeking statutory penalties up to $110 per day for each participant that received inadequate notice.

Many COBRA notice lawsuits have been filed in Florida, with others filed in venues that include New York and South Carolina. The number of such lawsuits has recently been spurred by COVID-19 layoffs. Plaintiffs’ allegations are substantially similar across cases, and generally allege that COBRA notices were deficient for one or more of the following reasons:

  1. Notice failed to identify the name, address, and telephone number of the plan administrator;
  2. Notice failed to identify the qualifying event;
  3. Notice failed to explain how to enroll in COBRA coverage;
  4. Notice failed to provide all the required explanatory language regarding the coverage;
  5. Notice was not written in a manner calculated to be understood by the average plan participant; and/or
  6. Notice failed to comply with the model notice created by the Department of Labor (“DOL”).

The influx of COBRA notice litigation highlights the importance for employers of reviewing their COBRA notices to assess whether any changes may be necessary to ensure compliance with statutory guidelines and regulations. To assist employers, the DOL has issued model notices on its website that employers can review against their own notices to ensure they are in compliance. Employers who have outsourced COBRA administration should also periodically check in with their third-party administrators to confirm compliance with all guidelines and regulations and may want to consider clearly assigning responsibility for compliance with notice requirements in their vendor agreements.

III.   Key Decisions on Important ERISA Procedural Issues

The courts also issued important guidance this year to ERISA practitioners, plan sponsors, and plan administrators concerning ERISA procedural issues. In particular, the courts issued rulings concerning the standard of review for benefits claims, and provided further guidance on the ability to compel arbitration of claims brought by participants on behalf of a plan. Both of these topics are discussed below.

A.   The Evolving Abuse of Discretion Standard of Review

In 2020, courts continued to wrestle with the degree of deference owed to benefit determinations made by plan administrators. The well-established rule is that a court reviews the plan administrator’s decision de novo unless the terms of the benefit plan give the administrator discretion to interpret the plan and award benefits. See Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 115 (1989). Where the plan terms grant this discretion to the administrator, courts review the administrator’s determinations under a deferential “abuse of discretion” standard (or arbitrary and capricious review, as some circuits call it). Id. Because it is common for benefit plans to give the administrator this discretion, the deferential standard often applies, and the Supreme Court has repeatedly parried attempts by plaintiffs to strip administrators of this deference. See Metro. Life Ins. Co. v. Glenn, 554 U.S. 105, 115 (2008) (abuse of discretion standard applies even when administrator has conflict of interest); Conkright v. Frommert, 559 U.S. 506, 522 (2010) (abuse of discretion standard applies even when court of appeals found previous related interpretation by administrator to be invalid).

Last year, plaintiffs persisted in their efforts to curtail the deferential abuse of discretion standard, and they found success in some instances. For example, in Lyn M. v. Premera Blue Cross, 966 F.3d 1061 (10th Cir. 2020), even though the plan gave the administrator discretion, the court nonetheless held that a de novo standard applied because plan members “lacked notice” of the discretion. Id. at 1065. The administrator failed to disclose the document granting discretion, and the plan summary it did disclose “said nothing about the existence” of that document. Id. at 1067. To preserve plan discretion under Lyn M., plan documents—including the summary plan description that plans are required to provide to their members—should disclose either the grant of discretion to the administrator or the precise document conferring that discretion.

Additionally, even when an abuse of discretion standard is found to apply, courts have developed ways to limit the degree of deference given to plan administrators. The Ninth Circuit, for example, continues to apply varying degrees of “skepticism” to the administrators’ determinations—as part of abuse of discretion review—when certain factors such as a conflict of interest are present. The precise degree of skepticism applied may provide a focal point for appellate review. In Gary v. Unum Life Insurance Co. of America, 831 F. App’x 812 (9th Cir. 2020), the circuit held that the district court “applied the incorrect level of skepticism to its abuse-of-discretion review.” Id. at 814. The district court had applied a “moderate degree” of skepticism because it found that the plan administrator had a structural conflict of interest (based on the district court’s belief that the administrator was responsible both for assessing and paying out claims) and had failed to afford the plaintiff a “full and fair review.” Id. at 813. But the Ninth Circuit held that, viewing the evidence in the light most favorable to the plaintiff, the circumstances in the case called for an even “higher degree of skepticism.” Id. This heightened skepticism was warranted, in the court’s view, because it found that the administrator’s consultants had “cherry-picked certain observations from medical records numerous times,” the administrator had not conducted an in-person examination of the plaintiff, and the administrator had reversed in part its initial decision denying benefits in full. Id. at 814. This decision suggests that, at least in the Ninth Circuit, courts may limit the degree of deference afforded to administrators—even under an abuse of discretion review—in particular circumstances.

However, not all circuits have been so receptive to plaintiffs’ efforts. The Eighth Circuit recently clarified its case law in this area, holding that, despite what an older circuit decision may have suggested and whatever other circuits may hold, a plan administrator’s delay in deciding an appeal of a benefits denial does not warrant de novo review. McIntyre v. Reliance Standard Life Ins. Co., 972 F.3d 955, 960, 964–65 (8th Cir. 2020). As with a conflict of interest, such delay is just a factor to be considered when applying abuse of discretion review. Id. at 965. The First Circuit also recently reaffirmed “the importance of giving deference” to plan administrators. Arruda v. Zurich Am. Ins. Co., 951 F.3d 12, 24 (1st Cir. 2020). The plaintiff in Arruda argued that courts can find an administrator’s decision arbitrary even when the administrator “relied on several independent experts” and a record consistent with its benefits determination. Id. at 21–22, 24. The First Circuit disagreed, finding this proposal to be “in considerable tension with” the abuse of discretion standard. Id. at 24.

Last year also saw circuit courts rebuff creative attempts by plaintiffs to avoid abuse of discretion review. For instance, in Ellis v. Liberty Life Assurance Co. of Boston, 958 F.3d 1271 (10th Cir. 2020), petition for cert. filed, (U.S. Jan. 8, 2021) (No. 20-953), all parties agreed that the plan conferred discretion on the administrator, and the plan provided that it was governed by the law of Pennsylvania, but the plaintiff sought de novo review on the ground that a Colorado statute prohibited grants of discretion in insurance policies. Id. at 1275. The court rejected the plaintiff’s argument that Colorado law should apply, holding that the law of the state selected by a plan’s choice-of-law provision normally applies, “to effectuate ERISA’s goals of uniformity and ease of administration.” Id. at 1280. Notably, the court observed that this choice-of-law question “could be avoided if ERISA preempts the Colorado statute,” but it declined to resolve this preemption issue, leaving it open for future litigation. Id. at 1279.

Finally, in Davis v. Hartford Life & Accident Insurance Co., 980 F.3d 541 (6th Cir. 2020), once again all parties agreed that the plan conferred discretion to the administrator, but the plaintiff contended that the administrator exercised no discretionary authority because a different company in the same corporate family had actually made the decision to terminate benefits. See id. at 545–46. But the Sixth Circuit found this argument “d[id] not add up as a factual matter.” Id. at 546. Even though the plan’s decisionmakers received their salaries from the other company, they were still adjudicating claims under the administrator’s policies, not the other company’s policies. Id. This precedent presents a potential obstacle for future plaintiffs who try to use the structure of a plan administrator’s corporate family as a backdoor means of securing de novo review.

B.   A Possible Split on Arbitrability of ERISA § 502(a)(2) Claims

Arbitrability of ERISA section 502(a)(2) fiduciary-breach claims brought on behalf of a plan continued to be a hot topic in 2020 as courts applied key appellate decisions in this space from 2018 and 2019. In 2018, the Ninth Circuit held that section 502(a)(2) claims belong to the Plan, not the individual employee(s), and thus individual arbitration agreements that bound plan participants to arbitrate could not be used to compel the arbitration of claims brought on behalf of the plan. Munro v. Univ. of S. Cal., 896 F.3d 1088, 1092 (9th Cir. 2018). One year later, the court accordingly held that § 502(a)(2) claims are, in fact, arbitrable when the Plan has agreed to arbitration. Dorman v. Charles Schwab Corp., 780 F. App’x 510, 513–14 (9th Cir. 2019). According to the Ninth Circuit, “[t]he relevant question is whether the Plan agreed to arbitrate the § 502(a)(2) claims,” and when a “Plan [does] consent in the Plan document to arbitrate all ERISA claims,” a mandatory arbitration agreement is enforceable. Id. (emphasis added). Hence, in the Ninth Circuit, even when an individual employee has “agreed to arbitrate their claims in their employment contracts,” a § 502(a)(2) claim belongs to the plan and “that claim is not subject to arbitration unless the plan itself has consented.” Ramos v. Natures Image, Inc., 2020 WL 2404902, at *6–7 (C.D. Cal. Feb. 19, 2020) (emphasis added). Meanwhile, as noted in one of our recent class action updates, the Supreme Court has continued to enforce arbitration provisions in various contexts, and these decisions can be brought to bear in ERISA cases as well.

A circuit split may now be emerging on this issue. In Smith v. Greatbanc Trust Co., the U.S. District Court for the Northern District of Illinois rejected the Ninth Circuit’s holding in Dorman, even though in Smith (like Dorman) the plan documents indicated that the plan agreed to arbitrate. 2020 WL 4926560, at *3–4 (N.D. Ill. Aug. 21, 2020), appeal docketed, No. 20-2708 (7th Cir. Sept. 9, 2020). The court in Smith concluded that failure to notify a former employee (who remained a participant in the plan) of changes to the plan that compelled arbitration was inconsistent with ERISA’s notice requirements, and that, to the extent the arbitration agreement served as a “waiver of a party’s right to pursue statutory remedies,” the agreement was unenforceable. Id. (quoting Am. Express Co. v. Italian Colors Restaurant, 570 U.S. 228, 235–36 (2013)). The case is now pending appeal.

These decisions provide important guidance for employers considering amending their plans (or other plan-related documents, such as administrative services contracts) to include arbitration provisions. Under the Ninth Circuit’s Dorman decision, arbitration provisions in the plan documents can be used to bind the plan and to compel arbitration of claims brought on behalf of the plan. The Smith decision, however, underscores the importance of providing plan participants notice of any changes to plans, such as the addition of arbitration provisions, that would potentially impact participants’ rights to pursue statutory remedies.

IV.   ERISA Health Plan Litigation

Finally, litigation concerning health plans remains a substantial part of the ERISA litigation landscape. In 2020, the federal courts of appeals addressed a significant number of disputes over behavioral-health coverage and issued a wide range of decisions addressing plan participants’ ability to assign their rights to providers.

A.   Behavioral Health and Residential Treatment

ERISA disputes over behavioral-health coverage and residential treatment remained a significant source of litigation and appeals in 2020. Appellate decisions in this area mainly involved individual claims by patients challenging coverage determinations. Last year the courts of appeals decided at least 9 cases involving the denial of coverage for behavioral-health treatment, each of which involved individual claims by patients.

In disputes over individual coverage, the appellate courts in 2020 tended to afford significant deference to plan administrators’ determinations that behavioral-health treatment—and in particular residential treatment—was not medically necessary or did not qualify as emergency care. For example:

  • In Doe v. Harvard Pilgrim Health Care, Inc., the First Circuit affirmed a district judge’s application of de novo review when she found that a patient’s residential treatment for psychological illness was medically unnecessary because medical experts had concluded that the patient did not require 24-hour supervision, her condition could be managed at a lower level of care, and medication had improved her condition before treatment. 974 F.3d 69, 72–74 (1st Cir. 2020).
  • In Tracy O. v. Anthem Blue Cross Life & Health Insurance, the Tenth Circuit concluded that Anthem did not act arbitrarily and capriciously in denying coverage for a residential stay at a psychiatric facility because Anthem reasonably relied on four doctors’ conclusions that the patient’s condition had not significantly deteriorated and that her behavior could be managed in an outpatient setting. 807 F. App’x 845, 853–55 (10th Cir. 2020).
  • In Brian H. v. Blue Shield of California, the Ninth Circuit affirmed a district judge’s determination that Blue Shield had not abused its discretion because it reasonably relied on expert opinions that a patient’s stay at a residential-treatment facility was not medically necessary because he would not have posed a danger to himself or others if treated in a less intensive setting. 830 F. App’x 536, 537 (9th Cir. 2020).
  • In Meyers v. Kaiser Foundation Health Plan, Inc., the Ninth Circuit affirmed a district judge’s conclusion that Kaiser (regardless of whether de novo or abuse-of-discretion review applied) properly denied coverage for a patient’s out-of-network residential treatment because it did not meet the plan’s requirements for out-of-network coverage: It did not qualify as emergency services and, even if the treatment was unavailable in-network, the patient did not obtain Kaiser’s permission prior to treatment. 807 F. App’x 651, 653–54 (9th Cir. 2020).
  • In Todd R. v. Premera Blue Cross Blue Shield of Alaska, 825 F. App’x 440, 441–42 (9th Cir. 2020), the Ninth Circuit, vacating the district court’s de novo judgment for the plaintiffs, held that a plan administrator correctly determined that a medical policy’s criteria for residential treatment were not met but remanded for the district court to consider in the first instance the plaintiff’s argument that those criteria were improper.

In each of these decisions, the court of appeals accorded deference to individual denials of coverage by administrators. By contrast, in Katherine P. v. Humana Health Plan, Inc., 959 F.3d 206, 209 (5th Cir. 2020), the Fifth Circuit determined that the district judge improperly granted summary judgment to the plan administrator. The Fifth Circuit reaffirmed prior precedent holding that when review of a coverage determination is de novo, the ordinary summary-judgment standard applies and a material dispute of fact should be decided by a bench trial. Id. The panel thus vacated the district judge’s grant of summary judgment to a plan administrator and remanded for the district judge to decide a dispute of material fact about whether treatment at a level of care less intense than partial hospitalization had been unsuccessful in controlling the plaintiff’s eating, purging, and compulsive exercise. Id. at 209–10; see also Lyn, 966 F.3d at 1064 (remanding for district court to apply de novo review to residential treatment claim rather than abuse of discretion standard).

Given the broad judicial deference ordinarily accorded to plan administrators’ medical determinations, plaintiffs have sought other grounds for challenging denials of coverage for behavioral healthcare. One common strategy is to invoke the federal Mental Health Parity and Addiction Equity Act, and related state parity acts, which require that health plans provide equal coverage for mental illnesses and physical illnesses. In Stone v. UnitedHealthcare Insurance Co., for instance, the plaintiff alleged that the health plan and its administrator violated the federal and California mental health parity acts when they refused to cover her daughter’s out-of-state residential-care treatment, but the Ninth Circuit affirmed the judgment for the defendants. 979 F.3d 770, 774–77 (9th Cir. 2020). Because the plan imposed the same limitations on out-of-state mental- and physical-health treatments, the plaintiff had not shown that the defendant treated mental health less favorably than physical health. Id. at 777.

More novel theories have met skepticism in the courts of appeals. In I.M. v. Kaiser Foundation Health Plan, Inc., for example, the plaintiff alleged that Kaiser breached its fiduciary duty to him by excluding coverage for residential treatment for eating disorders from its plans and inhibiting physicians from referring him to a residential-treatment facility. 2020 WL 7624925, at *2 (9th Cir. Dec. 22, 2020). The Ninth Circuit disagreed, finding no evidence in the record that Kaiser had erected barriers to residential treatment. Id.

B.   Assignments and Anti-Assignment Clauses

The assignment of benefits remains a critical issue in ERISA health plan litigation. Under ERISA § 502(a), only “a participant or beneficiary” may sue an insurer to recover benefits owed to her or to enforce her rights under her plan. 29 U.S.C. § 1132(a)(1)(B). Ordinarily, this would mean that a patient herself would have to sue an insurer under § 502(a). However, courts have deemed it permissible for participants to “assign” their benefits to healthcare providers. See, e.g., Plastic Surgery Ctr. v. Aetna Life Ins. Co., 967 F.3d 218, 228 (3d Cir. 2020). Once a participant has validly assigned her benefits to a healthcare provider, that provider can stand in the shoes of the participant and bring suit against an insurer for non-payment under § 502(a). Id. The appellate courts in 2020 addressed a variety of issues related to the assignment of benefits

1.   Scope of the Rights Conveyed

Appellate courts continue to grapple with the scope of the rights conveyed by an assignment. Decisions in 2020 reflect at least two distinct approaches. In American Colleges of Emergency Physicians v. Blue Cross & Blue Shield of Georgia, the Eleventh Circuit took a blanket approach, holding categorically that “the assignment of the right to payment includes the right to seek equitable relief.” 833 F. App’x 235, 240 (11th Cir. 2020). The Sixth and Ninth Circuits, in contrast, held that the scope of an assignment of benefits depends on the specific language used; where an assignment’s language appears to encompass only causes of actions for benefits, then additional potential causes of action under ERISA are not included. See DaVita Inc v. Amy’s Kitchen, Inc., 981 F.3d 664, 678–79 (9th Cir. 2020) (holding that assignment of “any cause of action . . . for purposes of creating an assignment of benefits” did not include the right to seek equitable relief); DaVita, Inc. v. Marietta Mem’l Hosp. Emp. Health Benefit Plan, 978 F.3d 326, 344 (6th Cir. 2020) (concluding that identical language did not include the right to bring breach-of-fiduciary-duty claims under § 1104(a)(1)(B)); see also McKennan v. Meadowvale Dairy Emp. Benefit Plan, 973 F.3d 805, 808–09 (8th Cir. 2020) (holding that an assignment of “any and all causes of action” did not include the right to challenge the rescission of the assignor’s coverage, at least where deceased assignor failed to comply with plan provisions as to third-party representatives). These decisions can be a mixed bag for plans, insurers, and administrators. The Eleventh Circuit’s approach allows providers to bundle benefits claims with equitable claims, while protecting insurers against having to litigate separate claims by patients and providers as to the same underlying treatment. The opposite is true for the Sixth and Ninth Circuit decisions: Where the assignment excludes equitable relief, providers have fewer arrows in their quiver to use against insurers, but insurers could face multiple lawsuits for the same treatment.

2.   Waivability of Assignment Issues

Courts sometimes treat the existence and scope of an assignment as a jurisdictional question—going to the existence of Article III standing—that therefore cannot be waived. Cell Sci. Sys. Corp. v. La. Health Serv., 804 F. App’x 260, 264 (5th Cir. 2020) (stating that the existence “of valid and enforceable assignments of benefits” is necessary for Article III standing). In the Sixth Circuit’s DaVita decision, however, the court held that a defendant had waived the argument that one of the plaintiff’s claims fell outside of the scope of the assignment. 978 F.3d at 345. The panel explained that “[t]he question of whether [a patient] has transferred their interest to [a provider] . . . deals not with Article III standing” but with Federal Rule of Civil Procedure 17’s requirement that an action “‘must be prosecuted in the name of the real party in interest.’” Id. The court thus found Article III standing without deciding the dispute about the scope of the assignment. Id. at 341 n.8.

3.   Anti-Assignment Clauses

In recent years, ERISA health plans have increasingly elected to include “anti-assignment” clauses. See Plastic Surgery Ctr., 967 F.3d at 228. These clauses bar patients from assigning their benefits to providers, or place certain limits on the scope of what claims can be assigned (or in what circumstances), putting providers back in the position of having to bill patients directly. Id. Should the patient prove unable or unwilling to pay, providers must then either rely on the patient to bring an ERISA suit or sue the patient directly. Id.

Many circuits have addressed these clauses, and they have unanimously determined that the clauses are, in general, permissible and enforceable. See Am. Orthopedic & Sports Med. v. Indep. Blue Cross Blue Shield, 890 F.3d 445, 453 (3d Cir. 2018). Still, appellate decisions in 2020 reflect multiple strategies through which providers have attempted to avoid the effect of anti-assignment clauses, with varying degrees of success:

  • In Beverly Oaks Physicians Surgical Center, LLC v. Blue Cross & Blue Shield of Illinois, the Ninth Circuit held that an insurer had waived its right to invoke an anti-assignment clause by failing to raise it during the administrative claim process. 983 F.3d 435, 440–42 (9th Cir. 2020). The court also held that the plaintiff had pleaded sufficient facts to adequately allege that insurer was “equitably estopped from raising” the anti-assignment clause because the insurer had promised the provider that it was eligible to receive payment under plan. Id. at 442–43.
  • In Cell Science, by contrast, the Fifth Circuit rejected an argument that an insurer was estopped from invoking anti-assignment clause. 804 F. App’x at 264–66. The court emphasized that there was “no indication from the record that [the insurer] either misrepresented or misled [the provider] with respect to its intention to enforce the anti-assignment clause in its plan.” Id. at 265.
  • In King v. Community Insurance Co., the Ninth Circuit held that an assignment fell outside of the scope of the plan’s anti-assignment clause. 829 F. App’x 156, 159–60 (9th Cir. 2020). The plan expressly allowed payments to “providers” and forbade beneficiaries from assigning benefits to “anyone else.” Id. at 159. The Ninth Circuit rejected the insurer’s argument that the phrase “anyone else” meant anyone other than the beneficiary. Id. at 160. The court also held that the anti-assignment clause was unenforceable because it was not properly included in any plan document. Id. at 160–62.

____________________

[1] Congress may also attempt to take action against the rule. The Congressional Review Act provides a procedure for Congress to pass a Joint Resolution of Disapproval within 60 legislative working days that, if signed by the President, deems recent administrative rulemaking to not have had any effect. The DOL’s new rule is still within that 60-day timeframe.


The following Gibson Dunn lawyers assisted in the preparation of this alert: Karl Nelson, Geoffrey Sigler, Katherine Smith, Heather Richardson, Lucas Townsend, Jennafer Tryck, Matthew Rozen, Jennifer Roges, Luke Zaro, Daniel Weiss, Jialin Yang, Christopher Wang, Robert Batista, Zachary Copeland, and Brian McCarty.

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 any of the following:

Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Geoffrey Sigler – Washington, D.C. (+1 202-887-3752, [email protected])
Katherine V.A. Smith – Los Angeles (+1 213-229-7107, [email protected])
Heather L. Richardson – Los Angeles (+1 213-229-7409,[email protected])
Lucas C. Townsend – Washington, D.C. (+1 202-887-3731, [email protected])
Jennafer M. Tryck – Orange County (+1 949-451-4089, [email protected])
Matthew S. Rozen – Washington, D.C. (+1 202-887-3596, [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 February 5, 2021, in a unanimous decision, the UK Supreme Court ruled that the SFO’s so-called “Section 2” power, found in section 2(3) of the Criminal Justice Act 1987 (“CJA”), cannot be used to compel a foreign company that has no UK registered office or fixed place of business and which has never carried on business in the UK, to produce documents it holds outside the UK. In so ruling, the Supreme Court overruled a 2018 Divisional Court decision that held that the SFO could use its power in this way, provided that there was a “sufficient connection” between the foreign company and the UK.

In this alert we provide an overview of the Supreme Court’s decision and offer our observations on the implications of the judgment for the SFO and foreign companies under investigation. We conclude with an illustrative summary of the different methods available to the SFO to obtain documents following the Supreme Court’s decision.

The decision will come as a setback for the SFO, which will now have to rely on the often cumbersome and slow Mutual Legal Assistance (“MLA”) route to obtain documents in these circumstances. The loss is compounded as the Supreme Court decision comes shortly after the UK lost access to certain investigatory powers it enjoyed by virtue of the UK’s (now prior) Membership of the European Union (“EU”), such as the European Investigation Order (“EIO”), which enabled the SFO to quickly obtain evidence, including documents, located in the EU.

Waiting to become operational is the agreement signed between the UK and U.S. in October 2019 to implement the Crime (Overseas Production Orders) Act 2019. Once in effect, the SFO, as well as other UK investigations agencies, including the Financial Conduct Authority, will be able to obtain certain “electronic data” located or controlled from the U.S. via an Overseas Production Order (“OPO”). OPOs will be issued by an English court, and the recipient must provide the data, ordinarily within seven days, to the agency named in the OPO. Although OPOs will enable authorities to obtain evidence faster, they do not apply to hard copy and certain other material, such that MLA requests will remain a necessary route in many instances. Whilst it is the intention of the UK Government to enter into agreements with other countries and blocs such as the EU, the UK/U.S. agreement is the only such agreement currently in place.

The Supreme Court decision will obviously be disappointing for the SFO. However, it will support an argument that the Government needs to consider the scope of the SFO’s powers, to ensure it has the tools necessary to investigate sophisticated, organised criminal wrongdoing in an increasingly globalised world.

Section 2 Notices

Section 2(3) of the CJA provides that “The Director [of the SFO] may by notice in writing require the person under investigation or any other person to produce … any specified documents which appear to the Director [of the SFO] to relate to any matter relevant to the investigation or any documents of a specified description which appear to him so to relate”.

It is a criminal offence to fail to comply with section 2(3) of the CJA without a reasonable excuse.

Section 2 notices are attractive to the SFO because the SFO alone may determine whether to compel a recipient to produce documents, and may serve the notice directly upon the recipient and enforce non-compliance. It requires no court or other third-party intervention, thereby providing a rapid, effective and largely self-regulated method of compelling the production of documents.

Background

KBR, Inc. is a U.S. incorporated engineering and construction company and the parent company of the KBR Group. In 2017, KBR, Inc.’s UK subsidiary, Kellogg Brown & Root Ltd (“KBR UK”), was under investigation by the SFO for suspected bribery. During this investigation, a representative of KBR, Inc. attended a meeting with the SFO in the UK to discuss its investigation into KBR UK. During that meeting, the SFO issued a notice to KBR, Inc. under section 2(3) of the CJA compelling the production of documents held outside of the UK (the “July Section 2 Notice”). KBR, Inc. did not have a fixed place of business in the UK and had never carried on business in the UK.

KBR, Inc. sought permission to apply for judicial review of the decision and to quash the July Section 2 Notice in the Divisional Court, on three grounds:

  1. The July Section 2 Notice was ultra vires the CJA as it requested material held outside of the UK from a company incorporated outside of the UK;
  2. The Director of the SFO made an error of law in issuing the July Section 2 Notice instead of using its power to seek MLA from the U.S. authorities under the UK’s 1994 bilateral U.S. MLA Treaty; and
  3. The July Section 2 Notice was not properly served on KBR, Inc. under the CJA.

In September 2018, the Divisional Court held that the SFO could require a foreign company to produce documents held overseas pursuant to section 2(3) of the CJA where there is a “sufficient connection between the company and the jurisdiction”. The Court held that there was a sufficient connection between KBR, Inc. and the UK in this case, as payments made by KBR UK required the express approval of KBR, Inc., were paid by KBR, Inc. through its U.S.-based treasury function, and for a period of time KBR, Inc.’s compliance function was required to approve the payments. In addition, an officer of KBR, Inc. was based in the KBR Group’s UK office. The fact that KBR, Inc. was the parent company of KBR UK was not sufficient by itself to establish a “sufficient connection”.

The Supreme Court Case

KBR, Inc. was granted leave to appeal and made the following arguments in the Supreme Court:

  1. Presumption against Extra-Territorial Effect and Principle of International Comity: there is a presumption under English law that a statute has no extra-territorial effect, as this would constitute a breach of international comity – namely, the principle of recognising, upholding and respecting other jurisdictions’ legislative and judicial acts.
  2.  Wording of the CJA: the terms of the CJA do not suggest a Parliamentary intention to confer extraterritorial powers upon the SFO.
  3. Role of Parliament vs the Court and the “Sufficient Connection” test: the decision regarding the extraterritorial application of the CJA is a matter for Parliament rather than the Court. As such, the decision to introduce a “sufficient connection” test would be a question to be answered by legislation, rather than one of judicial interpretation.

Presumption against Extra-Territorial Effect and Principle of International Comity

The Supreme Court held that the “starting point” for the consideration of the scope of section 2(3) is the presumption in English law that “legislation is generally not intended to have extra-territorial effect”. This presumption, according to the Supreme Court, is rooted in both the requirements of international law and the concept of comity, which is founded on mutual respect between states.

The Supreme Court emphasised that whilst the principle of comity was not a “rule of international law” as such, the “lack of precisely defined rules in international law as to the limits of legislative jurisdiction makes resort to the principle of comity as a basis of the presumption applied by courts in this jurisdiction all the more important”.

Lord Lloyd-Jones, writing for the Supreme Court, acknowledged the “legitimate interest of States in legislating in respect of the conduct of their nationals abroad”, however, he held that this case did not concern the conduct of a UK national or UK registered company abroad. If the addressee of the July Section 2 Notice had been a UK registered company, section 2(3) would have authorised the service of a notice to produce documents held abroad by that company.

Since the addressee of the July Section 2 Notice, KBR, Inc., had never carried on business in the UK or had a registered office or any other presence in the UK, the Supreme Court held that the presumption against extra-territorial effect clearly did apply to this case. The question for the Supreme Court was, therefore, whether Parliament intended section 2(3) to displace the presumption to give the SFO the power to compel a foreign registered company with no registered office or fixed place of business in the UK and which did not conduct business in the UK to produce documents it holds outside the UK.

Wording of the CJA

With respect to the question of whether the presumption against extra-territorial effect had been rebutted by the language of the CJA, the Supreme Court held that the “answer will depend on the wording, purpose and context of the legislation considered in the light of relevant principles of interpretation and principles of international law and comity.

The Supreme Court noted that “when legislation is intended to have extra-territorial effect Parliament frequently makes express provision to that effect” and, unlike other statutory provisions, section 2(3) “includes no such express provision”. Moreover, the Supreme Court found that the other provisions of the CJA do not provide “any clear indication, either for or against the extra-territorial effect.”

Role of Parliament vs the Court and the “Sufficient Connection” Test

KBR, Inc. submitted that:

  • The extraterritorial application of an investigatory power involving criminal sanctions, where the regulatory authority purports to exercise those powers in relation to persons and documents abroad, is a matter more appropriate for the legislature to assess rather than the court – as Parliament would be able to simultaneously address the issue of international comity and the proper conditions / safeguards to be imposed with such a power; and
  • The court should resist the suggestion made on behalf of the SFO that the court should imply into section 2(3) of the CJA a “sufficient connection” test, as no such test was incorporated by Parliament into this statutory scheme.

The Supreme Court held that there was no basis for the Divisional Court’s ruling that the SFO could use the power in section 2(3) of the CJA to require foreign companies to produce documents held outside the UK if there was a “sufficient connection” between the company and the UK. Implying a “sufficient connection” test into section 2(3) “would exceed the appropriate bounds of interpretation and usurp the function of Parliament” and would involve illegitimately re-writing the statute.

Implications

The SFO has been using section 2(3) notices to compel the production of documents held outside of the UK for many years. Their use suited not only the SFO but also often recipients who were provided with a seemingly lawful basis to produce often confidential and sensitive documents to the SFO. In its use of the power, the SFO has generally proceeded judiciously, avoiding potential disputes from section 2notice -recipients it perceived as likely to take jurisdictional arguments. It may now be regretting its decision to use the section 2 power against KBR, Inc.; the SFO’s apparent impatience caused it to err in its judgment and use the power against a suspect with every reason to challenge the jurisdiction of the notice.

Although this case could be characterised as something of an “own goal” for the SFO, and is doubtless a setback, the Supreme Court’s decision may provide a basis for the SFO to argue that the Government needs to reconsider the scope of its powers, in order to ensure that it has the tools it needs to operate as a leading criminal enforcement agency. Many of the laws it is expected to enforce (not least the Bribery Act 2010) have extraterritorial reach after all.

In the meantime, the setback caused by this judgment is amplified by the fact that, like other UK prosecuting agencies, it has recently lost access to certain cross-border investigatory powers it enjoyed while the UK was a Member of the EU. In the context of document gathering, the loss of the EIO, that facilitated streamlined obtaining of evidence located in the EU as an alternative to MLA, is the most significant loss.

For the SFO, all is not lost as a result of this decision, however. Since the Divisional Court decision in 2018, the UK passed the Crime (Overseas Production Orders) Act 2019, which entered into force on October 9, 2019. That Act enables officers of specified investigative agencies, including the SFO, to apply to a UK court for an OPO requiring the production within seven days of stored electronic data located or controlled outside the UK, for use in the investigation and prosecution of certain indictable offences. This power can only be exercised where a designated international co-operation arrangement exists between the UK and the country where the electronic data is located or from where it is controlled. To date, the UK has only agreed one such agreement, with the U.S. in October 2019. The agreement is yet to become operational, but when it is, it will provide an alternative to the MLA route, although the scope of the agreement provides for production of a narrow category of documentation. Further, unlike the use of section 2(3) CJA, the SFO will need to make an application to a court and require the UK Central Authority, which coordinates MLA requests, to approve and serve the OPO.

Unless the SFO can convince the Government to extend the scope of its evidence-gathering powers by passing new legislation, and until OPOs become operational, the SFO will have little choice but to rely, in most cases, on the cumbersome and slow MLA route to obtain evidence from foreign registered companies with no registered office or fixed place of business in the UK or which do not carry on business from the UK.

Practical Implications

The following diagram provides a summary of the different ways that the SFO can obtain documentary evidence, both now and when OPOs become operational:

Flow chart

Illustrative Practical Examples:

  • The SFO can compel the production of documents held by overseas branch offices of UK registered entities.
  • The SFO can compel production of documents held in the cloud by a UK registered entity.
  • The SFO cannot compel documents held or controlled by an overseas parent or subsidiary of a UK registered entity.
 

The following Gibson Dunn lawyers assisted in the preparation of this article: Patrick Doris, Sacha Harber-Kelly, Steve Melrose, Katie Mills and Rebecca Barry.

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you would like to discuss this alert in detail, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the firm’s UK disputes practice in London:

Patrick Doris (+44 (0) 20 7071 4276, [email protected])
Sacha Harber-Kelly (+44 (0) 20 7071 4205, [email protected])
Steve Melrose (+44 (0) 20 7071 4219, [email protected])
Allan Neil (+44 (0) 20 7071 4296, [email protected])
Matthew Nunan (+44 (0) 20 7071 4201, [email protected])

Please also feel free to contact the following leaders and members of the firm’s White Collar Defense and Investigations practice:

Kelly Austin – Hong Kong (+852 2214 3788, [email protected])
Joel M. Cohen – New York (+1 212-351-2664, [email protected])
Nicola T. Hanna – Los Angeles (+1 213-229-7269, [email protected])
Charles J. Stevens – San Francisco (+1 415-393-8391, [email protected])
F. Joseph Warin – Washington, D.C. (+1 202-887-3609, [email protected])