Part One: EU Developments

Introduction

The concept of mandatory corporate human rights due diligence is gaining momentum, both within Europe and on the international stage.

In this two-part alert, we examine key global legislative developments and proposals on this important topic. In Part One, we look at very recent steps taken by the institutions of the EU towards implementation of legislation at a pan-European level. In Part Two, we will consider developments at a national level within the EU and also look beyond Europe as we discuss the position in APAC, the US and Canada.

Mandatory Corporate Human Rights Due Diligence: EU Developments

What exactly should be the responsibilities of directors and companies with regard to sustainability and mandatory human rights due diligence? That question has been high on the agenda at European level for some time, with both the European Commission (the executive branch) (the “Commission”) and the European Parliament (the legislature) (the “EU Parliament”) advocating strongly for legislation that would provide for mandatory corporate due diligence on human rights and environmental issues. Most recently, on 27 January 2021 the EU Parliament Committee on Legal Affairs (the “CLA”) adopted a draft report containing a proposal for a directive on Corporate Due Diligence and Corporate Accountability (the “draft directive”).

Background

In April 2020, a few months after more than a hundred civil society organisations had called on the Commission to develop human rights and environmental due diligence legislation, EU Justice Commissioner Didier Reynders announced that the Commission would (by early 2021) propose a law requiring corporates to undertake mandatory environmental and human rights due diligence across their supply chain and business relationships.

In July 2020, the Commission then published a study that focused on the root causes of “short termism” in corporate governance. Among those causes were, in the Commission’s opinion, a narrow view of directors’ duties, board remuneration that focused on short-term shareholder value, and the lack of a strategic perspective over sustainability. The study concluded that non-financial reporting obligations “have proven insufficient to overcome pressures to focus on short-term financial performance and to influence companies and their investors to prioritise sustainability.[1]

Since these announcements, both the Commission and the EU Parliament have considered several legislative initiatives, which are the focus of this alert:

  • On 2 September 2020, Commissioner Reynders announced the Commission’s intention to submit a proposal for a mandatory human rights and environmental due diligence and sustainable corporate governance framework in 2021. The initiative would aim to impose on directors an obligation to consider the interests of all stakeholders (and not just the interests of the company’s shareholders).
  • On 11 September 2020, the CLA published a report containing the draft directive. Both the report and the draft directive focus on mandatory human rights, environmental and governance due diligence throughout a company’s value chain.

The Commission’s Sustainable Corporate Governance Initiative

The Commission has indicated that it will put forward a proposal for corporate governance legislation in Q1 2021. The Inception Impact Assessment (a plan prepared by the Commission which sets out preliminary ideas for the initiative and allows for stakeholder feedback) indicates that measures could include a combination of new due diligence obligations on companies, as well as a new duty on directors “to take into account all stakeholders’ interests which are relevant for the long-term sustainability of the firm.”[2] Those new duties would be supplemented by an appropriate facilitating, enforcement and implementation mechanism.

The Commission: Next Steps

  • A public consultation launched on 26 October 2020 closed on 8 February 2021.
  • The Commission plans to submit a proposal for a directive in Q1 2021, taking account of feedback during the consultation.

EU Parliament Draft Directive on Corporate Due Diligence and Corporate Accountability

As mentioned above, on 11 September 2020, the CLA published a report that included the draft directive on corporate due diligence and corporate accountability. As things stand, the draft directive, which was adopted (with significant amendments to the September 2020 version) by the CLA on 27 January 2020, provides the best indication of what mandatory due diligence legislation might look like at EU level. While it is by no means final, the draft directive contains important considerations for businesses. This alert also considers the Compromise Amendments to the draft directive, which reflect the outcome of the CLA’s consideration of the report and the amendments published on 27 January.[3] A consolidated version of the report and accompanying revised draft directive are still awaited.

The Draft Directive: Key Points

  • The obligation of due diligence: undertakings should be under an obligationto identify, assess, prevent, cease, mitigate, monitor, communicate, account for, address and remediate the potential and/or actual adverse human rights, environmental and good governance impacts that their own activities and those of their value chains and business relationships may pose.
  • Due diligence is moved away from a “tick box” exercise towards a mandatory, meaningful, and ongoing obligation.
  • Due diligence should apply to a company’s own activities and those of its value chains (both upstream and downstream) and its business relationships (including suppliers and sub-contractors).   
  • Companies should be required to:
    • undertake a risk assessment and implement a due diligence strategy (proportionate to the company’s size and level of risk);
    • conduct an annual review of the risk assessment and due diligence strategy; and
    • provide grievance mechanisms and remediation processes in connection with a potential or actual adverse human rights, environmental or good governance impact.
  • As to directors’ duties: it is notable that the September 2020 version of the draft directive included a provision which imposed liability on members of administrative, management and supervisory bodies for breaches of due diligence duties. However, this provision was removed from the January 2021 version adopted by the CLA.
  • Due diligence obligations would apply not only to undertakings established in the EU, but also to those established outside the EU but selling goods or providing services in the EU.
  • Member States would be required to:
    • implement rules to ensure that companies carry out effective due diligence;
    • designate independent national competent authorities responsible for the supervision of the application of the directive, and for the dissemination of due diligence best practices;
    • implement a civil liability regime under which companies can be held liable for any harm arising out of potential or actual adverse impacts on human rights, the environment or good governance that they, or undertakings under their control, have caused or contributed to by acts or omissions.  The regime should include a rebuttable presumption in favour of the victim, and so companies would have to prove that they did not have control over a business entity involved in the human rights abuse; and
    • implement a penalty regime, including regulatory sanctions and administrative fines.  Pursuant to the draft directive’s recital, these could be “comparable in magnitude to fines currently provided for in competition law and data protection law”.  To put this into context, the UK competition regulator (the Competition and Markets Authority) may impose a financial penalty of up to 10% of the worldwide turnover of the undertaking concerned and in the case of the General Data Protection Regulation fines could be up to €10,000,000 or, in the case of an undertaking, up to 2% of its entire global turnover of the preceding fiscal year, whichever is higher.
  • The provisions of the draft directive would be considered “mandatory provisions” under the Rome II Regulation (864/2007/EC), which means that the particular governing law applicable under Rome II may be overridden by any relevant provisions of the draft directive.

The Draft Directive: Next Steps

  • The draft directive is scheduled to be tabled at a Plenary Meeting of the EU Parliament on 8 March 2021.
  • If adopted, it will then take the form of a request from the EU Parliament to the Commission, asking the Commission to submit a legislative proposal along the lines of the draft directive.   Whether or not the Commission does so is a matter for the Commission’s discretion.
  • If the directive is eventually adopted by the EU, it would then need to be implemented into the national laws of Member States.

It is important to note that there is no guarantee that the Commission will submit a proposal for legislation in the form of the draft directive. Indeed, between 2009 and 2019, the Commission put forward a legislative proposal in respect of only 7 out of the EU Parliament’s 29 legislative initiatives. While the Commission has expressed interest in this type of initiative (and, as explained above, is currently working on a similar initiative of its own), it may decide to make amendments to the draft legislative framework or simply propose its own framework. The future path of the draft directive in its current form is therefore by no means clear.

Other EU Parliament Initiatives

The developments just described feature among a whole suite of EU Parliament initiatives.

Other measures include a separate mandatory due diligence initiative focusing on forest and ecosystem-risk commodities (“FERC”). At the moment, this initiative is in the form of a report, which was adopted by the EU Parliament on 22 October 2020, and which requests that the Commission propose an EU legal framework to halt and reverse EU-driven global deforestation. The report contains recommendations, including that companies which place FERC on the EU market (or companies providing finance to such operators) should be required to conduct due diligence on their supply chains. In the case of non-compliance with the obligations proposed in the initiative, the report recommends criminal and civil penalties for individuals as well as for companies, irrespective of the company’s legal form, size, location or the complexity of its value chains.[4]

Further, on 17 December 2020, the EU Parliament approved a report on sustainable corporate governance.[5] The report does not put forward any legislative proposals but focuses on perceived shortcomings in the implementation of the Non-Financial Reporting Directive (“NFRD”), which governs the disclosure of non-financial and diversity information by large companies. The report invites the Commission to review the NFRD. The report calls for a new framework to introduce an enhanced director duty of care in company law, noting in particular that “the duty of care of directors towards their company should be defined not only in relation to short-term profit maximisation by way of shares, but also sustainability concerns.” The report also calls for additional measures to make corporate governance more sustainability-oriented. It “considers that linking the variable part of the remuneration of executive directors to the achievement of the measurable targets set in the [company’s sustainability] strategy would serve to align directors’ interests with the long-term interests of their companies; [and] calls on the Commission to further promote such remuneration schemes for top management positions.” The report is a way for the EU Parliament to exert pressure on the Commission to put forward a legislative proposal on corporate governance, and could also be an indicator that the EU Parliament will be supportive of the Commission’s corporate governance initiative.

Conclusion

If the European initiatives become law in their current form, or in a similar form, they will impose substantive requirements on companies with an EU footprint, whether based in Europe or providing goods or services into the EU. The expectation that companies should conduct mandatory due diligence for environmental and human rights impacts may extend to a requirement to conduct that due diligence across the company’s entire value chain, with potential administrative fines and civil liability for failures which have led (or might lead) to adverse human rights impacts. While we understand that director liability has been removed from the draft directive, the Commission’s sustainable corporate governance initiative means that legal risks could still arise at both a corporate and director level.

However these initiatives evolve, when viewed with other national and international developments (to be discussed in Part Two of this alert), it is clear that companies proactively need to be considering their value chain management and risk management frameworks for human rights, environmental and good governance considerations, and readying themselves for stricter controls and expectations in this field.

________________________

[1] Study on directors’ duties and sustainable corporate governance (29 July 2020), available at: https://op.europa.eu/en/publication-detail/-/publication/e47928a2-d20b-11ea-adf7-01aa75ed71a1/language-en.

[2] Emphasis added. The Inception Impact Assessment for the Commission’s Initiative is available at: https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12548-Sustainable-corporate-governance.

[3] The September 2020 draft of the report is available at: https://www.europarl.europa.eu/meetdocs/2014_2019/plmrep/COMMITTEES/JURI/PR/2021/01-27/1212406EN.pdf. The amendments to the draft are available at: https://www.europarl.europa.eu/meetdocs/2014_2019/plmrep/COMMITTEES/JURI/DV/2021/01-27/Votinglist_Corporateduediligence_amendments_EN.pdf. As at the date of this article, a consolidated version of the draft report has not been published, but should soon be made available at: https://www.europarl.europa.eu/committees/en/juri/documents/latest-documents.

[4] Available at: https://www.europarl.europa.eu/doceo/document/TA-9-2020-0285_EN.html.

[5] Available at: https://www.europarl.europa.eu/doceo/document/TA-9-2020-0372_EN.html.


Susy Bullock, Allan Neil and Alexa Romanelli are members of Gibson Dunn’s Environmental, Social and Governance (ESG) Practice. Further information about the ESG Practice can be found at: https://www.gibsondunn.com/practice/environmental-social-and-governance-esg/.

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, or the following authors in London:

Susy Bullock (+44 (0) 20 7071 4283, [email protected])
Allan Neil (+44 (0) 20 7071 4296, [email protected])
Alexa Romanelli (+44 (0) 20 7071 4269, [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 January 29, 2021, Pharmaceutical Care Management Association (“PCMA”), a national trade association representing pharmacy benefit managers (“PBMs”), secured a one-year stay in a challenge to a new regulation issued by the Department of Human Health and Services Office of Inspector General (“HHS-OIG”) that sought to prohibit PBMs and plan sponsors from accepting retrospective manufacturer rebates under Medicare Part D plans.  In response to a complaint and a motion for partial summary judgment, together with a request for expedited consideration, filed by Gibson Dunn behalf of PCMA in the United States District Court for the District of Columbia, HHS-OIG offered to delay the effective date of a challenged regulation while it considers whether to withdraw or modify the rule.

PBMs administer prescription drug plans for more than 270 million Americans with health coverage through their employers, the health insurance market, or federal programs including Medicare Part D.  Plan sponsors engage PBMs to maximize the value of prescription drug benefits by negotiating price concessions from drug manufacturers and pharmacies, in addition to providing numerous other services.  Since the mid-1990s and through the earliest days of Part D, PBMs and manufacturers in both the commercial and Part D contexts have converged around a business model in which manufacturers pay retrospective rebates to PBMs after the product is dispensed to the enrollee, and PBMs pass rebates on to plan sponsors.

On November 30, 2020, HHS-OIG issued the “Rebate Rule,” a new regulation that attempted to prohibit PBMs and plan sponsors from accepting retrospective manufacturer rebates under Medicare Part D plans.  HHS-OIG issued the rule despite concerns from within the Trump administration that the Rule would weaken PBMs’ ability to negotiate price concessions, drive up net drug prices, increase premiums for Medicare Part D enrollees by 25 percent, and increase federal spending by $196 billion over the next decade—concerns confirmed by actuarial analyses from multiple federal agencies and the Department of Health and Human Services’ own actuaries.  HHS-OIG set the Rebate Rule’s provisions eliminating retrospective rebates to take effect January 1, 2022, even though the process of negotiating with drug manufacturers, designing Medicare Part D plans, and submitting bids to the government to provide coverage in 2022 was already well underway, with bids due in June 2021.

The timing of the rule thus interrupted ongoing negotiations and left PBMs and plan sponsors without adequate guidance or regulation from the government about how the new rule would impact bidding and the operation of Medicare Part D for the 2022 contract year.  PCMA and its member PBMs sought immediate relief because the Rebate Rule had disrupted their work midstream and left them in regulatory limbo without enough time to receive necessary operational guidance and regulations before they submit bids in June.

In response, Gibson Dunn developed a strategy to challenge the rule as arbitrary and capricious under the Administrative Procedure Act and to delay its effective date.  After filing a complaint on January 12, 2021, Gibson Dunn then filed a motion for partial summary judgment on January 25, 2021 targeting the Rebate Rule’s impending effective date.  Gibson Dunn contemporaneously filed a motion asking for an expedited ruling on the effective date’s validity within five weeks.

At a status hearing on January 29, 2021 before Judge John D. Bates, the government responded to the motion for partial summary judgment by offering to delay the effective date of the Rebate Rule for a full calendar year, with a new effective date of January 1, 2023.  The parties stipulated to that approach, and the court approved the delayed effective date, which restored the status quo and provided plan sponsors and PBMs clarity as they work to submit bids in June 2021 to provide Medicare coverage for millions of Americans, and held the case in abeyance.  During the stay, the Biden administration will study the rule adopted by its predecessors and determine whether to repeal or modify it.  If HHS-OIG ultimately elects to leave the Rule in place, or fails to make a decision before planning for contract year 2023 begins, Gibson Dunn is prepared to proceed with its remaining challenges to the Rule.

The case is Pharmaceutical Care Management Association v. U.S. Department of Health and Human Services, et al., No. 21-cv-95 (D.D.C.).


The following Gibson Dunn lawyers assisted in the litigation and in the preparation of this client update: Helgi C. Walker, Matthew Rozen, Brian Richman, Aaron Smith, and Max Schulman.

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 Administrative Law and Regulatory Practice Group, or the following authors:

Helgi C. Walker – Chair, Administrative Law and Regulatory Practice, Washington, D.C. (+1 202-887-3599, [email protected])

Matthew S. Rozen – Member, Administrative Law and Regulatory Practice, 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.

This edition of Gibson Dunn’s Federal Circuit Update summarizes the three pending Supreme Court cases originating in the Federal Circuit and key filings for certiorari review. We address the Federal Circuit’s updates to its Oral Argument Guide and its new procedures for handling highly sensitive information.  And we discuss other recent Federal Circuit decisions concerning the validity of assignment agreements, motions to transfer from the Western District of Texas, waiver, forfeiture, and venue for ANDA cases.

In case you missed it, on January 11, 2021, Gibson Dunn published its eighth “Federal Circuit Year In Review,” providing a statistical overview and substantive summaries of the 130 precedential patent opinions issued by the Federal Circuit between August 1, 2019, and July 31, 2020.

Federal Circuit News

Supreme Court:

The Supreme Court has three pending cases originating in the Federal Circuit.

Minerva Surgical Inc. v. Hologic Inc. (U.S. No. 20-440): As we summarized in our May 2020 update, a Federal Circuit panel (Stoll, J., joined by Wallach and Clevenger, JJ.) held that, under Federal Circuit precedent, the doctrine of assignor estoppel barred Minerva, the original assignor of the asserted patents, from challenging invalidity of the asserted patents in the district court. The doctrine did not apply to IPRs, however, which allowed Minerva to challenge the validity of the asserted patents via an IPR. The Supreme Court granted certiorari on the following issue: “Whether a defendant in a patent infringement action who assigned the patent, or is in privity with an assignor of the patent, may have a defense of invalidity heard on the merits.” Briefing is complete, but oral argument has not yet been scheduled.

United States v. Arthrex, Inc. (U.S. Nos. 19-1434, 19-1452, 19-1458): As we summarized in our November 2019 update and in our November 5, 2019 alert, a panel of the Federal Circuit (Moore, J., joined by Reyna and Chen, JJ.) held that PTAB administrative patent judges (APJs) were improperly appointed principal Officers under the Appointments Clause. To cure this defect, the court ruled that the statutory provision of for-cause removal for PTO officials is unconstitutional as applied to APJs. In the Supreme Court, no party defends the Federal Circuit’s decision. The United States and Smith & Nephew argue that APJs are inferior Officers because, “from soup to nuts,” their work is supervised by principal Officers, such as the Director. By contrast, Arthrex maintains that APJs are principal Officers solely because the Director does not have the power to directly “review and modify” APJ decisions, which Arthrex claims is an “indispensable” component of supervision. Briefing is nearly complete (Arthrex will file its final brief in mid-February) and oral argument is calendared for March 1, 2021. Gibson Dunn partner Mark Perry is co-counsel for Smith & Nephew.

Google LLC v. Oracle America, Inc. (U.S. No. 18-956): As we summarized in our March 2018 update, our November 2019 update, and our May 2020 update, a Federal Circuit panel (O’Malley, J., joined by Plager and Taranto, JJ.) held in 2014 that a software interface comprising of declaring code for the Java programming language was copyrightable. The same panel of the Federal Circuit ruled in 2018 that Google’s use of the Java declaring code in its Android operating system was not fair use. The Supreme Court granted certiorari to consider two issues: “(1) Whether copyright protection extends to a software interface; and (2) whether, as the jury found, the petitioner’s use of a software interface in the context of creating a new computer program constitutes fair use.” On October 7, 2020, the Court heard oral argument in this case. On the first issue, the Court challenged both sides’ arguments concerning the applicability of the merger doctrine (under which there is no copyright protection if there is only one conceivable form of expression) in this case. The Court also questioned whether merger should be evaluated when the program was first written or when it was used, particularly if the use occurs well after the program becomes the accepted method in the industry. On the second issue, the Court was concerned that the Federal Circuit applied an incorrect standard of review and did not give the jury verdict of fair use sufficient deference. Gibson Dunn partners Mark Perry and Blaine Evanson serve as counsel for Amicus Curiae Rimini Street, Inc. supporting reversal.

Noteworthy Petitions for a Writ of Certiorari:

There are two potentially impactful petitions that are asking for clarification of Section 101 jurisprudence currently pending before the Supreme Court.

American Axle & Manufacturing, Inc. v. Neapco Holdings LLC (U.S. No. 20-891): “[1] What is the appropriate standard for determining whether a patent claim is ‘directed to’ a patent-ineligible concept under step 1 of the Court’s two-step framework for determining whether an invention is eligible for patenting under 35 U.S.C. § 101? [2] Is patent eligibility (at each step of the Court’s two-step framework) a question of law for the court based on the scope of the claims or a question of fact for the jury based on the state of art at the time of the patent?”

Ariosa Diagnostics, Inc. v. Illumina, Inc. (U.S. No. 20-892): “Whether a patent that claims nothing more than a method for separating smaller DNA fragments from larger ones, and analyzing the separated DNA for diagnostic purposes, using well-known laboratory techniques is unpatentable under Section 101 and Myriad.”

The Court will consider American Axle during its February 19 conference. Ariosa has not yet been scheduled for conference.

Noteworthy Federal Circuit En Banc Petitions:

This month we highlight the pending en banc petition in In re Apple Inc. (Fed. Cir. No. 20-135).

The panel majority, over Judge Moore’s dissent, granted Apple’s mandamus petition, finding that Judge Albright (Western District of Texas) clearly abused his discretion in denying Apple’s motion for transfer to the Northern District of California. The panel opinion is further summarized below. Uniloc 2017 (plaintiff in the district court) filed an en banc petition presenting the issues of the level of deference that should be afforded, on mandamus review, to discretionary transfer decisions, and the circumstances in which a clear abuse of discretion can occur. US Inventor, Inc., filed an amicus brief in support of rehearing. At the court’s invitation, Apple responded to Uniloc 2017’s petition on December 29, 2020.

Other Federal Circuit News:

Dan Bagatell published his fourth annual article, providing an empirical review of the Federal Circuit’s decisions in patent cases during calendar year 2020. Bagatell found that the Federal Circuit’s affirmance rate in PTAB appeals rose over 5% to nearly 86% in 2020. IPR appeals, specifically, were affirmed 83% of the time. Notably, appellants prevailed outright in only 6% of PTAB appeals and 7% of IPR appeals. Patent challenger appellants fared slightly better than patent owner appellants, prevailing outright 17% of the time as compared to only 10% for patent owner appellants.

Federal Circuit Practice Update

In response to recent disclosures of widespread breaches of both private sector and government computer systems, the Federal Circuit has adopted new procedures for the handling of highly sensitive documents outside of the court’s electronic case filing system (CM/ECF) as well as for documents already electronically filed in CM/ECF. The administrative order and new procedures go into effect immediately and are available on the court’s website here and here.

The Clerk’s Office has also updated the Federal Circuit’s Guide for Oral Argument, which includes minor procedural clarifications and designates new Access Coordinators responsible for coordinating auxiliary aids and services to participants in proceedings who have communication disabilities.

Our May 2020 update summarized the key rule changes the Federal Circuit first proposed last spring. The December 2020 updated rules have taken effect and are now available on the court’s website.

Upcoming Oral Argument Calendar

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

The court is scheduled to hear argument in 52% of the cases on its February 2021 calendar. This is up from the early days of the pandemic when, for example, the court heard argument in only 29% of its April 2020 cases. The number of argued cases, however, is still dramatically lower than pre-pandemic numbers. For example, in February 2020, the court heard argument in 81% of its scheduled cases.

Case of Interest:

On Friday, February 12, the court will hear argument in Mylan Laboratories Ltd. v. Janssen Pharmaceutica, N.V. on Janssen’s motion to dismiss Mylan’s appeal. Janssen and the USPTO, as intervenor, argue that Mylan’s appeal should be dismissed for lack of jurisdiction because the Director’s institution decision is “final and nonappealable.” 35 U.S.C. § 314(d). Mylan maintains that judicial review remains available because the PTAB exceeded its congressional authority and violated Mylan’s due process rights by denying Mylan’s timely IPR petition based on the NHK/Fintiv rule.

Key Case Summaries (November 2020–January 2021)

Whitewater W. Indus., Ltd. v. Alleshouse, 981 F.3d 1045 (Fed. Cir. 2020): Alleshouse, while an employee of Whitewater, signed an agreement assigning to Whitewater, all of his rights or interests in any invention he “may make or conceive,” “whether solely or jointly with others,” if the invention is either “resulting from or suggested by” his “work for” Whitewater or “in any way connected to any subject matter within the existing or contemplated business of” Whitewater. Alleshouse left Whitewater to start his own venture, Pacific Surf. Alleshouse then began filing patent applications. Whitehouse sued, alleging breach of contract and that Alleshouse had to assign Pacific Surf’s patents to Whitehouse. The district court upheld the agreement as valid and determined that Alleshouse breached the contract by failing to assign the patents.

The Federal Circuit panel (Taranto, J., joined by Dyk and Moore, JJ.) reversed. The Federal Circuit held that the agreement’s assignment provision was invalid for violating California Business and Professions Code § 16600, which as applied by California courts, forbids employers from impairing post-employment liberties of former employees.

In re Google Tech. Holdings LLC, 980 F.3d 858 (Fed. Cir. 2020): Google appealed a PTAB decision that sustained the Examiner’s final rejection of certain claims for obviousness, arguing that the Board relied on incorrect claim constructions.

The Federal Circuit panel (Chen, J., joined by Taranto and Stoll, JJ.) affirmed, and found that Google had forfeited the claim construction arguments by not presenting them to the Board. The court also noted the distinction between forfeiture and waiver: “Whereas forfeiture is the failure to make the timely assertion of a right, waiver is the ‘intentional relinquishment or abandonment of a known right.’”

In re Apple Inc., 979 F.3d 1332 (Fed. Cir. 2020): Apple moved to transfer Uniloc 2017’s lawsuit from the Western District of Texas (“WDTX”) to the Northern District of California (“NDCA”). Judge Alan Albright held a hearing and stated that he would deny the motion to transfer, but did not enter an order. After holding a Markman hearing, issuing a claim construction order, holding a discovery hearing, and issuing a discovery order, Apple filed a writ of mandamus at the Federal Circuit. Judge Albright issued his order denying the transfer a week later.

The Federal Circuit (Prost, C.J., joined by Hughes, J.) granted Apple’s mandamus petition. The majority held that the district court made several errors in assessing whether the Fifth Circuit’s public and private factors favor transfer. First, the majority held that the factor dealing with the relative ease of access to sources of proof analyzes only non-witness evidence, such as documents and physical evidence. Second, the majority held that the district court erred by too rigidly applying the Fifth Circuit’s 100-mile rule regarding witness inconvenience. The majority found that New York–based witnesses will only be slightly more inconvenienced by having to travel to California than to Texas. Third, the district court erred by faulting Apple for the fact that significant steps, such as the Markman hearing, had occurred in the case because those steps occurred after Apple moved for a transfer. Fourth, the panel found that the district court erred in its analysis of court congestion and time to trial. The panel found that WDTX and NDCA have had comparable times to trial and that the district court cannot set an aggressive trial date and then conclude other forums are more congested. Fifth and finally, the panel held that the consideration of local interests analyzes whether there are significant connections between a particular venue and the events that gave rise to the suit and not the parties’ connections to each forum writ large.

Judge Moore dissented, emphasizing the deferential clear abuse of discretion standard of review.

Valeant Pharm. N. Am. LLC v. Mylan Pharm. Inc., 978 F.3d 1374 (Fed. Cir. 2020): Valeant filed a Hatch-Waxman action against Mylan Pharmaceuticals Inc. (“MPI”), a West Virginia corporation; Mylan Inc., a Pennsylvania Corporation; and Mylan Laboratories Ltd. (“MLL”), a foreign corporation based in India. The defendants moved to dismiss for improper venue under § 1400(b) because the only alleged act of infringement—submission of the ANDA—did not occur in New Jersey, and the defendants do not reside or have regular and established places of business in New Jersey. The district court granted the motion to dismiss.

The Federal Circuit (O’Malley, J., joined by Newman and Taranto, JJ.) affirmed-in-part, reversed-in-part, and remanded. The panel held that, in cases brought under 35 U.S.C. § 271(e)(2)(A), infringement occurs for venue purposes only in districts where actions related to the submission of the ANDA occur, and not in all locations where future distribution of the generic products specified in the ANDA is contemplated. The Federal Circuit therefore affirmed the district court’s dismissal of MPI and Mylan Inc. for improper venue. The Federal Circuit, however, reversed the venue-based dismissal against the foreign-based entity MLL, which is subject to venue in any district, and remanded for consideration of the failure to state a claim defense, based on whether MLL’s involvement in submission of the ANDA is sufficient for it to be considered a “submitter,” and thus amenable to suit.

The court denied Valeant’s petition for en banc rehearing on January 26, 2021.


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.

With the 117th Congress now fully seated, the private sector is set to face greater scrutiny from the Legislative Branch than it has in a decade, as Democrats regain control of both chambers of Congress and the presidency for the first time since 2010. Democrats are assuming unitary control as a number of hot-button issues involving private sector entities are front and center in the public discourse—many of which are drawing bipartisan interest—including COVID-19 relief spending, climate change, healthcare and prescription drug costs, cybersecurity breaches, and regulation of big technology companies. And, because Democratic committee chairs are likely to spend significantly less time investigating the Executive Branch under a Biden Administration, additional staff resources will be deployed on the private sector, which should expect the spotlight to be even brighter.

Unlike receiving a civil complaint or compulsory process in an Executive Branch investigation, when a congressional letter or subpoena arrives, targeted organizations may have only a matter of days to consider their response and devise a strategy, and often must do so amid significant media scrutiny and public attention. Congressional investigations often involve public attacks on a company’s reputation, which can imperil the goodwill upon which the company has built its business and maintains its competitive advantages. It is therefore crucial that potential targets evaluate their exposure to likely investigations in the 117th Congress, familiarize themselves with how such inquiries unfold—including the rules and procedures that govern them—and consider potential responses.

To assist possible targets and interested parties in assessing their readiness for responding to a potential congressional investigation, Gibson Dunn presents our view of the new landscape that the 117th Congress will present. We also present a brief overview of how congressional investigations are often conducted, Congress’ underlying legal authorities to investigate, and various defenses that can be raised in response. In addition, we discuss missteps that subjects of investigations sometimes make when receiving an inquiry, and best practices for how to respond.

I. Lay of the Land in the 117th Congress

House of Representatives

As expected when Democrats regained control of the House Chamber in 2019 after eight years of GOP control, numerous private sector industries quickly saw a sharp uptick in congressional scrutiny. Moreover, as we explained in a prior client alert, upon assuming control of the House in the last Congress, Democrats expanded the investigative tools at their disposal in a number of ways. These expanded authorities have been carried over to the 117th Congress, and certain others have been added. Committees will organize over the coming weeks, and additional investigative tools could be added to their arsenals.

Expanding investigative powers: In the rules package for the 117th Congress, Democrats have continued the trend of expanding and strengthening their investigative powers. This includes permitting certain committees to issue subpoenas before the committees are formally organized. Specifically, the House has authorized the Chair of the Committee on Oversight and Reform to issue subpoenas related to the investigation into the accuracy and timing of the 2020 census, and the Chair of the re-authorized Select Subcommittee on the Coronavirus Crisis has the power to issue subpoenas related to its investigation into political interference at the Department of Health and Human Services and Centers for Disease Control and Prevention.

In addition to the strengthened subpoena power, Democrats will maintain broad deposition authority. In the prior Congress, Democrats expanded the House’s deposition authority by permitting staff counsel to conduct depositions and removing the requirement that a member be present during the taking of a deposition. As we previously noted, such broad authority makes it more difficult for minority members to affect, influence, or otherwise hinder investigations to which they are opposed. It is also important to remember that, unlike in the Senate, nearly every House committee chair is empowered to issue a deposition subpoena unilaterally, that is, without the ranking member’s consent or a committee vote, after mere “consultation” with the ranking member.

Likely investigative priorities: As for investigative priorities, a wide array of topics is likely to be covered by House committees; however, Democrats have signaled that immediate priorities include investigating issues related to climate change and the ongoing coronavirus pandemic response. To that end, in addition to re-authorizing the House Select Subcommittee on the Coronavirus Crisis, the House also re-authorized the Select Committee on the Climate Crisis. The Subcommittee on the Coronavirus Crisis has been actively investigating various aspects of the pandemic since it was established by the CARES Act; it has a full suite of authorities, including subpoena power, pursuant to its organizing resolution. While much of the Subcommittee’s focus during the last Congress was on the government’s pandemic response, we expect more of the Subcommittee’s attention will turn to private actors that are involved in the response or recipients of relief funds.

The Select Committee on the Climate Crisis was formed to deliver climate policy recommendations to Congress and was given the jurisdiction to “study, make findings, and develop recommendations on policies, strategies, and innovations” to tackle the climate crisis.[1] The Committee has the power to “hold public hearings in connection with any aspect of its investigative functions.”[2] The Committee does not have subpoena power of its own, but it can request that other committees issue subpoenas. The Committee has thus far focused on holding climate policy hearings on topics such as clean energy, industrial emissions, and the health impacts of the climate crisis rather than on conducting investigations. However, the Committee may turn its attention towards the private sector’s impact on climate change as the Biden Administration makes climate change a focus of its first term.

House Democrats have authorized another new committee, the Select Committee on Economic Disparity and Fairness in Growth. This Committee has been given broad jurisdiction covering “economic fairness, access to education, and workforce development.”[3] It is possible this Committee will be interested in a range of private sector industries, including consumer-facing financial institutions, student loan lenders, and credit agencies. Like the Climate Crisis Committee, this committee does not have its own subpoena power and must rely on standing committees to issue subpoenas in support of its investigations. This arrangement makes it unlikely that either of these select committees’ investigations will involve the issuance of subpoenas unless House Democratic leadership tasks this or the Climate Crisis Committee with a contentious investigation and instructs standing committees to back up the investigation with subpoena authority.

While the Democrats’ focus is likely to shift to the private sector as the Biden Administration begins its term, there will no doubt be a continued desire to investigate former President Trump and the outgoing administration, particularly in light of the violent events at the Capitol on January 6. To that end, the House Democrats’ new rules package includes explicit language allowing the House to issue subpoenas to “the President, and the Vice President, whether current or former, in a personal or official capacity” as well as White House and executive office employees.[4] Additionally, private parties with business connections to President Trump or his organization may continue to face scrutiny.

Senate

Democrats will steer the Senate’s investigative agenda during the 117th Congress after ten years of being in the minority. While Senate committees have yet to organize and publish their rules, it is likely that Democrats will spare little time in getting a number of investigations off the ground, particularly those that complement the Biden Administration’s first-100-days policy priorities.

Key committees to watch: Two committees to pay particular attention to will be the Senate Finance Committee and the Senate Committee on Banking, Housing and Urban Affairs. Senator Ron Wyden (D-OR) is expected to become Chairman of the Senate Finance Committee. Senator Wyden has a reputation as an aggressive investigator, and his past work has included investigations into international trade issues, the NRA, tax benefit abuse, and other topics. Recently, Senator Wyden, together with Senator Grassley (R-IA), issued a report illuminating the extensive connections among opioid manufacturers, opioid-related products, and tax-exempt entities. Wyden and Grassley also teamed up last Congress on a two-year investigation into insulin pricing. Companies can expect Senator Wyden to continue to pursue investigations into a wide range of consumer protection issues and other topics.

The Senate Committee on Banking, Housing and Urban Affairs is similarly likely to be active. Senator Sherrod Brown (D-OH) is expected to become Chairman of the Committee and likely will conduct aggressive oversight of the banking industry. Senator Elizabeth Warren (D-MA) may become Chairwoman of the Subcommittee on Financial Institutions and Consumer Protection, or even of a newly-created oversight committee. This would give Senator Warren oversight and investigation authority, including the ability to hold hearings and to issue subpoenas. Senator Warren has long been a proponent of broader regulation of financial institutions, including calling for stricter separation between commercial banks and investment banks and for efforts to expand access to lenders for average Americans.

Another committee to watch is the Commerce, Science, and Transportation Committee, which Senator Maria Cantwell (D-WA) is expected to chair. The panel has a wide set of responsibilities, including overseeing the regulation of technology companies and handling transportation infrastructure—both issues that are likely to demand attention in the new Congress. It also sets policy for research agencies including NSF, the National Oceanic and Atmospheric Administration, and the National Institute of Standards and Technology. Senator Cantwell, a former technology industry executive, has a strong interest in research and climate issues, which could influence the panel’s work, particularly in light of the Biden Administration’s stated commitment to advancing climate change legislation. While Senator Cantwell has historically not been an active investigator, we can expect the Committee to be active in its legislative activities, and it may launch investigations that are ancillary to these legislative activities.

One final investigative body of note is the Senate Permanent Subcommittee on Investigations (“PSI”), which is a subcommittee of the Senate Homeland Security and Government Affairs Committee. PSI has the responsibility of studying and investigating the efficiency and economy of operations relating to all branches of the government and is also tasked with studying and investigating the compliance or noncompliance with rules, regulations, and laws, investigating all aspects of crime and lawlessness within the United States which have an impact upon or affect the national health, welfare, and safety, including syndicated crime, investment fraud schemes, commodity and security fraud, computer fraud, and the use of offshore banking and corporate facilities to carry out criminal objectives. While it is unclear who will chair PSI at this time, we can expect it to be active in its investigations.. When Democrats last controlled the Senate, former Michigan Senator Carl Levin chaired PSI and launched a series of high profile and wide-ranging investigations of the financial sector. It’s likely the next Democratic Chair will follow Levin’s lead and adopt an aggressive posture. Also worth watching is who will fill former Senator Kamala Harris’s seat on PSI.

Potential Changes to Subpoena and Deposition Authority: We will also be closely watching whether Senate Democrats strengthen their investigative arsenal, particularly when it comes to subpoena and deposition authority. With respect to subpoenas, currently only the Chair of PSI is authorized to issue a subpoena unilaterally, a significant difference with the House where nearly all committee chairs may do so. Because Senate investigations have historically been more bipartisan than those in the House, there has been a longstanding hesitation on both sides to expand unilateral subpoena power. It remains to be seen if that philosophy will continue to hold sway in the 117th Congress.

It is also important to keep a close watch on Senate deposition authority. In the last Congress, seven Senate bodies had authorization to take depositions: (1) Judiciary, (2) Homeland Security and Governmental Affairs (“HSGAC”), (3) PSI, (4) Aging, (5) Indian Affairs, (6) Ethics, and (7) Intelligence. Of these, HSGAC, PSI, Judiciary, and Aging can subpoena an individual to appear at a deposition. HSGAC, Judiciary, and Aging rules require concurrence of the ranking member or a Committee vote to authorize the issuance of a subpoena, while the Chair of PSI is empowered to issue a subpoena unilaterally. Moreover, staff is expressly authorized to take depositions in each of these committees except in the Indian Affairs and Intelligence Committees. However, heretofore the Senate’s view is that Senate Rules do not authorize staff depositions pursuant to subpoena. Hence, Senate committees cannot delegate that authority to themselves through committee rules, absent a Senate resolution or a change in Senate rules. It remains to be seen whether and to what extent Democrats may expand these authorities.

II. Unique Features of Congressional Investigations   

As a practical matter, numerous motivations (not always legitimate) often drive a congressional inquiry, including: advancing a chair’s political agenda or public profile, exposing alleged criminal wrongdoing or unethical practices, pressuring a company to take certain actions, and responding to public outcry. Recognizing the presence of these underlying objectives and evaluating the political context surrounding an inquiry can therefore be a key component of developing an effective response strategy.

Congress’s power to investigate is broad—as broad as its legislative authority. The “power of inquiry” is inherent in Congress’s authority to “enact and appropriate under the Constitution.”[5] And while Congress’s investigatory power is not a limitless power to probe any private affair or to conduct law enforcement investigations, but rather must further a valid legislative purpose,[6] the term “legislative purpose” is understood broadly to include gathering information not only for the purpose of legislating, but also for overseeing governmental matters and informing the public about the workings of government.[7]

Congressional investigations present a number of unique challenges not found in the familiar arenas of civil litigation and Executive Branch investigations. Unlike the relatively controlled environment of a courtroom, congressional investigations often unfold in a hearing room in front of television cameras and on the front pages of major newspapers and social media feeds.

III. Investigatory Tools of Congressional Committees

Congress has many investigatory tools at its disposal, including: (1) requests for information; (2) interviews; (3) depositions; (4) hearings; (5) referrals to the Executive Branch for prosecution; and (6) subpoenas for documents and/or testimony. If these methods fail, Congress can use its contempt power in an effort to punish individuals or entities who refuse to comply with subpoenas. It is imperative that targets be familiar with the powers (and limits) of each of the following tools to best chart an effective response:

  • Requests for Information: Any member of Congress may issue a request for information to an individual or entity, which request may seek documents or other information.[8] Absent the issuance of a subpoena, responding to such requests is entirely voluntary as a legal matter (although of course there may be public and/or political pressure to respond). As such, recipients of such requests should carefully consider the pros and cons of different degrees of responsiveness.
  • Interviews: Interviews also are voluntary, led by committee staff, and occur in private (in person or over the phone). They tend to be less formal than depositions and are sometimes transcribed. Committee staff may take copious notes and rely on interview testimony in subsequent hearings or public reports. Although interviews are typically not conducted under oath, false statements to congressional staff can be criminally punishable as a felony under 18 U.S.C. § 1001.
  • Depositions: Depositions can be compulsory, are transcribed, and are taken under oath. As such, depositions are more formal than interviews and are similar to those in traditional litigation. The number of committees with authority to conduct staff depositions has increased significantly over the last few years. In the last Congress, the House required (with limited exceptions) that one or more Members of Congress be present during a deposition. Importantly, the House rules for the 117th Congress have eliminated this requirement (see infra, Section IV), which will likely result in an increase in the use—or at least threatened use—of depositions as an investigative tool.[9] It is expected that the House Rules Committee soon will issue guidance on how staff depositions are to be conducted. In the 116th Congress, staff of five Senate committees/subcommittees were authorized to conduct staff depositions: Judiciary, HSGAC, PSI, Aging and Ethics.[10] However, Judiciary required that a member be present during deposition, unless waived by agreement of the chair and ranking member.The House Rules Committee’s regulations for staff depositions in the 117th Congress will likely mirror in many respects the regulations issued by that Committee in the 116th Congress. Significantly, those regulations changed past practice by authorizing the immediate overruling of objections raised by a witness’s counsel and immediate instructions to answer, on pain of contempt. Those regulations also appeared to eliminate the witness’s right to appeal rulings on objections to the full committee (although committee members may still appeal). Assuming these changes are preserved in the 117th Congress, as seems likely, they will continue to enhance the efficiency of the deposition process, as prior to the 116th Congress the staff deposition regulations required a recess before the chair could rule on an objection. Additionally, the regulations for the 116th Congress expressly allowed for depositions to continue from day to day and permit, with notice from the chair, questioning by members and staff of more than one committee. Finally, the regulations removed a prior requirement that allowed objections only by the witness or the witness’s lawyer. This change appears to allow objections from staff or members who object to a particular line of questioning.[11]
  • Hearings: While both depositions and interviews allow committees to acquire information quickly and (at least in many circumstances) confidentially,[12] testimony at hearings, unless on a sensitive topic, is conducted in a public session led by the members themselves (or, on occasion, committee counsel).[13] Hearings can either occur at the end of a lengthy staff investigation or take place more rapidly, often in response to an event that has garnered public and congressional concern. Most akin to a trial in litigation (though without many of the procedural protections or the evidentiary rules applicable in judicial proceedings), hearings are often high profile and require significant preparation to navigate successfully.
  • Executive Branch Referral: Congress also has the power to refer its investigatory findings to the Executive Branch for criminal prosecution. After a referral from Congress, the Department of Justice may charge an individual or entity with making false statements to Congress, obstruction of justice, or destruction of evidence. Importantly, while Congress may make a referral, the Executive Branch retains the discretion to prosecute, or not.

Subpoena Power

As noted above, Congress will usually seek voluntary compliance with its requests for information or testimony as an initial matter. If initial requests for voluntary compliance meet with resistance, however, or if time is of the essence, it may compel disclosure of information or testimony through the issuance of a congressional subpoena.[14] Like Congress’s power of inquiry, there is no explicit constitutional provision granting Congress the right to issue subpoenas.[15] But the Supreme Court has recognized that the issuance of subpoenas is “a legitimate use by Congress of its power to investigate” and its use is protected from judicial interference in some respects by the Speech or Debate Clause.[16] Congressional subpoenas are subject to few legal challenges,[17] and “there is virtually no pre-enforcement review of a congressional subpoena” in most circumstances.[18]

The authority to issue subpoenas is initially governed by the rules of the House and Senate, which delegate further rulemaking to each committee.[19] While nearly every standing committee in the House and Senate has the authority to issue subpoenas, the specific requirements for issuing a subpoena vary by committee. These rules are still being developed by the committees of the 117th Congress, and can take many forms.[20] For example, several House committees authorize the committee chair to issue a subpoena unilaterally and require only that notice be provided to the ranking member. Others, however, require approval of the chair and ranking member, or, upon the ranking member’s objection, require approval by a majority of the committee.

Contempt of Congress

Failure to comply with a subpoena can result in contempt of Congress. Although Congress does not frequently resort to its contempt power to enforce its subpoenas, it has three potential avenues for seeking to implement its contempt authority.

  • Inherent Contempt Power: The first, and least relied upon, is Congress’s inherent contempt power. Much like the subpoena power itself, the inherent contempt power is not specifically authorized in the Constitution, but the Supreme Court has recognized its existence and legitimacy.[21] To exercise this power, the House or Senate must pass a resolution and then conduct a full trial or evidentiary proceeding, followed by debate and (if contempt is found to have been committed) imposition of punishment.[22] As is apparent in this description, the inherent contempt authority is cumbersome and inefficient, and it is potentially fraught with political peril for legislators. It is therefore unsurprising that Congress has not used it since 1934.[23]
  • Statutory Criminal Contempt Power: Congress also possesses statutory authority to refer recalcitrant witnesses for criminal contempt prosecutions in federal court. In 1857, Congress enacted this criminal contempt statute as a supplement to its inherent authority.[24] Under the statute, a person who refuses to comply with a subpoena is guilty of a misdemeanor and subject to a fine and imprisonment.[25] “Importantly, while Congress initiates an action under the criminal contempt statute, the Executive Branch prosecutes it.”[26] This relieves Congress of the burdens associated with its inherent contempt authority. The statute simply requires the House or Senate to approve a contempt citation. Thereafter, the statute provides that it is the “duty” of the “appropriate United States attorney” to prosecute the matter, although the Department of Justice maintains that it always retains discretion not to prosecute, and often declines to do so.[27] Although utilized as recently as the 1980s, the criminal contempt power has largely fallen into disuse.[28]
  • Civil Enforcement Authority: Finally, Congress may seek civil enforcement of its subpoenas, which is often referred to as civil contempt. The Senate’s civil enforcement power is expressly codified.[29] This statute expressly authorizes the Senate to seek enforcement of legislative subpoenas in a U.S. District Court. In contrast, the House does not have a civil contempt statute, but it may pursue a civil contempt action “by passing a resolution creating a special investigatory panel with the power to seek judicial orders or by granting the power to seek such orders to a standing committee.”[30] In the past, the full House has typically “adopt[ed] a resolution finding the individual in contempt and authorizing a committee or the House General Counsel to file suit against a noncompliant witness in federal court.”[31] In the 116th Congress, however, the Chairman of the House Rules Committee took the position that the House rules empower the Bipartisan Legal Advisory Group (“BLAG”; consisting of the Speaker, the Majority and Minority Leaders, and the Majority and Minority Whips) to authorize a civil enforcement action without the need for a House vote.[32] The House subsequently endorsed that position, and the BLAG authorized at least one civil enforcement action during the 116th Congress.[33] It seems likely that this authority will be continued in the 117th Congress.

IV. Defenses to Congressional Inquiries

While potential defenses to congressional investigations are limited, they are important to understand—likely more so now with Democrats taking control of both chambers. The principal defenses are as follows:

Jurisdiction and Legislative Purpose

As discussed above, a congressional investigation is required generally to relate to a legislative purpose, and must also fall within the scope of legislative matters assigned to the particular committee at issue. In a challenge based on these defenses, the party subject to the investigation must argue that the inquiry does not have a proper legislative purpose, that the investigation has not been properly authorized, or that a specific line of inquiry is not pertinent to an otherwise proper purpose within the committee’s jurisdiction. Because courts generally interpret “legislative purpose” broadly, these challenges can be an uphill battle. Nevertheless, this defense should be considered when a committee is pushing the boundaries of its jurisdiction or pursuing an investigation that arguably lacks any legitimate legislative purpose.

Constitutional Defenses

Constitutional defenses under the First and Fifth Amendments may be available in certain circumstances. While few of these challenges are ever litigated, these defenses should be carefully evaluated by the subject of a congressional investigation.

When a First Amendment challenge is invoked, a court must engage in a “balancing” of “competing private and public interests at stake in the particular circumstances shown.”[34] The “critical element” in the balancing test is the “existence of, and the weight to be ascribed to, the interest of the Congress in demanding disclosures from an unwilling witness.”[35] Though the Supreme Court has never relied on the First Amendment to reverse a criminal conviction for contempt of Congress, it has recognized that the First Amendment may restrict Congress in conducting investigations.[36] Courts have also recognized that the First Amendment constrains judicially compelled production of information in certain circumstances.[37] Accordingly, it would be reasonable to contend that the First Amendment limits congressional subpoenas at least to the same extent.

The Fifth Amendment’s privilege against self-incrimination is available to witnesses—but not entities—who appear before Congress.[38] The right generally applies only to testimony, and not to the production of documents,[39] unless those documents satisfy a limited exception for “testimonial communications.”[40] Congress can circumvent this defense by granting transactional immunity to an individual invoking the Fifth Amendment privilege.[41] This allows a witness to testify without the threat of a subsequent criminal prosecution based on the testimony provided. Supreme Court dicta also suggests the Fourth Amendment can be a valid defense in certain circumstances related to the issuance of congressional subpoenas.[42]

Attorney-Client Privilege & Work Product Defenses

Although committees in the House and Senate have taken the position that they are not required to recognize the attorney-client privilege, in practice the committees generally acknowledge the privilege as a valid protection. Moreover, no court has ruled that the attorney-client privilege does not apply to congressional investigations. Committees often require that claims of privilege be logged as they would in a civil litigation setting. In assessing a claim of privilege, committees balance the harm to the witness of disclosure against legislative need, public policy, and congressional duty. Notably, in 2020, the Supreme Court for the first time acknowledged in dicta that the attorney-client privilege is presumed to apply in congressional investigations. In Trump v. Mazars, the Supreme Court stated that “recipients [of congressional subpoenas] have long been understood to retain common law and constitutional privileges with respect to certain materials, such as attorney-client communications and governmental communications protected by executive privilege.”[43] It remains to be seen if members and committee staffers will take the same view going forward.

The work product doctrine protects documents prepared in anticipation of litigation. Accordingly, it is not clear whether or in what circumstances the doctrine applies to congressional investigations, as committees may argue that their investigations are not necessarily the type of “adversarial proceeding” required to satisfy the “anticipation of litigation” requirement.[44]

V. Top Mistakes and How to Prepare

Successfully navigating a congressional investigation requires a multifaceted mastery of the facts at issue, careful consideration of collateral political events, and crisis communications.

Here are some of the more common mistakes we have observed:

  • Facts: Failure to identify and verify the key facts at issue;
  • Message: Failure to communicate a clear and compelling narrative;
  • Context: Failure to understand and adapt to underlying dynamics driving the investigation;
  • Concern: Failure to timely recognize the attention and resources required to respond;
  • Legal: Failure to preserve privilege and assess collateral consequences;
  • Rules: Failure to understand the rules of each committee, which can vary significantly; and
  • Big Picture: Failure to consider how an adverse outcome can negatively impact numerous other legal and business objectives.

The consequences of inadequate preparation can be disastrous on numerous fronts. A keen understanding of how congressional investigations differ from traditional litigation and even Executive Branch or state agency investigations is therefore vital to effective preparation. The most successful subjects of investigations are those that both seek advice from experienced counsel and employ multidisciplinary teams with expertise in government affairs, media relations, e-discovery, and the key legal and procedural issues.

* * *

Democratic control of both congressional chambers and the White House is certain to usher in a more perilous landscape over the next two years for a wide array of public-facing industry actors, particularly those intertwined with current policy debates and hot button issues. Gibson Dunn lawyers have extensive experience in both running congressional investigations and defending targets of and witnesses in such investigations. If you or your company become the subject of a congressional inquiry, or if you are concerned that such an inquiry may be imminent, please feel free to contact us for assistance.

____________________

  [1]   H.R. Res. 6, 116th Cong. § 104(f)(2)(B) (2019).

  [2]   Id.

   [3]   H.R. Res. 8, 117th Cong. § 4(g)(2)(B) (2021).

  [4]   H.R. Res. 8, 117th Cong. § 2(m) (2021).

   [5]   Barenblatt v. United States, 360 U.S. 178, 187 (1957).

   [6]   See Wilkinson v. United States, 365 U.S. 399, 408-09 (1961); Watkins v. United States, 354 U.S. 178, 199-201 (1957).

   [7]   Michael D. Bopp, Gustav W. Eyler, & Scott M. Richardson, Trouble Ahead, Trouble Behind: Executive Branch Enforcement of Congressional Investigations, 25 Corn. J. of Law & Pub. Policy 453, 456 (2015).

   [8]   Id.

   [9]   See H.R. Res. 6, 116th Cong. § 103(a)(1) (2019).

[10]   See The Power to Investigate: Table of Authorities of House and Senate Committees for the 116th Congress, https://www.gibsondunn.com/wp-content/uploads/2019/07/Power-to-Investigate-Table-of-Authorities-House-and-Senate-Committees-116th-Congress-07.2019.pdf. Consistent with past practice, Gibson Dunn will release a client alert outlining the specific subpoena rules for each committee in the 117th Congress as soon as they become available.

[11]   See 165 Cong. Rec. H1216 (Jan. 25, 2019) (statement of Rep. McGovern).

[12]   Bopp, supra note 7, at 457.

[13]   Id. at 456-57.

[14]   Id. at 457.

[15]   Id.

[16]   Eastland v. U.S. Servicemen’s Fund, 421 U.S. 491, 504-05 (1975).

[17]   Bopp, supra note 7, at 458.

[18]   Id. at 459. The principal exception to this general rule arises when a congressional subpoena is directed to a custodian of records owned by a third party. In those circumstances, the Speech or Debate Clause does not bar judicial challenges brought by the third party seeking to enjoin the custodian from complying with the subpoena, and courts have reviewed the validity of the subpoena. See, e.g., Trump v. Mazars, 140 S. Ct. 2019 (2020); Bean LLC v. John Doe Bank, 291 F. Supp. 3d 34 (D.D.C. 2018).

[19]   Id. at 458.

[20]   Gibson Dunn will detail these rules when they are finalized in an upcoming publication.

[21]   Bopp, supra note 7, at 460 (citing Anderson v. Dunn, 19 U.S. 204, 228 (1821)).

[22]   Id.

[23]   Id. at 466.

[24]   Id. at 461.

[25]   See 2 U.S.C. §§ 192 and 194.

[26]   Bopp, supra note 7, at 462.

[27]   See 2 U.S.C. § 194.

[28]   Bopp, supra note 7, at 467.

[29]   See 2 U.S.C. §§ 288b(b), 288d.

[30]   Bopp, supra note 7, at 465. However, the law on this point is currently unsettled after a panel of the U.S. Court of Appeals for the D.C. Circuit ruled in August of 2020 that the House may not seek civil enforcement of a subpoena absent statutory authority. Committee on the Judiciary of the United States House of Representatives v. McGahn, No. 19-5331 (D.C. Cir. 2020). The ruling is currently being considered en banc.

[31]   Id.

[32]   See 165 Cong. Rec. H30 (Jan. 3, 2019) (“If a Committee determines that one or more of its duly issued subpoenas has not been complied with and that civil enforcement is necessary, the BLAG, pursuant to House Rule II(8)(b), may authorize the House Office of General Counsel to initiate civil litigation on behalf of this Committee to enforce the Committee’s subpoena(s) in federal district court.”) (statement of Rep. McGovern); House Rule II.8(b) (“the Bipartisan Legal Advisory Group speaks for, and articulates the institutional position of, the House in all litigation matters”).

[33]   See H. Res. 430 (116th Cong.) (“a vote of [BLAG] to authorize litigation . . . is the equivalent of a vote of the full House of Representatives”); Br. for House Committee at 33, Committee on Ways and Means, United States House of Representatives v. U.S. Dep’t of the Treasury, No. 1:19-cv-01974 (D.D.C. 2019) (stating BLAG authorized suit by House Ways & Means Committee to obtain President Trump’s tax returns pursuant to 26 U.S.C. § 6103(f)).

[34]   Barenblatt, 360 U.S. 109, 126 (1959).

[35]   Id.

[36]   See id. at 126-7.

[37]   See, e.g., Perry v. Schwarzenegger, 91 F.3d 1147, 1173 (9th Cir. 2009).

[38]   See Quinn v. United States, 349 U.S. 155, 163 (1955).

[39]   See Fisher v. United States, 425 U.S. 391, 409 (1976).

[40]   See United States v. Doe, 465 U.S. 605, 611 (1984).

[41]   See 18 U.S.C. § 6002; Kastigar v. United States, 406 U.S. 441 (1972).

[42]   Watkins, 354 U.S. at 188.

[43]   See Trump v. Mazars USA, LLP (591 U.S. ___ (2020)).

[44]   See In re Grand Jury Subpoena Duces Tecum, 112 F.3d 910, 924 (8th Cir. 1997).


The following Gibson Dunn attorneys assisted in preparing this client update: Michael D. Bopp, Thomas G. Hungar, Roscoe Jones Jr., Alexander W. Mooney, Rebecca Rubin and Jillian N. Katterhagen.

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work or the following lawyers in the firm’s Congressional Investigations group in Washington, D.C.:

Michael D. Bopp – Chair, Congressional Investigations Group (+1 202-955-8256, [email protected])
Thomas G. Hungar (+1 202-887-3784, [email protected])
Roscoe Jones, Jr. (+1 202-887-3530, [email protected])

© 2020 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 start of a new year is often greeted with the phrase “out with the old, in with the new”. For those involved in cross-border litigation, the phrase has rarely seemed as appropriate as it does at the start of 2021.

It will have escaped no-one’s attention that 1 January 2021 marked the end of the Brexit transition period. This has resulted in a number of significant changes to the applicable cross-border procedural rules which litigators and those responsible for drafting commercial contracts will need to have in mind. This note provides a high level overview of the key developments. It is worth noting at the outset that the Trade and Cooperation Agreement between the UK and the EU, which was announced on 24 December 2020, is silent on each of the topics discussed below.

1. Governing law

The old: EC Regulations No 593/2008 on the law applicable to contractual obligations (Rome I) and No 864/2007 on the law applicable to non-contractual obligations (Rome II)

Rome I allows parties to choose the law which will govern a contract, and provides a series of rules to determine which law should apply in the event that the contract does not make this clear. Rome II sets out rules which govern the law applicable to non-contractual obligations arising in a number of different contexts including unfair competition, infringement of intellectual property rights and in tort, and also allows parties to agree the governing law. The regulations require the courts of each Member State (apart from Denmark) to apply those rules to determine the applicable law in a dispute.

The new: still Rome I and II

Post-Brexit, for the remaining EU Member States the Rome regulations continue to apply. Importantly, both Rome I and Rome II make clear that parties can choose as governing law the law of a non-Member State. Subject to the existing exceptions contained within the regulations, therefore, EU courts ought to continue to respect parties’ choice of English law.

While the UK may no longer be a Member State, the UK government has already enacted domestic legislation which provides that the rules set out in Rome I and Rome II continue to apply in the UK too. Nothing in the Trade and Cooperation Agreement changes that.

What does this mean for our clients?

In the current, shifting legal landscape, it is of some comfort that the rules on governing law remain unchanged. There is no reason to stop using English law as the choice of law in your contracts: the reasons which would have led you to do so in the first place, such the well-developed body of law and the reputation for delivering legal certainty and fairness, are unaffected by Brexit.

2. Jurisdiction

The old: EC Regulation No 1215/2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (Brussels Recast)

Brussels Recast sets out rules governing which Member State’s courts can hear a dispute, and what happens when the courts in two different Member States are both seised of a claim involving the same parties and cause of action.

The new: the Hague Convention of 30 June 2005 on choice of court agreements, failing which national law

As a result of Brexit, Brussels Recast no longer applies in the UK. What happens now is not straightforward.

The first thing to establish in any new dispute is whether there is an exclusive jurisdiction clause in favour of courts in the UK or in a Member State. If there is, the Hague Convention on choice of court agreements may apply: the UK was previously a party to the convention in its capacity as an EU Member State, and has acceded in its own right as of 1 January 2021. The convention also applies to Singapore, Mexico and Montenegro.

However, there is already a dispute between the UK and the EU about when the Hague Convention will apply: the UK believes that it will apply where there is an exclusive jurisdiction clause in a contract entered into after 1 October 2015, which is the date on which the UK acceded to the convention in its capacity as an EU Member State; the EU’s position is that the convention will only apply where the contract has been entered into after 1 January 2021, when the UK acceded in its own right. How the courts in the UK and in the EU deal with this in practice remains to be seen.

If the convention does apply, the courts designated in the exclusive jurisdiction clause are required to hear the case, and if a court in another contracting state is seised of the matter, it will have to suspend or dismiss the proceedings.

If the convention does not apply, then it is the local law of the state(s) in question which will apply. This may arise because of the date on which the contract was entered into, because there is no jurisdiction clause at all, or because the jurisdiction clause is non-exclusive (it provides for proceedings to be heard in a particular jurisdiction, but does not prevent the parties from beginning proceedings in any other jurisdiction) or is asymmetric (it provides that one party must bring proceedings in a particular jurisdiction, but allows the other party to begin proceedings in any jurisdiction).

The position may yet change again. In April 2020, the UK applied to accede to the 2007 Lugano Convention on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters. This would result in a very similar set of rules to those in force before Brexit under Brussels Recast. Note that one key difference is that, unlike Brussels Recast, the Lugano Contention has no solution to the infamous “Italian Torpedo”, whereby a party subject to an exclusive jurisdiction clause first brings proceedings before a court in a different country with a reputation for taking a long time to rule that it does not have jurisdiction, in order to delay and frustrate proceedings before the court designated in the exclusive jurisdiction clause. By contrast, Brussels Recast provides that the court designated in the exclusive jurisdiction clause must hear the dispute, and any other court seised of the matter must stay the proceedings, even if those proceedings began before those in the jurisdiction designed in the clause. We may therefore see the return of the Italian Torpedo, regardless of whether the UK accedes to the Lugano Convention.

The UK’s application to accede to the Lugano Convention must first be approved by all existing contracting parties: Switzerland, Iceland and Norway have indicated their support, but as at the time of writing the EU and Denmark (a contracting party in its own right) are yet to consent.

What does this mean for our clients?

Having previously been able to rely on a single set of rules, we are now left with a different set of rules, potential disputes about whether those rules apply, defaulting to the national laws of each different EU Member State when the rules do not apply. This lack of clarity will inevitably give rise to litigation.

When drafting contracts, clients may wish to opt for exclusive jurisdiction clauses if seeking certainty about the body of rules which will apply, and therefore about the courts which will hear any future dispute. However, it goes without saying that care must be taken in deciding whether this is the right option in all the circumstances, and legal advice should be taken as appropriate.

3. Enforcement of judgments

The old: EC Regulations No 1215/2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (Brussels Recast) and No 805/2004 creating a European Enforcement Order for uncontested claims (EEO Regulation)

Under Brussels Recast, a judgment handed down by the courts of one Member State is enforceable not only in that Member State but also in any other Member State, as if it were a judgment of a court of that other Member State. The EEO Regulation sets out a simple process by which an uncontested judgment from one Member State can be enforced in another Member State (except Denmark). For proceedings brought from 1 January 2021 onwards, Brussels Recast and the EEO Regulation no longer apply in the UK.

The new: the Hague Convention of 30 June 2005 on choice of court agreements, failing which national law

The post-Brexit position for the enforcement of judgments is similar to that described above in relation to jurisdiction. Where an exclusive jurisdiction clause is involved, and subject to the date of the contract, the Hague Convention on choice of court agreements will apply and will mean that a judgment granted by the court designated in the exclusive jurisdiction clause must be recognised and enforced in the other contracting states.

In all other circumstances, it is the local law of the state(s) in which the judgment is being enforced which will apply. Note that, before joining the EU, the UK entered into a number of bilateral treaties for the reciprocal recognition and enforcement of judgments with certain current EU Member States, including France, Germany, Italy and the Netherlands: it may be that these can be revived and relied upon once again.

As mentioned above, the UK has applied to accede to the 2007 Lugano Convention and if that application is successful, the position would once again be very similar to the way it was under Brussels Recast. It remains to be seen if the EU (and Denmark) allow this to happen.

What does this mean for our clients?

Where the Hague Convention does not apply, the enforcement of judgments is likely to be slower, more cumbersome and ultimately more expensive than it was under Brussels Recast.

When drafting contracts, as things stand exclusive jurisdiction clauses may lead to judgments which are easier to enforce in the future. Of course, there is likely to be a significant gap between the entering into of a contract and the obtaining of a judgment following a related dispute, and the rules may well have changed several times in the intervening period.

4. Service of documents

The old: EC Regulation 1393/2007 on the service in EU countries of judicial and extrajudicial documents in civil or commercial matters (Service Regulation)

Following Brexit, the Service Regulation will no longer apply between the UK and the EU. The regulation aims to establish a standardised and speedy procedure for the service of documents between parties in different Member States. Each Member State designates transmitting and receiving agencies, with the transmitting agency in one country sending the documents to the receiving agency in another, and the receiving agency is then responsible for service. Member States are also permitted to serve directly on a party in another Member State by registered post.

The new: the Hague Convention of 15 November 1965 on the service abroad of judicial and extrajudicial documents in civil and commercial matters

As of 1 January 2021, the Hague Convention of 15 November 1965 will apply instead in the UK. This instrument already applied to the service of documents between the UK and Denmark and the EFTA countries (apart from Lichtenstein), as well as between the UK and the USA and many other countries: there are some 78 contracting parties in total.

The good news is that all 27 EU Member States are signatories to the convention: you will not need to consider if some instrument other than the convention applies, regardless of which EU Member State you are dealing with. The bad news is that each of the 27 Member States has made reservations and declarations in relation to the convention. You will therefore have to look closely at the rules which apply in the relevant country.

In practice, the means of service may not turn out to be terribly different under the Hague Convention. Contracting states are required to designate a central authority to which requests for service can be addressed, and that authority will then arrange for service in accordance with the national laws of its country. Service by mail is also possible under the Hague Convention, although some contracting countries have objected and do not allow this.

Notably, as the UK reverts to a piece of legislation enacted in 1965, the EU is already looking to the future: a new regulation on the service of documents will come into force on 1 July 2022 and seeks to streamline the service process further, including allowing for electronic service.

What does this mean for our clients?

The main impact you are likely to notice is on the time it takes to serve documents. Under the EC Regulation, receiving agencies were expected to serve documents within one month of receipt. In due course, electronic service ought to speed things up further. The Hague Convention contains no similar provision. We will have to wait to see how quickly EU Member States will deal with requests for service under the Hague Convention as opposed to the EC Regulation, but from experience, delays of several months would not be uncommon.

Bear in mind, too, the need to consider the rules applied by the country in which you are seeking to serve: it may be that you need to seek local advice, which could add further delay and expense.

If entering into a new contract with a counterparty in the EU, you would be well advised to include a process agent clause in the contract which makes clear who has authority to accept service on the counterparty’s behalf: this could save time and cost if you are later required to issue proceedings.

5. Obtaining evidence

The old: EC Regulation 1206/2001 on cooperation between the courts of the EU countries in the taking of evidence in civil or commercial matters

As of 1 January 2021, EC Regulation 1206/2001 no longer applies in the UK. This regulation aims to speed up the process of obtaining evidence located in one Member State for use in proceedings in another, and allowed courts to make requests directly to the court in the other Member State.

The new: Hague Convention of 18 March 1970 on the taking of evidence abroad in civil and commercial matters

The UK is a contracting party to the Hague Convention of 18 March 1970, as are 24 of the remaining EU Member States (i.e. all but Austria, Belgium and Ireland). This convention will now govern requests for evidence between the UK courts and the courts of those 24 Member States. As with the Hague Convention on service discussed above, all of those Member States bar Slovenia have made reservations and declarations to the convention, so again you will have to look closely at the rules which apply in the relevant country.

In practice, as with service and subject to each Member State’s reservation, the process of obtaining evidence from an EU Member State which is a signatory to the convention may not be very different. A letter of request must be sent by the judicial authority of one state to the competent authority of the other state. The evidence sought must be for use in contemplated or commenced judicial proceedings. Note in particular Article 23, which permits a contracting state to declare that it will not execute letters of request issued for the purpose of obtaining pre-trial discovery: while documents can be obtained for the purposes of proceedings not yet commenced, these cannot take the form of fishing expeditions designed to establish what documents an opponent might hold.

In the cases of Austria, Belgium and Ireland, letters of request will need to be sent to the courts of those countries via diplomatic channels, which will almost certainly add further delay. You may need to take local advice if trying to obtain evidence form one of those countries.

This new state of affairs can be contrasted with the former position under the EC Regulation, which aims for requests to be executed within 90 days of receipt. There is no such expectation under the convention.

What does this mean for our clients?

As with service, the main differences are likely to be the speed with which evidence can be obtained, which could result in delays in beginning or progressing proceedings, and the potential need for local advice in the country in which the evidence is sought, which will also add delay and expense. If seeking evidence from Austria, Belgium or Ireland, the potential for such delay and expense is even greater.

It remains to be seen if EU Member States will execute requests made under the convention by a UK court more quickly than they currently respond to requests from other contracting parties such as the US, but our experience in dealing with such requests is that they can often be long, inefficient and cumbersome processes.

 

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, or the following authors in London:

Philip Rocher (+44 (0) 20 7071 4202, [email protected])
Susy Bullock (+44 (0) 20 7071 4283, [email protected])
Christopher Loudon (+44 (0) 20 7071 4249, [email protected])

Please also feel free to contact any of the following members of the Dispute Resolution Group in London:

Patrick Doris (+44 (0) 207 071 4276, [email protected])
Charlie Falconer (+44 (0) 20 7071 4270, [email protected])
Osma Hudda (+44 (0) 20 7071 4247, [email protected])
Allan Neil (+44 (0) 20 7071 4296, [email protected])
Doug Watson (+44 (0) 20 7071 4217, [email protected])

© 2020 Gibson, Dunn & Crutcher LLP

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

In a decision with far-reaching implications for the online gaming industry, on January 20, 2021, the U.S. Court of Appeals for the First Circuit held that the prohibition on the transmission of interstate wagers under the Wire Act, 28 U.S.C. § 1084, applies only to bets and wagers placed on sporting events, and not, as the Office of Legal Counsel within the United States Department of Justice had opined, to all types of bets and wagers. New Hampshire Lottery Comm’n v. Rosen, No. 19-1835 (1st Cir. Jan. 20, 2021). In this alert, we summarize (1) the background of the Wire Act, (2) the First Circuit’s decision, and (3) the potential impact of the ruling.

I. Overview of the Wire Act

The Wire Act, enacted in 1961 as part of Attorney General Robert F. Kennedy’s effort to crackdown on organized crime, provides, in relevant part:

Whoever being engaged in the business of betting or wagering knowingly uses a wire communication facility for the transmission in interstate or foreign commerce of bets or wagers or information assisting in the placing of bets or wagers on any sporting event or contest, or for the transmission of a wire communication which entitles the recipient to receive money or credit as a result of bets or wagers, or for information assisting in the placing of bets or wagers, shall be fined under this title or imprisoned not more than two years, or both.

18 U.S.C. § 1084(a). The legislative history surrounding the enactment of the statute makes clear that the intent was to target sports bookmakers who supplied an important stream of revenue for organized crime. For many years after its enactment, the Department of Justice took the view that the statute’s express reference to “bets or wagers on any sporting event or contest” meant that the statute prohibited only interstate bets or wagers on sporting events, and not other types of interstate gambling. Representatives of the Department expressly testified as much in hearings before Congress in the 1990s.

In the early 2000s, however, the Department began to take the position, in various informal letters to gaming commissions and state lottery operators, that interstate transmissions of non-sports wagers would also violate the Wire Act. That change in position prompted New York and Illinois—both of whom operated lotteries that relied in some part on interstate wire facilities—to seek clarification in 2009 from the Department as to the scope of the Wire Act.

In 2011, the Office of Legal Counsel (“OLC”) within the Department issued an opinion concluding that the Wire Act’s prohibitions with respect to the interstate transmission of bets and wagers apply only to those bets or wagers involving sporting events—meaning that sales of lottery tickets online were not covered by the statute. The OLC concluded as much by examining the text of the statute, and also by considering the absurd consequences that would follow if the statute were read to cover certain types of non-sports betting activities, but not others. In reliance on that opinion, States began moving their lottery systems online, taking full advantage of the freedom and certainty afforded by the OLC opinion.

In late 2018, however, the Trump Administration’s OLC issued a new opinion, reversing the interpretation adopted in the 2011 OLC opinion, and arguing that the Wire Act does extend beyond sports betting. The 2018 opinion concluded that the statute’s limiting language—“on any sporting event or contest”—applied only to the transmission of “information assisting in the placing of bets or wagers,” and not to the transmission of bets or wagers themselves, or to the transmission of information regarding payment on a bet or wager. As a result, the 2018 opinion called into question the legality of state lotteries that sold tickets online, or even those that simply used the Internet to facilitate their operations. The 2018 opinion expressly acknowledged that “some may have relied on the” 2011 opinion, including States that “began selling lottery tickets via the Internet after [its] issuance.”

Gibson Dunn filed suit in the U.S. District Court for the District of New Hampshire on behalf of NeoPollard Interactive LLC and Pollard Banknote Limited—a parent and subsidiary that provides lottery infrastructure for the New Hampshire Lottery Commission—arguing that the 2011 opinion was contrary to law and seeking declaratory relief. NeoPollard and Pollard joined their lawsuit with one filed the same day by the New Hampshire Lottery Commission, seeking the same relief. The Department opposed the lawsuit on the ground that in the absence of a pending or threatened prosecution, the dispute was not ripe for review, and that the 2018 interpretation was legally correct.

Judge Paul J. Barbadoro expedited the proceedings, and held in June 2019 that the 2011 OLC opinion was correct in holding that the Wire Act is limited in all respects to bets and wagers placed on sporting events, declaring the 2018 OLC opinion wrong as a matter of law and vacating the decision as contrary to law under the Administrative Procedure Act, 5 U.S.C. § 706. The Department appealed to the First Circuit.

II. The First Circuit’s Decision

On January 20, 2021, the First Circuit affirmed the district court’s decision in all relevant aspects. It agreed with the district court’s decision that the dispute was ripe for review and that the Wire Act is limited to sports betting. The Court departed from the district court only in that it did not believe vacatur under the Administrative Procedure Act was a necessary form of relief.

With respect to standing and ripeness, the Court explained that in the pre‑enforcement context, it is not necessary that there be an actual threatened prosecution against the specific plaintiff. Rather, it was sufficient that the government had declared that the conduct plaintiffs were engaged in was criminal. The Court pointed out that the Department had expressly warned at least one state lottery (Illinois) that its operations were in violation of the Wire Act as construed prior to 2011, and also that the Department had prosecuted non-sports-betting operations in the past.

The First Circuit rejected the Department’s argument that a memorandum released during the pendency of the proceedings—which purported to reserve decision on whether state lotteries, specifically, were subject to the prohibitions of the Wire Act—rendered the case moot or unripe. The new memorandum, the Court observed, did not disclaim that the Wire Act covered state lotteries, but rather offered only a temporary forbearance from prosecution.

On the merits, the First Circuit agreed with the district court that the plain text of the statute is not clear as to the scope of the prohibition. The Court thus focused instead principally on the structure and context of the statute, concluding that the Department’s proffered reading made no sense. The First Circuit observed, in particular, that reading the sports limitation to apply to only some of the prohibitions in the statute would be incongruent, as it would criminalize the transmission of any type of bet or wager, but would not reach the transmission of information with respect to bets or wagers other than those on sporting events. The Court also examined the history of the statute, agreeing with the district court that the history confirmed that the statute was directed at sports betting.

The Court thus affirmed the district court’s grant of declaratory relief, although it vacated the relief awarded under the Administrative Procedure Act on the ground that such relief was not necessary.

III. Implications of the Decision

The First Circuit’s decision gives some comfort and certainty to those state lotteries and other industry participants who relied on the 2011 opinion in taking their operations online. The decision restores the 2011 interpretation of the Wire Act, which was itself sought by state lotteries seeking to operate online facilities. It also has similar implications for gaming platforms other than state lotteries, who similarly faced a threat of prosecution as a result of the 2018 opinion if they used the Internet to process bets or wagers.

It is important to note, however, that as a formal matter, the First Circuit directly binds the Department only with respect to the named parties in the lawsuit. It also precludes, as a matter of binding precedent, any attempted prosecutions within the First Circuit that are based on the interpretation advanced in the 2018 opinion. The Department could, however, adhere to its 2018 interpretation in other federal circuits, and pursue prosecutions of online lotteries and other non-sports gambling operations in defiance of the First Circuit’s interpretation.

There is some indication, however, that the Biden Administration is not inclined to take such an aggressive stance. In July 2019, then former-Vice-President Biden stated his position that if elected, he “would reverse the White House opinion [on the Wire Act] that was then reversed and overruled by the [district] court. The court is correct. That should be the prevailing position.” Dustin Gouker, Should You Vote for Biden or Trump if You Want Legal Online Poker and Gambling?, Online Poker Report (Oct. 23, 2020), https://perma.cc/595G-2EVH. He later stated at an event in December 2019 that he did not “support adding unnecessary restrictions to the gaming industry like the Trump Administration has done.” Howard Stutz, Biden Says DOJ’s Wire Act Changes Add “Unnecessary Restrictions” to the Gaming Industry, CDC Gaming Reports (Dec. 16, 2019), https://perma.cc/R9XU-U6NX. The decision of the First Circuit may push the Biden Administration to make its stance on the statute clear right away, perhaps through a formal rescission of the 2018 opinion, or through a memo advising U.S. Attorneys to adhere to the First Circuit’s decision.

Even if the Biden Administration does not make a formal announcement, given the First Circuit’s decision and President Biden’s express opposition to the 2018 re-interpretation, it seems unlikely that the Department of Justice is poised to pursue an aggressive campaign to disobey or overturn the First Circuit’s decision. Indeed, the Department’s principal argument before the First Circuit was that the dispute was not ripe. Although the Department also defended the 2018 opinion on the merits, there may be little appetite for maintaining that position now that there has been a firm decision by a U.S. court of appeals and a change in administration.


Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, or the following authors:

Theodore B. Olson – Washington, D.C. (+1 202-955-8500, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])
Matthew D. McGill – Washington, D.C. (+1 202-887-3680, [email protected])
Lochlan F. Shelfer – Washington, D.C. (+1 202-887-3641, [email protected])
Joshua M. Wesneski – Washington, D.C. (+1 202-887-3598, [email protected])

© 2020 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 January 13, 2021, the Office of the Comptroller of the Currency (“OCC”) conditionally approved the charter conversion application for Anchorage Trust Company (“Anchorage”), permitting Anchorage to become a national trust bank.[1] This is the first approval by the OCC of a virtual currency firm’s becoming a federally regulated banking institution and demonstrates the ongoing leadership that the OCC has shown with respect to virtual currency issues.

Although this development is significant in and of itself, the Anchorage approval relies on a new OCC Chief Counsel’s Interpretation, released as OCC Interpretive Letter 1176,[2] that substantially increases the trust powers of national banks, making them a more attractive business model generally and particularly for fintech firms. This Client Alert discusses these developments.

I. The Anchorage Approval – Virtual Currency Activities Are Permissible Fiduciary Activities under the National Bank Act

The OCC’s approval order affirms that the following virtual currency activities, which were fiduciary in nature under the law of Anchorage’s home state, South Dakota, are permissible under the National Bank Act:

  1. Fiduciary custody of digital assets.
  2. Custody of cash deposits (Anchorage holds such deposits at FDIC-insured banks, in omnibus accounts for its clients).
  3. Providing on-chain governance services allowing Anchorage clients to participate in the governance of the underlying protocols on which their virtual assets operate.
  4. Via an affiliate or otherwise, operating validator nodes, providing staking as a service, and providing clients the ability to delegate staking to third-party validators.
  5. Settling transactions facilitated by its affiliates, other third-party brokers, and clients. Clients or their brokers may direct Anchorage Trust to receive digital assets into and to transfer digital assets out of their vaults from and to external accounts or digital asset addresses controlled by third parties, including but not limited to transfers made in connection with the settlement of a purchase or sale of digital assets.[3]

Tellingly, the OCC did not discuss each of these activities as fiduciary activities under its applicable regulation, 12 C.F.R. Part 9. Part 9 defines “fiduciary capacity” as follows:

Fiduciary capacity means: trustee, executor, administrator, registrar of stocks and bonds, transfer agent, guardian, assignee, receiver, or custodian under a uniform gifts to minors act; investment adviser, if the bank receives a fee for its investment advice; any capacity in which the bank possesses investment discretion on behalf of another; or any other similar capacity that the OCC authorizes pursuant to 12 U.S.C.§ 92a.

12 C.F.R. § 9.2(e).

Relying on Section 9.2(e) would have required analogies to have been drawn to the specific activities in that section. Rather than making such analogies, the approval order notes simply that “since ADB-NA will continue performing the current activities of Anchorage Trust, in a manner authorized by South Dakota law for a state trust company, ADB-NA will be a national bank whose operations are those of a trust company and activities related thereto. Accordingly, ADB-NA’s activities are permissible pursuant to the plain terms of 12 U.S.C. § 27(a).”[4]

II. New Expansion of National Bank Fiduciary Powers

12 U.S.C. § 27(a), which was enacted in 1978 in reaction to a federal district court case that called into question the propriety of the OCC’s chartering a non-depository trust bank under the National Bank Act, states that “[a] National Bank Association . . . is not illegally constituted solely because its operations are or have been required by the Comptroller of the Currency to be limited to those of a trust company and activities related thereto.”[5]

Section 27(a) thus clearly authorizes national trust banks. However, notwithstanding an apparently clear statutory command that national bank fiduciary powers include “any other fiduciary capacity in which State banks, trust companies, or other corporations which come into competition with national banks are permitted to act under the laws of the State in which the national bank is located,” 12 U.S.C. § 92a, the OCC has traditionally not exercised its legal authority to the full extent under that statute. Rather, as Interpretive Letter 1176 states, a prior OCC interpretation had required that the OCC look to state law “to determine whether a fiduciary capacity of national bank is permissible [only] after the activity is determined to be ‘fiduciary’ within the meaning of 12 U.S.C. § 92a.”[6]

Interpretive Letter No. 1176 reverses this at least 37-year-old position. For the OCC to use Section 92a’s so-called “bootstrap provision” and determine that an activity that a state’s law regards as being performed in a fiduciary capacity is a fiduciary capacity for purposes of 12 U.S.C § 92a, the OCC must determine that a national bank is engaging in the relevant activity, role, or function consistent with the parameters provided for in the relevant state law to the same extent as a state bank to qualify as a fiduciary capacity. This will make conversions of state trust companies much easier as a powers matter.

This new interpretation accords not only with the plain language of Section 92a, but also with its legislative history, when the relevant provision was added to the Federal Reserve Act in 1918.[7] As an example, under the New York Banking Law in 1918, a national bank was prohibited by state law from acting as a fiscal and paying agent in New York,[8] even though doing so was a permissible fiduciary activity for a New York state-chartered trust company. Section 92a was enacted to level this playing field.

III. Confirmation That National Trust Banks Are Not Limited to Performing Primarily in a Fiduciary Capacity and May Exercise Banking Powers

In addition, Interpretive Letter 1176 confirms that national trust banks may perform other national bank activities permitted under 12 U.S.C. § 24(SEVENTH), and, indeed, that fiduciary activities need not be their primary business activity: “ A national bank that only performs one fiduciary capacity under 12 U.S.C § 92a would need trust powers. Conversely, there is also no requirement that a national trust bank chartered under 12 U.S.C. § 27(a) perform primarily in a fiduciary capacity.”[9]

This confirmation – of what is clearly the case under the National Bank Act – is an important one. National trust banks are clearly authorized by Congress under 12 U.S.C. § 27(a), and they not “banks” within the meaning of the Bank Holding Company Act.

The OCC’s confirmation means that as long as a national trust bank has a valid fiduciary business, it may engage in a traditional bank power such as lending, with all of the preemption benefits of a national charter, without concern over whether such activities are beyond the OCC’s authority to permit as a matter of statutory interpretation.

IV. Confirmation That Certain State Trust Company Activities May Be Permissible for National Banks under Traditional Banking Powers

Interpretive Letter 1176 also confirms that the OCC may find that an activity of a state-chartered trust company is permissible under 12 U.S.C. § 24(Seventh), which permits national banks may engage in the business of banking and activities incidental to the business of banking.

When determining whether an activity is part of the business of banking, the OCC considers the following factors under 12 C.F.R. § 7.5001(c)(1):

  • Whether the activity is the functional equivalent to, or a logical outgrowth of, a recognized banking activity;
  • Whether the activity strengthens the bank by benefiting its customers or its business;
  • Whether the activity involves risks similar in nature to those already assumed by banks; and
  • Whether the activity is authorized for state-chartered banks.

The OCC stated that, given the fourth factor, “an activity permitted for state trust banks may be part of the business of banking under the authority of 12 U.S.C. § 24(Seventh) for national banks if the activity is authorized for state-chartered banks, and the OCC is satisfied that the remaining three factors are also sufficiently met.”[10]

V. Conclusion

The Anchorage approval came at the end of Brian Brooks’ tenure as Acting Comptroller of the Currency. It is another sign of the OCC’s leadership on virtual currency issues and Acting Comptroller Brooks’ pushing at the boundaries of the National Bank Act to facilitate innovation in financial services. In this case, the expansion of the national trust bank fiduciary and banking powers is well grounded in federal statutory law, and should benefit numerous companies, including fintech companies, that are seeking to benefit from a federal charter.

Gibson Dunn has extensive experience with the issues related to national trust bank chartering and would be pleased to discuss them with you.

____________________

   [1]   https://www.occ.treas.gov/news-issuances/news-releases/2021/nr-occ-2021-6a.pdf.

   [2]   https://occ.gov/topics/charters-and-licensing/interpretations-and-actions/2021/int1176.pdf.

   [3]   OCC Conditional Approval, Application by Anchorage Trust Company to Convert to a National Trust Bank (January 13, 2021).

   [4]   Id.

   [5]   12 U.S.C. § 27(a).

   [6]   Interpretive Letter No. 1176, OCC Chief Counsel’s Interpretation on National Trust Banks (January 11, 2021) (emphasis added) (citing OCC Interpretive Letter No. 265, reprinted in [1983-1984 Transfer Binder] Fed. Banking L. Rep. (CCP) ¶ 85,429 (July 14, 1983)). Interpretive Letter 1176 states that Interpretive Letter 265’s position on this issue is superseded.

   [7]   Walter S. Logan, “Amendments to the Federal Reserve Act,” The Annals of the American Academy of Political and Social Science, Vol. 99, The Federal Reserve System – Its Purpose and Work (January 1922), pp. 114-121. The authority over national bank fiduciary powers was transferred from the Federal Reserve Board to the OCC in 1962.

   [8]   New York Banking Law, § 223 (1918) (currently, Section 131 of the New York Banking Law).

   [9]   Interpretive Letter No. 1176, OCC Chief Counsel’s Interpretation on National Trust Banks (January 11, 2021).

  [10]   Id.


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:

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

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

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])
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, [email protected])

© 2020 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 January 20, 2021, the inaugural day of the new presidency, the Biden administration issued a series of across-the-board regulatory directives. These directives press pause on federal rulemakings, rescind Trump-era executive orders on the regulatory process, and set a framework for “modernizing” review of regulatory actions.

First, the new administration issued a memorandum freezing rulemakings pending review. Covered agencies are not to “propose or issue” any rule “until a department or agency head appointed or designated” by President Biden “approves the rule,” unless the rule falls into an exception “for emergency situations or other urgent circumstances relating to health, safety, environmental, financial, or national security matters,” as permitted by the Director of the Office of Management and Budget (“OMB”). For rules that have been published in the Federal Register but have not yet taken effect, agencies should consider “postponing the rules’ effective dates for 60 days” and opening a new “30-day comment period” to evaluate the rules further. After the 60-day delay, if a rule raises “substantial questions of fact, law, or policy,” agencies should “take further appropriate action in consultation” with the Director of OMB. This memorandum applies broadly to all “substantive action by an agency” that is anticipated to lead to “a final rule or regulation.” It does not appear to include independent agencies, though there is some ambiguity; while the memorandum is addressed to executive departments and agencies, its definition of “rule” is expansive enough that it could be read to cover actions by independent agencies such as the SEC. Either way, this memorandum will likely cause reconsideration of a wide variety of rules proposed or issued in the final days of the Trump administration.

This memorandum is similar to the regulatory freeze put in place on the first day of the Trump administration four years ago, though there are notable differences. For example, the Trump administration left agencies with no choice but to postpone by 60 days the effective date of any regulations published in the Federal Register that had not yet taken effect. By contrast, and as noted above, the Biden administration’s freeze instructs agencies to “consider” instituting this 60-day delay for such rules, which gives them more flexibility. Even with this added flexibility, it is still expected that many agencies will exercise the option to delay rules.

Second, President Biden issued an Executive Order revoking a number of Trump-era orders on the regulatory process, including:

  • Executive Order 13771 “Reducing Regulation and Controlling Regulatory Costs” (Jan. 30, 2017), which created the 2-for-1 rule requiring agencies to repeal two regulations for every one new regulation they issued. This order also established a budgeting process that required agencies to limit the incremental cost of new regulations under supervision of the OMB Director.
  • Executive Order 13777 “Enforcing the Regulatory Reform Agenda” (Feb. 24, 2017), which required each agency to designate a Regulatory Reform Officer and establish a Regulatory Reform Task Force to oversee regulatory reform initiatives and recommend regulations to be repealed. The order further required agencies to measure and report their progress in implementing these reforms.
  • Executive Order 13875 “Evaluating and Improving the Utility of Federal Advisory Committees” (June 14, 2019), which required each executive department and agency (independent regulatory agencies excepted) to review, reduce, and limit the number of federal advisory committees, terminating at least one-third of these committees by September 30, 2019. The order also capped the government-wide total number of advisory committees at 350.
  • Executive Order 13891 “Promoting the Rule of Law Through Improved Agency Guidance Documents” (Oct. 9, 2019), which required agencies to treat guidance documents as “non-binding both in law and in practice,” maintain an online database of all guidance documents, rescind outdated guidance documents, and establish procedures for issuing new guidance documents, including a clear statement of their non-binding effect, opportunities for the public to petition for withdrawal or modification of guidance documents, and a 30-day period of notice and comment for certain significant guidance documents.
  • Executive Order 13892 “Promoting the Rule of Law Through Transparency and Fairness in Civil Administrative Enforcement and Adjudication” (Oct. 9, 2019), which limited agencies’ ability to enforce standards of conduct that were not publicly stated or issued in formal rulemakings. It also provided that agencies issuing notices of noncompliance provide an affected party the opportunity to be heard, encouraged “self-reporting of regulatory violations . . . in exchange for reductions or waivers of civil penalties,” and imposed requirements governing administrative inspections and certain statutory obligations.
  • Executive Order 13893 “Increasing Government Accountability for Administrative Actions by Reinvigorating Administrative PAYGO” (Oct. 10, 2019), which sought to ensure compliance with the “pay-as-you-go” requirement (“PAYGO”) first adopted in 2005. PAYGO mandates that agencies propose ways to reduce mandatory spending whenever they undertake a discretionary action that would increase mandatory spending. Executive Order 13893 required agencies to submit proposed discretionary actions and proposals for compliance with PAYGO to the OMB Director for review.

In sum, this sweeping order undoes many of the reforms implemented by the Trump administration that were designed to reduce regulatory burdens, cut costs, shrink the size of government, and increase agency transparency.

Third, the Biden Administration issued a memorandum on “Modernizing Regulatory Review,” which instructs the Director of OMB to make “recommendations for improving and modernizing” review of regulations. Such recommendations should provide “concrete suggestions” on how to “promote public health and safety, economic growth, social welfare, racial justice, environmental stewardship, human dignity, equity, and the interests of future generations” in the regulatory process. Specifically, these recommendations should ensure that policies “reflect new developments in scientific and economic understanding,” account for “regulatory benefits that are difficult or impossible to quantify,” and do not cause detrimental “deregulatory effects.” OMB is also instructed to evaluate ways that the Office of Information and Regulatory Affairs (“OIRA”) can partner with agencies to support “regulatory initiatives that are likely to yield significant benefits” and to identify reforms that further the “efficiency” and “transparency” of the interagency review process.

* * * *

We will continue to monitor changes to the regulatory and rulemaking process taken by the new administration and keep you apprised of significant developments.


The following Gibson Dunn lawyers assisted in the preparation of this client update: Helgi C. Walker, Lucas Townsend, Michael Bopp, Jessica Wagner, Matt Gregory, Robert Batista, and Matthew Butler.

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 Administrative Law and Regulatory Practice Group or Congressional Investigations Practice Group, or the following authors:

Helgi C. Walker – Chair, Administrative Law and Regulatory Practice, Washington, D.C. (+1 202-887-3599, [email protected])

Michael D. Bopp – Chair, Congressional Investigations Practice, Washington, D.C. (+1 202-955-8256, [email protected])

Lucas C. Townsend – Member, Administrative Law and Regulatory Practice, Washington, D.C. (+1 202-887-3731, [email protected])

© 2020 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 December 3, 2020, the Commodity Futures Trading Commission (“CFTC” or the “Commission”) Division of Enforcement (the “Division”) announced a settlement with Vitol Inc. (“Vitol”), an energy and commodities trading firm in Houston, Texas. This is the first public action coming out of the CFTC’s initiative to pursue violations of the Commodity Exchange Act (“CEA”) involving foreign corruption. The CFTC’s action rests on an aggressive theory that seeks to approach allegations of corruption through its historic ability to pursue fraud and manipulation, which has not yet faced a serious legal challenge. It is an enforcement area we expect will continue to be a priority for the CFTC. This settlement involved cooperation between U.S. and Brazilian regulators in what appears to be another significant corporate resolution associated with the Operation Car Wash corruption investigations in Brazil. We expect to see the continued convergence of enforcement by a variety of U.S. enforcement authorities and regulators approaching aspects of alleged foreign corruption from a range of angles corresponding to their primary focus of interest. Depending on the facts, the same conduct that the Department of Justice (“DOJ”) and the Securities and Exchange Commission (“SEC”)—the principal FCPA investigation authorities—investigate for violations of the Foreign Corrupt Practices Act (“FCPA”) already may face scrutiny by DOJ’s Money Laundering and Asset Recovery Section (“MLARS”) on a money laundering basis (including its Kleptocracy Asset Recovery initiative where foreign plutocracy is involved and its Bank Integrity Unit where banks are involved), by the CFTC for violations of the CEA where commodities trading is involved, and by the Federal Reserve for violations of banking regulations. And in the Biden Administration, this convergence may accelerate as the Administration aligns with more vigorous corporate enforcement anticipated in the new era. Navigating the expanding investigations field will become more complex, even more so to the extent that agencies flexing their muscles do not coordinate their efforts.

Given the CFTC’s aggressive approach to bringing enforcement actions involving foreign corruption, and its stated intention to continue to do so, it is particularly important that companies regulated by the CFTC assess and update their compliance programs to meet the standards set forth in the guidance on evaluating compliance programs that the CFTC issued in September 2020.[1] Moreover, in light of the multi-agency targeting of conduct involving foreign corruption, such companies should also make sure that their compliance programs meet the standards of other agencies, such as DOJ.[2]

The Vitol Settlement

The CFTC asserted that from 2005 to early 2020, Vitol engaged in manipulative and deceptive conduct involving foreign corruption and physical and derivatives trading in the U.S. and global oil markets.[3] Specifically, the CFTC’s order found that Vitol violated the CEA [4] in a few different ways, using for the first time the alleged foreign corrupt conduct as a basis for a finding of manipulative or fraudulent acts cognizable under the statute.[5] First, it allegedly made corrupt payments, such as bribes and kickbacks, to employees and agents of certain state-owned entities (“SOEs”) in Brazil, Ecuador, and Mexico to obtain preferential treatment and access to trades with the SOEs to the detriment of the SOEs and other market participants.[6] Vitol, according to the CFTC, concealed this conduct by funneling the payments through offshore bank accounts or to shell entities, and by issuing deceptive invoices.[7] Second, it allegedly made corrupt payments to employees and agents of the Brazilian SOE in exchange for confidential information about trading in physical oil and derivatives, such as the specific price at which Vitol would win a supposedly competitive bidding or tender process.[8] Additionally, Vitol attempted to manipulate two Platts fuel oil benchmarks in order to benefit Vitol’s physical and derivatives positions.[9] If Vitol’s attempts to manipulate the benchmarks had been successful, charged the CFTC, it would have harmed those market participants who held opposing positions and those who rely on the benchmarks as an untainted price reference for U.S. physical or derivative trades.[10]

The same day, the Fraud Section of the DOJ and the United States Attorney’s Office for the Eastern District of New York announced a parallel action in which they entered a Deferred Prosecution Agreement (“DPA”) with Vitol on charges of conspiracy to violate the FCPA.[11] Vitol agreed to pay a criminal penalty of $135 million under the DPA, and the DOJ noted that it would credit $45 million against the amount Vitol agreed to pay to resolve an investigation by the Brazilian Ministério Público Federal (“MPF”) for conduct related to the company’s bribery scheme in Brazil.[12] Specifically, on December 3, 2020, the MPF entered into a leniency agreement with Vitol Inc. and Vitol do Brasil Ltda. in connection with Operation Car Wash. In a December 29, 2020 securities filing, Brazilian state-run oil company Petrobras announced that it received 232.6 million reais (or $44.65 million) as a result of this leniency agreement.[13]

The CFTC ordered Vitol to pay more than $95 million in civil monetary penalties and disgorgement.[14] Notably, it recognized Vitol’s cooperation during the investigation in the form of a reduced civil monetary penalty.[15] It also recognized and offset a portion of the criminal penalty that Vitol agreed to pay to the DOJ in the parallel criminal action.[16]

CFTC’s Foreign Corrupt Practices Initiative

The CFTC launched its foreign corrupt practices initiative on March 6, 2019, when the Division issued an advisory on self-reporting and cooperation for CEA violations involving foreign corrupt practices (the “Enforcement Advisory”).[17] It announced that it would apply a presumption, absent aggravating circumstances, that it would not recommend imposing a civil monetary penalty in a CFTC action involving foreign corrupt practices where a company or individual not registered or required to be registered with the CFTC (i) voluntarily discloses violations of the CEA involving foreign corrupt practices, (ii) provides full cooperation, and (iii) appropriately remediates.[18] The CFTC bolstered its initiative in May 2019 by issuing a whistleblower alert targeting foreign corrupt practices in the commodities and derivatives markets.[19] To date, this is only the fourth area of potential misconduct regarding which the CFTC has proactively sought tips from would-be whistleblowers.

Implications of Settlement

First, we expect the CFTC to continue pursuing more cases involving foreign corruption in the future. This is the first case brought by the CFTC involving foreign corruption, but it is unlikely to be the last. There are public reports of at least two additional foreign corruption investigations undertaken by the CFTC involving commodities traders. The Enforcement Advisory was issued on the heels of a voluntary disclosure by Switzerland-based mining company Glencore, in April 2019, that it was the subject of an investigation by the CFTC involving foreign corruption claims. Glencore also has announced anti-corruption investigations by the DOJ for potential violations of the FCPA and U.S. money laundering statutes, Brazilian authorities, and Swiss prosecutors,[20] and it disclosed that the CFTC’s investigation had a similar scope as the ongoing DOJ investigation.[21] No settlement or charges have been announced with respect to the Glencore investigations. News sources also report that Trafigura Group Pte. Ltd., a Singapore-based commodity trading company, is under investigation by the CFTC and Brazilian authorities for similar allegations.[22]

The CFTC’s 2019 issuance of a whistleblower alert soliciting tips about foreign corrupt practices further shows that it is serious about bringing enforcement actions in this area. The CFTC’s whistleblower program pays a qualified tipster 10 to 30 percent of any fine over $1 million levied against a firm for violations of CFTC regulations, and it has significantly enhanced the CFTC’s enforcement program. Whistleblowing is likely to increase, not just because there may be conduct to report, but because those aware of it and lawyers working to facilitate reporting will see the benefit of doing so through the CFTC’s initiative. Just as the Dodd-Frank whistleblowing award program has significantly increased FCPA tips to the SEC (and DOJ), we expect the CFTC’s whistleblowing push could significantly increase the amount of information the CFTC receives and, in turn, the CFTC’s ability to bring enforcement actions relating to foreign corruption.

With the announcement of the Vitol settlement, the CFTC has reaffirmed its interest in pursuing CEA violations involving foreign corruption. The CFTC has identified the following examples of foreign corrupt practices that could constitute violations of the CEA and thus be the focus of a CFTC enforcement action:

  • The use of bribes to secure business in connection with regulated activities like trading, advising, or dealing in swaps or derivatives;
  • Manipulation of benchmarks that serve as the basis for related derivatives contracts;
  • Reporting prices that are the product of corruption to benchmarks; and
  • Corrupt practices that might alter the prices in commodity markets that drive U.S. derivatives prices.[23]

Second, the CFTC will continue to coordinate closely with other regulators in its pursuit of foreign corruption. The CFTC frequently coordinates with the DOJ, SEC, and other law enforcement partners, often bringing parallel enforcement actions in areas such as spoofing, misappropriating funds, violations of registration provisions of the federal securities laws, and the manipulation of benchmark interest rates (e.g., the LIBOR cases).[24] The Vitol settlement underscores that this cooperation will continue in its foreign corruption initiative. We expect the CFTC to continue to utilize its partnerships with other regulators to pursue foreign corruption, with commodities trading serving as the CFTC’s entry point to police foreign corruption under the CEA. That Gary Gensler, formerly the CFTC Chair from 2009 to 2014, is expected to be nominated to serve as the next SEC Chair may smooth the way for the two regulators to collaborate more in foreign corruption (and other) investigations and bringing parallel enforcement actions.[25]

While the CFTC has stated publicly that it is not trying to enforce the FCPA or “pile on” when it comes to penalties,[26] if there is a commodities trading component to a foreign corruption scheme, the CFTC has made clear it has a role to play in investigating and charging such conduct. In announcing the CFTC’s foray into foreign bribery, the former Director of Enforcement emphasized the agency’s intention to coordinate closely with DOJ, SEC, and other regulators, including foreign authorities, so that it is “investigat[ing] in parallel with other enforcement authorities” to “avoid duplicative investigative steps,” account for penalties imposed by other authorities, and give “credit for disgorgement or restitution payments in connection with other related actions.”[27] But the CFTC’s involvement creates an added layer of liability and a potentially expanded universe of relevant conduct that companies with international operations must be mindful of going forward. As we have seen with navigating other multi-agency investigations where conflicting investigative approaches and duplicative penalty demands occur too frequently, early and careful coordination between investigations is critical to ensuring outcomes are proportionate.

Third, going forward, we expect that foreign corruption allegations involving commodities-related business will continue to be investigated and pursued by multiple agencies, domestic and foreign, approaching the issue from different angles. In other words, as the growing number of multi-jurisdictional and agency anti-corruption resolutions suggest, the FCPA units of the DOJ and SEC are not the only cops on the beat, and they have not been for quite some time. As a growing number of regulators in the U.S. and abroad get involved in anti-corruption enforcement, the enforcement landscape only becomes more complex. By way of domestic examples, DOJ’s Money Laundering and Asset Recovery Section (“MLARS”) has repeatedly teamed up with its FCPA colleagues to pursue foreign corruption through the lens of the anti-money laundering statutes, both to recover huge sums through its Kleptocracy Program and in prosecuting companies and individuals involved in moving tainted bribery proceeds. In the financial sector, the Federal Reserve has demonstrated its resolve to pursue banks for similar conduct under its authority to supervise banks’ financial controls and oversight functions.[28] Not to be outdone, the CFTC has joined the fray, making clear it will aggressively pursue foreign corruption under the CEA where commodities or related derivatives are involved.[29]

Finally, energy firms in particular should be aware of this development. Although they will not be the CFTC’s only focus, energy trading firms are squarely in the CFTC’s sights. They have historically engaged in transactions that fall under the CEA and often involve contact with risky counterparties. The Vitol settlement makes clear that energy is one industry the CFTC is monitoring with respect to foreign corruption. We expect to see the CFTC under the Biden Administration focus on energy trading cases involving foreign corrupt practices, including assertions that such conduct in energy pricing has disadvantaged the consumer.

In sum, the CFTC will likely become increasingly active in using the CEA as a tool to go after perceived foreign corruption in the commodities markets, claiming such conduct constitutes manipulation or even fraud, while working in parallel with the DOJ and possibly other domestic and foreign regulators intent on vindicating their particular enforcement mandate. Businesses that are involved in cross-border derivatives work should be prepared for potential scrutiny of their transactions, particularly those involving contact with foreign officials or sovereign wealth funds. The CFTC previously has launched broad industry initiatives (for example, with regard to LIBOR interest rate benchmarks), and it remains to be seen whether the CFTC will take such an approach, or pursue foreign corruption on a company-by-company basis as evidence surfaces. Either way, as the CFTC made clear in its 2020 compliance guidance, the CFTC expects companies to address potential corrupt behavior that may harm commodities markets through compliance program enhancements.

______________________

   [1]   CFTC, Guidance on Evaluating Compliance Programs in Connection with Enforcement Matters (Sept. 10, 2020), https://www.cftc.gov/media/4626/EnfGuidanceEvaluatingCompliancePrograms091020/download.

   [2]   Dep’t of Justice, Evaluation of Corporate Compliance Programs (June 3, 2020), https://www.justice.gov/criminal-fraud/page/file/937501/download.

   [3]   CFTC Press Release Number 8326-20, 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.

   [4]   The CFTC relied on allegations involving corruption to establish fraud under the CEA, even though corruption and fraud are distinct acts with different harms. The CFTC appears to believe that the corruption in this case was a form of deceptive practice and that it need only prove that such corruption infected the market. This is an aggressive theory to which there may be defenses.

   [5]   Order Instituting Proceedings, In re Vitol Inc., CFTC Docket No. 21-01 (Dec. 3, 2020), https://www.cftc.gov/media/5346/enfvitolorder120320/download.

   [6]   Id. at 4.

   [7]   Id.

   [8]   Id. at 5.

   [9]   Id. at 6-7.

[10]   Id.

[11]   Dep’t of Justice, Press Release, Vitol Inc. Agrees to Pay over $135 Million to Resolve Foreign Bribery Case (Dec. 3, 2020), https://www.justice.gov/opa/pr/vitol-inc-agrees-pay-over-135-million-resolve-foreign-bribery-case.

[12]   Id.

[13]   Petróleo Brasileiro S.A. – Petrobras Form 6-K (Dec. 29, 2020), here; see Petrobras receives $45 million in Vitol corruption settlement, Reuters (Dec. 29, 2020), https://www.reuters.com/article/us-petrobras-vitol-settlement/petrobras-receives-45-million-in-vitol-corruption-settlement-idUSKBN294043.

[14]   Id. at 11-12.

[15]   Id. at 3, 8.

[16]   Id. at 11, 12, 14.

[17]   See CFTC Enforcement Advisory: Advisory on Self-Reporting and Cooperation for CEA Violations Involving Foreign Corrupt Practices (Mar. 6, 2019) (“Enforcement Advisory”); CFTC Press Release Number 7884-19, CFTC Division of Enforcement Issues Advisory on Violations of the Commodity Exchange Act Involving Foreign Corrupt Practices (Mar. 6, 2019), https://www.cftc.gov/PressRoom/PressReleases/7884-19; Remarks of CFTC Director of Enforcement James M. McDonald at the American Bar Association’s National Institute on White Collar Crime (Mar. 6, 2019), https://www.cftc.gov/PressRoom/SpeechesTestimony/opamcdonald2 (“McDonald Remarks”).

[18]   Registrants are not eligible for the presumptive recommendation of no penalty. However, registrants who self-report, cooperate, and remediate will continue to be eligible for a “substantial reduction in penalty” under the existing Enforcement Advisories. See McDonald Remarks.

[19]   CFTC Whistleblower Alert: Blow the Whistle on Foreign Corrupt Practices in the Commodities and Derivatives Markets (May 2019), https://www.whistleblower.gov/whistleblower-alerts/FCP_WBO_Alert.htm.

[20]   Glencore, Update on subpoena from United States Department of Justice (July 11, 2018), https://www.glencore.com/media-and-insights/news/Update-on-subpoena-from-United-States-Department-of-Justice; Jeffrey T. Lewis et al., Brazil’s Car Wash Probe Eyes Glencore, Vitol, Trafigura for Paying Millions in Bribes, The Wall Street Journal (Dec. 5, 2018), https://www.wsj.com/articles/brazils-car-wash-probe-eyes-glencore-vitol-trafigura-for-paying-millions-in-bribes-1544021378; Glencore, Investigation by the Office of the Attorney General of Switzerland (June 19, 2020), https://www.glencore.com/media-and-insights/news/investigation-by-the-office-of-the-attorney-general-of-switzerland.

[21]   Glencore, Announcement re the Commodity Futures Trading Commission (Apr. 25, 2019), https://www.glencore.com/media-and-insights/news/announcement-re-the-commodity-futures-trading-commission.

[22]   Rob Davies, Trafigura investigated for alleged corruption, market manipulation, The Guardian (May 31, 2020), https://www.theguardian.com/world/2020/may/31/trafigura-investigated-for-alleged-corruption-market-manipulation; Dave Michaels and Dylan Tokar, Energy Trader Vitol Paying $163 Million to Settle Corruption, Manipulation Charges, The Wall Street Journal (Dec. 3, 2020), https://www.wsj.com/articles/energy-trader-vitol-to-pay-90-million-to-settle-u-s-corruption-charges-11607023519.

[23]   McDonald Remarks.

[24]   See, e.g., CFTC Press Release Number 7884-19; CFTC Press Release Number 8074-19, CFTC Orders Proprietary Trading Firm to Pay Record $67.4 Million for Engaging in a Manipulative and Deceptive Scheme and Spoofing (Nov. 7, 2019), https://www.cftc.gov/PressRoom/PressReleases/8074-19; CFTC Press Release Number 8120-20, CFTC Charges Investment Firm and VP with Commodity Pool Fraud (Feb. 20, 2020), https://www.cftc.gov/PressRoom/PressReleases/8120-20; Press Release, Securities and Exchange Comm’n, SEC Charges Bitcoin-Funded Securities Dealer and CEO (Nov. 1, 2018), https://www.sec.gov/litigation/litreleases/2018/lr24330.htm; CFTC Press Release Number 7159-15, Deutsche Bank to Pay $800 Million Penalty to Settle CFTC Charges of Manipulation, Attempted Manipulation, and False Reporting of LIBOR and Euribor (Apr. 23, 2015), here.

[25]   See Andrew Ackerman and Dave Michaels, Biden Is Expected to Name Gary Gensler for SEC Chairman, Wall Street Journal, https://www.wsj.com/articles/biden-is-expected-to-name-gary-gensler-for-sec-chairman-11610487023.

[26]   McDonald Remarks.

[27]   Id.

[28]   See Board of Governors of the Federal Reserve System, Press Release, Federal Reserve Board orders JPMorgan Chase & Co. to pay $61.9 million civil money penalty (Nov. 17, 2016), https://www.federalreserve.gov/newsevents/pressreleases/enforcement20161117a.htm; Board of Governors of the Federal Reserve System, Press Release, Federal Reserve Board fines the Goldman Sachs Group, Inc. $154 million for failure to maintain appropriate oversight, internal controls, and risk management with respect to 1Malaysia Development Berhad (1MDB) (Oct. 22, 2020), https://www.federalreserve.gov/newsevents/pressreleases/enforcement20201022a.htm.

[29]   While it is difficult to predict whether other U.S. regulators will prioritize focusing on foreign bribery conduct, the statutory support may already be there for other banking regulators, as well as even FinCEN. For example, FinCEN has authority under the Bank Secrecy Act (“BSA”) and AML laws to hold U.S. financial institutions accountable for weak controls. And, notably, on January 1, 2020, the Senate passed the Anti-Money Laundering Act of 2020 (“AMLA”), which is the most comprehensive set of reforms to the AML laws in the United States since the USA PATRIOT Act in 2001. See William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, H.R. 6395. The AMLA has a number of provisions that could result in significantly increased civil and criminal enforcement of AML violations, including, among others, a significantly expanded whistleblower award program that parallels that of the CFTC. See AMLA, § 6314 (adding 31 U.S.C. § 5323(b)(1)). The AMLA is discussed in detail in a separate Gibson Dunn client alert: Gibson Dunn, The Top 10 Takeaways for Financial Institutions from the Anti-Money Laundering Act of 2020 (Jan. 1, 2021), https://www.gibsondunn.com/the-top-10-takeaways-for-financial-institutions-from-the-anti-money-laundering-act-of-2020/.


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 Derivatives, Securities Enforcement or White Collar Defense and Investigations practice groups, or the following authors:

Joel M. Cohen – New York (+1 212-351-2664, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
Patrick F. Stokes  – Washington, D.C. (+1 202-955-8504, [email protected])
Lawrence J. Zweifach – New York (+1 212-351-2625, [email protected])
Emily A. Cross – New York (+1 212-351-4068, [email protected])
Darcy C. Harris – New York (+1 212-351-3894, [email protected])

Please also feel free to contact any of the following practice leaders:

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])

Securities Enforcement Group:
Barry R. Goldsmith – New York (+1 212-351-2440, [email protected])
Richard W. Grime – Washington, D.C. (+1 202-955-8219, [email protected])
Mark K. Schonfeld – New York (+1 212-351-2433, [email protected])

White Collar Defense and Investigations Group:
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])

© 2020 Gibson, Dunn & Crutcher LLP

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

In this update, we look back at the key developments in UK employment law over the course of 2020 and look forward to anticipated developments in 2021.

A brief overview of developments and key cases which we believe will be of interest to our clients is provided below, with more detailed information on each topic available by clicking on the links.

1.   Coronavirus Job Retention Scheme (“CJRS”) (click on link)

In this update we describe the current offering under the CJRS, which is set to remain operational until 30 April 2021.

2.   Vicarious Liability (click on link)

We consider two decisions of the UK Supreme Court in 2020, which consider vicarious liability in relation to: (i) the actions of a doctor who was found to be an independent contractor; and (ii) the criminal actions of an employee who leaked the personal data of almost 100,000 employees. The “employer” was not held to be vicariously liable in either case.

3.   Transfer of Undertakings (click on link)

We consider two important decisions from the last year related to the operation of the Transfer of Undertakings (Protection of Employment) Regulations 2006 (SI 2006/246) (“TUPE”) which protect the rights of employees in situations such as the sale of a business as a going concern.

4.   Post-termination Restrictive Covenants (click on link)

We consider two decisions looking at the enforceability of post-employment restrictive covenants, including a Court of Appeal decision which considered the circumstances in which a new employer would be liable for inducing a breach of contract by a new hire.

We also consider a recent High Court decision which considered the enforceability of restrictive covenants against a recent joiner who left during her probationary period.

5.   Forthcoming Changes (click on link)

We briefly outline changes to the off-payroll and IR35 system, designed to prevent workers from avoiding tax by operating as contractors, and report on developments in gender and ethnicity pay gap reporting and racial and ethnic diversity in business as well as notable government consultations for employment contracts.


APPENDIX

1.   Coronavirus Job Retention Scheme (“CJRS”)

We have addressed the introduction of and updates to the UK government’s CJRS mechanism to support employment levels through the COVID-19 pandemic in past publications; these updates are available on the Gibson Dunn website – March 20, 2020, March 27, 2020, May 18, 2020, June 2, 2020, and webcast of December 1, 2020.

If employers cannot maintain their UK workforce because their operations have been affected by COVID-19, they can put their employees onto “furlough”, a temporary leave of absence, and apply for a government grant to cover a portion of the usual wages. There have been various alterations to the finer detail of the CJRS (including the level of contribution to be made by employers as opposed to under grant, changes which took place between August and October 2020) but the essential position at the time of writing is:

  • Employees can be put on full-time furlough or “flexible furlough”, when employees work part-time and are regarded as being on furlough when they are not working.
  • Employers have to pay for hours worked but can claim the grant for hours not worked.
  • The grant amounts to the lower of 80% of wage costs or £2,500 per calendar month for those hours.
  • Employers must pay for employer national insurance contributions and employer pension contributions on all amounts paid to the employee, including the amount paid by the grant.
  • Employers are still free to top up wages, above the level of the grant, if they wish.
  • Since 1 December 2020, the CJRS cannot be used for employees who are under notice of termination.

The CJRS is set to run until 30 April 2021. This month the government is due to determine whether employers should contribute more towards employee costs. The government will shortly begin publishing information about employers who claim under the CJRS, in order to deter fraudulent claims.

2.   Vicarious Liability

As reported previously, the boundaries to the law on vicarious liability, which determines the circumstances in which an employer will be deemed liable for the acts of its officers and employees, have been expanding. However, two decisions of the UK Supreme Court in 2020 signal limits to this expansion and some helpful clarity for employers.

2.1   Vicarious Liability and Employment Status

In Barclays Bank plc (Appellant) v Various Claimants (Respondents), a bank had engaged a doctor to conduct medical examinations of prospective employees as part of the bank’s recruitment process. The Supreme Court held that the doctor was acting as an independent contractor rather than an employee, therefore the bank was not vicariously liable for sexual assaults he was alleged to have committed during these examinations.

The key question for the court was whether the doctor was acting as an independent contractor, carrying on business on his own account, or if his relationship to the bank was akin to employment. In circumstances where the doctor had other clients, remained free to refuse examinations, did not receive a retainer from the bank and carried his own medical liability insurance, it was clear that he was an independent contractor.

2.2   Vicarious Liability and Data Protection

In WM Morrison Supermarkets plc (Appellant) v Various Claimants (Respondents), the UK Supreme Court held that Morrison was not liable for data breaches by an employee who leaked the personal data of almost 100,000 employees.

The employee was authorised to transmit payroll data for Morrison’s workforce to its external auditors. He did so, but kept a copy of the data on a USB stick, which he later shared online. The employee has since been criminally convicted for his actions. Some of the affected individuals brought claims against Morrison for misuse of private information, breach of confidence and breach of its statutory duty under the Data Protection Act 1998, for which they alleged Morrison was either primarily or vicariously liable.

The question for the Supreme Court was whether the employee’s wrongful disclosure of the data was so closely connected with the task(s) that he was authorised to do that it could fairly and properly be considered to have been done whilst acting in the course of his employment. The Court found that this was not so and that, as a consequence, the employer was not vicariously liable for his actions: the disclosure was part of a personal vendetta by the employee, and the employee was not furthering his employer’s business when he committed the wrongdoing.

What this means for employers

Employers will take some comfort from these Supreme Court decisions. The Barclays Bank decision confirms that employers are unlikely to be held vicariously liable for the actions of true third party contractors.

The Morrison Supermarkets decision also makes clear that employers are unlikely to be held liable for employees’ wrongful acts where they are the result of a personal vendetta; the mere opportunity to commit wrongful acts, provided by employment, is insufficient alone to render employers vicariously liable. However, employers should continue to be mindful of the potential vicarious liability under data protection legislation for employees’ activities that do satisfy the “close connection” test. Safeguarding personal data and keeping risk of data breaches to a minimum should remain a priority.

3.   Transfer of Undertakings

The Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”) protect: (i) employees working in a business or undertaking that is in the UK, that is sold or transferred; (ii) employees in Great Britain who carry out activities that are subject to insourcing, outsourcing or transfer to a different outsourced contractor (a so-called “service provision change”); and (iii) those employees who are otherwise affected by that sale, transfer, insourcing or outsourcing. In essence, these employees’ contracts of employment are transferred to the recipient of the business, undertaking, or service provision change, who steps into the shoes of the previous employer and must, generally speaking, continue to employ them on their pre-transfer terms and conditions of employment. TUPE also provides other protections for affected employees, including the right to be informed and consulted in advance of a transfer.

3.1   Contractual Changes

Under regulation 4(4) of TUPE, variations to a contract of employment for which the sole or principal reason is the relevant transfer are void (unless certain specific exceptions apply). In Ferguson and others v Astrea Asset Management Ltd, the Employment Appeal Tribunal (“EAT”) held that regulation 4(4) applies to such variations, irrespective of whether they are beneficial or detrimental to the employee. In this case, two months prior to the transfer by way of service provision change from one property management company to another, the owner-directors of the first company varied their own employment terms to their advantage (in particular, guaranteed bonuses of 50% of salary, termination payments of a month’s salary for each year worked, and enhanced notice periods). The EAT held that regulation 4(4) rendered these variations void; the second company was not bound by them.

In arriving at its decision, the EAT cited the aim of the Acquired Rights Directive (2001/23/EC) (on which TUPE is based) as safeguarding employees’ rights, rather than improving them, and distinguished earlier case law on the bases that the variation occurred post-transfer and before regulation 4(4) was in force, and the Court of Appeal had not said that advantageous changes could not be declared void.

What this means for employers

In the context of TUPE transfers, the EAT decision provides helpful clarity to transferees on the enforceability of transfer-related contractual changes, confirming that where senior executives attempt tactical pre-transfer changes to their own terms and conditions, transferees will not be bound by the new terms. Difficult questions about whether such a variation is to the benefit or detriment of the employee are not necessary. However, outsourcing agreements should continue to contain provisions to render void any changes to terms and conditions made by the service provider once notice has been served to terminate the contract.

3.2   Long-term disability benefits

In ICTS (UK) Limited v Visram, the Court of Appeal considered whether an employee was entitled to benefit from a long-term disability benefits (“Disability Benefit”) policy when he could not restart his old job, as opposed to taking another appropriate role.

Under the terms of an insurance-backed Disability Benefit scheme, during periods of illness the employee was entitled to two thirds of his salary, with payment being conditional on the employee remaining employed, and to continue until the earlier of his return to work, death or retirement. The Court held that on closer inspection of the terms of the scheme, “return to work” was properly construed as return to the work the employee did before he became sick; had the parties intended that the benefit be available until the employee could return to any remunerated full-time work they could have specified this in the terms.

The case also raises the issue of liability for Disability Benefit where an employee has transferred to a new employer under TUPE. The claimant in this case had transferred to a new employer during his long-term sick leave; since employees who transfer under TUPE do so on their existing terms and conditions, including contractual benefits, the transferee employer was liable to provide the benefit until the employee’s return to his prior role, his death, or his retirement.

The transferee employer had dismissed the employee during his sickness absence. The employee then succeeded in claims for unfair dismissal and disability discrimination, hence the Employment Tribunal awarded compensation on the basis that benefits under the Disability Benefit plan should have continued until death or retirement. The EAT and Court of Appeal both upheld this finding.

What this means for employers

This case serves to remind employers and their advisors of the importance of specificity in drafting contractual benefit entitlement provisions, and the need to consider the nature of employee’s benefits and impact any termination may have on them prior to taking action. It is also a reminder of the full reach of contractual burden transferee employers take on in the context of TUPE transfers and the need to conduct full due diligence to identify potential liabilities around employees off sick and Disability Benefit.

4.   Post-Termination Restrictive Covenants

4.1   Restrictive Covenants and Breach of Contract

Post-termination restrictive covenants are commonly included in the contracts of employment of senior and other key employees. Should that employee commit a breach of their restrictive covenants, for example, by joining a competitor in breach of a non-compete covenant then the new (competitor) employer will not ordinarily be liable to the former employer in respect of that employee’s breach. However, should that new (competitor) employer induce that employee to breach the terms of their former contract of employment then both the new (competitor) employer and employee may be liable to the former employer.   To bring a claim for inducing a breach of contract, a claimant must show that the third party knowingly and intentionally induced and procured the breach without reasonable justification. The Court of Appeal in Allen t/a David Allen Chartered Accountants v Dodd & Co, held that an accountancy firm was not liable for inducing breach of contract when it recruited a tax adviser in breach of his 12-month contractual post-termination restrictions, where the firm had received legal advice in advance of the recruitment that the employee’s restrictive covenants were unlikely to be enforceable. The firm was advised that the covenants were unenforceable due to lack of consideration and an unreasonably long duration and that the non-solicitation and non-dealing restrictions “probably” and “on balance” failed, allowing the tax adviser to contact the clients of David Allen, his former employer.

In the High Court the judge found that parts of the restrictive covenants were enforceable and the employee had breached them. However, the accountancy firm had been entitled to rely on the legal advice it had received. David Allen appealed on the grounds that the legal advice received by the accountancy firm had been equivocal, and therefore the new employer was aware that there was a risk that the restrictive covenants would turn out to be enforceable.

In reaching its decision to dismiss the appeal, the Court of Appeal noted that the fact that the legal advice had been equivocal did not prevent the firm from honestly relying on it. It acknowledged that lawyers rarely provide unequivocal advice, and therefore responsibly sought legal advice should be able to be relied upon, even if it later turns out to be incorrect. Further, the required level of knowledge for inducement was that of knowledge of a legal outcome, not just knowledge of a fact. This level of knowledge could not be proven where the numerous breach of contract cases in the courts have shown that it is often difficult to predict legal outcomes. The Court did not opine on legal advice that merely states that it is arguable no breach will be committed, but advice that states it is more probable than not that there will be no breach is enough to rely upon.

What this means for employers

Employers can take comfort in this decision which confirms that they are entitled to rely on legal advice even where it is equivocal. Unless it can be proven that they knew their actions would breach the contract, as opposed to “might” breach the contract, liability for inducement to breach will not be made out.

4.2   Restrictive Covenants as Unlawful Restraint of Trade

Post-termination restrictive covenants will only be enforceable in the UK to the extent that they protect a legitimate business interest (such as an employer’s trade connections with customers or suppliers, confidential information and maintaining the stability of its workforce) and do so in a manner which is reasonable (lasting no longer and being no wider in scope than is reasonably necessary to protect the employer’s legitimate business interest). Restrictive covenants commonly take the form of “non-competes” (the most onerous form of restrictive covenant, which prevent the employee from working in a competing business for a restricted period of time), “non-solicit” and “non-dealing” restrictions which prevent an employee from soliciting and/or dealing with certain clients or customers of the business during a restricted period after leaving and “non-poaching” restrictions which prevent an employee from poaching or attempting to poach former colleagues during a restricted period after leaving.

In Quilter Private Client Advisers Ltd v Falconer and another, the High Court found that the non-compete, non-solicitation and non-dealing clauses in a financial adviser’s employment contract were an unreasonable restraint of trade and therefore invalid. Whilst the Court did find that the adviser had breached her employment contract in a number of ways, including via misuse of confidential information, her 9-month non-compete was unreasonable in the context of leaving employment within a six month probation period. In addition, her 12-month non-dealing and non-solicitation clauses, which covered anyone who had been a client of the employer at any time in the 18 months prior to termination, were held to be unreasonable and excessive given the nature of her client relationships during her period of employment.

What this means for employers

This case serves to highlight the importance of tailoring the drafting of restrictive covenants to both the circumstances of the business and the restricted employee. Particular care should be taken as to the scope and duration of restrictive covenants which an employer would seek to enforce against an employee who leaves during their probationary period.

5.   Forthcoming Changes

5.1   Off-payroll working and IR35

We have previously reported that changes to the IR35 legislation (which governs the payroll tax arrangements for certain individuals who supply services through an intermediary, usually a personal service company (“PSC”)) were due to take place in April 2020 (link). However, these changes have been postponed until April 2021 in recognition of the COVID-19 disruption. On 1 July 2020, MPs voted against a proposed amendment to the Finance Bill to delay the changes until 2023-2024. Should the changes now go ahead as expected in a matter of months, medium and large sized end-user clients will take over responsibility from the intermediary for assessing whether, but for the intermediary’s presence, the individual would be deemed an employee of the end-user client for tax purposes and, if so, for paying such taxes.

5.2   Gender Pay Gap

Similarly to the IR35 postponement, as we previously noted in March 2020 (link), the Government Equalities Office and the Equality and Human Rights Commission (EHRC) suspended enforcement of the gender pay gap deadlines for the reporting year 2019/20 due to the pressures of the COVID-19 pandemic. The requirement to report for 2020/21 has not yet been suspended, and on 14 December 2020 the government published a new set of guidance for employers, though the reporting requirements remain unchanged.

5.3   Ethnicity Pay Gap and racial and ethnic diversity in the boardroom

Amid a global surge in debate on racial equality, a petition to the UK Parliament calling for mandatory ethnicity pay gap reporting for UK firms with 250 or more staff has obtained enough signatures to mean it ought to be debated in Parliament. The government had said it would respond by the end of 2020 in light of the consultation it ran between 2018 and 2019, but we still await a response. In a leaked report obtained by the BBC in December from the government’s 2018 pay gap reporting consultation exercise, three quarters of employers (of 321 responders) wanted large firms to be forced to release ethnicity pay gap data.

Whilst gender pay gap reporting was enacted through regulations, the government would need to pass a new Act of Parliament to create any new ethnicity pay reporting scheme. Despite reporting not yet being mandatory, two in three UK companies surveyed recently by PwC (link) are now collecting data on ethnicity, with over one fifth now calculating their ethnicity pay gap; those not collecting data or calculating were concerned about data protection, systems capabilities, low response rates, or unease about posing the questions. Given how multifaceted information about ethnicity can be, it is not yet clear exactly what information would need to be provided under any new mandatory scheme.

Legal and General Investment Management (“LGIM”) has urged FTSE 100 boards to include at least one black, Asian or other minority ethnic member by January 2022 or suffer “voting and investment consequences” – LGIM would vote not to re-elect their nomination committee chair. It will also demand more transparency around race and ethnicity data, including ethnicity pay data and inclusive hiring policies. LGIM is the largest fund manager in the UK, holding an interest in most FTSE 100 companies.

Meanwhile, the Confederation of British Industry has announced a new campaign, “Change the Race Ratio”, in partnership with a number of firms and charitable and academic organisations. This incorporates commitments: (i) to ensure FTSE 100 and 250 boards have at least one racially and ethnically diverse member (by end 2021 and by 2024 respectively); (ii) to increase racial and ethnic diversity in senior leadership, by setting and publishing targets; (iii) to increase transparency, via published target action plans and progress reports and with ethnicity pay gaps disclosed by 2022; and (iv) to create an inclusive, open and supportive environment through recruitment, development and support processes, more diversity in suppliers/partners, and use of data. The campaign offers support to businesses to sign up to the commitments and thereby increase inclusion in business.

In December, Liz Truss MP, Minister for Women and Equalities, gave a speech at the Centre for Policy Studies setting out the government’s new approach to tackling inequality, consisting of the “biggest, broadest and most comprehensive equality data project yet”, to look across the UK and identify where people are held back and what the biggest barriers are. This will not be limited to the Equality Act 2010’s nine protected characteristics (which include sex and race). While Ms. Truss acknowledged that people in these groups suffer discrimination, she suggested that the focus on protected characteristics has led to a narrowing of the equality debate that overlooks socio-economic status and geographic inequality. Initial findings will be reported this summer.

5.4   Government consultations for employment contracts

On 4 December 2020, the government launched two consultations, both of which are expected to close on 26 February this year. One pertains to measures to extend the ban on exclusivity clauses in employment contracts for employees under the Lower Earnings Limit (currently £120 per week), which would prevent employers from contractually restricting low earning employees from working for other employers – it appears this stems from the fact low earners have been particularly adversely affected by the COVID-19 pandemic and many employers are currently unable to offer their employees sufficient hours. The second consultation relates to measures to reform post-termination non-compete clauses in employment contracts (previously discussed at section 4 of this update), including proposals to: (i) require employers to confirm in writing to employees the exact terms of a non-compete clause before their employment commences; (ii) introduce a statutory limit on the length of non-compete clauses; and (iii) ban the use of post-termination non-compete clauses altogether. We will report in due course on any developments following the government consultations.


Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these and other developments. Please feel free to contact the Gibson Dunn lawyer with whom you usually work or the following members of the Labor and Employment team in the firm’s London office:

James A. Cox (+44 (0)20 7071 4250, [email protected])

Georgia Derbyshire (+44 (0)20 7071 4013, [email protected])

Charlotte Fuscone (+44 (0)20 7071 4036, [email protected])

Heather Gibbons (+44 (0)20 7071 4127, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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In 2020, the COVID-19 pandemic taught the world another lesson about the unpredictability of life. Each country responded to the challenges posed by the pandemic in its own way. The German Government in its familiar technocratic and sober approach quickly unlocked massive financial resources to mitigate any immediate economic damage. It supported a further relaxation of the purse strings at EU level and put legislative acts in place that helped manage the uncertainty in the most affected industries for now. Hit by a second wave of the pandemic in an unexpectedly hard way, Germany is now left wondering whether the country really was smart in the spring or just lucky. The new year 2021 will provide the answer to this question.

The disruption caused by the pandemic is not over; it has just started. On a positive note, we have seen an unprecedented move towards more efficient means of communication through the use of new media and the leveraging of technology in general. For example, long overdue changes to the handling of annual shareholder meetings of German joint stock corporations were implemented within weeks to facilitate the annual reporting season under lock-down conditions. By providing short term work allowances to compensate for losses in remuneration resulting from temporary cuts in working hours, the German system helped employers to hold onto their highly-skilled work force in the hope of a quick recovery thereby avoiding immediate hardship for those hit hard by the imposed restrictions. A speedy process to amend legislation addressing topics from suspending rent payments and interest payments to the temporary relaxation of insolvency filing obligations flanked by a coherent communication strategy added to the sentiment of most Germans of having been governed well, so far.

2021 will be different and bigger challenges certainly lie in wait. Instead of throwing hundreds of billions of Euros at the problem, German politicians will now have to explain to the public who is going to pick up the bill for all the important measures taken. The inadequate accords reached with the twenty-seven European Union members states that remain after Brexit designed to stabilize the weakest member state economies will require rigorous implementation and oversight. To date, hope rests on what has been a series of blink-decisions taken in face of an imminent European crisis coupled with the expectation that this will all result in a more aligned and more integrated European Union. A very optimistic scenario, indeed.

Apart from the emergency measures triggered by the COVID-19 pandemic, the EU and Germany have set and started to implement an ambitious agenda with regard to the regulation of international trade (by the introduction of tightened rules on foreign direct investments), antitrust laws (responding to the topics of market dominance in the digital age), consumer protection (with the introduction of collective redress within the EU), increased corporate responsibility in the white collar area (with the long-discussed introduction in Germany of criminal corporate liability), and the fight against money laundering and tax evasion.

And, finally, Angela Merkel’s term ends in the fall of 2021. She will have been the longest serving Chancellor in German history. This brings a 16-year era to an end that served Germany well and also helped Europe to navigate through difficult waters. She is expected to leave a temporary vacuum in German and European leadership that comes at the wrong time and is difficult to be filled in the short term.

Is this a dramatic crisis? No. Should we be concerned? Maybe. Should we act? Yes.

There are many things that each of us can do to turn the many challenges ahead into something new and potentially better. Here is our favorite list: First, stay healthy, look after yourself and your loved ones. Second, take informed and careful decisions each day to tackle the problems ahead, instead of rushing to beat “long-term-trends” with blurry visionary steps or short-sighted activism. Third, stay connected with the world, avoid narrow-minded thinking and a further fragmentation of the world, while staying connected to your local community. Learn where you can, challenge where you can, and help where you can. We are all in this together and only when we join forces, will we navigate the challenging times ahead of us.

At Gibson Dunn, we are proud and honored to be at your side to help solve your most complex legal questions and to continue our partnership with you in the coming year in Germany, in Europe and the world. We trust you will find this German Law Year-End Update insightful and instructive for the best possible start in 2021.

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Table of Contents

  1. Corporate, M&A
  2. Tax
  3. Financing and Restructuring
  4. Labor and Employment
  5. Real Estate
  6. Compliance / White Collar
  7. Data Privacy – Regulatory Activity and Private Enforcement on the Rise
  8. Technology
  9. Antitrust and Merger Control
  10. International Trade, Sanctions and Export Control
  11. Litigation
  12. Update on COVID-19 Measures in Germany

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1.         Corporate, M&A

1.1       Next Round – Virtual-only Shareholder’s Meetings of Stock Corporations in 2021

The temporary COVID-19-related legislation of March 2020 allowing to hold virtual-only shareholders’ meetings of stock corporations in 2020[1] has been extended until the end of 2021 by means of an executive order of the German Ministry of Justice and Consumer Protection (Bundesministerium der Justiz und für Verbraucherschutz) issued in October 2020. While the legal framework of the temporary regime for virtual-only meetings remained unchanged, the regulator strongly appealed to the management of the relevant corporations to use the emergency instrument of a virtual-only meeting in a responsible manner, taking into account the specific individual circumstances due to the pandemic situation.

In addition to this mere moral appeal by the executive branch, just before year-end and somewhat surprisingly, the parliamentary legislator modified the March 2020 legislation with regard to the shareholders’ right to information in virtual-only meetings as a concession to the widespread criticism in the aftermath of the March 2020 legislation. The March 2020 legislation had reduced the shareholders’ right to information to a mere possibility to submit questions in electronic form prior to the meeting, leaving it up to management in its sole discretion as to whether and in which manner to answer such questions. Additionally, it allowed management to set a submission deadline of up to two days prior to the meeting.

The October legislation, addressing widespread criticism raised not only by shareholder activists and institutional investors but also by legal scholars, restored the shareholder’s right to ask questions in the 2021 season for shareholders’ meetings taking place after February 28, 2021: It will again constitute a genuine information right requiring management to duly answer all shareholders’ questions submitted in time prior to the meeting. In addition, the cut-off deadline for the submission of shareholders’ questions may not exceed one day.

Furthermore, the parliamentary legislator also clarified in its last minute amendments that counter-motions by shareholders that are submitted for publication with the company at least 14 days prior to the shareholders’ meeting must be dealt with in the virtual-only shareholders’ meeting if the submitting shareholder has duly registered for the virtual shareholders meeting.

The virtual-only format is available to shareholders’ meetings of stock corporations which are held by December 31, 2021. In light of the current pandemic, the extensive use of the virtual-only format and the frequently observed extraordinary high participation-rate of shareholders in 2020, it can be expected that most stock corporations will again hold their shareholders’ meetings in a virtual-only format in 2021.

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1.2       Legislative Initiative to Strengthen Market Integrity after the Wirecard Scandal

In the aftermath of the spectacular collapse of German payment solutions provider Wirecard last summer, the German Government on December 16, 2020 presented a draft bill (Regierungsentwurf) for an Act on the Strengthening of the Financial Market Integrity (FinanzmarktintegritätsstärkungsgesetzFISG) which aims to restore and strengthen trust in the German financial market.

The draft bill provides for new rules designed to bolster both the internal (in particular, via the supervisory board) and external (e.g. by strengthening the independence of external auditors and their supervision) corporate governance of companies of public interest, including listed companies.

This includes, in particular, the explicit obligation for the management board of a listed stock corporation to implement an adequate and effective internal control and risk management system. Furthermore, the draft bill also aims to strengthen the accounting and audit expertise present in the supervisory board of listed companies: Whereas the law currently only requires that, at least, one supervisory board member shall have expertise in the fields of accounting and auditing, the draft bill requires that, at least, one board member has expertise in the fields of accounting and, at least, one other board member has expertise in the fields of auditing, thus increasing the minimum number of experts to, at least, two board members. In addition, the establishment of an audit committee by the supervisory board shall no longer be discretionary but becomes compulsory for companies of public interest, including all listed companies.

In order to strengthen the independence of the auditor as part of a company’s external safeguards, the draft bill suggests the tightening of the mandatory external rotation. The external rotation of the auditor shall occur no later than after ten years for all companies of public interest, including listed companies, thus eliminating national exemptions from the EU audit regime, which currently allow for a maximum term of 24 years, and introduces further restrictions on non-audit services that can be provided by the auditor.

In reaction to the widespread criticism leveled at the response of Germany’s Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) to the events that led to Wirecard’s collapse and the perceived failure of the supervisory and enforcement procedures and mechanisms in financial reporting, the draft bill also proposes revisions to the current supervisory and enforcement procedures, including further-reaching competences for the financial regulator BaFin itself.

Last but not least, the draft bill provides for increased civil liability for damages caused by auditors as well as a tightening of criminal and administrative penalties for misrepresentations made by company representatives and statutory auditors in connection with the preparation and audit of company accounts.

The Government’s draft bill essentially corresponds to a joint ministerial draft of October 26, 2020 by the Federal Ministry of Finance (Bundesministerium für Finanzen) and the Federal Ministry of Justice and Consumer Protection (Bundesministerium der Justiz und für Verbraucherschutz), which had been met with widespread criticism arguing that the proposals were not going far enough and failed to address the shortcomings of the current system which were also identified by the EU’s securities market regulator, the European Securities and Markets Authority (ESMA), in its special report on the Wirecard collapse published in November 2020. It remains to be seen whether and to which extent this criticism will be taken up by the lawmaker in the upcoming parliamentary process by providing for more fundamental changes and reforms.

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1.3       German Foreign Direct Investment Control – Rule-Tightening in Light of COVID-19 and the EU Screening Regulation

In December 2020, for the very first time, the German Federal government officially prohibited the indirect acquisition of a German company with specific expertise in satellite/radar communications and 5G millimeter wave technology by a Chinese state-owned defense group. The decision is the culmination of an eventful year which has seen various changes to the rules on foreign direct investments (the “FDIs”) in light of, inter alia, COVID-19 and the application of the EU Screening Regulation[2].

Below is an overview of the five key changes that have become effective over the course of 2020:

    1. Extension of the catalog of select industries triggering a mandatory filing with the German Ministry of Economy and Energy (Bundesministerium für Wirtschaft und Energie, BMWi) upon acquisition of 10% or more of the voting rights in a German company by a non-EU/non-EFTA acquirer to include (i) personal protective equipment, (ii) pharmaceuticals that are essential for safeguarding the provision of healthcare to the population as well as (iii) medical products and in-vitro-diagnostics used in connection with life-threatening and highly contagious diseases.
    2. No more gun-jumping: All transactions falling under the cross-sector review that require a mandatory notification (i.e., FDIs of 10% or more of the voting rights by a non-EU/non-EFTA investor in companies active in one or more of the conclusively listed select industries) may only be consummated upon conclusion of the screening process (condition precedent).
    3. Introduction of penalties (up to five years imprisonment or criminal fine (in case of willful infringements and attempted infringements) or an administrative fine of up to EUR 500,000 (in case of negligence)) for certain actions pending (deemed) clearance by the BMWi, namely: (i) enabling the investor to, directly or indirectly, exercise voting rights, (ii) granting the investor dividends or any economic equivalent, (iii) providing or otherwise disclosing to the investor certain security-relevant information on the German target company, and (iv) the non-compliance with enforceable restrictive measures (vollziehbare Anordnungen) imposed by the BMWi.
    4. Implementation of the EU-wide cooperation mechanism as required under the EU Screening Regulation.
    5. Expansion of the grounds for screening under German FDI rules to include public order or security (öffentliche Ordnung oder Sicherheit) of a fellow EU member state as well as effects on projects or programs of EU interest, and tightening of the standard under which an FDI may be prohibited or restrictive measures may be imposed from “endangering” (Gefährdung) to “likely to affect” (voraussichtliche Beeinträchtigung) the public order or security, so as to reflect the EU Screening Regulation.

For additional details on these and other changes in 2020 to foreign investment control and an overview on the overall screening process in Germany, please refer to our respective client alerts published in May 2020[3] and November 2020[4].

Further changes to the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung, AWV) are announced for 2021. In particular, the catalog of critical industries are to be extended further. Based on earlier announcements by the BMWi, artificial intelligence, robotics, semiconductors, biotechnology and quantum technology will likely be added to the catalog of critical industries.

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1.4       Gender Quota for (Certain) Management Boards on the Horizon

Five years after the (first) Management Position Act (Führungspositionen-Gesetz) for the first time implemented a mandatory female quota for the composition of supervisory boards of certain German companies in 2016,[5] the German government coalition parties now support a mandatory quota also for management boards. In the future, under the contemplated Second Management Position Act (Zweites Führungspositionen-Gesetz) (i) listed companies, (ii) which are subject to the 50% employee co-determination under the Co-Determination Act (Mitbestimmungsgesetz) and (ii) whose management board consists of more than three members, must appoint at least one female management board member whenever a position becomes vacant.

The new management board quota will only apply with regard to the rather limited number of companies who meet all of the above criteria. However, it is nevertheless a strong signal by the German coalition parties to a German business community in which voluntary commitments to increase gender equality have failed to gain significant momentum in the past. Under the 2015 Management Position Act which had introduced the mandatory gender quota for supervisory boards, companies were, in addition, requested to set themselves gender targets for the composition of their management boards. Rather than taking the opportunity to consider voluntary targets in line with the specific circumstances of a company, a large number of affected companies simply set the target at “zero” year after year. By contrast, the mandatory 30% gender quota for the composition of supervisory boards has not just been met but even exceeded and is currently polling at approximately 37%.

For all companies in which governmental authorities hold a majority, the contemplated Second Management Position Act will also (i) provide for a mandatory 30% female quota for the composition of supervisory boards and (ii) introduce a minimum number of mandatory female management board members. In addition, public law corporations (Körperschaften des öffentlichen Rechts) primarily active in the health and insurance sectors which typically employ a large number of female staff, will be required to appoint at least one female board member if the board is composed of two or more members.

The draft legislation was approved by the cabinet in early January 2021 and will now be submitted to the German Parliament. The new gender quota should in any event come into force prior to the German federal elections in autumn 2021.

While a number of corporations welcome the move towards more gender equality as Germany is lagging behind in comparison to, in particular, Scandinavian and UK companies, others oppose the quota law arguing undue interference with the right of the supervisory board to appoint the best available candidate. It will be interesting to see if and how investors position themselves.

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1.5       New Developments on Taxation of Remuneration for Supervisory Board Members

As a consequence of a ruling by the German Federal Fiscal Court (Bundesfinanzhof, BFH) late in 2019, the tax classification of compensation paid to supervisory board members has been modified in terms of value-added tax (VAT). In order to avoid potential adverse tax effects based on the incorrect tax treatment of supervisory board compensation, both individual supervisory board members and the companies they serve should be familiar with the ruling.

Previously, the tax authorities presumed without further differentiation between fixed or variable supervisory board compensation that members of supervisory boards were engaged in independent entrepreneurial activity and their remuneration was to be charged with VAT. It was irrelevant whether the respective member of the supervisory board was an elected member, served on the board as a shareholder delegate or in a capacity as an employee representative. At least in those cases where supervisory board members receive a fixed compensation for their service, future invoices will no longer be permitted to charge a VAT component.

The respective ruling by the BFH applied an earlier decision of the European Court of Justice (ECJ) taken on June 13, 2019 at the national level and confirmed the ECJ’s view that supervisory board members who receive fixed remuneration are not qualified as independent. The ECJ held in its decision that supervisory board members, who act on behalf of and in the sphere of responsibility of the supervisory board, do not bear any economic risk for their activities and therefore do not perform entrepreneurial activities due to a lack of independence. The BFH followed the argumentation of the ECJ and agreed that supervisory board members who receive a fixed remuneration which is neither dependent on their attendance at meetings nor on the services actually performed, cannot be classified as entrepreneurs. The BFH left it open whether independent entrepreneurial activities can be deemed to exist in cases where a variable remuneration is agreed with the individual member of the supervisory board.

For the individual supervisory board member, such classification as a dependent activity means, at least, in the case of fixed remuneration, that he or she may no longer add a VAT element to the remuneration in invoices issued to the company. Otherwise the supervisory board member would owe such tax, while the company would not be able to deduct such an incorrectly added tax component as an input tax deductible. Likewise, input tax amounts incurred in connection with the activity as a supervisory board member (e.g. VAT on travel expenses or office supplies) would no longer be recoverable due to the lack of independence of the supervisory board member.

If the supervised company is entitled to an unrestricted input tax deduction, this new jurisprudence should not have any adverse economic impact on the company, provided correct invoices are issued. Industries which are not entitled to deduct input tax or only entitled to deduct it to a limited extent – such as banks, insurance companies or non-profit organizations – actually benefit if the supervisory board member issues invoices without VAT.

The tax authorities have so far not yet published any guidelines in response to the new case law. It therefore remains to be seen whether the tax authorities will draw a distinction between fixed and variable compensation when qualifying the activities of a supervisory board member for VAT purposes. It would also be conceivable that the tax authorities would now generally assume that a supervisory board member’s services are deemed to be a dependent activity which is generally not subject to VAT.

However, since a short-term response to the case in the administrative guidelines is to be expected in the near future, the ruling should be applied to fixed compensation and VAT should not be included in any future invoice. In the case of variable compensation and in view of the previous administrative practice, the invoicing of a separate VAT component would continue to be required until the tax authorities have communicated their new position on the matter or – if variable compensation is also to be accounted for without VAT – legal action may become necessary. It also remains to be seen whether the tax authorities will apply the new case law retrospectively and whether and how it would take into account considerations of the protection of legitimate expectations (Vertrauensschutz).

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2.         Tax

2.1       Taxation of Transactions involving German Registered IP

In a decree issued on November 6, 2020, the German tax authorities expressed their opinion that transactions between non-German parties, which relate to IP registered in a German register, are subject to tax in Germany. The tax provision the German tax authorities are referring to has been in existence for almost 100 years but in practice this provision has not been applied to transactions where both contracting parties reside outside of Germany. The German tax authorities now deviate from past practice and take the view that such extraterritorial transactions with German registered IP are taxable in Germany. In essence, such interpretation of the German tax authorities creates a taxable nexus in Germany only by virtue of the German registration of IP. As a consequence, royalties paid by a non-German licensee to a non-German licensor for German registered IP are subject to German withholding tax at a flat rate of 15.8%. A potential upfront tax relief under European directives or applicable double tax treaties may be applicable but requires a formal application by the licensor and a certification by the German tax authorities prior to payment of the royalties. If the withholding tax was not withheld, which is the typical case for German registered IP, the licensee as well as the licensor may be held liable for the payment of the withholding tax.

Only two weeks after the issuance of the decree, the German government released a draft tax bill on November 20, 2020 recognizing the far reaching interpretation of the tax authorities. Under the draft tax bill German tax for registered IP in Germany would only apply if the IP is exploited through a German permanent establishment or facility of the licensee; the pure registration of IP in a German register would not be sufficient anymore to become taxable in Germany. It is still unclear if and to what extent the draft tax bill becomes effective and, therefore, the November 6 decree remains for now the only currently valid administrative guidance on the taxation of IP registered in Germany.

Affected tax payers are well advised to closely monitor the further legislative process.

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2.2       Anti-Tax-Avoidance Directive

In 2016, the EU enacted the Anti-Tax-Avoidance Directive (ATAD) containing a package of legally binding measures to combat tax avoidance to be implemented into national law by all EU member states by 2018/2019. Germany has so far delayed implementation, exposing itself to EU infringement proceedings for failure to implement ATAD into national law in time. Almost one year after publication of the first draft bill, Germany is now considering implementing ATAD requirements in early 2021. Implementation has been delayed because Germany wanted to introduce several measures beyond a one-to-one implementation of the Directive, such as new rules on cross-border intercompany financing or exit taxation for individuals.

As part of the most relevant gap between existing German tax rules and ATAD requirements, Germany will introduce rules which limit the deduction of operating expenses for certain hybrid arrangements between related parties. Significant changes under ATAD regarding the current controlled foreign corporation (CFC) rules (Außensteuergesetz) will be a new control criterion and introduction of a shareholder-based approach. Control shall be deemed to exist if a German-resident shareholder, alone or jointly with related persons, holds a majority stake in the foreign company. The current concept of domestic control by adding up the participations of all German taxpayers will be abandoned. The current CFC rules, according to which a foreign company is considered as lowly taxed if the income tax is below 25%, shall, however, be retained.

This has evoked strong criticism by commentators since even in many developed countries the income tax rate is below 25% and CFC regulations in Germany can therefore be triggered too easily.

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2.3       New Anti-Treaty Shopping Rule

The European Court of Justice (ECJ) has consistently declared Germany’s attempts at creating a treaty-overriding anti-abuse provision to be a violation of EU fundamental freedoms. On November 20, 2020, the German government released a draft tax bill and launched another attempt at making the anti-abuse provision compatible with EU law. The draft law takes into account recent ECJ case law and provisions under the ATAD. Under the new wording of the anti-abuse provision a foreign company has no claim for relief from withholding tax to the extent that it is owned by persons, which would not be entitled for such relief, had they been the direct recipients of the income, and as far as the source of income is not materially linked to economic activity of this foreign company. Receiving the income and its onward transfer to investors or beneficiaries as well as any activity that is not carried out using business substance commensurate with the business purpose cannot be regarded as an economic activity. Withholding tax relief shall be given in so far as the foreign company proves that none of the main purposes of its interposition is obtaining a tax advantage or if the shares in the foreign company are materially and regularly traded on a recognized stock exchange.

If the new rule becomes law, it could in the future be harmful for a holding company to be interposed between its parent and a German income source even if the holding company and the parent are in different countries and both German tax treaties applicable to the holding and the parent company provide for the same withholding tax benefits. In such case it may be required to create a sufficient economic link between the German income source and the economic activity of the holding company in order to avoid the application of the anti-treaty shopping rule. An active management holding company should be regarded as a sufficient economic activity and such holding company should not to fall under the new rules. Further clarifications in that respect by the German tax authorities are expected in the first half of 2021.

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3.         Financing and Restructuring

With the COVID-19 pandemic hitting the German economy hard, the areas of financing and restructuring saw some of the most significant changes and sustained reform in 2020. The initial legislative response focused, in particular, on providing new sources of emergency funding and a temporary relaxation of the traditionally strict German insolvency filing obligations for companies perceived to be in financial disarray through no fault of their own due to the effects of the pandemic.[6]

On December 17, 2020, the German Parliament then adopted the Act on the Continued Development of Restructuring and Insolvency Law (Sanierungs- und Insolvenzfortentwick­lungsgesetz – SanInsFoG) to address (i) the fear of a large-scale “insolvency wave” upon the originally scheduled expiry of the COVID-19 pandemic triggered partial suspension of the insolvency filing requirement due to over-indebtedness on December 31, 2020,[7] and (ii) the implementation of the European Union Directive (EU) 2019/1029 of June 23, 2019 on preventive restructuring frameworks, the discharge of debt and measures to increase the efficiency of restructuring and insolvency proceedings (the “Restructuring Framework Directive”) into German law which would have been due by July 2021.

This reform of German restructuring and insolvency law, which was pushed through the parliamentary process in a very short period of time, has been labeled by many commentators as potentially the most significant reform of the German restructuring landscape since the introduction of the German Insolvency Code (Insolvenzordnng, InsO) in 2001.

A selection of key changes introduced by the SanInsFoG reform which came into effect on January 1, 2021 are highlighted in the below sections:

3.1       Reform of the German Insolvency Code (InsO) by the SanInsFoG

  • The insolvency reason of over-indebtedness (Überschuldung) was modified in such a way that the period for the necessary continuation prognosis (Fortführungsprognose), during which a mathematically over-indebted company must be able to meet its obligations when they fall due, was shortened to twelve months only. Before the reform, the relevant period was the current and the following business year.
  • If certain special requirements during the period of the pandemic are met, the prognostication period is shortened further to only four months in order to deal with the economic effects of the pandemic which makes reliable long term planning difficult if not impossible. This provision is designed further to soften the effects of the pandemic and applies only from January 1, 2021 to December 31, 2021.
  • The suspension of the insolvency filing obligation under the COVInsAG was further extended for all of January 31, 2021. The suspension applies to all over-indebted and/or illiquid companies (i) who filed an application for public support under the “November and December COVID-relief funds” (November- und Dezemberhilfen) but the respective funds were not yet paid out or (ii) such application was not possible for technical or legal reasons even though a business was entitled to apply. The extension does not apply if the receipt of such funds would not be sufficient to cure the existence of the insolvency reason or such application would clearly be unsuccessful.
  • For the insolvency reason of over-indebtedness only, the previous maximum period for mandatory insolvency filing of three weeks was extended to a maximum of six weeks.
  • The prognostication period for the determination of impending illiquidity (drohende Zahungsunfähigkeit) is now as a general rule twenty-four months.
  • Certain provisions relevant for the liability of the managing directors in times of distress were removed from various corporate statutes and concentrated in modified form in a new provision of the Insolvency Code (§ 15b InsO). The legislator, in particular, clarified and extended the payments permitted by the management of a debtor company after the time an insolvency reason has already occurred if a timely filing is later made.
  • The provisions on future access to own administration by management (Eigenverwaltung) and so-called protective umbrella proceedings (Schutzschirmverfahren) in the Insolvency Code were modified and partly restricted to address past undesirable developments. However, exceptions apply for entities who became insolvent due to the pandemic: (i) Illiquid entities may rely on the protective umbrella proceedings which otherwise are only available in case of impending illiquidity, and (ii) companies may under certain specific circumstances continue to avail themselves of the less restrictive pre-reform rules on own administration by management if such proceedings are applied for during the year 2021.

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3.2       Introduction of a New Pre-Insolvency Restructuring Tool Kit

The core piece of the SanInsFoG is the new, stand-alone act called the Business Stabilization and Restructuring Act (Unternehmensstabilisierungs- und -restrukturierungsgesetzStaRUG, the “Restructuring Act”). This Restructuring Act contains the German rules to transpose the requirements of the Restructuring Framework Directive into local German law, but partly goes beyond such minimum requirements.

Without any claims to be complete, clients and their management ought to be aware of the following key items in the Restructuring Act:

  • The Restructuring Act introduces a general obligation for management to install continuous supervision and early warning systems that enable management to detect any developments endangering their company’s existence or financial wellbeing.
  • Once a company is faced with impending illiquidity, and has opted for voluntary pre-insolvency restructuring proceedings, management of the debtor has to conduct the business with the care of prudent business person in restructuring and thus, in particular, has to safeguard the interests of the community of creditors. Conflicting shareholder instructions may not be complied with.
  • In voluntary pre-insolvency restructuring proceedings, management of the company must draw up a detailed, descriptive (darstellend) and executive (gestaltend) restructuring plan in order to restructure the company’s business or individual types of liabilities or contractual obligations. Measures may, for example, include haircuts and amendments of the rights of secured or unsecured creditors, but a comparative calculation/analysis needs to be attached which outlines the effects of the restructuring on individual creditors compared to a regular insolvency situation. It should be noted that claims of employees (including pension claims) may not be restructured or changed as part of the restructuring plan.
  • Approval of the restructuring plan requires a majority of 75% of the voting rights per creditor group. Subject to additional requirements, non-consenting creditors can be overruled via a court approved cross-class cram-down.
  • The court may upon request of the restructuring company further impose a temporary three-month moratorium on individual enforcement measures. Such moratorium may under certain circumstances be extended to a maximum period of eight months.
  • The handling of the entire pre-insolvency restructuring can be assisted or facilitated by the involvement of two newly-created functional experts appointed by the competent court, the so-called restructuring agent (Restrukturierungsbeauftragter) and the restructuring moderator (Sanierungsmoderator). In addition, the competent court may appoint a so-called creditor’s advisory committee (Gläubigerbeirat) ad officium if the proposed restructuring plan affects all creditors (except for creditors of exempt claims such as claims of employees) and, thus, is of such general application to all groups of creditors that the proceedings are akin to universal proceedings (gesamtverfahrensartige Züge). Such creditor advisory committee may also include members that are unaffected by the restructuring plan like e.g. employee representatives or others.
  • If illiquidity or over-indebtedness occurs during the restructuring proceedings, management is obliged to immediately inform the restructuring court, but the formal duty to file for insolvency is suspended. Such insolvency filings do remain possible, though, and the restructuring court may close the restructuring matter to allow for formal insolvency proceedings. Failure to inform the restructuring court duly or timely may incur personal liability for management.
  • The tools, procedures and restructuring measures contained in the Restructuring Act are mostly new and untested. It can thus be expected that the need for specialist advice for distressed companies will generally increase.

The need for additional expert assistance and the relatively heavy load of technical and procedural safeguards may pose a challenge in particular for small and medium-sized distressed businesses who suffer heavily from the pandemic and who may not have the financial and other resources to benefit from the Restructuring Act. It therefore remains to be seen whether and how the new Restructuring Act will stand the test of time in this regard. It can be expected, though, that the Restructuring Act will offer interesting options and restructuring potential, at least, for bigger and more sophisticated players in the German or international business arena. We would thus recommend that interested circles, i.e. German managing directors and board members but also investors or shareholders, familiarize themselves with the fundamentals of the Restructuring Act.

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4.         Labor and Employment

4.1       Employers’ Options during the COVID-19 Pandemic

The German lawmaker has enacted several support measures and subsidies for companies to cope with the ongoing COVID-19 pandemic, especially enhancing short-time work options. In a nutshell, short-time work means that working hours are reduced (even down to zero) and that the state pays between 60% and 87% of the net income lost by the affected employees. Currently, such a scheme can be extended to 24 months with the government even covering the social security costs.

Companies that make use of this generous scheme are not barred from carrying out redundancy measures. However, the narrative for such lay-offs is different: A termination for business reasons requires a permanent, not only a temporary loss of work. Regardless of these strict requirements, we have seen an uptick of redundancies during the pandemic.

For a more detailed insight we would refer to our client alert on the topic.[8]

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4.2       Reclassification Risk of Crowd-Workers into De-Facto Employees

The German Federal Labor Court (Bundesarbeitsgericht, BAG) has recently held that crowd-workers, i.e. freelancers hired over an online platform, can be classified as employees of the platform (9 AZR 102/20). This would entitle them to certain employee-protection rights, such as protection against dismissal, continued payment of remuneration and vacation claims.

In this particular case, the crowd-worker was considered an employee because the platform controlled the details of the work (place, date and contents) and featured a rating system that incentivized him to continuously perform activities for the platform operator. In the opinion of the court that sufficed to show that the crowd-worker was integrated in the platform operator’s business, making him an employee.

While the ruling will not render the business model of crowd-working platforms entirely impossible, especially platform operators using incentive systems should have these arrangements double-checked to mitigate the risk of costly reclassification of their crowd-workers.

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4.3       Pension Claims in Insolvency (Distressed M&A)

The European Court of Justice (ECJ) has issued an important ruling concerning the liability of acquirers of insolvent companies for occupational pensions. According to German case law, such acquirers have not been liable for their new employees’ rights with regard to occupational pension schemes as far as these rights had been accrued prior to insolvency. Instead, such claims are covered by the German Insolvency Protection Fund (Pensionssicherungsverein, PSV), which secures them to a certain extent, but not always entirely.

The plaintiffs in the underlying German court proceedings sued the acquirer for acknowledgement of their full pension claims disregarding reductions due to the insolvency. The ECJ now ruled on September 9, 2020 that the limited liability of the acquirer regarding occupational pension claims was only in line with European Union law if national law provided a certain minimum protection regarding the part not covered by the acquirer (C-674/18 and C-675/18). Regrettably, the ruling does not make it entirely clear who would be liable for a possible difference in benefits – the acquirer or the PSV. According to the few publications available so far, it appears more convincing that the PSV would have to cover said deficit. However, due to the lack of certainty, investors ought to take this potential risk into account when acquiring insolvent businesses.

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5.         Real Estate

5.1       Conveyance requires Domestic German Notary

The transfer of title to German real estate requires (i) the agreement in rem between the transferor and the acquiror on the transfer (conveyance) and (ii) the subsequent registration of the transfer in the competent land register. To be effective, the conveyance needs to be declared in the presence of both parties before a competent agency. While a notary appointed in Germany fulfills this criterium, it is disputed among German scholars whether the conveyance may also be effectively declared before a notary public abroad.

In its decision of February 13, 2020, the German Federal Supreme Court (BundesgerichtshofBGH) held that the conveyance may not be effectively declared before a notary who has been appointed outside of Germany. Engaging a notary abroad for the conveyance to get the benefit of (often considerably) lower notarial fees abroad, is thus not a viable option. In case of a sale of real estate under German law, additional notarial fees for the conveyance, however, may be avoided if the conveyance is included in the notarial real estate sale agreement recorded by a German notary.

The feasibility of a notarization before a notary public abroad is still disputed with respect to the notarization of the sale and transfer or the pledging of shares in a German limited liability company (GmbH). It remains to be seen whether this decision on real estate conveyance may also impact the dispute and arguments on the permissibility of foreign notarization of share sales and transfers or pledges.

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5.2       Update regarding Commercial Lease Agreements

Further developments of potential relevance for the real estate world, which were triggered by the COVID-19 pandemic, are discussed in the context of the continuing legal impact of the pandemic in sections 12.3 and 12.4 below.

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6.         Compliance / White Collar

6.1       Corporate Sanctions Act: Extended Liability for Criminal Misconduct

The German Federal Government is still pursuing its plan to implement a corporate criminal law into German law. After the Federal Council (Bundesrat) had demanded some changes to the previous draft bill, the Federal Government introduced its draft to Parliament on October 21, 2020. Unlike many other countries, German criminal law does not currently provide for corporate criminal liability. Corporations may only be fined for an administrative offense. Based on the draft bill, corporations will be responsible for business-related criminal offenses committed by their leading personnel and will be liable for fines of up to 10% of the annual – worldwide and group-wide – turnover. In addition to this fine, profits can be disgorged and the corporation will be named in a sanctions register as a convicted party for up to 15 years.

Furthermore, if implemented, public prosecutors would be legally obliged to open investigations against the corporation on the basis of a reasonable suspicion (currently, it is in their discretion), and a written legal framework for internal investigations will be established. A corporation will benefit from considerable mitigation of the sanction if it carries out an internal investigation that meets certain criteria (such as a cooperation with the authorities in an uninterrupted and unlimited manner, organizational separation between investigation and criminal defense, and adherence to fair trial standards).

In view of these developments, corporations should not only revise existing compliance systems to prevent corporate criminal misconduct, but also set up an action plan to be prepared for criminal investigations under the planned Corporate Sanctions Act. Considering that the current legislative period will end in the autumn of 2021, it is expected that a final resolution on the Corporate Sanctions Act will soon be reached by the legislator.

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6.2       Money Laundering: The German Government’s Intensified Fight for AML Compliance

In the past, the FATF (Financial Action Task Force) and others have often portrayed Germany as being too lenient in its efforts to combat money laundering, and the German regulatory framework was branded as containing too many loopholes. Recent developments surrounding the collapse of German pay service provider Wirecard have done little to assuage such views.

In response to such criticism, Germany has recently increased its efforts towards introducing a more forceful AML framework. A prime example of Germany’s new-found vigor in this regard is the fact that the German government opted not only to implement the 5th EU Money Laundering Directive, but to go above and beyond the minimum requirements set by the EU. As already discussed in sections 1.4, 5.2 and 6.2 of last year’s client alert, a number of legislative changes came into effect.[9]

In addition, the German government issued two distinct resolutions, namely the eleven points “National Strategy Package” and – in direct conjunction with the Wirecard collapse – the “16-Points Action Plan”. The corresponding changes are not limited to the German Criminal Code and the Anti Money Laundering Act (Geldwäschegesetz, GwG), but extend to establishing an improved organization of the German AML authorities.

The provision on money laundering in the German Criminal Code (section 261) will, according to the current Ministry of Justice draft bill, undergo a fundamental change. Pursuant to the intended legislation, the scope of section 261 of the German Criminal Code will be significantly broadened as any criminal wrongdoing may in the future constitute a predicate offense for money laundering.

Under the current state of the law, only a limited set of criminal offenses may give rise to money laundering. Importantly, criminal acts committed abroad may serve as predicate offenses for money laundering as well. The new legislation extends the scope of relevant prior offenses to certain acts which under EU law is required to be rendered punishable under the respective local criminal laws of the member states, irrespective of whether such act is in fact punishable in the jurisdiction at the place it is committed. Moreover, the offense of grossly-negligent money laundering has been re-introduced into the draft after a heated debate in this regard.

As supporting measures to the amended Anti Money Laundering Act, the German government decided to subject numerous economic players to (new or partially enhanced) AML requirements, including private financial institutions, crypto currency traders, real estate agencies and notaries who would be burdened with extended new obligations to disclose AML-related concerns regarding their customers and clients. These measures are mainly reflected in this year’s draft of a regulation on obligations to report certain facts surrounding real estate (Verordnung zu den nach dem Geldwäschegesetz meldepflichtigen Sachverhalten im Immobilienbereich).

Key German AML institutions were – as a direct result of the aforementioned government’s resolutions – significantly strengthened:

  • The Financial Intelligence Unit’s (FIU) personnel was more than doubled, and its data access rights were significantly expanded. In addition, a high level government body was established between German federal and local state authorities.
  • The German Federal financial supervisory authority BaFin was requested to ensure that companies and persons under its supervision implement any statutory obligations, and BaFin’s related supervisory competences were broadened.
  • The transparency registry which may be accessed by members of the public was established, collecting key relevant data including the UBO. Registration in the transparency register is mandatory for all companies with business activities in or related to Germany.

The German business community and relevant AML specialists should, at least, inform themselves or gain an in depth understanding of the new and extended regulatory framework. New monitoring systems need to be put in place to follow up on future predicate offenses. Therefore, relevant risk factors including those arising from new business models such as crypto currency trading have to be evaluated as a first step prior to implementing the new provisions.

While Germany has failed to implement new European AML requirements by December 3, 2020, the corresponding draft bill is expected to come into force soon.

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6.3       Cross-Border European Investigations: The European Public Prosecutor’s Office

To fight crimes against the fiscal interests of the European Union, the European Public Prosecutor’s Office (“EPPO”) is expected to become operative in 2021. The EPPO will act both on a centralized level with European Prosecutors based in Luxembourg having a supervisory and coordinating function and on a decentralized level with European Delegated Public Prosecutors situated in the participating EU member states having the same powers as national prosecutors to investigate specific cases. Its activities will focus on the prosecution of offenses to the detriment of the EU such as subsidy fraud, bribery and cross-border VAT evasion.

After the originally intended start of the new authority was delayed at the end of 2020, it is anticipated that investigation activities will start in 2021. In addition to the existing national criminal prosecution authorities and European institutions such as OLAF, Europol and Eurojust, a genuine European criminal prosecution authority will enter the stage and possibly bring about a shift in European enforcement trends. It is to be hoped that crimes affecting the EU’s financial interests will be pursued in a more robust manner and that international coordination of investigations will be significantly improved.

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7.         Data Privacy – Regulatory Activity and Private Enforcement on the Rise

The German Data Protection Authorities (“DPAs”) have certainly had a busy year. While, the trend towards higher fine levels for GDPR violations continues, the German DPAs have also initiated a number of investigations and issued guidance on a variety of issues, such as COVID-19 related data privacy concerns, the consequences of the “Schrems II” ruling of the Court of Justice of the European Union (judgment of July 16, 2020, case C-311/18)[10] and the use of video conferencing services and other technological tools in the context of working from home.

With regard to fines, in 2020 the German DPAs issued fines in the total amount of EUR 36.6 million (approx. USD 44.8 million). In October 2020, the Hamburg Data Protection Authority imposed a record-breaking fine in the amount of EUR 35.3 million (approx. USD 43.2 million) on a retail company for comprehensively and extensively collecting sensitive personal data from its employees, including health data and data about the employees’ personal lives, without having a sufficient legal basis to do so. This was the highest fine ever issued by a German DPA.

However, for companies it may well pay off to push back against such fines: The District Court (Landgericht) of Bonn largely overturned a fining decision issued by the German Federal Commissioner for Data Protection and Freedom of Information against a German telecommunications service provider in December 2019. While the court confirmed a violation of the GDPR, the court significantly reduced the fine in the amount of EUR 9.5 million (approx. USD 11.6 million) to EUR 900,000 (approx. USD 1.1 million).

Another important trend is the increasing number of private enforcements in the context of data protection violations. In particular, consumers are seeking judicial help to enforce information and access requests as well as compensation claims for material or non-material damages suffered as a result of GDPR violations, especially in the employment context. But German courts are apparently not (yet) prepared to award larger amounts to plaintiffs for this kind of GDPR violations. For example, in a case where an employee requested damages in the amount of EUR 143,500 (approx. USD 175,800) the Labor Court of Düsseldorf has awarded damages in the amount of only EUR 5,000 (approx. USD 6,000). Nevertheless, companies are well advised to keep an eye on future developments as courts may raise the amount of damages awarded if an increasing number of cases were to show that current levels of damages awarded are not sufficient to have a deterrent effect.

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8.         Technology

8.1       Committee Report on Artificial Intelligence

In November 2020, the German AI inquiry committee (Enquete-Kommission Künstliche Intelligenz des Deutschen Bundestages, hereafter the “Committee”) presented its final report, which provides broad recommendations on how society can benefit from the opportunities inherent in AI technologies while acknowledging the risks they pose. The Committee was set up in late 2018 and comprises 19 members of the German Parliament and 19 external experts.

The Committee’s work placed a focus on legal and ethical aspects of AI and its impact on the economy, public administration, cybersecurity, health, work, mobility, and the media. The Committee advocates for a “human-centric” approach to AI, a harmonious Europe-wide strategy, a focus on interdisciplinary dialog in policy-making, setting technical standards, legal clarity on testing of products and research, and the adequacy of digital infrastructure.

At a high level, the Committee’s specific recommendations relate to (1) data-sharing and data standards; (2) support and funding for research and development; (3) a focus on “sustainable” and efficient use of AI; (4) incentives for the technology sector and industry to improve scalability of projects and innovation; (5) education and diversity; (6) the impact of AI on society, including the media, mobility, politics, discrimination and bias; and (7) regulation, liability and trustworthy AI.

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8.2       Proposed German Legislation on Autonomous Driving

The German government announced plans to pass a law on autonomous vehicles by mid-2021. The new law is intended to regulate the deployment of connected and automated vehicles (“CAV”) in specific operational areas by the year 2022 (including Level 5 “fully automated vehicles”), and will define the obligations of CAV operators, technical standards and testing, data handling, and liability for operators. The proposed law is described as a temporary legal instrument pending agreement on harmonized international regulations and standards.

Moreover, the German government also plans to create, by the end of 2021, a “mobility data room”, described as a cloud storage space for pooling mobility data coming from the car industry, rail and local transport companies, and private mobility providers such as car sharers or bike rental companies. The idea is for these industries to share their data for the common purpose of creating more efficient passenger and freight traffic routes, and support the development of autonomous driving initiatives in Germany.

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9.         Antitrust and Merger Control

9.1       Enforcement Overview 2020

The German Federal Cartel Office (Bundeskartellamt), Germany’s main antitrust watchdog, has had another very active year in the areas of cartel prosecution, merger control, consumer protection and its focus on the digital economy.

On the cartel prosecution side, the Bundeskartellamt concluded several investigations in 2020 and imposed fines totaling approximately EUR 358 million against 19 companies and 24 individuals from various industries including wholesalers of plant protection products, vehicle license plates, and aluminum forging. It is of note that the fining level decreased by more than 50 % compared to 2019. While the Bundeskartellamt received 13 notifications under its leniency program, the increasing risks associated with private follow-on damage claims clearly reflect on companies’ willingness to cooperate with the Bundeskartellamt under its leniency regime. The authority stressed that it is continuing to explore alternative means to detect illegitimate cartel conduct, including through investigation methods like market screening and the expansion of its anonymous whistle-blower system.

In 2020, the Bundeskartellamt also reviewed approximately 1,200 merger control filings (i.e., approximately 14 % less than in 2019). As in previous years, more than 99 % of these filings were concluded during the one-month phase one review. Only seven merger filings required an in-depth phase-two examination. Of those, five were cleared in phase-two (subject to conditions in two of these cases), and two phase-two proceedings are still pending.

Looking ahead to the year 2021, the Bundeskartellamt will likely continue to focus on the digital economy and conclude its sector inquiry into online advertising. The agency also announced to go live with its competition register in Q1 of 2021 for public procurement purposes. This database will list companies that were involved in competition law infringements and other serious economic offenses.

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9.2       Paving the Way for Private Enforcement of Damages

In its Otis decision (C-435/18 of December 12, 2019), the European Court of Justice (ECJ) paved the way for private enforcement in cases concerning antitrust damages. The ECJ held that even a party not active on the market related to the one affected by the cartel may seek damages if there is a causal link between the damages incurred and the violation of Article 101 of the Treaty on the Functioning of the European Union (TFEU). The ECJ also reaffirmed that the scope of the right to compensation under Article 101 TFEU, i.e. the “who,” “what” and “why”, is governed by EU law while the national laws of the member states determine how to enforce the right.

Private enforcement of cartel damages is gaining momentum. Since the Otis decision, German courts, in particular the German Federal Supreme Court (Bundesgerichtshof, BGH), have further explored the course set by the ECJ in several antitrust damages cases concerning the so-called rail cartel.

The BGH held that Article 101 TFEU and, therefore, also the right to damages under German law, does not require the claimant to prove that a certain business transaction has directly been affected by the cartel at issue. Instead, it is sufficient if the claimant establishes that the cartel infringement is abstractly capable of causing damages to the claimant. As a result, courts only need to evaluate one long-lasting cartel infringement instead of individual breaches. The BGH further clarified in its decisions that the extent of an impairment by a cartel is a question of “how” a claimant would be compensated and, therefore, subject to German procedural law. As a consequence, the BGH encouraged courts to exercise judicial discretion when weighing the parties’ factual submissions and assessing cartel damages.

The BGH also ruled that the passing-on defense could apply if the claimant had received public grants which otherwise would not or not in such an amount have been paid to the claimant if the cartel had not existed. The court explained, however, that the defense may be barred when the damage is scattered to the downstream market level. In this case, it is inappropriate for the initiator of the cartel to walk free only because the individual damages were too minor to prompt claims for damages.

In the future, businesses will do well to monitor these ongoing developments as private enforcement actions of damages further gather pace and may develop into a sharp sword to police anti-competitive practices of other market players.

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9.3       Adoption of the “GWB Digitalization Act” expected for 2021

The draft bill for the 10th Amendment of the German Competition Act, also known as “GWB Digitalization Act” endorsed by the German Federal Government on September 9, 2020 is currently undergoing the legislative procedure in the German Parliament. The adoption of the bill is expected for early 2021. Having said that, the final discussions of the bill originally scheduled for December 17, 2020 were postponed until January 14, 2021.

As reported in our Year-End Alert 2019,[11] the draft bill addresses topics such as market dominance in the digital age and introduces a number of new procedural simplifications. For example, the bill currently foresees that companies, which depend on data sets of market-dominating undertakings or platforms, would have a legal claim to data access against such undertakings or platforms. Further, the draft bill introduces a rebuttable presumption whereby it is presumed that direct suppliers and customers of a cartel are affected by the cartel in case of transactions during the duration of the cartel with companies participating in the cartel.

Compared to the draft bill discussed in our Year-End Alert 2019, the governmental revision contains certain changes, in particular in the area of merger control. Thus, the draft bill currently features an increase of the two domestic turnover thresholds by EUR 5 million (approx. USD 6 million), i.e. from EUR 25 million to EUR 30 million (from approx. USD 30.6 million to approx. USD 36.8 million), and from EUR 5 million to EUR 10 million (from approx. USD 6.1 million to approx. USD 12.3 million), respectively. Additionally, a new provision was introduced in the legislative procedure, whereby the German Federal Cartel Office (Bundeskartellamt,) may require companies, which are deemed to reduce competition through a series of small company acquisitions in markets in which the Bundeskartellamt conducted sector inquiries, to notify every transaction in one or more specific sectors provided that certain thresholds are met. This notification obligation can be imposed on a company, if (i) the company has generated global turnover of more than EUR 500 million in the last business year, (ii) there are reasonable grounds for the presumption that future mergers could significantly impede effective domestic competition in the sectors for which the obligation has been imposed and (iii) the company has a market share of at least 15% in Germany in the sectors for which the obligation has been imposed. However, a notification will only be required if the target company has (i) generated turnover of more than EUR 2 million in the last business year and (ii) has generated more than two-thirds of its turnover in Germany. The notification obligation lasts for three years.

In light of the recent publication of the draft regulation on an EU Digital Markets Act by the European Commission, it remains to be seen how the German legislator will react to the proposals put forward by the Commission and how the national legislative procedure will evolve.

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10.       International Trade, Sanctions and Export Control

10.1     The New Chinese Export Control Law and its Impact on German Companies

The challenges, which German companies, specifically those with a U.S. parent or another U.S. nexus, face in light of the EU Blocking Statute’s prohibition to comply with certain U.S. sanctions on Iran and on Cuba, are well documented.[12] While 2021 might see calmer waters in the West due to the expected (yet far from certain) return to a more multilateral focus of the incoming Biden Administration, further complications await the German export business community in the East.

On December 1, 2020, a comprehensive new Chinese export control law went into effect. Generally speaking, the Chinese export control law reflects key elements of U.S. and EU/German export control related law. Particularly, licensing requirements for the export of controlled Chinese goods (including technologies) are determined on the basis of lists of goods and a catch-all clause.

As early as December 4, 2020, China’s Ministry of Commerce along with other authorities already published the first such lists of goods in the area of “commercial cryptography”, i.e. regarding goods and technologies which can be used for encryption, inter alia, in telecommunication applications, VPN equipment or quantum cryptographic devices.

It is likely that any significant restrictions on, inter alia, exports of certain U.S. origin items and technology to China will eventually be mirrored in the respective Chinese lists to also impose significant restrictions on the export of certain Chinese origin items and technology to the U.S. For many German-based companies with a diversified supply chain this raises the unenviable prospect that they may use suppliers whose sourced goods originate in the U.S. and in China, respectively, which feature on each of the respective lists. This conflict may eventually limit the number of counterparties the German company can export the final product to without jeopardizing either supply chain. It may also limit the possibility of cooperation (e.g. technology transfer) with U.S. and/or Chinese suppliers and customers alike.

Further, China’s new Export Control Law contains regulation comparable to the (U.S.) concept of “deemed export” via the definition of “exports”, which applies when a Chinese person transfers listed goods to a foreign person. Depending on how extensively this is interpreted by the Chinese authorities, this could, for example, result in Chinese export control law also applying to transfers by Chinese individuals located in Germany to a German person. Therefore, the details of this potential extraterritorial effect of Chinese export control law, as well as a vague reference to an extension of Chinese export control law to re-exports of listed goods and technologies or goods and technologies covered by the catch-all regime, raises numerous questions that will presumably only be clarified in time by the publication of specific regulations or guidance by the Chinese authorities.

Additionally, the EU is also taking initial steps to further strengthen its defense mechanisms against perceived and potential interference with its sovereignty by the extraterritorial effects of U.S. and Chinese export control laws. Specifically, the EU Parliament requested a study[13] on extraterritorial sanctions on trade and investments and European responses, that, inter alia, suggests the establishment of an EU agency of Foreign Assets Control (EU-AFAC) with the aim of more efficient and effective enforcement of, inter alia, the EU Blocking Statute, which might also come to include parts of the Chinese export control law.

In any case, any German export control compliance department would be well-advised to update its Internal Compliance Program to be able to identify conflicting compliance obligations early and establish a process to swiftly resolve them – without breaching applicable anti-boycott regulations – in order to avoid the supply-chain-management of the company being negatively impacted.

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10.2     Update on the German Rules regarding Foreign Direct Investment Control

For a summary of the recent reforms of German foreign investment control laws, reference is made to section 1.3 above.

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11.       Litigation

11.1     Establishment of Commercial Courts in Germany – An Emerging Forum for International Commercial Disputes?

Over the past few years, Germany has taken several efforts to become a more attractive forum venue for international disputes. In 2010, three District Courts (Landgerichte) in Cologne, Bonn and Aachen had established English-speaking divisions for civil disputes. Since January 2018, the Frankfurt district court has allowed oral hearings in international commercial disputes to be conducted in English, provided the parties agree. The same now applies for the district courts in Mannheim and Stuttgart where two civil and two commercial divisions specially established for this purpose have started their work in November 2020. The civil divisions consist of three professional judges, respectively. The commercial divisions offer a combination of legal and industry-specific expertise and are led by one professional judge and two honorary judges from the local business community. All divisions have been equipped with state-of-the-art technical equipment, allowing for video-conferences and video testimonies of witnesses and experts.

Provided that the district court in Mannheim or in Stuttgart has jurisdiction (or the parties agree), the Commercial Courts in Mannheim or Stuttgart may hear corporate disputes, post-M&A disputes as well as disputes concerning mutual commercial transactions. Additionally, the court in Mannheim is available for disputes resulting from banking and financial transactions. While the Commercial Court in Stuttgart does not limit its jurisdiction to a certain litigation value, the court in Mannheim (its patent division enjoys global recognition) requires an amount in dispute of at least EUR 2 million. To ensure an effective review at the appellate level, the Higher District Courts (Oberlandesgerichte) in Stuttgart and Karlsruhe have also established specialized appeal panels responsible for dealing with appeals and complaints against the decisions of the new Stuttgart and Mannheim Commercial Courts.

The new Commercial Courts are supposed to let international litigants benefit from the high quality of the German court system and the advantages of its procedural rules. Overall, the duration of court proceedings in Germany is fairly short. There is no “American-style” discovery process. Costs are moderate by international standards, and must be borne by the losing party. Hearings are usually held in public, but the public can be excluded when business secrets are discussed. Additionally, parties may decide whether or not to allow for an appeal.

Despite these benefits, it remains to be seen whether the Commercial Courts in practice will measure up to these high expectations: Even though oral hearings may be conducted in English and a translation of English appendices is no longer required, every written submission must still be filed in German, and the decisions the court renders are in German as well. In any case, the new Commercial Courts seem to be a further step into the right direction towards a more international business-friendly approach.

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11.2     Directive for Collective Redress – Class Action at EU-Level

On December 4, 2020, following an agreement between the EU-institutions in June 2020, the EU-Parliament has approved the “Directive on representative actions for the protection of the collective interests of Consumers” (the “Directive”)[14], introducing the possibility of collective redress across the borders within the EU. The Directive aims to strengthen the protection of EU-consumer rights in case of mass damages, covering both domestic and cross-border infringements, especially with regard to data protection, energy, telecoms, travel and tourism, environment and health, airline rights and financial services. The EU Member States need to implement the Directive into their national laws within two years and six months, i.e. by mid-2023.

Under the Directive, collective legal actions may only be taken by “qualified entities” on behalf of consumers against traders, seeking injunction and/or redress measures. For the purpose of cross-border representative actions, the qualified entities may only be designated (by the Member State) if they comply with EU-wide criteria (i.e. non-profit, independent, transparent and ensure a legitimate interest in consumer protection). To prevent abusive litigation, the defeated party has to bear the costs of the proceedings (“loser pays”) and courts or administrative authorities may dismiss manifestly unfounded cases. Consumers can join the action by either opt-in or opt-out mechanisms, depending on the decision regarding procedure which each Member State takes.

Even though the legal orders of many Member States already provide for the possibility of collective redress, the Directive assures (i) a harmonized approach to collective redress and (ii) mandatory redress measures in every Member State such as compensation, repair or price reduction without the need to bring a separate action. Therefore, the Directive goes beyond some existing regulations, which only allow declaratory actions or injunctive relief. At the same time, individual actions by plaintiffs remain possible and unregulated at the EU level. As the diesel emissions lawsuits in Germany demonstrate, this can lead to waves of mass actions and a massive clogging of court dockets.

Even though the deadline for the implementation of the Directive is still sometime down the road, the adoption of laws and regulations in the Member States to implement the Directive will need to be closely monitored by companies and law firms, in particular with regard to the various Member States’ chosen path on such issues as opt-in vs. opt-out and discovery or disclosure of documents.

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11.3     German Courts and the COVID-19 Pandemic

COVID-19 has affected all areas of life, including the court system. Over the year 2020, German courts had to learn how to litigate despite the pandemic and conduct oral hearings, as well as litigation in general, as safe as possible for everyone involved.

During the first wave of the pandemic in spring 2020, non-urgent matters were mostly postponed. Some courts in areas particularly troubled by the virus were forced to close their buildings to the public. However, the German administration of justice was never completely suspended or paused.

During the summer of 2020, with fewer COVID-19 cases, court proceedings started to normalize and courts developed concepts to continue with litigation despite the pandemic. In appropriate cases, courts tried to avoid oral hearings and, with the parties’ consent, conducted the proceedings in writing only. Courts also slowly started to hold oral hearings using video conferencing tools. While the German Rules of Civil Procedure (Zivilprozessordnung, ZPO) allow this method since 2001, German Courts were reluctant to use it before the pandemic. However, in the vast majority of cases, German Courts still conduct oral hearings despite the COVID-19 situation. Most courts adhere to hygiene concepts for these hearings, such as wearing face masks, keep sufficient distance between the individuals and ventilate the court room frequently.

For the year 2021, we expect that more and more courts elect to conduct the proceedings in writing or by videoconference. If an oral hearing is necessary nevertheless, the courts now have hygienic routines in place. Thus, unless we see a dramatic change in the COVID-19 infection rates, we do not expect that German courts will need to reduce their working speed in 2021.

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12.       Update on COVID-19 Measures in Germany

As in other jurisdictions, the COVID-19 pandemic has led to a large variety of legislative measures in Germany, which were aimed at mitigating the impact of the pandemic on the economy. These measures included in particular a moratorium for continuing obligations (temporary right to refuse performance under certain contracts), a temporary deferral of payment for consumer loans, the Special Program 2020 set up by the Kreditanstalt für Wiederaufbau (KfW) and the introduction of the Economic Stabilization Fund (Wirtschaftsstabilisierungsfonds). While many of these state measures and programs are still in place unchanged, others have been amended and adapted in time and some have lapsed without replacement. The following summary therefore gives a short overview on the current status of the COVID-19-induced state measures and programs in Germany. Most of the measures mentioned in this alert have already been covered in more detail in previous alerts published throughout 2020, that can be found here.[15]

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12.1     Economic Stabilization Fund (Wirtschaftsstabilisierungsfonds)

The Act on the Introduction of an Economic Stabilization Fund (Gesetz zur Errichtung eines Wirtschaftsstabilisierungsfonds – WStFG) entered into force on March 28, 2020. This act provides the statutory framework for state stabilizing measures, in particular, guarantees and recapitalization measures, like the acquisition of subordinated debt instruments, profit-sharing rights (Genussrechte), silent partnerships, convertible bonds and the acquisition of shares. After the introduction of the Economic Stabilization Fund was approved under state aid law by the EU Commission in July 2020 and the legal regulations for its implementation were published in the Federal Law Gazette in October 2020, the Economic Stabilization Fund has become fully operational.

Moreover, in July 2020 the new Economic Stabilization Acceleration Act (Wirtschaftsstabilisierungsbeschleunigungsgesetz – WStBG) came into force, which provides for temporary modifications of German corporate law in order to implement the state aid measures by the Economic Stabilization Fund more efficiently. These changes include, inter alia, facilitations for capital measures and transactions (capital increases, capital reductions, etc.) in connection with stabilization measures, which significantly relax minority protection.

Since the introduction of the Economic Stabilization Fund, there have been several high profile cases, in which those measures have been effectively put into action: Deutsche Lufthansa (silent participation in the amount of EUR 5,7 billion and subscription of shares by way of a capital increase amounting to 20% of the share capital), TUI (convertible bond and various other emergency support measures in the amount of EUR 1.3 billion), FTI Touristik (subordinated loan in the amount of EUR 235 million), MV Werften Holding (subordinated loan in the amount of EUR 193 million) and German Naval Yards Kiel (subordinated loan in the amount of EUR 35 million).

Originally, (i) guarantees under the Economic Stabilization Fund could only be granted until December 31, 2020 and (ii) the application period for recapitalization measures was set to run until June 30, 2021. These deadlines have now been extended and (i) guarantees can now be granted until June 30, 2021 and (ii) recapitalizations can be granted until September 30, 2021, respectively.

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12.2     Corporate Law Modifications pursuant to the COVID-19 Pandemic Mitigation Act

The COVID-19 Pandemic Mitigation Act (Gesetz zur Abmilderung der Folgen der COVID-19-Pandemie im Zivil-, Insolvenz- und Strafverfahrensrecht) provided for, inter alia, (i) a modification of the Limited Liability Company Act (GmbHG), which facilitates shareholder resolutions in text form or by written vote (circulation procedure) without requiring the consent of all shareholders to such procedure, and (ii) a modification of the Conversion Act (UmwG) with regard to measures requiring the submission of a closing balance sheet, where the balance sheet reference date (Bilanzstichtag) used in such filings can now be up to twelve months old at the time of the register filing instead of a maximum of eight months as under the regular statutory rules.

Both of these COVID-19-induced rules were extended by legislative decree dated October 20, 2020 (Verordnung zur Verlängerung von Maßnahmen im Gesellschafts-, Genossenschafts-, Vereins- und Stiftungsrecht zur Bekämpfung der Bekämpfung der Auswirkungen der COVID-19-Pandemie) and are effective until December 31, 2021.

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12.3     Moratorium for Continuing Obligations and Consumer Loans, Restriction of Lease Terminations

The COVID-19 Pandemic Mitigation Act also introduced a moratorium for substantial continuing obligations (i.e. those which serve to provide goods or services of general interest, such as the supply of energy and water), which allowed obligors to refuse to fulfill their obligations if they were no longer able to meet their obligations as a result of the COVID-19 pandemic. This moratorium was limited to June 30, 2020. It could theoretically have been extended thereafter by legislative decree until September 30, 2020, but the government decided not to make use of the option to extend the moratorium. The moratorium therefore expired on June 30, 2020.

Likewise, the payment deferral for consumer loan agreements, which stipulated that claims of lenders for payment of principal or interest due between April 1 and June 30, 2020 were deferred by three months, was not extended by the government, either. As a result, debtors can no longer defer payment, and in order to avoid a double burden for the debtor, the period of the loan agreement will be extended by three months, unless the lender under such a consumer loan and the debtor have reached another arrangement.

Furthermore, the COVID-19 Pandemic Mitigation Act restricts the landlords’ termination right concerning German real estate lease agreements. Until June 30, 2022, a landlord is not entitled to terminate such a lease agreement solely based on the argument that the tenant is in default with payment of the rent for the period April 1, 2020 through June 30, 2020 if the tenant provides credible evidence that the payment default is based on the impact of the COVID-19 pandemic. The landlord’s other contractual and statutory termination rights as well as its rental payment claims for such period, however, remained unaffected by the COVID-19 Pandemic Mitigation Act. Likewise, the government did not make use of the option to extend the termination restrictions to backlogs in tenants’ payments for the period July 1, 2020 through September 30, 2020.

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12.4     Request for Adjustment of Commercial Lease Agreements

The German Parliament (Bundestag) passed a bill on December 17, 2020 that is supposed to increase the chances of tenants of German commercial property or room leases to successfully request an adjustment of the contractual lease terms or even termination of the lease pursuant to Section 313 German Civil Code (Bürgerliches Gesetzbuch – BGB) due to the COVID-19 pandemic. A request pursuant to Section 313 BGB requires that (i) circumstances that are the mutually accepted basis of the contract have significantly changed since the conclusion of the contract, (ii) the parties would not have entered into the contract or only with different content if they had foreseen this change, and (iii) the party making such a request cannot reasonably be expected to be held to the terms of the contract without adjustments or even at all taking into account all circumstances of the specific case, in particular, the contractual or statutory distribution of risk between the parties.

According to this bill, circumstances that are the mutual basis of the contract are refutably deemed to have significantly changed if the use of such leased premises is significantly restricted due to public measure for the purpose of combating the COVID-19 pandemic. As the tenant still needs to show that the other conditions are fulfilled, in particular, that the balancing of interest under (iii) above is in its favor, it remains to be seen whether this bill has the desired effect. Attempting to find an amicable solution may still be the better option for both the landlord and the tenant.

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12.5     Miscellaneous

In addition to the legislative measures mentioned above, Germany has introduced a varied array of additional programs to stabilize and support the German economy. Particularly noteworthy is the KfW’s Special Program 2020 (“KfW Sonderprogramm 2020 für Investitions- und Betriebsmittelfinanzierung”), which includes the KfW Entrepreneur Loan (“KfW Unternehmerkredit”), the ERP Start-Up Loan – Universal (“EPR Gründerkredit – Universell”) and the KfW Special Program Syndicated Lending (KfW Sonderprogramm “Direktbeteiligung für Konsortialfinanzierung“). The Special Program 2020 was originally set to run until December 31, 2020 and has in the meantime been extended until June 30, 2021. The European Commission has not yet approved the program under state aid law, but this is expected to take place in the near future.

The Immediate Corona Support Program for small(est) enterprises and sole entrepreneurs (Corona Soforthilfe für Kleinstunternehmen und Soloselbstständige) was a one-off payment for three months during the first lockdown in the spring of 2020, that has not been relaunched by the government in connection with the second lockdown in Germany in the fall of 2020. However, similar support has been provided to companies which are particularly affected by the lockdown (most notably restaurants and hotels) through the so-called “November and December COVID-relief” program (November- und Dezemberhilfen).

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12.6     Conclusion

The COVID-19 pandemic is obviously not over yet and it is difficult to predict how things will develop going forward. It is important for companies to keep an eye on the current status of the COVID-19 support measures and programs and how they will be amended or evolve over time. Otherwise, there is the risk that new support programs will be overlooked or deadlines for existing programs will be missed.

The following webpage provides a good overview of the current support measures for businesses in Germany: https://www.bmwi.de/Redaktion/DE/Coronavirus/coronahilfe.html.

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____________________

   [1]   Also see our alerts dated March 27, 2020, section III., published under https://www.gibsondunn.com/whatever-it-takes-german-parliament-passes-far-reaching-legal-measures-in-response-to-the-covid-19-pandemic/ and dated September 24, 2020, published under https://www.gibsondunn.com/covid-19-german-rules-on-possibility-to-hold-virtual-shareholders-meetings-likely-to-be-extended-until-end-of-2021/.

   [2]   EU Regulation (EU) 2019/452 of March 19, 2019 establishing a framework for screening of foreign direct investments into the EU, available in the English language version under: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32019R0452&from=EN.

   [3]   “German Foreign Investment Control Tightens Further”, available under https://www.gibsondunn.com/german-foreign-investment-control-tightens-further/.

   [4]   “Update on German Foreign Investment Control: New EU Cooperation Mechanism & Overview of Recent Changes”, available under https://www.gibsondunn.com/update-on-german-foreign-investment-control-new-eu-cooperation-mechanism-and-overview-of-recent-changes/.

   [5]      In this context, see section 1.6 of 2015 Year End Alert available under https://www.gibsondunn.com/2015-year-end-german-law-update/.

   [6]   We refer you to our earlier alerts in this regard available at: https://www.gibsondunn.com/whatever-it-takes-german-parliament-passes-far-reaching-legal-measures-in-response-to-the-covid-19-pandemic/ and at https://www.gibsondunn.com/european-and-german-programs-counteracting-liquidity-shortfalls-and-relaxations-in-german-insolvency-law/, as well as more specifically on insolvency filing obligations https://www.gibsondunn.com/temporary-german-covid-19-insolvency-regime-extended-in-modified-form/.

   [7]   Again see our alert at https://www.gibsondunn.com/temporary-german-covid-19-insolvency-regime-extended-in-modified-form/.

   [8]   Available under https://www.gibsondunn.com/covid-19-short-term-reduction-of-personnel-costs-under-german-labor-law/.

   [9]   Available under https://www.gibsondunn.com/2019-year-end-german-law-update/.

[10]   See https://www.gibsondunn.com/the-court-of-justice-of-the-european-union-strikes-down-the-privacy-shield-but-upholds-the-standard-contractual-clauses-under-conditions/.

[11]   Section 7.2 in the Year-End Alert published under https://www.gibsondunn.com/2019-year-end-german-law-update/.

[12]   Available under https://www.gibsondunn.com/new-iran-e-o-and-new-eu-blocking-statute-navigating-the-divide-for-international-business/.

[13]   This study is available under: https://www.europarl.europa.eu/RegData/etudes/STUD/2020/653618/EXPO_STU(2020)653618_EN.pdf.

[14]   See at https://eur-lex.europa.eu/legal-content/en/TXT/PDF/?uri=CELEX:32020L1828&from=DE.

[15]   These earlier alerts are available under https://www.gibsondunn.com/european-and-german-programs-counteracting-liquidity-shortfalls-and-relaxations-in-german-insolvency-law/, under https://www.gibsondunn.com/whatever-it-takes-german-parliament-passes-far-reaching-legal-measures-in-response-to-the-covid-19-pandemic/ and under https://www.gibsondunn.com/corporate-ma-in-times-of-the-corona-crisis-current-legal-developments-for-german-business/.

 

The following Gibson Dunn lawyers assisted in preparing this client update:  Birgit Friedl, Marcus Geiss, Carla Baum, Silke Beiter, Andreas Dürr, Lutz Englisch, Ferdinand Fromholzer, Daniel Gebauer, Kai Gesing, Franziska Gruber, Selina Grün, Johanna Hauser, Alexander Horn, Markus Nauheim, Patricia Labussek, Wilhelm Reinhardt, Markus Rieder, Richard Roeder, Sonja Ruttmann, Martin Schmid, Annekatrin Schmoll, Benno Schwarz, Ralf van Ermingen-Marbach, Linda Vögele, Friedrich Wagner, Frances Waldmann, Michael Walther, Georg Weidenbach, Finn Zeidler, Mark Zimmer, Stefanie Zirkel and Caroline Ziser Smith.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. The two German offices of Gibson Dunn in Munich and Frankfurt bring together lawyers with extensive knowledge of corporate, M&A, finance and restructuring, tax, labor, real estate, antitrust, intellectual property law and extensive compliance / white collar crime experience. The German offices are comprised of seasoned lawyers with a breadth of experience who have assisted clients in various industries and in jurisdictions around the world. Our German lawyers work closely with the firm’s practice groups in other jurisdictions to provide cutting-edge legal advice and guidance in the most complex transactions and legal matters. For further information, please contact the Gibson Dunn lawyer with whom you work or any of the following members of the German offices:

General Corporate, Corporate Transactions and Capital Markets
Lutz Englisch (+49 89 189 33 150), [email protected])
Markus Nauheim (+49 89 189 33 122, [email protected])
Ferdinand Fromholzer (+49 89 189 33 170, [email protected])
Dirk Oberbracht (+49 69 247 411 510, [email protected])
Wilhelm Reinhardt (+49 69 247 411 520, [email protected])
Birgit Friedl (+49 89 189 33 122, [email protected])
Silke Beiter (+49 89 189 33 170, [email protected])
Annekatrin Pelster (+49 69 247 411 521, [email protected])
Marcus Geiss (+49 89 189 33 115, [email protected])

Finance, Restructuring and Insolvency
Sebastian Schoon (+49 69 247 411 540, [email protected])
Birgit Friedl (+49 89 189 33 122, [email protected])
Alexander Klein (+49 69 247 411 518, [email protected])
Marcus Geiss (+49 89 189 33 115, [email protected])

Tax
Hans Martin Schmid (+49 89 189 33 110, [email protected])

Labor Law
Mark Zimmer (+49 89 189 33 130, [email protected])

Real Estate
Hans Martin Schmid (+49 89 189 33 110, [email protected])
Daniel Gebauer (+49 89 189 33 115, [email protected])

Technology Transactions / Intellectual Property / Data Privacy
Michael Walther (+49 89 189 33 180, [email protected])
Kai Gesing (+49 89 189 33 180, [email protected])

Corporate Compliance / White Collar Matters
Benno Schwarz (+49 89 189 33 110, [email protected])
Michael Walther (+49 89 189 33 180, [email protected])
Mark Zimmer (+49 89 189 33 130, [email protected])
Finn Zeidler (+49 69 247 411 530, [email protected])
Ralf van Ermingen-Marbach (+49 89 189 33 161, [email protected])

Antitrust
Michael Walther (+49 89 189 33 180, [email protected])
Jens-Olrik Murach (+32 2 554 7240, [email protected])
Georg Weidenbach (+69 247 411 550, [email protected])
Kai Gesing (+49 89 189 33 180, [email protected])

Litigation
Michael Walther (+49 89 189 33 180, [email protected])
Markus Rieder (+49 89 189 33 160, [email protected])
Mark Zimmer (+49 89 189 33 130, [email protected])
Finn Zeidler (+49 69 247 411 530, [email protected])
Kai Gesing (+49 89 189 33 180, [email protected])

International Trade, Sanctions and Export Control
Michael Walther (+49 89 189 33 180, [email protected])
Richard Roeder (+49 89 189 33 122, [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 January 9, 2021, the Ministry of Commerce of the People’s Republic of China (the “MOFCOM”) issued the MOFCOM Order No. 1 of 2021 on Rules on Counteracting Unjustified Extraterritorial Application of Foreign Legislation and Other Measures (the “Chinese Blocking Statute”). The Chinese Blocking Statute establishes the first sanctions blocking regime in China to counteract the impact of foreign sanctions on Chinese persons.[1] While the law is effective immediately, as noted below, it currently only establishes a legal framework. The law will become enforceable once the Chinese government denotes the specific extraterritorial measures—likely sanctions and export controls the United States is increasingly levying against Chinese companies—to which it then will apply.

The European Union has a comparable set of rules – known as the “EU Blocking Statute” – which seeks to restrict the impact on EU parties of unilateral, extraterritorial U.S. sanctions.[2] The new Chinese rules appear to borrow much from the European model.

There are several core components to the new Chinese rule:

Reporting Obligation: The Chinese Blocking Statute creates a reporting obligation for Chinese persons and entities impacted by extraterritorial foreign regulations. Under the new rules, when “a [Chinese] citizen, legal person or other organization … is prohibited or restricted by foreign legislation and other measures from engaging in normal economic, trade and related activities with a third State (or region) or its citizens, legal persons or other organizations,” the Chinese person or entity is required to report such matters to China’s State Council within 30 days.[3] Critically, this reporting obligation is applicable to Chinese subsidiaries of multinational companies.

A comparable reporting requirement, including the 30-day reporting obligation, is also found in the EU Blocking Statute.[4]

Implicated Foreign Laws: Unlike the EU Blocking Statute, the specific laws and measures covered by the Chinese Blocking Statute have yet to be identified. Specifically, the Chinese Blocking Statute establishes a mechanism for the government to designate specific foreign laws as “unjustified extraterritorial applications,” and subsequently issue prohibitions against compliance with these foreign laws. Under the Chinese Blocking Statute, a “working mechanism” led by the State Council is responsible for assessing and determining whether the foreign sanctions laws constitute “unjustified extra-territorial application of foreign legislation and other measures.” The law sets out an open-ended and largely undefined list of factors for the State Council to consider, including whether the law represent “a violation of principals of international relations,” impacts China’s “national sovereignty, security and development interests,” or effects the “legitimate rights and interests” of Chinese persons and entities, as well as “other factors that shall be taken into account.”[5] If the working mechanism confirms the existence of an “unjustified extraterritorial application” of a foreign law, it will direct the State Council to issue an order prohibiting parties in China from complying with the law.[6]

The EU Blocking Statute, in comparison, applies only to a specific set of laws specified in its Annex[7]–which presently consists principally of certain U.S. sanctions on Cuba and Iran. While the Chinese model may appear to provide individuals and entities with time to adjust and comply as the Chinese government will only list laws and measures in the future, the Chinese rules might eventually target substantially more foreign laws and measures.

Exemption Process: A Chinese person or entity will be able to apply for an exemption from compliance with the prohibition by submitting a written application to the State Council. Such request will need to provide the reasons for and the scope of the requested exemption. The State Council will then decide whether to approve such application within 30 days or less.[8] The format for applying for an exemption is not yet clear.

The EU Blocking Statute has a similar exemption mechanism. However, the EU Blocking Statute provides for approval “(…) without delay[9]—which in practice can mean significantly more than 30 days.

Private Right of Action: Like the EU Blocking Statute, the Chinese rule creates a private right of action for Chinese persons or entities to seek civil remedies in Chinese courts from anyone who complies with prohibited extraterritorial measures, unless the State Council has granted an exemption to the prohibition order.[10] Under the EU Blocking Statute, EU entities are also entitled to sue for damages, including legal costs, arising from the application of the extraterritorial measures (enforcement of which claims may extend to seizure and sale of assets).[11]

A Chinese person or entity who suffers “significant losses” due to a counterparty’s compliance with a prohibited law may also obtain “necessary support” from the Chinese government[12].

Consequences of Non-Compliance: A Chinese person or entity who fails to comply with the reporting obligation or the prohibition order may be subject to government warnings, orders to rectify, or fines.[13] Under the EU Blocking Statute, individual member states exercise enforcement authority. In several such states, entities have been threatened with fines, and have even been subject to mandated specific performance of contractual obligations which may expose them to risk of liability under U.S. sanctions.

While the Chinese regulations remain nascent and the initial list of extra-territorial measures that the Blocking Statute will cover has yet to be published, the law marks a material escalation in the longstanding Chinese rhetoric threatening counter-measures against the United States (principally) by establishing a meaningful Chinese legal regime that will challenge foreign companies with operations in China. If the European model for the Blocking Statute continues to be Beijing’s inspiration, we will likely see both administrative actions to enforce the measures as well as private sector suits to compel companies to comply with contractual agreements, even if doing so is in violation of their own domestic laws.

U.S. authorities recognize the challenge posed by the EU Blocking Statute, and the recent increasingly robust public and private sector enforcement of it. However, the U.S. Government has not formally adjusted U.S. sanctions programs to account for the legal conflict faced by U.S. and European companies eager to remain on the right side of both U.S. and European regulations. The question for the United States with respect to this new Chinese law will be how to balance the progressively aggressive suite of U.S. sanctions and export control measures levied against China—which the U.S. Government is unlikely to pare back—against the growing regulatory risk for global firms in China that could be caught between inconsistent compliance obligations.

As has long been the case, international companies will continue to be on the front lines of Beijing-Washington tensions and they will need to remain flexible in order to respond to a fluid regulatory environment and maintain access to the world’s two largest economies.

______________________

   [1]   MOFCOM Order No.1 of 2021 on Rules on Counteracting Unjustified Extra-Territorial Application of Foreign Legislation and Other Measures (January 9, 2021) (“Chinese Blocking Statute”), http://www.mofcom.gov.cn/article/b/c/202101/20210103029710.shtml (Chinese), http://english.mofcom.gov.cn/article/policyrelease/questions/202101/20210103029708.shtml (English)

   [2]   https://www.gibsondunn.com/new-iran-e-o-and-new-eu-blocking-statute-navigating-the-divide-for-international-business/

   [3]   Chinese Blocking Statute (Article 5)

   [4]   Article 2 of Council Regulation (EC) No 2271/96 of 22 November 1996 protecting against the effects of the extra-territorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom.

   [5]   Chinese Blocking Statute (Articles 4 & 6)

   [6]   Id. (Article 7)

   [7]   Id. (Article 5); Annex of Council Regulation (EC) No 2271/96 of 22 November 1996 protecting against the effects of the extra-territorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom. Under Article 11a, the European Commission has power to adopt legislation adding further foreign extraterritorial laws to the Annex to the EU Blocking Statute.

   [8]   Chinese Blocking Statute (Article 8)

   [9]   Article 5 of Commission Implementing Regulation (EU) 2018/1101 of 3 August 2018 laying down the criteria for the application of the second paragraph of Article 5 of Council Regulation (EC) No 2271/96 protecting against the effects of the extra-territorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom.

[10]   Chinese Blocking Statute (Article 9)

[11]   Article 6 of Council Regulation (EC) No 2271/96 of 22 November 1996 protecting against the effects of the extra-territorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom.

[12]   Chinese Blocking Statute (Article 11)

[13]   Chinese Blocking Statute (Article 13)


The following Gibson Dunn lawyers assisted in preparing this client update: Kelly Austin, Judith Alison Lee, Adam M. Smith, Patrick Doris, Ronald Kirk, Ning Ning, Chris Timura, Stephanie Connor, and Richard Roeder.

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])
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])
Ben K. Belair – Washington, D.C. (+1 202-887-3743, [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])
Jesse Melman – New York (+1 212-351-2683, [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 and Europe:
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])
Joerg Bartz – Singapore – (+65 6507 3635, [email protected])
Peter Alexiadis – Brussels (+32 2 554 72 00, [email protected])
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])

© 2020 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 past year saw the enactment of a variety of new employment laws in California, including new disclosure requirements for employers and changes to the independent contractor landscape. In addition, the COVID-19 pandemic has touched nearly every sector of society, in nearly every corner of the world, and employment law in California is certainly no exception. The pandemic has ushered in a new legal landscape marked by heightened requirements for employers stretching from 2020 into 2023.

Below, we outline four new laws that require attention from California employers in the new year: (1) the new requirements for California employers in reporting wage and hour data; (2) the continuing evolution of the worker classification standard and the recent passage of Proposition 22; (3) the new COVID-19 notice requirements that will require employers to notify employees of possible exposure; and (4) the new Workers’ Compensation Disputable Presumption under SB 1159. We also highlight California’s current plan for rolling out the recently approved COVID-19 vaccines, a strategy that will no doubt develop more in the next few months as essential workers become eligible to receive the vaccine.

____________________

Table of Contents

I.        California Employers Required to File Equal Pay Report to California DFEH (SB 973)

II.       Amendment to ABC Test Under Assembly Bill 2257 and Proposition 22

III.     COVID-19 Notice Requirements Under Assembly Bill 685

IV.      Workers’ Compensation Disputable Presumption Under Senate Bill 1159

V.        COVID-19 Vaccine – Who Will Get It and When?

____________________

I.  California Employers Required to File Equal Pay Report to California DFEH (SB 973)

On September 30, 2020, California Governor Gavin Newsom signed Senate Bill 973 (“SB 973”) into law, which requires employers to submit pay and hours data for various categories of employees to California’s Department of Fair Employment and Housing (“DFEH”). The stated goals of SB 973 are to decrease gender and racial pay disparities in California and fill the gap of the currently suspended federal effort to collect data for these purposes.

A.  Background on SB 973 – From President Obama to Governor Newsom

Since the 1960s, employers with 100 or more employees have been required to report certain demographic data to the Equal Employment Opportunity Commission (“EEOC”). The Obama Administration expanded the reporting requirements in 2016, adding hours and pay data to the report, which would be broken down by job category, race, ethnicity and gender. The EEOC collected this data until September 2019, when it announced that it would no longer collect the information. SB 973 was enacted in an effort to continue the Obama Administration’s equal pay policies by imposing largely the same requirements that existed under those policies.

B.  When Does the Law Take Effect?

The law took effect on January 1, 2021, and the first report is due on March 31, 2021, with subsequent reports due each year thereafter. Employers should begin compiling the relevant data as soon as possible to ensure compliance. The DFEH has stated that it intends to issue standard forms that employers will be able to use to prepare the reports.

C.  Who Does the Law Apply To?

The law applies to private employers with 100 or more employees, or employers who are required to file a federal Employer Information Report EEO-1 form. According to current DFEH guidelines, employees both inside and outside of California are counted when determining whether an employer has 100 or more employees. Temporary workers will also count toward the determination of whether an employer meets 100 employees, if the employer is required to include the temporary workers in an EEO-1 report, and if the employer is required to withhold federal social security taxes from their wages.

D.  What Information Does the Report Require?

Employers will need to create a “snapshot,” counting all employees (part and full-time) in a given category during a single pay period of the employer’s choice between October 1 and December 31 of the prior calendar year (the “Reporting Year”). To prepare the report, employers should first count and record the number of employees by race, ethnicity, and gender organized by job categories (which are the same categories used by the federal government in the EEO-1 report).[1]

Second, employers will need to further break down the data by separating employees in each category by pay band.[2] To determine what pay band an employee falls into, the employer should look at the employee’s W-2 earnings for the entire Reporting Year, regardless of whether that employee worked for the full calendar year.

Third, using the same general format, the employer must include the total number of hours worked by each employee counted in each pay band during the Reporting Year.

The employer will be permitted, but not required, to provide clarifying remarks. The report must be in searchable and sortable format. If the employer has multiple establishments, it will need to submit a separate report for each establishment, as well as a consolidated report. Each report should include the employer’s North American Industry Classification System (NAICS) code.

If an employer fails to submit a report, the DFEH may seek an order requiring the employer to comply with the requirements and will be entitled to recover the costs associated with seeking the order for compliance.

E.  What Does the Law Mean For Employers, Besides Additional Reporting?

While the intent is for the DFEH to use the reported data to “more efficiently identify wage patterns and allow for targeted enforcement of equal pay or discrimination laws,” in reality, these goals are more likely to be impeded than helped by the data collected. This is because W-2 data is not a precise—or even remotely reliable—measure of wages paid.

For instance, W-2 compensation reflects an employee’s reported income for a calendar year, which is not necessarily tied to the number of hours worked or the employee’s earnings in that year. Identically compensated employees may have a wide variance in W-2 data in any given year for reasons other than differences in wage rates. For example, if an employee’s compensation package includes equity grants, such compensation will not be reflected on a W-2 until the stock option is exercised or the rights vest, which may be years later (and potentially after unforeseen or unpredictable events that may significantly increase or decrease the value of the equity). Other non-wage compensation, such as reimbursement of relocation expenses or payment of recruitment bonuses, will also be reflected in the W-2, but do not have any meaningful tie to compensation level.

W-2 data also does not report hours worked, or account for employees who worked only part of the year (for example, employees who took a leave of absence, or were hired or quit in the middle of the year). SB 973 tries to account for these potential gaps by requiring employers to report the hours worked by the employee. But many employers do not track hours of exempt employees, and will be forced to either leave that portion blank or estimate hours, which may skew the analysis.

Additionally, the pay data report asks employers to categorize employees based on the federal EEO-1 job categories. But those categories do not account for different skills required between jobs in the same category for which the market dictates different compensation. The job categories also do not account for differences in an employee’s education, training or experience within the same job category, all variables that greatly affect compensation and which the law acknowledges should be considered in evaluating wage rates under the Equal Pay Act.[3]

As a result of these many deficiencies of the reported W-2 data, many employers who are actively and conscientiously working to ensure equitable compensation may nevertheless face allegations of pay discrimination. To reduce this risk, employers should consider providing clarifying remarks, as is permitted by the statute, but should work closely with experienced counsel to determine how much and what kind of clarifying data they should provide.

II.  Amendment to ABC Test Under Assembly Bill 2257 and Proposition 22

In 2018, the California Supreme Court in the Dynamex case articulated a new test for classification of independent contractors, which the legislature codified in Assembly Bill 5 (“AB 5”) a year later—albeit with numerous exemptions of varying complexity. The Legislature this year passed Assembly Bill 2257 (“AB 2257”), which provides still more exemptions than already existed under AB 5, and revises many of the exemptions that AB 5 had put in place the previous year. And just recently, California voters passed Proposition 22, which further narrowed the reach of AB 5. Thus, while 2020 has brought some clarity concerning classification of independent contractors, many questions remain that will need to be addressed in 2021 and thereafter.

A.  History of the Worker Classification Test and the Adoption of the ABC Test

In 2018, the California Supreme Court imported a new legal standard for determining worker classification for purposes of California wage orders: the “ABC test.” In contrast to the flexible, multi-factor analysis that had been in place for nearly three decades, the Court in Dynamex Operations West, Inc. v. Superior Court, 4 Cal. 5th 903 (2018), held that companies seeking to classify workers as independent contractors must prove three elements:

  1. The worker remains free from the hiring entity’s control and direction in connection with the performance of the work, both under the contract and in fact;
  2. The worker performs work that is outside the usual course of the hiring entity’s business; and
  3. The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity.

On September 18, 2019, Governor Newsom signed AB 5 into law, declaring it “landmark legislation” for “workers and our economy.” AB 5 not only codified the ABC test, but also clarified that this test applies broadly to claims arising under the Labor Code and Unemployment Insurance Code, and not just the narrower wage orders to which Dynamex is limited. But AB 5 also exempted many industries from its otherwise broad reach and permitted those industries to continue using the more employer-friendly test in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal. 3d 341 (1989)—the standard before Dynamex.[4] Notably, truck drivers, journalists, and on-demand app-based workers, such as ride-share workers, were not expressly exempted.

B.  AB 2257—Providing More Exemptions to AB 5

On September 4, 2020, AB 2257 was signed into law. Among other things, AB 2257 widened the business-to-business and referral agency exemptions, and introduced 109 additional categories of workers exempted from AB 5. The business-to-business exemption involves business entities such as corporations and partnerships contracting with other businesses to provide services, while the referral agency exemption applies to business entities that perform services through a referral agency. These business entities prefer to be labeled as an independent contractor, and not employee, of the referral agencies. Yet, even though these exemptions were broadened, once again, gig economy workers were not among the many expressly exempted industries.

C.  Prop 22—Creating a Safe Harbor for App-Based Workers and Companies

In November, California voters passed the Protect App-Based Drivers and Services Act (Prop 22) to ameliorate the threat of AB 5 for on-demand, app-based rideshare and delivery companies in California. Prop 22 ensures AB 5 cannot be applied to “app-based workers,” enabling “network compan[ies]” to continue classifying app-based workers as independent contractors.

Companies can classify workers as independent contractors and take advantage of Prop 22’s safe harbor as long as they qualify as a Delivery Network Company or Transportation Network Company and meet the requirements of Prop 22’s four-element independent contractor standard:

  1. The network company does not unilaterally prescribe specific dates, times of day, or minimum number of hours during which the app-based driver must be logged into the network company’s online enabled platform;
  2. The network company does not require the app-based driver to accept any specific rideshare service or delivery service request as a condition of maintaining access to the network company’s online-enabled application or platform;
  3. The network company does not restrict the app-based driver from performing rideshare services or delivery services through other network companies except during engaged time; and
  4. The network company does not restrict the app-based driver from working in any other lawful occupation or business.

Prop 22 also requires network companies to provide workers with certain levels of compensation and specific benefits to ensure the “economic security” of app-based rideshare and delivery drivers. These benefits include hourly compensation of at least 120% of the local minimum wage plus $0.30 per mile; a healthcare subsidy consistent with contributions required under the Affordable Care Act for certain qualifying workers; occupational accident insurance; and protection against discrimination and sexual harassment.

D.  What Questions Remain Regarding Worker Classification After AB 2257 and Prop 22?

While AB 2257 and Prop 22 have provided more clarity regarding the classification of independent contractors in California, many questions remain. Thus, over the next year, we expect to see courts addressing the reaches of both the ABC Test and Prop 22. For example, we expect decisions regarding:  

  • Retroactive Application of Dynamex’s ABC Test: On November 3, 2020, the California Supreme Court heard oral arguments in Vazquez v. Jan-Pro Franchising International, Inc., No. S258191 (filed Sept. 26, 2019), where it is poised to determine whether Dynamex applies retroactively.
  • Federal Preemption of the ABC Test Under the FAAAA: Parties have challenged the ABC Test, both under Dynamex and AB 5, as preempted by federal law. In particular, trucking groups and companies have challenged AB 5 as preempted by the FAAAA, which regulates motor carriers. See California Trucking Association, et al. v. Xavier Becerra, et al., 433 F. Supp. 3d 1154 (S.D. Cal. 2020) (issuing preliminary injunction of AB 5 as applied to motor carriers in California because of FAAAA preemption); see also People v. Superior Court of Los Angeles County (Cal Cartage Transportation Express, LLC), 57 Cal.App.5th 619 (Cal. Ct. App. 2020), petition for review pending (finding that the ABC test is not preempted by the FAAAA).
  • Reach of Prop 22: Parties have already begun filing cases concerning whether Prop 22 can apply retroactively and whether it is a partial repeal of AB 5, among other questions.

The focus on worker classification issues is not likely to fade in 2021. Companies with independent contractor workforces should review their practices and contracts to make sure that they can comply with the applicable legal standard, and should stay apprised of the many developments we expect to see in this area over the coming year.

III.  COVID-19 Notice Requirements Under Assembly Bill 685

On September 17, 2020, Assembly Bill 685 (“AB 685”) was signed into law by Governor Newsom in order to strengthen access to information regarding the spread of COVID-19. AB 685 imposes two new notice requirements on employers regarding COVID-19, effective January 1, 2021. First, employers are required to notify certain employees and representatives concerning a possible exposure to COVID-19. Second, should the number of cases reach an “outbreak” as defined by the State Department of Public Health, the employer must notify the local public health agency.

A.  Notice of Potential Exposure

When an employer is aware of potential exposure to COVID-19 at a worksite, the employer must provide written notice of the potential exposure to all employees who were on the same worksite as the qualifying individual who caused the potential exposure, as well as notice to all employers of subcontracted employees, and to any exclusive representatives (e.g. union representatives) of potentially exposed employees.

1.  What counts as a potential exposure?

If an employee, or an employee of a subcontractor, has been on the premises at the same worksite as a qualifying individual within the infectious period of COVID-19, that is a potential exposure. A qualifying individual is a person who has: (1) a laboratory-confirmed positive case; (2) a diagnosis from a licensed health care provider; (3) received an isolation order from a public health official; or (4) died due to COVID-19. If the individual developed symptoms, the infectious period begins 2 days before the symptoms were first developed, and ends when 10 days have passed since the symptoms first appeared, 24 hours have passed with no fever, and other symptoms have improved. If the individual never developed symptoms, the infectious period begins 2 days before the specimen that tested positive was collected, and ends 10 days after the specimen was collected.[5]

2.  What kind of notice must be provided?

The required notice must be written, and given in a manner normally used by the employer to communicate employment-related information. This could include personal service, email, or text message if it can reasonably be anticipated to be received by the employee within one business day. The notice must be in both English and the language understood by the majority of the employees.

Each notice must include the following information:

  • That the employee may have been exposed to COVID-19;
  • Information regarding COVID-19 related benefits and employee protections, including protections from discrimination and retaliation for disclosing a positive diagnosis; and
  • Information on the disinfection and safety plan that the employer will implement and complete per CDC guidelines.

The notice must not include the name, or any other identifying information, of the qualifying individual.

3.  Are there any penalties for failing to provide notice?

The statute provides that the Division of Occupational Safety and Health (“Cal OSHA”) may issue a citation and civil penalties to employers who fail to provide the required notice of potential exposure, or if the notice does not include information regarding the employer’s disinfection and safety plan.

B.  Notice in Case of an “Outbreak”

AB 685 also requires non-healthcare employers to notify the local public health agency in the jurisdiction of the affected worksite within 48 hours in the case of a COVID-19 outbreak.

1.  What counts as an “outbreak”?

According to the current guidelines from the California Department of Health, a “COVID-19 outbreak in a non-healthcare workplace is defined as at least three COVID-19 cases among workers at the same worksite within a 14-day period.”[6] Whether a COVID-19 case exists is determined consistent with the criteria for a qualifying individual outlined above.

2.  What information must be given to the local public health agency?

The employer must provide the names, total number, occupation and worksite of the employees who are qualifying individuals. In addition, the employer must report the business address of the worksite and the North American Industry Classification System (NAICS) industry code.[7] The employer must continue to notify the agency of any subsequent cases, and the employer must provide the agency with any additional information it might request as part of the investigation.

C.  Takeaways

In order to meet the notice requirements in the time constraints under AB 685, employers should take immediate steps to:

  1. Implement a policy requiring employees working on-site to report COVID-19 positive tests and a process to then track those reports in a manner that will meet the standards required by AB 685 while also preserving employee privacy. This process should seek to incentivize employees to report results swiftly to the employer. The tracking method used should have the capacity to quickly determine what the infectious period is for each case.
  2. Draft a notice template that can be filled out and sent quickly that includes all of the required information.
  3. Implement a strategy for rapidly providing notice to employees (and subcontractors and union representatives) in case of exposure that meets the requirements of AB 685. This will require the capability to determine quickly which employees were on-site with the qualifying individual during the infectious period in order to generate the contact list for the notice that must be received within one business day.
  4. Implement a process to streamline communications with the local public health agency. This may include steps such as designating a point person ahead of time who will manage communications and send required notices to the agency, determining the appropriate contacts at the local health agency, and preparing templates in advance that can be quickly generated.

IV.  Workers’ Compensation Disputable Presumption Under Senate Bill 1159

Governor Newsom also signed Senate Bill 1159 into law on September 17, 2020. The bill creates a disputable (rebuttable) presumption that an illness or death resulting from COVID-19 is an injury that arises out of and in the course of employment, and is thus compensable under California’s workers’ compensation laws. The presumption only applies to certain claims from July 6, 2020 through January 1, 2023.

A.  What Conditions Create a Presumption?

For most employers, the presumption only applies if the employer maintains 5 or more employees, and an employee tests positive for COVID-19 within 14 days after reporting to their specific place of employment during an “outbreak.” A “specific place of employment” means the location where an employee performs work, but does not include the employee’s home or residence, unless the employee provides home health care services to another individual at the employee’s home or residence.

An “outbreak” exists for the purpose of the presumption if one of the following occurs:

  1. For employers with 100 employees or fewer at a specific place of employment, if 4 employees test positive for COVID-19 within 14 calendar days;
  2. For employers with more than 100 employees at a specific place of employment, if 4% of the number of employees who reported to the specific place of employment test positive for COVID-19 within 14 calendar days; or
  3. A specific place of employment is ordered to close by a local public health department, the State Department of Public Health, the Division of Occupational Safety and Health, or a school superintendent due to a risk of infection with COVID-19.

B.  How Can Employers Rebut the Presumption?

Employers can rebut the presumption that the injury or death arose out of employment by submitting evidence which tends to dispute the claims. For example, the employer can offer evidence of the measures it established to reduce potential transmission of COVID-19, or of the employee’s nonoccupational risks of COVID-19 infection.

C.  Are There Any Other Changes to the Workers’ Compensation Process?

Under SB 1159, the claims administrator only has 45 days to deny a claim based on COVID-19 once filed, as opposed to the typical 90 day period. If the claim is not denied, the illness is presumed compensable, and only evidence discovered subsequent to the 45-day period may be used to rebut this presumption. Thus, it is vital that employers work quickly to gather the necessary information as soon as a claim is filed.

D.  Additional Requirement: Report to Claims Administrator

The bill also requires an employer that knows or reasonably should know that an employee has tested positive for COVID-19 to submit a report containing the below information to its workers’ compensation claims administrator within three business days:

  • Notice that an employee has tested positive (the employee should not be identified unless the employee asserts the infection is work-related or has already filed a claim);
  • The date the employee tested positive;
  • The address of the employee’s specific place of employment during the 14-day period before the date the employee tested positive; and
  • The highest number of employees who reported to work at the specific place of employment of the employee who tested positive in the 45-day period preceding the last day that the employee worked.

Reporting this information to a claims administrator provides the claims administrator with information to determine whether an outbreak has occurred. If an employer intentionally submits false or misleading information or fails to submit information when reporting, the Labor Commissioner can impose a civil penalty of up to $10,000.

E.  First Responders and Healthcare Workers

The bill instituted a similar set of provisions for certain first responders such as firefighters, some peace officers, paramedics and EMTs, and healthcare workers, but with a few key distinctions. Crucially, no outbreak at the workplace is required to give rise to the presumption that a positive COVID-19 test arose from the first responder or healthcare worker’s employment, and the presumption is not limited to employers of a certain size. Moreover, healthcare employers may not rebut the presumption through evidence of preventative measures or the employee’s nonoccupational risks, but may rebut the presumption “by other evidence.” Finally, the claim administrator must deny the claim within 30 days of its being filed to avoid a presumption that the injury is compensable, instead of the 45-day period outlined above.

F.  Claims that Arose Before July 6, 2020.

For COVID-19 related claims between March 19, 2020 and July 5, 2020, there is still a disputable presumption that an injury from COVID-19 is presumed to have arisen out of and in the course of employment. An employee must, within 14 days of being present at the place of employment, either test positive for COVID-19 or be diagnosed by a licensed medical doctor, with the diagnosis confirmed by a test within 30 days. The presumption is disputable and may be controverted by other evidence. Employers are not required by the law to report employees who tested positive in this time frame to claim administrators.

G.  Takeaways

To best meet the requirements of SB 1159, several critical steps should be taken:

  1. Review records for confirmed COVID-19 illnesses or deaths from July 6, 2020, through the present. Implement a process to reliably and quickly record and report employee COVID-19 illnesses to your workers’ compensation claims administrator within three business days.
  2. Determine if any “outbreaks” have occurred since July 6, 2020. If there has been no outbreak, there is no presumption (except in the limited cases noted above). Create a method to automatically flag when an outbreak has occurred or might be imminent.
  3. Implement a strategy to dispute the presumption that an infection occurred in the workplace when appropriate. This should include preparing information regarding safety measures taken by the company to prevent transmission of COVID-19. Additionally, the company should employ an appropriate investigation strategy to determine if an employee was subject to any nonoccupational risks of exposure to COVID-19.

V.  COVID-19 Vaccine – Who Will Get It and When?

Finally, perhaps the most pressing question for employers and employees alike is when to expect the vaccines to rollout in California, and what this process will look like. The U.S. Food and Drug Administration has issued Emergency Use Authorization for two COVID-19 vaccines, with the possibility that more vaccines will be authorized in early 2021. California, with guidance from the CDC, has outlined a scalable, three-phased approach, starting with healthcare workers, and ending with the general population.[8]

A.  Phase 1-A: Healthcare Residents and Workers

Due to the currently limited availability of the vaccine, Phase 1-A includes three different tiers in order to provide gradual distribution. The first tier of potential vaccine recipients includes residents of skilled nursing facilities, assisted living facilities, and other similar long-term care settings for medically vulnerable or older populations. Also in the first tier are healthcare workers who come into direct contact with COVID-19 patients, and generally those medical professionals who are most at risk in terms of exposure, which include workers at correctional and psychiatric hospitals, nursing homes, acute care centers, and dialysis centers, as well as paramedics and emergency medical technicians.

The second tier within Phase 1-A includes those healthcare workers who work in intermediate care facilities, primary care clinics, urgent care clinics, rural health centers, correctional facility clinics, as well as home health care workers and public health field staff.

The third tier of healthcare workers includes workers in dental offices, specialty clinics, laboratories, and pharmacy staff not included in higher tiers.

B.  Phase 1-B: Frontline Essential Workers & Adults Age 65 and Older

Phase 1-B is slated to take place once the healthcare workers in Phase 1-A are mostly vaccinated. According to the CDC, this group should include “workers in essential and critical industries” such as teachers, child care workers, and first responders, among others.[9]

Similar to Phase 1-A, the Advisory Committee on Immunization Practices (“ACIP”) has proposed taking a tiered approach within Phase 1-B.[10] This proposal recommends that adults 75 and older as well as non-healthcare “frontline essential workers,” such as first responders, teachers, grocery store workers, food and agriculture workers, and manufacturing employees, among others, should take priority in Phase 1-B. This would then push the remaining essential non-frontline workers, such as those who work in construction, transportation, food services, IT, finance, the legal industry, and the media industry, among others, to Phase 1-C, along with adults age 65 or older (but under age 75) and adults with high-risk medical conditions. “Frontline essential workers,” for purposes of this proposal, has only been defined as including workers “in sectors essential to the functioning of society and are at substantially higher risk of exposure to SARS-CoV-2.”[11] So far, California seems to largely mirror the ACIP’s approach (which is accepted by the CDC), as California’s Community Vaccine Advisory Committee has agreed that non-healthcare frontline workers should be prioritized in Phase 1-B. Moreover, California’s approach separates Phase 1-B into two tiers: the first tier includes workers in education, childcare, emergency services, and food and agriculture industries and individuals age 75 and older, while the second tier within Phase 1-B includes workers in transportation and logistics, the industrial, commercial, and residential facilities and services industry, and critical manufacturing, along with individuals 65 to 74 years of age.[12]

C.  Phase 1-C: Non-Frontline Essential Workers, Adults Age 50 and Older, & High Risk Adults

This group includes adults 50 to 64 years of age, individuals with preexisting conditions that put them at high risk of getting severely ill from COVID-19, and the non-frontline essential workers excluded from Phase 1-B in industries such as water and wastewater, defense, energy, chemical and hazardous materials, financial services, communications and IT, government operations and community-based essential functions.[13]

D.  Remaining Phases

Phases 2 and 3 would include the general public and nonessential workers, although these categories are not fully fleshed out yet, and depend on a substantial increase in vaccine supply.

Overall, it is important to keep in mind that this is an evolving situation. On the state-wide level, there is no definitive guidance as to what exactly separates these frontline essential workers in the first tier of Phase 1-B from the other essential workers in California for purposes of the vaccine rollout. Moreover, the California Department of Public Health has not yet determined the details for allocation in Phase 1-B, as it has not yet released the allocation guidelines that tend to provide clarity to this rapidly changing process. Even if this tiered approach for Phase 1-B is carried out, essential workers will all be covered under Phase 1, whether in groups 1-A, 1-B, or 1-C, thus putting them ahead of the general population and nonessential workers in terms of eventually receiving the vaccine.[14]

____________________

[1]  The job categories required by the statute are:

  1. Executive or senior level officials and managers.
  2. First or mid-level officials and managers.
  3. Professionals.
  4. Technicians.
  5. Sales workers.
  6. Administrative support workers.
  7. Craft workers.
  8. Operatives.
  9. Laborers and helpers.
  10. Service workers.

[2]  The pay bands are those used by the United States Bureau of Labor Statistics in the Occupational Employment Statistics survey, and include the following categories:   (1) $19,239 and under; (2) $19,240 – $24,439; (3) $24,440 – $30,679; (4) $30,680 – $38,999; (5) $39,000 – $49,919; (6) $49,920 – $62,919; (7) $62,920 – $80,079; (8) $80,080 – $101,919; (9) $101,920 – $128,959; (10) $128,960 – $163,799; (11) $163,800 – $207,999; and (12) $208,000 and over.

[3]  California Equal Pay Act, California Labor Code § 1197.5 (a): “An employer shall not pay any of its employees at wage rates less than the rates paid to employees of the opposite sex for substantially similar work, when viewed as a composite of skill, effort, and responsibility, and performed under similar working conditions, except where the employer demonstrates: … (D) A bona fide factor other than sex, such as education, training, or experience.”

[4]  Some of the industry workers specifically exempted by AB 5 include physicians and other medical industry professionals, lawyers, accountants, engineers, architects, securities brokers, real estate agents, as well as certain professional service providers meeting six requirements (including workers in areas such as human resources and marketing, among others), and business-to-business contracting relationships that also satisfy certain conditions.

[5]  Employer Guidance on AB 685: Definitions, Cal. Dep’t of Public Health (last updated Oct. 16, 2020), https://www.cdph.ca.gov/Programs/CID/DCDC/Pages/COVID-19/Employer-Guidance-on-AB-685-Definitions.aspx.

[6]  Employer Guidance on AB 685: Definitions, Cal. Dep’t of Public Health (last updated Oct. 16, 2020), available at https://www.cdph.ca.gov/Programs/CID/DCDC/Pages/COVID-19/Employer-Guidance-on-AB-685-Definitions.aspx.

[7]  Companies can find their codes here: https://www.naics.com/search/.

[8]  State of California COVID-19 Vaccination Plan: Interim Draft, Cal. Dep’t of Pub. Health (Oct. 16, 2020), https://www.cdph.ca.gov/Programs/CID/DCDC/CDPH%20Document%20Library/COVID-19/COVID-19-Vaccination-Plan-California-Interim-Draft_V1.0.pdf.

[9]  How CDC is Making COVID-19 Vaccine Recommendations, Ctrs. for Disease Control and Prevention (last updated Dec. 23, 2020), https://www.cdc.gov/coronavirus/2019-ncov/vaccines/recommendations-process.html; see also Advisory Memorandum On Ensuring Essential Critical Infrastructure Workers’ Ability to Work During the COVID-19 Response, Cybersecurity & Infrastructure Sec. Agency (December 16, 2020), here.

[10]  The Advisory Committee on Immunization Practices’ Updated Interim Recommendation for Allocation of COVID-19 Vaccine – United States, December 2020, Ctrs. for Disease Control and Prevention (last updated December 22, 2020), https://www.cdc.gov/mmwr/volumes/69/wr/mm695152e2.htm.

[11]  ACIP COVID-19 Vaccines Work Group: Phased Allocation of COVID-19 Vaccines, Advisory Comm. on Immunization Practices (Dec. 20, 2020), https://www.cdc.gov/vaccines/acip/meetings/downloads/slides-2020-12/slides-12-20/02-COVID-Dooling.pdf.

[12]  Vaccines, Cal. ALL State Gov’t Website (Jan. 8, 2021), https://covid19.ca.gov/vaccines/#Vaccine-allocation-and-administration.

[13]  Id.

[14]  See Employer Playbook for the COVID “Vaccine Wars,” Gibson, Dunn & Crutcher LLP, https://www.gibsondunn.com/wp-content/uploads/2020/12/an-employer-playbook-for-the-covid-vaccine-wars.pdf.

 
 

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 authors:

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])
Daniel Weiss – Los Angeles (+1 213-229-7388, [email protected])
Megan Cooney – Orange County (+1 949-451-4087, [email protected])
Kat Ryzewska – Los Angeles (+1 310-557-8193, [email protected])

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

Catherine A. Conway – Los Angeles (+1 213-229-7822, [email protected])
Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, [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.

We are pleased to present Gibson Dunn’s eighth “Federal Circuit Year In Review,” providing a statistical overview and substantive summaries of the 130 precedential patent opinions issued by the Federal Circuit between August 1, 2019 and July 31, 2020. This term was marked by significant panel decisions with regard to the constitutionality of the PTAB and its jurisdiction and procedures (Arthrex, Inc. v. Smith & Nephew, Inc., 941 F.3d 1320 (Fed. Cir. 2019), Samsung Electronics America, Inc. v. Prisua Engineering Corp., 948 F.3d 1342 (Fed. Cir. 2020), and Nike, Inc. v. Adidas AG, 955 F.3d 45 (Fed. Cir. 2020)), subject matter eligibility (American Axle & Manufacturing, Inc. v. Neapco Holdings LLC, 967 F.3d 1285 (Fed. Cir. 2020) and Illumina, Inc. v. Ariosa Diagnostics, Inc.,952 F.3d 1367 (Fed. Cir. 2020)), and venue (In re Google LLC). The issues most frequently addressed in precedential decisions by the Court were: obviousness (43 opinions); infringement (24 opinions); claim construction (22 opinions); PTO procedures (21 opinions); and Jurisdiction, Venue, and Standing (19 opinions).

Use the Federal Circuit Year In Review to find out:

  • The easy-to-use Table of Contents is organized by substantive issue, so that the reader can easily identify all of the relevant cases bearing on the issue of choice.
  • Which issues may have a better chance (or risk) on appeal based on the Federal Circuit’s history of affirming or reversing on those issues in the past.
  • The average length of time from issuance of a final decision in the district court and docketing at the Federal Circuit to issuance of a Federal Circuit opinion on appeal.
  • What the success rate has been at the Federal Circuit if you are a patentee or the opponent based on the issue being appealed.
  • The Federal Circuit’s history of affirming or reversing cases from a specific district court.
  • How likely a particular panel may be to render a unanimous opinion or a fractured decision with a majority, concurrence, or dissent.
  • The Federal Circuit’s affirmance/reversal rate in cases from the district court, ITC, and the PTO.

The Year In Review provides statistical analyses of how the Federal Circuit has been deciding precedential patent cases, such as affirmance and reversal rates (overall, by issue, and by District Court), average time from lower tribunal decision to key milestones (oral argument, decision), win rate for patentee versus opponent (overall, by issue, and by District Court), decision rate by Judge (number of unanimous, majority, plurality, concurring, or dissenting opinions), and other helpful metrics. The Year In Review is an ideal resource for participants in intellectual property litigation seeking an objective report on the Court’s decisions.

Gibson Dunn is nationally recognized for its premier practices in both Intellectual Property and Appellate litigation. Our lawyers work seamlessly together on all aspects of patent litigation, including appeals to the Federal Circuit from both district courts and the agencies.

Please click here to view the FEDERAL CIRCUIT YEAR IN REVIEW


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:

Mark A. Perry – Washington, D.C. (+1 202-887-3667, [email protected])
Omar F. Amin – Washington, D.C. (+1 202-887-3710, [email protected])
Nathan R. Curtis – Dallas (+1 214-698-3423, [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:
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Mark A. Perry – Washington, D.C. (+1 202-887-3667, [email protected])

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© 2020 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 18 December 2020, the European Commission (the “Commission”) launched a comprehensive public consultation (the “Consultation”) on the revision of the European Union (“EU”) antitrust rules specifically applicable to distribution agreements, namely, the 2010 Vertical Block Exemption Regulation (Regulation 330/2010 or “VBER”) and the 2010 Vertical Guidelines, both of which will expire on 31 May 2022.[1]

The Commission is consulting with a view to gathering feedback on a number of policy options:[2]

  • On one side, the Commission proposes to adopt an arguably more lenient approach to the application of EU competition rules to certain types of vertical arrangements, ranging from: long-term non-compete obligations, efficiency-generating resale price maintenance (“RPM”), sustainability agreements in the context of the European Green Deal,[3] active sale restrictions outside of pure exclusive distribution, and measures indirectly restricting online sales.
  • On the other side, the Commission is considering adopting a stricter competition law enforcement strategy in relation to other types of vertical agreements such as: restrictions on price comparison websites and on online advertising, dual distribution and parity obligations (e.g., most favoured nation, or “MFN” clauses).

The Consultation is open until 26 March 2021, and will be followed by a report on the findings and results of the impact assessment phase. This will result in the publication of the proposed new draft VBER and accompanying Vertical Guidelines. Given the range of policy options under consideration by the Commission, this Consultation gives companies involved in both traditional and online retail business a unique opportunity to seek to influence the shape of future vertical restraint policies.

1.   Background & Historical Context

Since the 1960s, the Commission has had in place regulations and guidance exempting certain categories of distribution agreements from the application of EU competition rules prohibiting anti-competitive agreements or arrangements.[4] The current VBER entered into force on 1 June 2010.

The VBER block exempts from the application of EU competition law distribution agreements where the market shares of the supplier and reseller do not exceed 30% in the respective relevant markets. The exemption applies if the agreement does not include so-called ‘hard-core’ restrictions.[5] Where companies cannot safely determine that their distribution agreement is covered by the VBER ‘safe harbour’, the company will need to consider: (i) if the agreement contains any ‘hard-core’ or excluded restrictions, (ii) if it may have any foreseeably anti-competitive effects on competition, and (iii) if there are any efficiencies that may benefit the agreement from an individual exemption under Article 101(3) TFEU. The Vertical Guidelines provide guidance to companies to perform these individual assessments.

2.   The 2010 VBER and Vertical Guidelines and the Commission’s Approach to E-Commerce and Other Restrictions

The VBER and the Vertical Guidelines currently in force include rules and guidance that aim at fostering cross-border trade and online commerce as well as promoting competition. For example, the 2000 Vertical Guidelines allowed suppliers to require that quality standards be met in order to allow the resale of products through a distributor’s website.[6] The 2010 version of the Guidelines implicitly limited the application of such quality standards in the context of the Internet to situations involving selective distribution arrangements. And in any event, the standards had to be applied in an “overall equivalent” manner to both physical and online points of sale (i.e., stricter standards could not be applied only to online sales).[7] The 2010 Vertical Guidelines also set out a list of obligations and restrictions that suppliers were not permitted to impose on online resellers without potentially breaching EU competition law.[8]

The application of antitrust rules to e-commerce was significantly influenced by the 2011 Judgment of the Court of Justice of the EU (“CJEU”) in Pierre Fabre, which found that EU competition law prohibited manufacturers from engaging generally in online sales restrictions. In Pierre Fabre, the restriction resulted from the obligation on distributors to sell personal care products only in the presence of qualified pharmacists, de facto excluding sales through distributors’ websites.[9] The CJEU fully endorsed the view that e-commerce constituted a legitimate channel for the resale of products, and that a prohibition of e-commerce sales amounted to a hard-core restriction of competition ‘by object’. Pierre Fabre was followed by other decisions at EU and national level which confirmed the strict approach of European competition authorities and courts against measures likely to restrict e-commerce.[10]

By 2017, however, the Commission and the CJEU had started to become more nuanced in their approach to e-commerce, in particular regarding the sale of goods in online marketplaces. In the Commission’s final report in its E-Commerce Sector Enquiry, the Commission considered the perceived erosion of manufacturers’ freedom to limit online sales, and concluded that suppliers’ restrictions on distributors which made sales on online marketplaces were not per se anti-competitive.[11] Later that year, in Coty, the CJEU confirmed that manufacturers of luxury goods could seek to preserve the luxury image of those goods by preventing their sale in online marketplaces.[12]

3.   The Commission’s Review of the VBER and the Vertical Guidelines

Against the backdrop of the findings of the E-Commerce Sector Enquiry and the Coty judgment, in 2018 the Commission launched a review of the 2010 VBER and the Vertical Guidelines, which are due to be replaced by 31 May 2022.

The first part of the review process lasted through September 2020, with the Commission gathering evidence on the functioning of the current VBER and the Vertical Guidelines. Respondents indicated that both the 2010 VBER and the Vertical Guidelines had to be revised, especially in light of the profound impact of e-commerce and digitalisation, the increase in direct sales by manufacturers to customers, the wider use of retail price parity clauses, and the emergence of online platforms. Furthermore, the Commission found that there are certain practices and restrictions that have become more commonplace over the past few years, for which additional guidance is required (e.g., dual distribution, online platform bans and restrictions on the use of price comparison websites).[13]

4.   The Commission’s Ongoing Impact Assessment

On 23 October 2020, the Commission published a Roadmap[14] for an impact assessment of the initiatives tabled to address the deficiencies identified in the 2010 VBER and Vertical Guidelines, identifying the following priorities:

1)   The need to clarify, simplify and complete EU competition rules applicable to vertical agreements regarding:

  • the assessment of possible efficiencies resulting from resale price maintenance (“RPM”), which is currently a hard-core restriction under the VBER.
  • how to address restrictions that have become more prevalent since 2010 (e.g., restrictions on the use of price comparison websites, or online advertising restrictions).
  • the treatment of new market players, such as online platforms and marketplaces, especially in areas of distribution not addressed by the current case law, such as agency agreements and dual distribution (i.e., situations in which a supplier sells its goods or services directly to end customers, thereby competing with its distributors at the retail level).
  • the objectives of the European Green Deal,[15] in relation to agreements pursuing sustainability objectives.

2)   Non-compete clauses: These include obligations imposed on buyers not to manufacture, purchase, sell or resell goods or services which compete with those of the supplier, and are currently block exempted by the VBER provided that, inter alia, their duration does not exceed five years and is not automatically renewable. The Commission will consider a more lenient treatment of non-compete clauses whose duration may exceed this period due to automatic extensions, provided that they are subject to termination rights or renegotiation obligations.

3)   Dual distribution: This occurs where a supplier sells its products to consumers both directly and through independent resellers. The growth of online sales has led to a significant increase in dual distribution practices, leading the Commission to consider issues such as: (i) horizontal competition concerns arising from suppliers’ activities in the same market as resellers; (ii) the ability of dual distribution to satisfy the test for efficiencies that is used under Article 101(3) TFEU; and (iii) the comparison of the supplier’s situation with that of other wholesale distributors and resellers which are not in a position to benefit from the VBER in comparable situations.

To address the more widespread use of dual distribution, the Commission has identified the following policy options (with the possibility of Options 2 and 3 being introduced in combination):

  • Option 1: baseline scenario (i.e., no policy change).
  • Option 2: limiting the scope of the exemption to situations that are not likely to raise horizontal concerns by, for example, by introducing a threshold based on the parties’ market shares in the retail market, and by aligning the exemption with what is considered to be capable of being exempted in the case of agreements among competitors.[16]
  • Option 3: extending the exemption to dual distribution practices by wholesalers and/or importers.
  • Option 4: removing the exemption from the VBER, thereby requiring an individual assessment under Article 101(3) TFEU for all dual distribution cases.

4)   Active sales restrictions: The VBER treats as ‘hard-core’ situations where a supplier restricts the territory into which, or the customers to whom, a reseller can sell the products. Resellers should generally be allowed to approach direct individual customers (‘active sales’) and to respond to unsolicited requests from individual customers (‘passive sales’). However, the current rules permit restrictions on active sales in limited cases, notably where they are justified to protect investments made by exclusive distributors.

The rigidity of the current VBER framework regarding the treatment of active and passive sales can render it difficult for suppliers to implement distribution networks that are tailored to their specific needs. For example, the VBER and the Vertical Guidelines do not foresee the use of ‘shared exclusivities’ between two or more distributors in a particular territory (i.e., shielded from active sales by distributors established outside of their territory), or the genuine combination of exclusive and selective distribution methods for the same product lines in the same territory.[17]

The Commission has therefore identified the following policy options (with Options 2 and 3 possibly being introduced in combination):

  • Option 1: baseline scenario (i.e., no policy change).
  • Option 2: expanding the existing exemptions available for the prohibition of active sales in order to give suppliers more flexibility to design their distribution systems.
  • Option 3: ensuring more effective protection for selective distribution systems, by allowing restrictions on sales made from outside the allocated selective distribution territory to unauthorised distributors inside that territory.

5)   Indirect measures restricting online sales: As noted above, most restrictions on distributors to sell through the Internet are considered to be ‘hard-core’ restrictions, which will generally not benefit from the automatic exemption under the VBER.[18] The current versions of the VBER and the Vertical Guidelines apply the same approach to certain indirect measures that might hinder online sales, such as charging the same distributor a higher wholesale price for products intended to be sold online than with respect to products sold off-line (‘dual pricing’), or where selective criteria are imposed for online sales that are not truly equivalent to the criteria imposed in brick-and-mortar shops (the “overall equivalence” principle).[19]

The Commission recognises that, by not allowing suppliers to charge different wholesale prices depending on the actual costs of maintaining different channels, the current rules may prevent them from incentivising associated investments, notably in physical stores.

As a result, the Commission has identified the following policy options (with Options 2 and 3 possibly being introduced in combination):

  • Option 1: baseline scenario (i.e., no policy change).
  • Option 2: no longer treating dual pricing strategies as a ‘hard-core’ competition restriction, with certain safeguards to be defined in accordance with principles established under case law.
  • Option 3: no longer considering as a ‘hard-core’ restriction the imposition of selective criteria for online sales that are not “overall equivalent” to the criteria imposed in brick-and-mortar shops, with safeguards to be defined in accordance with principles set forth under case law.

6)   Parity obligations (so-called ‘most-favoured nation’, or “MFN”, clauses): These types of clause require a business to offer the same or better conditions to its contracting party as those it offers to any other party, or by the company itself through its direct sales channels. Parity obligations are generally block exempted under the conditions of the VBER. However, the increase in their use, notably by online platforms, has led to the identification of possible anti-competitive effects under certain scenarios (e.g., obligations that require parity with other indirect sales or marketing channels).

In order to address these scenarios, the Commission has identified the following policy options:

  • Option 1: baseline scenario (i.e., no policy change).
  • Option 2: removing the benefit of the VBER and including within the list of excluded restrictions (Article 5 VBER) obligations that require parity relative to specific types of sales channel – thereby requiring an individual effects-based assessment of such obligations under Article 101 TFEU. For example, the benefit of the VBER could be generally excluded for parity obligations that relate to indirect sales and marketing channels, including online platforms and other intermediaries.
  • Conversely, parity obligations relating to other types of sales channel would continue to benefit from the block exemption, on the basis that they are more likely to create efficiencies that satisfy the conditions of Article 101(3) TFEU.
  • Option 3: removing the benefit of the VBER ‘safe harbour’ for all types of parity obligations, by including them in the list of excluded restrictions (Article 5 VBER). This option would require companies to perform an individual effects-based assessment in all such cases.

5.   The Consultation – A Call for Action

With the release of its Consultation on 18 December 2020, the Commission is seeking to address the wide range of issues described above and to prepare for the adoption of a revised VBER and Vertical Guidelines in 2022.

While some of the issues addressed in the Consultation have long been highlighted by antitrust agencies, practitioners and industry stakeholders, a number of other issues have also raised heightened attention because of the extra impetus enjoyed by e-commerce during the last years.

The issues and potential solutions identified by the Commission in the Consultation (which is open until 26 March 2021) are important for manufacturers and resellers of all products, but especially for consumer products. Companies may therefore wish to take this opportunity to try to shape the future form of the EU competition rules which will apply to their distribution arrangements.

_____________________

[1]  The Consultation is available in the following link: https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12636-Revision-of-the-Vertical-Block-Exemption-Regulation/public-consultation.

[2]  These issues and policy options were first set out in the VBER’s inception impact assessment, published on 23 October 2020. See Ref. Ares(2020)5822391 – 23.10.2020, available at: https://ec.europa.eu/info/law/better-regulation/.

[3]  The European Green Deal is the EU plan to create a sustainable economy, and provides for an action plan to boost the efficient use of resources by moving to a clean, circular economy, and to restore biodiversity and cut pollution. See further: https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en.

[4]  Article 101(1) TFEU prohibits all agreements or concerted practices that have as their object or effect the restriction of competition where the effect of that restriction may affect trade between Member States.

[5]  See Article 4 of the VBER for a list of ‘hard-core’ restrictions. The VBER also identifies a limited number of restrictions which, if contained in a vertical arrangement, do not benefit from the VBER ‘safe harbour’ but which do not preclude the application of the VBER ‘safe harbour’ to the rest of the agreement (provided that the other conditions set out in the VBER are fulfilled).

[6]  See Commission notice – Guidelines on Vertical Restraints, OJ C 291, 13 October 2000, pp. 1-44, para. 51.

[7]  See Vertical Guidelines, para. 54.

[8]  See Vertical Guidelines, para. 52.

[9]  See Case C-439/09 Pierre Fabre Dermo-Cosmetique EU:C:2011:649.

[10]  For more information, see A. Font Galarza, E. Dziadykiewicz, and A. Guerrero Perez, ‘Selective Distribution and e-Commerce: Recent developments in EU and national case law’, e-Competitions Bulletin, No. 63958, 2014. See further, e.g., Case COMP/AT.40428 – Guess.

[11]  See Report from the Commission to the Council and the European Parliament, Final report on the E-commerce Sector Inquiry, COM(2017) 229 final, 10 May 2017; and the accompanying Staff Working Document, SWD(2017) 154 final, 10 May 2017, Section 4.4.8.

[12]  See Case C-230/16 Coty Germany GmbH v Parfümerie Akzente GmbH EU:C:2017:941.

[13]  See Commission Staff Working Document Evaluation of the Vertical Block Exemption Regulation, SWD(2020) 172 final, 8 September 2020.

[14]  See: https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12636-Revision-of-the-Vertical-Block-Exemption-Regulation.

[15]  The European Green Deal is the EU plan to create a sustainable economy, and provides for an action plan to boost the efficient use of resources by moving to a clean, circular economy, and to restore biodiversity and cut pollution. See further: https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en.

[16]  For Commission regulations that establish block exemptions applicable to horizontal agreements among competitors, see, e.g., Commission Regulation (EU) No 1217/2010 of 14 December 2010 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to certain categories of research and development agreements, OJ L 335, 18 December 2010, pp. 36-42; Commission Regulation (EU) No 1218/2010 of 14 December 2010 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to certain categories of specialisation agreements, OJ L 335, 18 December 2010, pp. 43-47; and Commission Regulation (EU) No 316/2014 of 21 March 2014 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to categories of technology transfer agreements, OJ L 93, 28 March 2014, pp. 17-23.

[17]  The Vertical Guidelines currently find that combined selective and exclusive distribution can only be block exempted if active selling in other territories is not restricted (para. 152). This dilutes significantly the impact that exclusivities are meant to have in a distribution network. The Vertical Guidelines currently only foresee the possibility of restricting active sales by selective retailers into other territories for the purpose of overcoming free-riding problems pursuant to an individual assessment (para. 63).

[18]  As indicated above, qualitative criteria that are “overall equivalent” to criteria imposed on physical stores may also be imposed on Internet stores. Suppliers may also request that distributors have one or more brick-and-mortar shops or showrooms as a condition for becoming a member of its distribution system (Vertical Guidelines, para. 54).

[19]  See Vertical Guidelines, paras. 52-56. The Commission foresees very specific exceptional scenarios where dual distribution may benefit from an individual exemption under Article 101(3) TFEU (see para. 64).


Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For additional information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition Practice Group, or the following authors:

Kai Gesing – Munich (+49 89 189 33 180, [email protected])
Alejandro Guerrero – Brussels (+32 2 554 7218, [email protected])
Jens-Olrik Murach – Brussels (+32 2 554 7240, [email protected])
Christian Riis-Madsen – Brussels (+32 2 554 72 05, [email protected])
Deirdre Taylor – London (+44 20 7071 4274, [email protected])
David Wood – Brussels (+32 2 554 7210, [email protected])

Antitrust and Competition Group:

Brussels
Peter Alexiadis (+32 2 554 7200, [email protected])
Attila Borsos (+32 2 554 72 11, [email protected])
Jens-Olrik Murach (+32 2 554 7240, [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])

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])

London
Patrick Doris (+44 20 7071 4276, [email protected])
Charles Falconer (+44 20 7071 4270, [email protected])
Ali Nikpay (+44 20 7071 4273, [email protected])
Philip Rocher (+44 20 7071 4202, [email protected])
Deirdre Taylor (+44 20 7071 4274, [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])
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])
Cynthia Richman (+1 202-955-8234, [email protected])
Jeremy Robison (+1 202-955-8518, [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])
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])

After a complicated path to passage, today the Senate completed the override of President Trump’s veto of the National Defense Authorization Act and, as part of that legislation, passed the Anti-Money Laundering Act of 2020 (“AMLA” or the “Act”).[1] The AMLA is the most comprehensive set of reforms to the anti-money laundering (“AML”) laws in the United States since the USA PATRIOT Act was passed in 2001. The Act’s provisions range from requiring many smaller companies to disclose beneficial ownership information to FinCEN to mandating awards to whistleblowers that report actionable information about Bank Secrecy Act (“BSA”)/AML violations. This alert identifies 10 of the biggest takeaways for financial institutions from the AMLA.[2]

  1. The AMLA May Lead to More AML Enforcement, Including Through Expanded Whistleblower Provisions

The AMLA has a number of provisions that could result in significantly increased civil and criminal enforcement of AML violations. First and foremost, it provides for a significantly expanded whistleblower award program. Specifically, it states that when an AML enforcement action brought by DOJ or the U.S. Treasury Department results in monetary sanctions over $1 million, the Secretary of the Treasury “shall” pay an award of up to 30 percent of what was collected to whistleblowers who “voluntarily provided original information” that led to a successful enforcement action.[3] The previous whistleblower award program limited awards in most cases to $150,000 and was discretionary[4] – in our experience, that much more modest award program did not generate significant interest among potential whistleblowers or the plaintiffs’ bar. The Act also includes anti-retaliation protections for whistleblowers and, in the event of a violation of these provisions, allows them to file a complaint with the Department of Labor and, if it is not adjudicated within a certain period of time, to seek recourse in federal district court.[5]

It would be hard to overstate the far-reaching potential effects of this new program. By way of analogy, in 2010, the SEC announced its own whistleblower program to reward individuals who provided the agency with high-quality information.[6] The program has prompted a significant number of tips to the SEC. As of October 2020, the SEC Office of the Whistleblower had received more than 40,000 tips from whistleblowers in every state in the United States and approximately 130 countries around the world.[7] And this program has led to some significant SEC whistleblower awards, which may have encouraged further reporting. In October 2020, for instance, the SEC awarded $114 million to a whistleblower, the largest single award in history.[8]

As with the SEC whistleblower program, the new awards for BSA whistleblowers may incentivize employees and plaintiffs’ attorneys to provide a substantial number of new tips to law enforcement, even if many of them do not result in enforcement actions. Indeed, the number of employees at financial institutions who have access to information that could potentially form the basis for an AML whistleblower complaint is many times greater than in other contexts. Many large financial institutions employ hundreds of individuals in functions with AML responsibilities. For example, it remains to be seen whether this provision will weaponize the information held by even front-line compliance employees tasked with elevating suspicious activity for potential SAR filings when those employees do not see a SAR ultimately get filed.

  1. The AMLA Increases Penalties for BSA/AML Violations in a Number of Ways

Another harbinger of increased enforcement is the expanded penalties enacted under the AMLA. As we explained in a January 2020 client alert, in recent years DOJ has been increasingly aggressive in using its money laundering authority to police international corruption and bribery, as illustrated by the 1MDB, FIFA, and PDVSA prosecutions.[9] And the incoming Biden administration has indicated that cracking down on illicit finance at home and abroad will be a top priority.[10]

The AMLA creates a number of new penalties that will help the government do so. It creates a new prohibition on knowingly concealing or misrepresenting a material fact from or to a financial institution concerning the ownership or control of assets involved in transactions over $1 million involving assets of a senior foreign political figure, close family member, or other close associate.[11] The Act also makes it a crime to knowingly conceal or misrepresent a material fact from or to a financial institution concerning the source of funds in a transaction that involves an entity that is a primary money laundering concern.[12] The penalties for violating these provisions are up to 10 years imprisonment and/or a $1 million fine.[13]

The Act also generally enhances penalties for various BSA/AML violations. For instance, it provides that any person “convicted” of violating the BSA shall, “in addition to any other fine under this section, be fined in an amount that is equal to the profit gained by such person by reason of such violation,” and, in the event the person was employed at a financial institution at the time of the violation, repay to the financial institution any bonus paid during the calendar year during or after which the violation occurred.[14] The Act additionally prohibits individuals who have committed an “egregious” violation of the BSA from sitting on the boards of U.S. financial institutions for 10 years.[15] Furthermore, the AMLA creates enhanced penalties for repeat violators, providing that if a person has previously violated the BSA, the Secretary of the Treasury “may impose” additional civil penalties of up to the greater of three times the profit gained or loss avoided by such person as a result of the violation or two times the maximum statutory penalty associated with the violation.[16]

  1. The AMLA Significantly Increases the Government Resources Committed to Address Money Laundering

The AMLA also contains a host of provisions designed to better resource the government to address money laundering. It establishes special hiring authority for FinCEN and the Office of Terrorism and Financial Intelligence.[17] It also creates a number of unique roles, including FinCEN domestic liaisons to oversee different regions of the United States, as well as Treasury attachés and FinCEN foreign intelligence unit liaisons to be stationed at U.S. embassies or foreign government facilities.[18] The Act additionally creates a Subcommittee on Innovation and Technology to advise the Secretary of the Treasury on innovation with respect to AML and calls for BSA “Innovation Officers” and “Information Security Officers” at FinCEN and other federal financial regulators.[19] Although these staffing reforms may not directly impact financial institutions, the government’s increased focus and sophistication in addressing money laundering may result in additional inquiries from law enforcement, regulations, and guidance.

  1. The AMLA Provides Additional Statutory Authority for DOJ to Seek Documents from Foreign Financial Institutions

DOJ typically has three avenues to pursue documents from foreign financial institutions. It can: (i) make a request under the Mutual Legal Assistance Treaty (or, in the absence of a treaty, a letter rogatory) with the country in question, which can be a slow process; (ii) it can issue a Bank of Nova Scotia subpoena, which requires written approval from DOJ’s Office of International Affairs[20]; or (iii) it can issue a subpoena pursuant to 31 U.S.C. § 5318(k) to a foreign financial institution that maintains a correspondent bank account in the United States.

The AMLA significantly expands the scope of DOJ’s (and Treasury’s) authority to seek and enforce correspondent account subpoenas under Section 5318. Previously, these subpoenas could be issued to any foreign bank that maintained a correspondent account in the United States and could “request records related to such correspondent account.”[21] The AMLA broadens this authority to allow DOJ to seek “any records relating to the correspondent account or any account at the foreign bank, including records maintained outside of the United States,” if the records are the subject of an investigation that relates to a violation of U.S. criminal laws, a violation of the BSA, a civil forfeiture action, or a Section 5318A investigation.[22] Thus, by statute, DOJ now has the authority to subpoena from foreign banks not only records related to correspondent accounts, but records from any account at the foreign bank if they fall within one of the broad investigative categories identified in the statute. The AMLA also requires the foreign financial institution to authenticate all records produced.[23] In the event a foreign financial institution fails to comply, the Act authorizes the Attorney General to seek contempt sanctions, and the Attorney General or Secretary of the Treasury may direct covered U.S. financial institutions to terminate their correspondent relationships with the foreign financial institution refusing to comply and can impose penalties on those institutions that fail to do so.[24]

  1. The AMLA Includes a Pilot Project for Sharing SAR Data Across International Borders

An issue that many of our financial institution clients face is how to share information contained in suspicious activity reports (“SARs”) across U.S. borders to affiliates located in other countries.[25] Historically, FinCEN has issued guidance to partially address the problem by permitting sharing of SAR information with foreign parent organizations or U.S. affiliates.[26] The AMLA further addresses this issue by providing that within a year after the legislation is enacted, the Treasury Department shall issue rules that create a pilot program for financial institutions to share information related to SARs, including their existence, “with the institution’s foreign branches, subsidiaries, and affiliates for the purpose of combating illicit finance risks.”[27] Notably, it contains jurisdictional carve-outs that would not permit sharing with any entities located in China or Russia (which can be waived by the Secretary of the Treasury on a case-by-case basis for national-security reasons) or in jurisdictions that are state sponsors of terrorism, subject to U.S. sanctions, or that the Secretary of the Treasury determines cannot reasonably protect the security and confidentiality of the data.[28] The pilot project is set to last three years, and can be extended for an additional two years upon a showing by the Treasury Department that it is useful and in the U.S. national interest.[29]

  1. The AMLA Specifically Applies the BSA to Nontraditional Value Transfers, Including Cryptocurrency

As financial institutions have become more adept at fighting money laundering in the past decade, the government has become increasingly concerned that criminals may turn to other mediums, such as cryptocurrency and art, to try to launder money. For instance, in November 2020, DOJ announced that it seized over $1 billion worth of Bitcoin that was tied to drug sales and other illicit products and services on the online marketplace Silk Road before it was shut down.[30] And using high-end artwork was one of the ways in which the alleged co-conspirators in the 1MDB scandal attempted to launder the proceeds of their alleged crimes, by purchasing various high-end pieces of art and then seeking banks or financiers “who take art as security for … bank loans.”[31]

While U.S. enforcers had argued that preexisting anti-money laundering authorities could reach transactions involving cryptocurrency and art, the application of preexisting AML regulations to cryptocurrency, in particular, has often been an uneasy fit. The preexisting AML regime was a set of rules written largely for an analog world, and its application to the digital realm left open important questions, particularly in the context of criminal enforcement actions. Now, however, the Act expands the definition of financial institution and money transmitting business to include businesses engaged in the exchange or transmission of “value that substitutes for currency,” potentially reinforcing the government’s position that the BSA applies to cryptocurrency.[32] The AMLA also adds antiquities dealers, advisors, and consultants to the definition of “financial institution” under the BSA.[33] As to art, the AMLA requires the government to prepare a study within a year that assesses money laundering and terrorist financing through the art trade, including “which markets … should be subject to regulation,” “the degree to which the regulations, if any, should focus on high-value trade in works of art,” and “the need, if any, to identify persons who are dealers, advisors, consultants, or any other persons who engage as a business in the trade in works of art.”[34]

  1. Many Smaller Companies Will Be Required to Disclose Beneficial Ownership Information to FinCEN, Which Will Also Be Available to Financial Institutions

The lack of a requirement for corporations to provide beneficial ownership information at the state or federal level in the United States has long been seen by law enforcement as a loophole that criminals can exploit. For instance, in 2016, the Financial Action Task Force (“FATF,” an international body that sets AML standards) recommended that the United States “[t]ake steps to ensure that adequate, accurate and current [beneficial owner] information of U.S. legal persons is available to competent authorities in a timely manner, by requiring that such information is obtained at the Federal level.”[35]

Accordingly, one of the most significant developments in the AMLA is the requirement for “reporting compan[ies]” to disclose beneficial ownership information to FinCEN, which will in turn maintain a nonpublic beneficial ownership database.[36] The definition of “reporting company” exempts a wide range of entities, including many classes of financial institutions (such as registered issuers, credit unions, broker-dealers, money transmitters, and exchanges) and larger U.S. companies, which are defined as companies that employ more than 20 full-time employees in the United States, had more than $5 million in gross revenue in the past year, and are operating at a physical office in the United States.[37] Thus, the new requirement is aimed at smaller businesses and shell companies.

Although the reporting requirement generally does not apply to financial institutions, it nevertheless has important consequences for them. The Act allows FinCEN to disclose beneficial ownership information to a financial institution with the reporting company’s consent to facilitate the financial institution’s compliance with Customer Due Diligence requirements.[38] As such, financial institutions will have to develop processes to effectively evaluate information from this beneficial ownership database. Moreover, the AMLA provides significant penalties for misuse of beneficial ownership information. Failure to disclose beneficial ownership information subjects a person to civil monetary penalties of $500 per day and a fine up to $10,000 and/or imprisonment of up to two years.[39] By contrast, unauthorized disclosure of beneficial ownership information is subject to the same civil penalty, but with fines up to $250,000—25 times the fine for failure to report—and/or imprisonment of up to five years.[40]

  1. The AMLA Requires the Government to Establish AML Priorities That Will Feed Into Examinations of Financial Institutions

The AMLA requires the Secretary of the Treasury to publish “public priorities for anti-money laundering and countering the financing of terrorism policy” within 180 days after the law’s enactment.[41] The priorities must be “consistent with the national strategy for countering the financing of terrorism and related forms of illicit finance.”[42] FinCEN will have 180 days after the priorities are released to promulgate rules to carry out these priorities.[43] Financial institutions, for their part, will be required to “review” and “incorporat[e]” these priorities into their AML programs, which will be a measure “on which a financial institution is supervised and examined.”[44]

  1. The AMLA Begins to Address Inefficiencies in SAR and CTR Filing Processes

Some argue that the current SAR and CTR filing processes are the worst of both worlds: they are incredibly burdensome for financial institutions but simultaneously bury enforcers with so much information that they cannot separate the wheat from the chaff. The $10,000 threshold for CTRs, for example, was set in 1970, and were it to be adjusted for inflation, the current threshold for filing a CTR today would be more than $60,000.[45] The lack of indexing for these thresholds has resulted in a swelling volume of mandatory reports; more than 16 million CTRs were filed in 2019.[46] Similarly, the SAR thresholds were set over 20 years ago, and the “current regime promotes the filing of SARs that may never be read, much less followed up on as part of an investigation”[47]—resulting in over 2.7 million SARs filed in 2019.[48]

The AMLA begins to take steps to address these criticisms. It requires that, when imposing requirements to report suspicious transactions, the Secretary of the Treasury shall, among other things, “establish streamlined, including automated, processes to, as appropriate, permit the filing of noncomplex categories of reports.”[49] It also requires the government to conduct formal reviews of whether the CTR and SAR thresholds should be adjusted and to determine if there are changes that can be made to the filing process to “reduce any unnecessarily burdensome regulatory requirements” while ensuring the information has a high degree of usefulness to enforcers.[50]

The AMLA also contains a number of provisions to try to ensure the usefulness of information provided by financial institutions. For instance, it requires FinCEN to periodically disclose to financial institutions “in summary form[] information on suspicious activity reports filed that proved useful to Federal or State criminal or civil law enforcement agencies during the period since the most recent disclosure,” provided the information does not relate to an ongoing investigation or implicate national security.[51] Similarly, the AMLA requires FinCEN to publish threat pattern and trend information at least twice a year to provide meaningful information about the preparation, use, and value of reports filed under the BSA.[52]

  1. The AMLA Continues to Promote Collaboration Between the Public and Private Sectors

As FinCEN has recognized, “[s]haring information through … public-private partnerships supports more, and higher-quality, reports to FinCEN and assists law enforcement in detecting, preventing, and prosecuting terrorism, organized crime, money laundering, and other financial crimes.”[53] To that end, FinCEN has sought to improve collaboration between law enforcement and financial institutions over the years. For instance, in 2017, FinCEN created the “FinCEN Exchange” to “enhance information sharing with financial institutions.”[54]

The AMLA contains a number of provisions designed to further promote collaboration between the public and private sectors. It formalizes the FinCEN Exchange by statute, and requires the Secretary of the Treasury to periodically report to Congress about the utility of the Exchange and recommendations for further improvements.[55] The Act requires that data shared under the Exchange be done so in accordance with federal law and in “such a manner as to ensure the appropriate confidentiality of personal information”; it also “shall not be used for any purpose” other than identifying and reporting on financial crimes.[56] Furthermore, the Act requires the Secretary of the Treasury to convene a team consisting of stakeholders from the public and private sector “to examine strategies to increase cooperation between the public and private sectors for purposes of countering illicit finance.”[57]

________________________

   [1]   William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, H.R. 6395. Division F of the NDAA is the Anti-Money Laundering Act of 2020, and Title XCVII within the bill contains additional provisions relevant to the financial services industry.

   [2]   This alert is not a comprehensive summary of every provision of the AMLA, the specific provisions of the law discussed herein, or the broader NDAA. For example, the NDAA contains a provision providing the SEC explicit authority to seek disgorgement in federal court, which is discussed in a separate Gibson Dunn client alert available here.

   [3]   AMLA, § 6314 (adding 31 U.S.C. § 5323(b)(1)).

   [4]   See 31 U.S.C. § 5323.

   [5]   AMLA, § 6314 (adding 31 U.S.C. § 5323(g)).

   [6]   Press Release, U.S. Secs. & Exch. Comm’n, SEC Proposes New Whistleblower Program Under Dodd-Frank Act, (Nov. 3, 2010), https://www.sec.gov/news/press/2010/2010-213.htm.

   [7]   U.S. Secs. & Exch. Comm’n, Whistleblower Program Annual Report 27-30 (2020), https://www.sec.gov/files/2020%20Annual%20Report_0.pdf.

   [8]   Press Release, SEC Issues Record $114 Million Whistleblower Award, Securities and Exchange Commission, Oct. 22, 2020, https://www.sec.gov/news/press-release/2020-266.

   [9]   Developments in the Defense of Financial Institutions – The International Reach of the U.S. Money Laundering Statutes, Gibson Dunn (Jan. 9, 2020), https://www.gibsondunn.com/developments-in-defense-of-financial-institutions-january-2020/.

[10]   Amy MacKinnon, Biden Expected to Put the World’s Kleptocrats on Notice, Foreign Policy (Dec. 3, 2020), https://foreignpolicy.com/2020/12/03/biden-kleptocrats-dirty-money-illicit-finance-crackdown/.

[11]   AMLA, § 6313 (adding 31 U.S.C. § 5335(b)).

[12]   AMLA, § 6313 (adding 31 U.S.C. § 5335(c)).

[13]   AMLA, § 6313 (adding 31 U.S.C. § 5335(d)).

[14]   AMLA, § 6312 (adding 31 U.S.C. § 5322(e)).

[15]   AMLA, § 6310 (adding 31 U.S.C. § 5321(g)).

[16]   AMLA, § 6309 (adding 31 U.S.C. § 5321(f)).

[17]   AMLA, § 6105.

[18]   AMLA, §§ 6106, 6107, 6108.

[19]   AMLA, §§ 6207, 6208, 6303.

[20]   Justice Manual § 9-13.525, U.S. Department of Justice, https://www.justice.gov/jm/jm-9-13000-obtaining-evidence#9-13.525 (“[A]ll Federal prosecutors must obtain written approval from the Criminal Division through the Office of International Affairs (OIA) before issuing any unilateral compulsory measure to persons or entities in the United States for records located abroad.”).

[21]   31 U.S.C. § 5318(k)(3)(A).

[22]   AMLA, § 6308 (31 U.S.C. § 5318(k)(3)(A)(i) as revised).

[23]   AMLA, § 6308 (31 U.S.C. § 5318(k)(3)(A)(ii) as revised).

[24]   AMLA, § 6308 (31 U.S.C. § 5318(k)(D), (E) as revised).

[25]   See 31 U.S.C. § 5318(g)(2)(A)(i) (providing that financial institutions or their employees involved in reporting suspicious transactions may not notify “any person involved in the transaction that the transaction has been reported.”).

[26]   Interagency Guidance on Sharing Suspicious Activity Reports with Head Offices or Controlling Companies (Jan. 20, 2006), https://www.fincen.gov/sites/default/files/guidance/sarsharingguidance01122006.pdf; Fin. Crimes Enf’t Network, FIN-2010-G006, Sharing Suspicious Activity Reports by Depository Institutions with Certain U.S. Affiliates (Nov. 23, 2010), https://www.fincen.gov/sites/default/files/shared/fin-2010-g006.pdf.

[27]   AMLA, § 6212 (adding 31 U.S.C. § 5318(g)(8)(B)(i)).

[28]   AMLA, § 6212 (adding 31 U.S.C. § 5318(g)(8)(C)).

[29]   AMLA, § 6212 (adding 31 U.S.C. § 5318(g)(8)(B)(iii)).

[30]   Press Release, U.S. Dept. of Justice, United States Files A Civil Action To Forfeit Cryptocurrency Valued At Over One Billion U.S. Dollars, (Nov. 5, 2020), https://www.justice.gov/usao-ndca/pr/united-states-files-civil-action-forfeit-cryptocurrency-valued-over-one-billion-us.

[31]   United States of America v. One Pen and Ink Drawing By Vincent Van Gogh Titled “La Maison De Vincent A Arles” et al., No. 2:16-cv-5366 (C.D. Cal. July 20, 2016), Dkt. 1 ¶¶ 440-43, https://www.justice.gov/archives/opa/page/file/877156/download

[32]   AMLA, § 6102(d); see also Press Release, Sen. Mark Warner, Warner, Rounds, Jones Applaud Inclusion of Bipartisan Anti-Money Laundering Legislation in NDAA (Dec. 3, 2020), https://www.warner.senate.gov/public/index.cfm/2020/12/warner-rounds-jones-applaud-inclusion-of-bipartisan-anti-money-laundering-legislation-in-ndaa (highlighting “[e]nsuring the inclusion of current and future payment systems in the AML-CFT regime” as among the achievements of the new NDAA).

[33]   AMLA, § 6110(a)(1) (31 U.S.C. § 5312(a)(2)(Y) as amended).

[34]   AMLA, § 6111(e).

[35]   FATF, Anti-money laundering and counter-terrorist financing measures in the United States: Executive Summary 11 (2016), http://www.fatf-gafi.org/media/fatf/documents/reports/mer4/MER-United-States-2016-Executive-Summary.pdf.

[36]   AMLA, § 6403 (adding 31 U.S.C. § 5336)

[37]   AMLA, § 6403 (adding 31 U.S.C. § 5336(a)(11)).

[38]   AMLA, § 6403 (adding 31 U.S.C. § 5336(c)(2)(B)(iii)).

[39]   AMLA, § 6403 (adding 31 U.S.C. § 5336(h)(3)(A)).

[40]   AMLA, § 6403 (adding 31 U.S.C. § 5336(h)(3)(B)).

[41]   AMLA, § 6101(a) (adding 31 U.S.C. § 5311(b)(4)(A)).

[42]   AMLA, § 6101(a) (adding 31 U.S.C. § 5311(b)(4)(C)).

[43]   AMLA, § 6101(a) (adding 31 U.S.C. § 5311(b)(4)(D)).

[44]   AMLA, § 6101(a) (adding 31 U.S.C. § 5311(b)(4)(E)).

[45]   Blaine Luetkemeyer, Steve Pearce, It’s Time to Modernize the Bank Secrecy Act, American Banker (June 13, 2018), https://www.americanbanker.com/opinion/its-time-to-modernize-the-bank-secrecy-act.

[46]   FinCEN Report of Transactions in Currency, 85 Fed. Reg. 29,022, 29,023 (May 14, 2020), https://www.govinfo.gov/content/pkg/FR-2020-05-14/pdf/2020-10310.pdf.

[47]   The Clearing House, A New Paradigm: Redesigning the U.S. AML/CFT Framework to Protect National Security and Aid Law Enforcement 13 (2017), here.

[48]   See FinCEN Report of Reports by Financial Institutions of Suspicious Transactions, 85 Fed. Reg. 31,598, 31,599 (May 26, 2020), https://www.govinfo.gov/content/pkg/FR-2020-05-26/pdf/2020-11247.pdf.

[49]   AMLA, § 6202 (adding 31 U.S.C. § 5318(g)(5)(D)).

[50]   AMLA, §§ 6204, 6205.

[51]   AMLA, § 6203(b).

[52]   AMLA, § 6206 (adding 31 U.S.C. § 5318(g)(6)).

[53]   Press Release, Fin. Crimes Enf’t Network, FinCEN Exchange in New York City Focuses on Virtual Currency, https://www.fincen.gov/resources/financial-crime-enforcement-network-exchange.

[54]   Press Release, Fin. Crimes Enf’t Network, FinCEN Launches “FinCEN Exchange” to Enhance Public-Private Information Sharing, (Dec. 4, 2017), https://www.fincen.gov/news/news-releases/fincen-launches-fincen-exchange-enhance-public-private-information-sharing.

[55]   AMLA, § 6103 (adding 31 U.S.C. § 310(d)(2), (3)).

[56]   AMLA, § 6103 (adding 31 U.S.C. § 310(d)(4)(A), (4)(B), 5(B)).

[57]   AMLA, § 6214.


The following Gibson Dunn lawyers assisted in preparing this client alert: Stephanie Brooker, M. Kendall Day, Linda Noonan, Ella Alves Capone, Chris Jones and Alexander Moss.

Gibson Dunn has deep experience with issues relating to the Bank Secrecy Act, other AML and sanctions laws and regulations, and the defense of financial institutions more broadly. For assistance navigating white collar or regulatory enforcement issues involving financial institutions, please contact any of the authors, the Gibson Dunn lawyer with whom you usually work, or any of the leaders and members of the firm’s Financial Institutions, White Collar Defense and Investigations, or International Trade practice groups.

Stephanie Brooker –  Washington, D.C. (+1 202-887 3502, [email protected])
M. Kendall Day– Washington, D.C. (+1 202-955-8220, [email protected])
Linda Noonan – Washington, D.C. (+1 202-887-3595, [email protected])
Ella Alves Capone – Washington, D.C. (+1 202-887-3511, [email protected])
Chris Jones* – San Francisco (+1 415-393-8320, [email protected])
Alexander Moss – Washington, D.C. (+1 202.887.3615, [email protected])

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

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])
Arthur S. Long – New York (+1 212-351-2426, [email protected])

White Collar Defense and Investigations Group:
Joel M. Cohen – New York (+1 212-351-2664, [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])

International Trade Group:

Ronald Kirk – Dallas (+1 214-698-3295, [email protected])
Judith Alison Lee – Washington, D.C. (+1 202-887-3591, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [email protected])

*Mr. Jones is admitted only in New York and Washington, D.C. and is practicing under the supervision of Principals of the Firm.

© 2020 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 December 4, 2020, Judge Rakoff of the Southern District of New York denied a motion to dismiss breach of fiduciary duty claims against former directors of Jones Group (the predecessor to Nine West).[1] The lawsuit arises from the board of directors’ approval of a buyout transaction that distributed $1.2 billion to Jones Group shareholders, while allegedly rendering the company insolvent. The Court allowed the claims to proceed, finding that the directors, by their own admission, failed to conduct a reasonable investigation into whether the transaction as a whole was beneficial to the company or would render the company insolvent. The Court concluded that the director defendants were not exempt from responsibility for the steps of the integrated transaction that were implemented after they resigned from the board because they allegedly knew that those steps were part of an integrated multi-step transaction and would be completed substantially concurrently with their resignation. The directors were not entitled to the protections of the business judgment rule because they expressly avoided any investigation regarding two key steps in the transaction; they allegedly turned a blind eye to the intention to complete those steps after the initial merger.

This preliminary decision merits discussion, but it does not represent a watershed expansion of exposure for directors or expansion of their fiduciary duties. Instead, it reinforces the simple rule that in order to obtain the protection of the business judgment rule the board must in fact make an informed business judgment, and declining to review key components of an integrated multi-step transaction is reckless. Ordinarily, the business judgment rule and the exculpatory provisions in a company’s bylaws offer a significant shield against liability for directors, except in the most egregious of circumstances. However, those protections only operate when the directors make a reasonable investigation and a business judgment, which the Jones Group directors expressly chose not to do when they opted not to approve or disapprove the key elements of the multi-step transaction that allegedly rendered the company insolvent. As the Court very aptly noted, “the business judgment rule presupposes that directors made a business judgment.”[2]

Facts of the Case

In the years leading up to the 2014 leverage buyout transaction, Jones Group—a publicly traded global footwear and apparel company—was suffering financially. The only bright spot was the performance of two brands, Stuart Weitzman and Kurt Geiger, that Jones Group had purchased for $800 million just a few years earlier.

In July of 2012, the board began considering a sale of the company and retained Citigroup Global Markets to act as its advisor. Citigroup advised the board, in relevant part, that in a transaction where Jones Group retained all of its businesses (including the successful Stuart Weitzman and Kurt Geiger brands), the company could support a maximum debt to EBITDA ratio of 5.1. The following year, the private equity firm Sycamore Partners Management reached a deal to purchase Jones Group for $15 per share, representing a $2.15 billion implied enterprise value for the company.

The merger agreement between Jones Group and Sycamore Partners originally involved five allegedly integrated components:

  1. Jones Group would merge with a Sycamore affiliate;
  2. Sycamore would contribute at least $385 million in equity to the post-merger surviving entity (“Nine West”);
  3. Nine West would increase its total debt burden from $1 billion to $1.2 billion;
  4. Jones Group shareholders would be cashed out at $15 per share (for a total of $1.2 billion); and
  5. the successful Stuart Weitzman and Kurt Geiger brands, along with one additional business unit, would be sold to another Sycamore affiliate for substantially less than fair market value.

The board unanimously approved the merger agreement on December 19, 2013 but excluded from its approval the 3rd and 5th steps (the debt increase and the carve-out transaction of the Stuart Weitzman and Kurt Geiger brands). The merger agreement included provisions that obligated Jones Group to assist Sycamore in both planning the carve-out transaction and syndicating the additional debt. The directors allegedly knew that these were parts of an integrated transaction, that all steps would occur substantially concurrently, and that their affirmative vote was putting the wheels in motion to strip the most valuable assets out of the merged company and burden it with unsustainable debt. They allegedly chose to approve parts of the multi-step transaction and turn a blind-eye to the harmful steps they allegedly knew they were facilitating.

Prior to the closing, Sycamore reduced its equity contribution from $395 million to $120 million, and increased the total amount of new debt from $1.2 billion to $1.55 billion. This raised the company’s post-transaction debt to EBITDA ratio to between 6.6 and 7.8.—well above the 5.1 maximum ratio that Citigroup initially indicated was sustainable. Although the merger agreement contained a fiduciary out clause, the directors did not reconsider their approval even after the initial transaction was modified in ways detrimental to the company.

In anticipation of the carve-out transaction, Sycamore hired valuation advisors to provide a solvency opinion for Jones Group as it would exist after the transfer of the successful Stuart Weitzman and Kurt Geiger brands (Jones Group without the successful brands, “RemainCo”). Sycamore allegedly created and provided to their advisors “unreasonable and unjustified” EBITDA projections for RemainCo to inflate its value and justify the below-market price for the Stuart Weitzman and Kurt Geiger brands. Sycamore ultimately settled on a $1.58 billion valuation of RemainCo, just above the $1.55 billion total debt burden that was planned by Sycamore. The directors of Jones Group were not, according to the complaint, directly aware of the fact that Sycamore had manipulated the projections of RemainCo in order to achieve the $1.58 billion valuation. However, the complaint alleged that the directors received updated reports and projections from Jones Group management on a monthly basis and were therefore aware of the poor performance of Jones Group overall, as well as the comparatively stellar performance of the Stuart Weitzman and Kurt Geiger brands.

The merger closed on April 8, 2014, at which point Jones Group directors were replaced by two Sycamore principals. As part of the closing of the merger, the new directors caused Nine West to sell the Stuart Weitzman and Kurt Geiger brands to a newly formed Sycamore affiliate for just $641 million. This number was far less than the $800 million that Jones Group had paid to acquire these brands just a few years earlier, even though these brands had been very successful during the interim. The complaint alleged that the fair market value of these brands was $1 billion. In April of 2018, about four years after the merger closed, Nine West filed for bankruptcy.

Allegations

The Court found that the following allegations justified denial of the motion to dismiss and refusal to apply the deferential business judgment standard of review to the actions of the directors:

  1. The directors chose not to review or approve two of the major steps of the merger transaction—the issuance of additional debt and a carve-out transaction that sold off the most successful parts of the company post-merger, even though they knew their approval of the merger would lead to the completion of these additional steps in the intended multi-step transaction. Both steps were crucially important in causing the overleveraging that eventually led to the bankruptcy of the company.
  2. The directors allegedly ignored certain “red flags” that should have caused them to investigate potential solvency issues related to the transaction. The failure to investigate these red flags when the directors could have withdrawn support for the transaction was, according to the Court, reckless.

Breach of Fiduciary Duty Claim

The director defendants moved to dismiss the breach of fiduciary duty claims on two grounds. First, they argued that their approval of the transaction was protected by the business judgment rule, and second, that even if the business judgment rule did not apply, they were protected by exculpatory provisions in Jones Group’s bylaws. The Court rejected both arguments based on the same fundamental allegations: the directors had not in fact exercised any business judgment because they expressly avoided approving the two key steps of the multi-step transaction, and the directors were responsible for those steps because they knew the entire multi-step transaction would be consummated substantially concurrently. The directors’ failure to review the merits of each step of the transaction was reckless.

Under Pennsylvania law, which is especially deferential towards directors in the merger context, adherence to the business judgment standard is presumed so long as a majority of the disinterested directors approve the merger unless the disinterested directors did not assent to such act in good faith after reasonable investigation.

The Court found that the complaint sufficiently alleged that the directors failed to conduct a reasonable investigation into whether the transaction as whole (including the additional debt burden and the carve-out transaction) would render the company insolvent. The complaint alleged that the directors had excluded from their approval the two steps in the multi-step transaction that rendered RemainCo insolvent, even after Sycamore substantially increased the debt burden and decreased its equity contribution. The Court concluded that the business judgment rule did not apply because the rule, even under the deferential merger standard, only protects decisions undertaken after reasonable investigation and the complaint alleged there was no investigation (reasonable or otherwise).

Furthermore, the Court rejected the directors’ argument that they could not be liable for actions effectuated after they ceased to be in control of the company, explaining that, accepting the allegation in the complaint as true for purposes of the motion to dismiss, the multi-step transaction “reasonably collapses into a single integrated plan.”[3] In making this determination, the Court found it significant that the directors allegedly knew about the post-merger steps and, further, that those post-merger steps were certain to occur upon approval of the transaction. In a different recent decision in the Southern District of New York, In re Tribune Co. Fraudulent Conveyance Litigation, 2018 WL 6329139 (S.D.N.Y. Nov. 30, 2018), the court declined to collapse a two-step LBO transaction where the second step occurred more than six months after the first and its occurrence was subject to various preconditions including regulatory approval and the issuance of a second solvency opinion.[4] Contrasted to the facts here, where all five steps of the transaction were certain to occur substantially concurrently, the second step in Tribune was subject to conditions precedent that might not be satisfied and, therefore, was not certain to occur when the first step occurred or when the board members resigned.[5]

Exculpatory Bylaw Provisions Did Not Protect the Directors

Jones Group’s bylaws contained an exculpatory provision that limited a director’s monetary liability to breaches involving self-dealing, willful misconduct, or recklessness. The Court found that the complaint sufficiently alleged that the directors’ decision to set in motion the multi-step transaction, including the two steps that allegedly rendered the company insolvent and stripped it of its best assets, without reviewing the merits of those steps, was reckless.

The complaint alleged that the directors consciously disregarded whether the additional debt and carve-out transactions were in the best interests of the company by specifically excluding those elements of the transaction from their assessment or approval. The Court found that the complaint also alleged certain “red flags” that should have put the director defendants on notice that the additional debt and carve-out transactions would leave the company insolvent.

The first red flag was that the $2.2 billion valuation that the company received in the transaction, minus the $800 million historical purchase price of the carve-out businesses, implied that the rest of Jones Group was worth, at most, $1.4 billion. This relatively simple math—that a company worth no more than $1.4 billion was to be saddled with $1.55 billion of debt—should have alerted the directors that they needed to investigate RemainCo’s solvency. The second red flag was the simple fact that the increased debt burden would increase the debt to EBITDA ratio to between 6.6 and 7.8—both of which were substantially above the 5.1 maximum ratio that Citigroup had previously advised the board was sustainable.

The Court held that the red flags alleged in the complaint, coupled with the failure of the board to conduct any investigation in the face of such notice, was reckless. The denial of the motion to dismiss and conclusion that the complaint adequately alleged recklessness is premised in large part on the directors’ alleged decision to abdicate their duties by not reviewing the merits of two of the steps of the multi-step transaction and not an indication that an informed, but incorrect, assessment of the merits of the transaction would not have been protected.

Aiding and Abetting the Breach of Fiduciary Duty Claim

In addition to claims for their own breaches of fiduciary duty, the directors also faced allegations of aiding and abetting the breaches of the fiduciary duties of the two Sycamore principals who became directors after the closing of the merger. The Court, rather summarily, upheld this claim for two reasons.

First, the Court rejected the directors’ argument that any acts taken before the Sycamore principals became directors cannot form the basis of this claim, finding that no such temporal requirement for the fiduciary relationship existed, and that there were no grounds for creating one. The allegations that the directors had enabled the Sycamore directors to strip away assets and overleverage RemainCo by approving the merger without reviewing the merits of the transfers of the crown jewels or the additional debt, even though the directors allegedly had actual knowledge these additional steps would be taken post-merger, was sufficient to state a claim for aiding an abetting the actions of the Sycamore directors.

Second, the complaint adequately pled that the director defendants knowingly participated in the breaches because the same “red flags” discussed above were sufficient to show that the directors had actual or constructive knowledge that the contemplated carve-out transactions constituted a breach of fiduciary duty by the Sycamore principals, which the director defendants knew the Sycamore directors intended to carry out as part of the multi-step transaction. The directors’ decision not to address the merits of two critical steps in the multi-step transaction may even justify an inference that the directors knew that these steps were problematic.

Key Considerations

While this decision is not a departure from established law, it does provide guidance to directors and other interested parties as to what practices must be employed to satisfy their fiduciary duties and minimize liability risk. Process is critical. To obtain the benefits of the business judgment rule directors must actually exercise business judgement and cannot intentionally distance themselves from responsibility for certain steps in an integrated multi-step transaction that they knowingly facilitate, especially when all steps in the transaction occur substantially concurrently.

This opinion denies a motion by the director defendants to dismiss the claims against them. It is not a ruling finally imposing liability. On a motion to dismiss, the court is required to accept all facts in the plaintiff’s complaint as true and to view them in the light most favorable to the plaintiff. Additionally, the Court was applying Pennsylvania law. While fiduciary duty law is fairly similar across jurisdictions, this decision is merely persuasive authority regarding one state’s fiduciary duty laws. That said, the Court refused to apply the business judgment standard, which is one of the key protections available to directors.

This decision reaffirms that directors must thoroughly and meaningfully review all parts of a transaction that are contemplated when they decide whether to approve it, even if some steps of a multi-step integrated transaction may occur after the director is no longer a board member. A director cannot evade the obligation to review part of the transaction by simply excluding it from the board approval analysis. Directors should anticipate that a multi-step transaction may be viewed by a court as a single transaction, even if certain steps are to be completed post-closing by different directors or entities. However, directors can further protect themselves by insisting on a bifurcated transaction structure with meaningful conditions so that any risky steps (e.g., incurrence of additional debt, spinoff transactions, etc.) will only occur if the company is solvent and can support the transaction.

In evaluating a transaction, directors should also consider whether the valuation metrics they receive are compatible all other current financial information that had been provided to the directors. While there is nothing in the Nine West decision to indicate that directors cannot rely on the analyses and presentations of advisors and experts, the Court’s comments regarding the disconnect between the numbers provided to the valuation advisors by the proposed buyer and other information available to the directors may imply an expectation that a reasonable exercise of business judgment requires directors to consider whether valuation metrics are at odds with the other information that they have regarding financial performance of the company.

______________________

  [1]   In re Nine W. LBO Sec. Litit., __ F. Supp. 3d __, 2020 WL 7090277 (S.D.N.Y. Dec. 4, 2020). All of the facts and legal analysis in this memorandum are from the above citation unless otherwise noted.

  [2]   Id. at * 29.

  [3]   Id. at * 30.

  [4]   In re Tribune Co. Fraudulent Conveyance Litig., 2018 WL 6329139, at *8-9 (S.D.N.Y. Nov. 30, 2018). In step one of the Tribune transaction, the company borrowed money to repurchase approximately 50% of its outstanding stock, and then in step two the company borrowed additional money to redeem the remaining stock through a go-private transaction. Id. at *2.

  [5]   This decision does not suggest that a director would be liable for a transaction undertaken by a future board for which the prior board had no knowledge. But these cases suggest that a board may be able to insulate itself from liability for future actions undertaken for which it has knowledge, so long as those future actions are considered in a meaningful way or, like in Tribune, future transactions are meaningfully bifurcated from the transaction that the directors approve.


Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or any of the following:

Michael A. Rosenthal – New York (+1 212-351-3969, [email protected])
Jeffrey C. Krause – Los Angeles (+1 213-229-7995, [email protected])
Oscar Garza – Orange County, CA (+1 949-451-3849, [email protected])
Matthew G. Bouslog – Orange County, CA (+1 949-451-4030, [email protected])
Douglas G. Levin – Orange County, CA (+1 949-451-4196, [email protected])

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

Business Restructuring and Reorganization Group:
David M. Feldman – New York (+1 212-351-2366, [email protected])
Scott J. Greenberg – New York (+1 212-351-5298, [email protected])
Robert A. Klyman – Los Angeles (+1 213-229-7562, [email protected])
Jeffrey C. Krause – Los Angeles (+1 213-229-7995, [email protected])
Michael A. Rosenthal – New York (+1 212-351-3969, [email protected])

© 2020 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 December 27, 2020, President Trump signed the bipartisan COVID-19 relief and government funding bill, which incorporated the Copyright Alternative in Small-Claims Enforcement Act of 2020 (“CASE Act”) that had been pending as part of H.R. 133, as well as legislation designed to increase criminal penalties for illicit streaming of copyright-protected content. The CASE Act contains various revisions to the Copyright Act, 17 U.S.C. §§ 101 et seq., with the goal of creating a new avenue for copyright owners to enforce their rights without having to file a lawsuit in federal court. The CASE Act creates a Copyright Claims Board within the United States Copyright Office that may adjudicate small claims of copyright infringement using streamlined procedures and award limited remedies, including no more than $30,000 in total damages in any single proceeding. The stimulus package also includes the language of a separate bipartisan bill, the Protecting Lawful Streaming Act, that amends Title 18 of the U.S. Code to make it a felony (rather than just a misdemeanor) to unlawfully stream copyright-protected content online for profit, with penalties of up to 10 years of imprisonment. We briefly summarize these key copyright provisions below.

  • Creation of Copyright Claims Board. While federal courts generally exercise exclusive jurisdiction over claims of copyright infringement,[1] the CASE Act establishes a Copyright Claims Board as an alternative forum in which parties may voluntarily resolve small claims of copyright infringement arising under Section 106 of the Copyright Act.[2] The Board consists of three Copyright Claims Officers who may conduct individualized proceedings to resolve disputes before them, including by managing discovery and conducting hearings as necessary, and awarding monetary and other relief.[3] The Officers must issue written decisions setting forth their factual findings and legal conclusions.[4]  But parties that choose to proceed before the Board waive their right to formal motion practice and a jury trial.[5] Participation in a proceeding before the Board is voluntary, and parties may opt out upon being served with a claim, choosing instead to resolve their dispute in federal court.[6]
  • Board Decisions. The CASE Act grants the Register of Copyrights authority to issue regulations setting forth specific claim-resolution procedures, but the CASE Act expressly articulates choice-of-law principles and states that Board decisions are not precedential.
    • Choice of Law: Although the Board sits within the Copyright Office in Washington, D.C., the Board must follow the law in the federal jurisdiction in which the action could have been brought if filed in federal court.[7] Given the conflicts that could arise where an action could have been brought in multiple jurisdictions that are split on a legal question, the Act provides that the Board may apply the law of the jurisdiction the Board determines has the most significant ties to the parties and conduct at issue.[8]
    • Board Decisions Are Not Precedential: The CASE Act provides that Board decisions may not be cited or relied upon as legal precedent in any action before any tribunal, including the Board.[9] And Board decisions have preclusive effect solely with respect to the parties to the proceeding and the claims asserted and resolved in the proceeding.[10]
  • Board Remedies. As in federal court, parties before the Board may seek actual or statutory damages. But the CASE Act caps the amount of damages the Board may award. Specifically, the Board may not award more than $15,000 in statutory damages per work, may not consider whether infringement was willful (and, therefore, may not increase a per work statutory award based on willfulness, as is permitted in federal court), and may not award more than $30,000 in total actual or statutory damages in any single proceeding, notwithstanding the number of claims asserted.[11] While attorneys’ fees are recoverable under the Copyright Act,[12] the Board may not award attorneys’ fees except in the case of bad faith conduct—in which case, any fee award may not exceed $5,000, absent extraordinary circumstances, such as where a party has engaged in a pattern of bad faith conduct.[13]
  • Limited Appellate Review. The CASE Act permits parties to seek limited review of Board decisions. After the Board issues its written decision in a matter, a party may submit to the Board a written request for reconsideration.[14] If the Board declines to reconsider its decision, the party may ask the Register of Copyrights to review the Board’s decision under an abuse of discretion standard of review.[15] If the Register does not provide the requested relief, the party may then seek an order from a district court vacating, modifying, or correcting the Board’s determination under only very limited circumstances: if (a) the determination was the result of fraud, corruption, misrepresentation, or other misconduct; (b) the Board exceeded its authority or failed to render a final determination; or (c) the determination was based on a default or failure to prosecute due to excusable neglect.[16]
  • Bar on Repeat Frivolous Filings. In an attempt to deter copyright trolls from filing repeated, frivolous claims before the Board, the CASE Act provides that any party who pursues a claim or defense in bad faith more than once in a 12-month period may be barred from initiating a claim before the Board for 12 months.[17] The CASE Act also grants the Register of Copyrights authority to issue regulations limiting the number of proceedings a claimant may initiate in any given year.[18]
  • Implications of the CASE Act. The CASE Act authorizes the Register of Copyrights to issue implementing regulations setting forth specific procedures for proceedings before the Board, so it remains to be seen exactly how the Board will conduct proceedings before it. It also is an open question how and whether the Board will resolve constitutional questions that arise in copyright infringement actions, such as First Amendment questions relating to the fair use defense. Further, it remains to be seen whether defendants in small copyright disputes will consent to Board proceedings, or will opt out in favor of the federal courts. Regardless, the CASE Act creates mechanisms for the more efficient and economical pursuit of small claims of copyright infringement, where the expense of litigating in federal court would otherwise exceed any potential recovery.
  • Protecting Lawful Streaming Act. The separate criminal copyright provisions tucked into the stimulus bill are designed to address a loophole under current law that allows the reproduction and distribution of copyright-protected material to be charged as felonies, but only allows the live streaming (or “publicly performing”) of such works to be charged as a misdemeanor. According to the legislative history, the bill sponsors thought it was important to recognize that streaming, rather than copying, has become the primary way that audiences consume entertainment. This new statutory language will allow the U.S. Justice Department to bring felony charges not against individual users, but rather against a digital transmission service that: (1) is primarily designed or provided for the purpose of streaming copyrighted works without the authority of the copyright owner or the law; (2) has no commercially significant purpose or use other than to stream copyrighted works without the authority of the copyright owner or the law; or (3) is intentionally marketed or directed to promote its use in streaming copyrighted works without the authority of the copyright owner or the law.[19] The statutory language represents a compromise with some critics who had feared that broader criminal provisions could be used to limit free speech online.

______________________

[1]   28 U.S.C. § 1338(a) (“The district courts shall have original jurisdiction of any civil action arising under any Act of Congress relating to … copyrights,” and “[n]o State court shall have jurisdiction over any claim for relief arising under any Act of Congress relating to … copyrights.”).

[2]   H.R. 133 § 1502(a); § 1504(c); see also 17 U.S.C. § 106 (“the owner of copyright under this title has the exclusive rights to … reproduce the copyrighted work”; “to prepare derivative works based upon the copyrighted work”; “to distribute copies or phonorecords of the copyrighted work to the public”; “to perform the copyrighted work publicly”; “to display the copyrighted work publicly”; and “to perform the copyrighted work publicly”).

[3]   H.R. 133 §§ 1502(b)(1)–(3), 1503(a)–(b), 1504(e)(2).

[4]   Id. § 1506(s)–(t).

[5]   Id. § 1506(c), (e)-(g), (m), (p).

[6]   Id. §§ 1504(a), 1506(g).

[7]   Id. § 1506(a)(2).

[8]   Id. § 1506(a)(2).

[9]   Id. § 1507(a)(3).

[10]   Id. § 1507(a).

[11]   Id. § 1504(e)(1)(A), (D).

[12]   17 U.S.C. § 505.

[13]   H.R. 133 §§ 1504(e)(3), 1506(y)(2).

[14]   Id. § 1506(w).

[15]   Id. § 1506(x).

[16]   Id. § 1508(c).

[17]   Id. § 1506(y)(3).

[18]   Id. § 1504(g).

[19]   18 U.S.C. § 2319C.


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

Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Ilissa Samplin – Los Angeles (+1 213-229-7354, [email protected])
Jonathan N. Soleimani – Los Angeles (+1 213-229-7761, [email protected])
Shaun Mathur – Orange County (+1 949-451-3998, [email protected])

Please also feel free to contact the following practice leaders:

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])

Media, Entertainment and Technology Group:
Scott A. Edelman – Los Angeles (+1 310-557-8061, [email protected])
Kevin Masuda – Los Angeles (+1 213-229-7872, [email protected])
Orin Snyder – New York (+1 212-351-2400, [email protected])

© 2020 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 last year has brought with it unprecedented challenges to our personal and professional lives as we sought to deal with the widespread ramifications of the coronavirus pandemic. Amidst this backdrop, we all watched in horror as the brutal killing of George Floyd by the police was captured on camera, sparking activism, protests, and discussions about racism and inequality in the United States and around the world, including here at Gibson Dunn. Immediately the firm spoke out and, more importantly, acted to reaffirm its commitment to addressing and tackling racial justice and equity issues. As part of that, we refocused and recommitted our efforts to take on pro bono matters that directly impact systemic racism and racial justice, including police reform, criminal justice reform, equity in education and health care, and much more. We have also launched several racial justice-focused pro bono collaborations with many of the Firm’s corporate clients. In the past six months, nearly 400 lawyers have dedicated more than 16,000 hours to over 50 matters dedicated to achieving racial equity.

As we all know, when this Firm puts its mind to a cause, we can achieve great things. And, just as we have with issues like LGBTQ rights and immigrant rights, Gibson Dunn is dedicated to playing a meaningful role in the fight against policies, practices, and actions that produce unequitable outcomes for people of color. Together we will achieve lasting, real change.

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On December 22, 2020, Congress passed the content of a pending bill, H.R. 6196, the “Trademark Modernization Act of 2020,” as part of its year-end virus relief and spending package.[1] The Act includes various revisions to the Lanham Act, 15 U.S.C. §§ 1051 et seq., intended to respond to a recent rise in fraudulent trademark applications. Among other things, the Act seeks to create more efficient processes to challenge registrations that are not being used in commerce, including by establishing new ex parte proceedings. The Act also seeks to unify the standard for irreparable harm with respect to injunctions in trademark cases, in light of inconsistencies that have emerged across federal courts after the Supreme Court’s decision in eBay v. MercExchange, LLC, 547 U.S. 388 (2006). We briefly summarize these key features of the Act below.

  • Presumption of Irreparable Harm. Section 6 of the Act provides that a “plaintiff seeking an injunction shall be entitled to a rebuttable presumption of irreparable harm” upon a finding of a violation or a likelihood of success on the merits, depending on the type of injunction sought.[2] That language effectively reinstates the standard that most courts applied in trademark cases until the Supreme Court’s decision in the patent case, eBay v. MercExchange, LLC, 547 U.S. 388 (2006). Before eBay, courts generally treated proof of likelihood of confusion as sufficient to establish both a likelihood of success on the merits and irreparable harm. In eBay, however, the Supreme Court concluded that courts deciding whether an injunction should issue must consider only “traditional equitable principles,” which do not permit “broad classifications.” Id. at 393. In light of that decision, some courts determined that liability for trademark infringement no longer presumptively supported injunctive relief and that irreparable injury had to be shown independently.[3] This Act resolves the division among the courts following eBay and clarifies that a rebuttable presumption of irreparable harm applies for trademark violations.
  • New Ex Parte Processes. Section 5 of the Act creates two new ex parte cancellation proceedings, designed to address concerns that the trademark register is becoming overcrowded with marks that have not been used in commerce properly, as the Lanham Act requires.[4] The first creates a new Section 16A to the Lanham Act, that allows for ex parte expungement of a registration that has never been used before in commerce.[5] The second creates a new Section 16B to the Lanham Act that allows for ex parte reexamination of a registration where the mark was not in use in commerce at the time of either the first claimed use, or when the application was filed.[6] The Act further authorizes the Director to promulgate regulations regarding the conduct of these proceedings.[7]
  • Changes to the Examination Process. The Act establishes two notable updates to the trademark examination process: first, it formalizes the process by which third-parties can submit evidence to the United States Patent and Trademark Office concerning a given application; second, it provides the Office with greater authority and flexibility to set the deadlines by which trademark applicants must respond to actions taken by the examiner.
    • Third-Party Evidence: The Act effectively codifies the longstanding informal practice by which third parties submit evidence to the Office regarding the registrability of a mark during the examination process. Section 3 expressly permits the submission of this evidence and also establishes new formalities concerning the process to do so—including by requiring that the submitted evidence include a description identifying the ground of refusal to which it relates, and by providing the Office with the authority to charge a fee for the submission.[8]
      The Act also imposes a two-month deadline for the Office to act on a third-party submission,[9] which should incentivize third-parties to submit relevant evidence to the examiner before he or she makes any decision on an initial application.
    • Response Times: Section 4 of the Act amends the Lanham Act’s provision that imposes a six month deadline for an applicant to respond to an examiner’s actions during the application process.[10]
      Specifically, Section 4 grants the Office the authority to determine, by regulation, response periods for different categories of applications, so long as the period is between 60 days and six months.[11]

It remains to be seen how the Office will interpret the Act and what procedures it will promulgate. It is also an open question whether the new ex parte and examination procedures created by the Act will address Congress’ underlying concerns that the register has become overcrowded with fraudulent registrations obtained by foreign entities, especially from China.[12] But it is clear that the Act will open up new fronts for administrative proceedings to challenge registered trademarks, and create new weapons for those who believe they are or would be affected by a pending application or registration. At the same time, the restoration of a formal presumption of irreparable harm in trademark infringement cases will make it procedurally easier for trademark owners to enjoin uses of confusingly similar marks and avoid consumer confusion about the source of a good or service.

_______________________

[1] See Office of Congressman Hank Johnson, Congressman Johnson’s Bipartisan, Bicameral Trademark Modernization Act Becomes Law, available at https://hankjohnson.house.gov/media-center/press-releases/congressman-johnson-s-bipartisan-bicameral-trademark-modernization-act (Dec. 22, 2020).

[2] The Act also clarifies that this amendment “shall not be construed to mean that a plaintiff seeking an injunction was not entitled to a presumption of irreparable harm before the date of the enactment of this Act.” H.R. 6196 § 6(a).

[3] See, e.g., Herb Reed Enters., LLC v. Fla. Entm’t Mgmt., Inc., 736 F.3d 1239, 1249 (9th Cir. 2013) (reading eBay as signaling “a shift away from the presumption of irreparable harm” and holding that a plaintiff must separately establish irreparable harm for a preliminary injunction to issue in a trademark infringement case); Salinger v. Colting, 607 F.3d 68, 78 n.7 (2d Cir. 2010) (suggesting that eBay’s “central lesson” that courts should not “presume that a party has met an element of the injunction standard” applies to all injunctions); see also Voice of the Arab World, Inc. v. MDTV Med. News Now, Inc., 645 F.3d 26, 31 (1st Cir. 2011) (questioning whether, after eBay, irreparable harm can be presumed upon a finding of likelihood of success on the merits of an infringement claim).

[4] See H.R. 6196 § 5(a); House Report Section C.1 (explaining the intent behind the new proceedings).

[5] H.R. 6196 § 5(a).

[6] Id. § 5(c).

[7] Id. § 5(d) (providing that the Director “shall issue regulations to carry out” the new “sections 16A and 16B” “[n]ot later than one year after the date of the enactment of this Act.”).

[8] See H.R. 6196 § 3(a) (“A third party may submit for consideration for inclusion in the record of an application evidence relevant to a ground for refusal of registration. The third-party submission shall identify the ground for refusal and include a concise description of each piece of evidence submitted in support of each identified ground for refusal. Within two months after the date on which the submission is filed, the Director shall determine whether the evidence should be included in the record of the application. The Director shall establish by regulation appropriate procedures for the consideration of evidence submitted by a third party under this subsection and may prescribe a fee to accompany the submission.”).

[9] Id.

[10] See 15 U.S.C. § 1062(b).

[11] See H.R. 6196 § 4.

[12] See, e.g., Tim Lince, Fraudulent Specimens at the USPTO: Five Takeaways from Our Investigation – Share Your Experience, World Trademark Rev. (June 19, 2019), https://www.worldtrademarkreview.com/brand-management/fraudulent-specimens-uspto-five-takeaways-our-investigation-share-your (reporting on investigation of nearly 10,000 US trademark applications filed in May 2019 with many seemingly fraudulent specimens originating from China).


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

Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Alexandra Perloff-Giles – New York (+1 212-351-6307, [email protected])
Doran J. Satanove – New York (+1 212-351-4098, [email protected])

Please also feel free to contact the following practice leaders:

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])

Media, Entertainment and Technology Group:
Scott A. Edelman – Los Angeles (+1 310-557-8061, [email protected])
Kevin Masuda – Los Angeles (+1 213-229-7872, [email protected])
Orin Snyder – New York (+1 212-351-2400, [email protected])

© 2020 Gibson, Dunn & Crutcher LLP

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