The General Court of the European Union (“General Court”) delivered three Judgments on 16 December 2020 which confirmed different aspects of the scope of the powers enjoyed by the European Commission (“the Commission”) in its application of competition rules in the European Union (“EU”). In a nutshell, the General Court has confirmed that the Commission:

• is entitled to apply competition rules to sports activities;
• has a very wide discretion in determining whether or not there is sufficient “Community interest” for it to pursue an infringement action under Articles 101 and 102 of the Treaty on the Functioning of the European Union (“TFEU”); and
• has a broad discretion in interpreting commitments given in merger proceedings to ensure they are in line with other EU policies.

I. Competition Law and Sports Associations: Case T-93/18 – International Skating Union v. Commission

In relation to the role of sports in the EU, Article 165 TFEU provides that: “The Union shall contribute to the promotion of European sporting issues, while taking account of the specific role of sport, its incentives based on voluntary activity and its social and educational function”. The General Court has confirmed that Article 165 TFEU does not prevent the Commission from determining whether rules adopted by sporting associations are contrary to the terms of Articles 101 or 102 TFEU (the EU equivalent of Sections 1 & 2 of the Sherman Act). In doing so, it rejected the appeal of the International Skating Union (the “ISU”) to overturn an earlier Commission’s Decision.[1]

Commission Decision

Following a complaint by two Dutch professional speed skaters, the European Commission initiated proceedings in relation to the ISU’s eligibility rules that provided that skaters who participated in events that were not authorized by the ISU would become ineligible to participate in all ISU events. The Commission concluded that these rules had both the object and effect of restricting competition and therefore breached EU competition rules.[2]

In its Decision, the Commission referred to the Meca-Medina Case, in which the Court of Justice found that the rules relating to the organisation of competitive sport were subject to EU competition law but might fall outside the application of Article 101 TFEU under certain circumstances, namely:

1. the overall context in which the rules were made or produced their effects, and their objectives;
2. whether the consequential effects which restricted competition were inherent in the pursuit of the objectives behind the rules; and
3. whether the rules were proportionate in pursuing such objectives.[3]

In the present case, the Commission found that the eligibility rules did not fall outside the application of Article 101 TFEU because they were neither inherent in the pursuit of legitimate objectives nor proportionate to achieve legitimate objectives, in particular in view of the disproportionate nature of the ISU’s ineligibility sanctions (possibly resulting in a lifetime ban).

General Court

Citing precedents from both Articles 102 and 106 TFEU, the General Court found that the ISU had placed itself in a position of potential conflict of interest because it had the powers of a regulator (inter alia by being responsible for the adoption of membership rules and setting the conditions of tournament participation) and was acting as a commercial body (in organising competitions as part of its commercial activities). That conflict of interest was – consistent with the administrative practice of the Commission and supported by the European Courts – likely to give rise to anti-competitive results.[4] This was borne out by the fact that the eligibility rules adopted by the ISU were not based on criteria that were clearly defined, objective, transparent, and non-discriminatory in nature. They allowed the ISU to retain a very broad discretion to refuse the authorisation of competitions proposed by third parties.[5] Finally, the severity of the penalties exacted by the ISU was disproportionate to the alleged infringements of such rules, both when considered in the light of ill-defined categories of infringement and the duration of the penalties relative to the average career length of a skater.[6]

In the circumstances, the General Court agreed with the Commission’s conclusion that the ISU’s rules went beyond any objectives outlined in Article 165 TFEU and, as such, constituted a restriction of competition law “by object”.[7]

The only aspect of the Commission’s analysis with which the Court did not agree related to the Commission’s conclusion that the exclusive arbitration procedure endorsed by the ISU where its decisions were challenged did not constitute an aggravating factor for the purpose of calculating the fine imposed on the ISU. According to the General Court, recourse to arbitration proceedings before the Court of Arbitration for Sport (CAS) did not constitute an aggravating circumstance in the determination of the level of the fine, as the CAS was an independent body that was appropriately placed to adjudicate disputes between the ISU and its members.[8]

Conclusions

The Judgment is not unexpected and is in line with previous case-law. It has been well established that EU competition rules apply to many elements of professional sport, similar to how the antitrust rules in the US have a long track record of being applied in a sporting context.[9] Such applicability does not undermine the essential social and cultural aspects of sport, which inevitably give rise elements of “solidarity” between competitive athletes that are necessary for the sustainability of competition in team and individual sports. As there has recently been a Complaint lodged against Euroleague,[10] this will inevitably prove to be an area which generates more competition issues in the future.

The rules on membership adopted by the ISU are viewed in a very similar way to how the Commission would look at the membership rules of trade associations and standardisation bodies. If there are foreclosure risks, the rules must be non-discriminatory and objective.[11] It is also interesting that the Court expressed concerns that the market ‘regulator’ was also having commercial activities.[12] One can envisage that this principle, especially with the General Court embracing Article 106 precedents, arguably provides the Commission with additional (albeit indirect) support in its actions against digital platforms engaged in so-called “self-preferencing” practices. At the heart of any theory of harm based on concerns about self-preferencing lies the view that the digital platform self-preferencing its own services is a de facto ‘regulator’ of the market in parallel with its role as a market player.[13]

In addition, the Judgment sets out some clear principles for the identification of a competition restriction “by object”. As is made clear by the Court, whether any given practice satisfies the “by object” characterisation turns not only on the nature of the offence but also on its particular market context and on the necessary implications for market actors likely to be affected by such restrictions. Although the General Court is not breaking new ground in this respect,[14] the clarity of its approach is welcome.

Finally, the General Court has not sought to challenge the traditional appellate hierarchy established by many international sporting bodies, which choose to settle their disputes either through litigation or arbitration in institutions lying outside the EU.

II. Community Interest and Competition Law Enforcement:
Case T-515/18 – Fakro v. Commission

The General Court dismissed the appeal of FAKRO Sp. z o.o. (“Fakro”) in its attempt to overturn a Commission Decision rejecting Fakro’s complaint that Velux, its roof-window specialist rival, had abused its dominant position by inter alia engaging in several categories of abuse, including a selective pricing policy (such as rebates, predatory pricing and price discrimination), by introducing “fighting brands” with the sole purpose of eliminating competition, and by brokering exclusive agreements.[15]

In so holding, the Court confirmed again that the Commission has a very large margin of discretion in determining whether or not to pursue complaints on the ground that they lack sufficient Community interest.[16]

Commission Decision

In its 2018 Decision, the Commission found that there were insufficient grounds to pursue claims that Velux had abused its dominant position in the market for roof windows and flashings, and that it would be disproportionate to conduct a further investigation into the alleged behaviour based on the resources that would be needed.[17] Fakro appealed, arguing that the Commission had:

1. committed a manifest error in concluding that there would be no “Community interest” in pursuing the action, as the Commission had not taken a definitive position either in relation to the finding of dominance or in relation to the elements of abusive behaviour that had been identified by Fakro;
2. infringed the principle of sound administration set forth under the Article 41 of the EU’s Charter of Fundamental Rights,[18] especially by taking as long as 71 months to adopt the Decision rejecting Fakro’s Complaint, thereby effectively preventing Fakro from approaching National Competition Authorities until national statutory limitation periods had elapsed; and
3. infringed Article 8(1) of Regulation 773/2004 by refusing Fakro access to the Commission’s file, thereby undermining its rights of defence.[19]

General Court

The General Court rejected all three pleas in their entirety.

First, the General Court did not look kindly on what it considered to be the lack of probative evidence submitted by Fakro. In such circumstances, it was wrong to expect that the Commission was in any position to establish the existence of the alleged abusive behaviour by Velux. Accordingly, the General Court was unwilling to oblige the Commission to engage on a speculative fact-finding exercise, holding that: “As the Commission is under no obligation to rule on the existence or otherwise of an infringement it cannot be compelled to carry out an investigation, because such investigation could have no purpose other than to seek evidence of the existence or otherwise of an infringement, which it is not required to establish”.[20]

Second, the General Court reminded Fakro that the Commission is “entrusted […] with the task of ensuring application of Articles [101 and 102 TFEU], is responsible for defining and implementing Community competition policy and for that purpose has a discretion as to how it deals with complaints”.[21] While acknowledging that the Commission’s discretionary powers are not unfettered, the General Court nevertheless concluded that the Commission was entitled to give different levels of priority to complaints and that it is not required to establish that an infringement has not been committed in order to decide not to open an investigation.[22]

As regards the length of the investigative procedure, the General Court acknowledged that a period of 71 months between the Complaint being lodged and the Decision to reject the Complaint is a “particularly long [period of time] accentuated by the fact that the applicant denounced the practices as soon as [July 2012]”.[23] However, the General Court also held that: (i) the length of the procedure was explained by the particular circumstances of the case; (ii) Fakro had not demonstrated that the Commission’s Decision to reject the Complaint was affected by the length of the procedure; and (iii) the length of the procedure could not, in and of itself, serve as a basis for an action for annulment.[24] Moreover, Fakro had failed to demonstrate to the General Court why it was impossible to pursue claims under Article 102 TFEU before National Competition Authorities or national courts.

Third, the General Court dismissed Fakro’s argument regarding access to the file, citing settled case-law according to which “the complainants’ right of access does not have the same scope as the right of access to the Commission file afforded to persons, undertakings and associations of undertakings that have been sent a statement of objections by the Commission, which relates to all documents which have been obtained, produced or assembled by the Commission Directorate-General for Competition during the investigation, but is limited solely to the documents on which the Commission bases its provisional assessment”.[25]

Conclusions

The General Court usefully delved deep into the evidence before arriving at its conclusions, rather than dismissing Fakro’s application with a blanket endorsement of the Commission’s wide discretion to reject competition law complaints. Clearly, Fakro’s shortcomings in producing sufficient evidence played a material role in the assessment of the Court.

By the same token, we have witnessed over the years a steady rise in the elevation of rights conferred under the EU’s Human Rights Charter being assimilated into the rights of the defence in competition cases. It might not be stretching the imagination too far to suggest that, absent the poor evidentiary record of abuse that was laid before the Commission, the European Courts might at some point in the future consider it unacceptable that a period as long as 71 months can be taken by the Commission to arrive at the threshold conclusion that it is not obliged to pursue a competition infringement action. Such delays do not sit comfortably with the principle of “good administration”.

III. Commission holds the whip-hand in the interpretation of the scope of commitments: Case T-430/18 – American Airlines

American Airlines (the “Applicant”) failed in its appeal against a Commission Decision granting Delta Air Lines (the “Intervener”) permanent rights to slots at London Heathrow and Philadelphia airports, which it had obtained in the context of commitments given by American Airlines and US Airways in order for their merger to be approved.[26]

Commission Decision

In the merger review proceedings, Delta Air Lines had submitted a formal bid for slots in order to operate on the London Heathrow – Philadelphia International Airports routes. By Decision of 19 December 2014, the Commission approved the Slot Release Agreement concluded between Delta Air Lines and American Airlines, appending the Agreement to its merger clearance Decision. The commitments provided that Delta Air Lines would acquire slot rights, provided it made “appropriate use” of the slots.

However, in September 2015, the Applicant claimed that Delta Air Lines had failed to operate the relevant slots in accordance with the terms of the Agreement because it had not operated them in accordance with the frequency that it had proposed in its bid for the slots, thereby under-using them. As a result, American Airlines claimed that the Delta Air Lines had not made ‘appropriate use’ of the slots remedy.

On 30 April 2018, the Commission adopted a Decision rejecting the Applicant’s claim, concluding that the Intervener had made an appropriate use of the slots,[27] despite the fact that the commitments did not include a definition of such term. The Commission concluded that the term ‘appropriate use’ should be interpreted as meaning ‘the absence of misuse’, and not as ‘use in accordance with the bid’, as had been argued by the Applicant.

General Court

The General Court upheld the Commission’s Decision and held that the term ‘appropriate use’ of the slots had to be interpreted as the absence of misuse. However, the General Court also held that the two interpretations were not irreconcilable and that “the term ‘appropriate’ implies a use of slots which may not always be completely ‘in accordance with the bid’ but nonetheless remains above a certain threshold”.[28] In order to determine that threshold, the General Court made reference to the “use it or lose it” principle that lies at the heart of the Airport Slots Regulation. According to that principle, use of 80% slot capacity constitutes a sufficient use of the allotted slots.[29] Based on this principle, the General Court concluded that “it cannot be considered to be self-evident that the entrant is expected to operate, in principle, the airline service in its bid at 100% in order to acquire Grandfathering rights”.[30]

Conclusions

The effectiveness of behavioural remedies to address competition problems in a merger review, especially those remedies that involve some form of access to infrastructure, have proven at times to be especially difficult for the Commission to monitor. That task is rendered somewhat easier for the Commission where the activities concerned are already subject to a regulatory regime which mandates access. This gives the Commission a benchmark in terms of the legal standard that needs to be satisfied.

In this particular case, the Commission went one step further. It relied on the Airport Slots Regulation to provide the basis of interpretation of the scope of an access remedy involving access to airport slots, rather than merely the modalities of access. In this way, any ambiguity in the meaning of the behavioural remedies that formed part of the Commission’s conditional clearance Decision involving the American Airlines’ merger could be resolved by reference to the structure and policy purpose behind the Regulation.

Even when analysing the significance of the commitments by reference to their precise language, the General Court purported to do so by interpreting their scope in accordance with the meaning attributed under the Airport Slots Regulation to the “misuse” of those rights. In this way, the Commission and the Court have both attributed higher value to the policy direction of a regulatory instrument in the sector rather than the express words agreed under the commitments. Merging parties may not find this to be a precedent to their liking, as it is arguably a case which adds little to the goal of legal certainty – unless of course the Ruling can be limited to the very specific facts of the case and the particular dynamics of the airline sector.

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[1]    Judgment of 16 December 2020, International Skating Union v. Commission, Case T-93/18, EU:T:2020:610.

[2]    Commission Decision of 08.12.2017 in Case AT.40208 – International Skating Union’s Eligibility Rules.

[3]    Judgment of 18 July 2006, Meca-Medina, Case C-519/04 P, ECLI:EU:C:2006:492, para. 42. The Commission added that the case-law of the Court of Justice does not create a presumption of legality of such rules. Sporting rules are not presumed to be lawful merely because they have been adopted by a sports federation.

[4]    Although the Commission’s action against the Applicant was brought under Article 101 TFEU, recourse to Article 102 TFEU precedents (and by extension, Article 106) was appropriate given that multilateral conduct otherwise falling under Article 101 was effected by an “association of undertakings” in this case, which can also be the subject of action under Article 102 where that association of undertakings (as was the case with the Applicant) holds a dominant position.

[5]    See Paragraph 118 of the Judgment.

[6]    See Paragraphs 90-95 of the Judgment.

[7]    A competition restriction by object is contrary to the terms of the prohibition of Article 101 (1) TFEU because it is highly likely to generate anti-competitive consequences given its very nature and contextual setting. In some respects, the concept is related, but not identical to, the concept of a per se offence under US antitrust rules.

[8]    Refer to discussion at Paragraphs 155-164 of the Judgment.

[9]    For example, refer to Federal Baseball Club of Baltimore, Inc. v. National League of Professional Baseball

Clubs, 259 U.S. 200 (1922); Denver Rocket v. All-Pro Management, Inc, 325 F. Supp. 1049, 1052, 1060 (C.D. Cal. 1971); Smith v. Pro-Football, 420 F. Supp. 738 (D.D.C. 1976); Brown v. Pro Football, Inc., 116 S.Ct. 2116 (1996). See also, more recently, a complaint against the Fédération International de Natation, available at: https://swimmingworld.azureedge.net/news/wp-content/uploads/2018/12/isl-lawsuit.pdf.

[10]   ULEB, the organization bringing together national basketball leagues in Europe, filed a complaint against Euroleague, claiming that Euroleague illegally boycotts the participation of the winners of some leagues in its competition. See Mlex “Euroleague targeted by fresh EU antitrust complaint from national leagues” (01.10.2020), available at: https://www.mlex.com/GlobalAntitrust/DetailView.aspx?cid=1229542&siteid=190&rdir=1.

[11]   For example, see Judgment of 10 March 1992, ICI v. Commission, Case T-13/89, EU:T:1992:35; Judgment of 30 January 1985, BNIC, Case C-123/83, EU:C:1985:33; Judgment of 7 January 2004, Aalborg Portland v. Commission, Case C-204/00 P, EU:C:2004:6.

[12]   For example, see Judgment of 28 June 2005, Dansk Rørindustri and Others v Commission, C-189/02 P, C-202/02 P, C-205/02 P to C-208/02 P and C-213/02 P, EU:C:2005:408, paras. 209 to 211.

[13]   A classic case in point is the Commission’s Decision in the Google Shopping Case, Commission Decision AT.39740 of 27 June 2017, with the issue of self-preferencing being raised in Google’s appeal of the Commission Decision to the General Court, Case T-612/17, Google and Alphabet v. Commission, OJ C 369 from 30.10.2017, p. 37 [pending].

[14]   For example, see Judgment of 6 October 2009, GlaxoSmithKline Services and Others v. Commission and Others, Joined Cases C-501/06 P etc., EU:C:2009:610; Judgment of 20 November 2008, Beef Industry Development and Barry Brothers, Case C-209/07, EU:C:2008:643; Judgment of 14 March 2013, Allianz Hungaria Biztosito and Others, Case C-32/11, Eu:C:2013:160.

[15]   Judgment of 16 December 2020, Fakro v. Commission, Case T-515/18, EU:T:2020:620. On 21 December 2020, Fakro announced that it would lodge a further appeal to the Court of Justice of the European Union.

[16]   This type of threshold assessment is necessary under the terms of procedural Regulation 1/2003 in order to determine whether it is the Commission or the Member States that are best placed to entertain particular types of competition law complaints.

[17]   Commission Decision of 14.06.2018 in Case AT.40026 – Velux.

[18]   Charter of Fundamental Rights of the European Union, OJ C 364, 18.12.2000, pp. 1-22.

[19]   Commission Regulation (EC) No 773/2004 of 7 April 2004 relating to the conduct of proceedings by the Commission pursuant to Articles [101 TFEU and 102 TFEU], OJ L 123, 27.4.2004, pp. 18-24, Article 8(1): “Where the Commission has informed the complainant of its intention to reject a complaint pursuant to Article 7(1) the complainant may request access to the documents on which the Commission bases its provisional assessment. For this purpose, the complainant may however not have access to business secrets and other confidential information belonging to other parties involved in the proceedings”.

[20]   Refer to discussion at Paragraph 208 of the Judgment. See also Judgment of 18 September 1991, Automec v. Commission, Case T-24/90, EU:T:1992:97, para. 76; Judgment of 16 October 2013, Vivendi v. Commission, Case T-432/10, EU:T:2013:538, para. 68; Judgment of 23 October 2017, CEAHR v. Commission, Case T-712/14, EU:T:2017:748, para. 61.

[21]   Refer to discussion at Paragraph 66 of the Judgment. See also Judgment of 26 January 2005, Piau v. Commission, Case T-193/02, EU:T:2005:22, para. 80 ; Judgment of 12 July 2007, AEPI v.Commission, Case T-229/05, EU:T:2007:224, para. 38; and Judgment of 15 December 2010, CEAHR v. Commission, Case T-427/08, EU:T:2010:517, para. 26.

[22]   Judgment of 4 March 1999, Ufex e.a. v. Commission, Case C-119/97 P, EU:C:1999:116, para. 88; Judgment of 16 May 2017, Agria Polska e.a. v. Commission, Case T-480/15, EU:T:2017:339, para. 34.

[23]   Refer to discussion at Paragraph 83 of the Judgment.

[24]   Indeed, as regards the application of the competition rules, exceeding reasonable time limits can only constitute a ground for annulment of infringement decisions and on condition that it has been established that this has infringed the rights of defence of the undertakings concerned. Apart from this specific type of case, the failure to comply with the obligation to act within a reasonable time does not affect the validity of the administrative procedure under Council Regulation (EC) No 1/2003 of 16 December 2002 on the implementation of the rules on competition laid down in Articles 81 and 82 [EC] (OJ 2003 L 1, p. 1) (see Judgment of 15 July 2015, HIT Groep v Commission, Case T-436/10, EU:T:2015:514, paragraph 244).

[25]   Refer to Paragraph 43 of the Judgment. See also Judgment of 11 January 2017, Topps Europe/Commission, Case T-699/14, EU:T:2017:2, para. 30; Judgment of 11 July 2013, Spira v Commission, T-108/07 and T-354/08, EU:T:2013:367, paras. 64 and 65.

[26]   Judgment of 16 December 2020, American Airlines v. Commission, Case T-430/18, EU:T:2020:603. The grandfathering rights are defined as “The Prospective Entrant will be deemed to have grandfathering rights for the Slots once appropriate use of the Slots has been made on the Airport Pair for the Utilization period. In this regard, once the Utilization period has elapsed, the Prospective Entrant will be entitled to use the Slots obtained on the basis of these Commitments on any city pair (‘Grandfathering’)”.

[27]   Commission Decision of 30.04.2018 in Case M.6607 – US Airways / American Airlines.

[28]   Refer to Paragraph 105 of the Judgment.

[29]   Council Regulation (EEC) No 95/93 on common rules for the allocation of slots at Community airports, OJ L 1993, 18.01.1993, p. 1, Article 10(2).

[30]   Refer to Paragraph 147 of the Judgment.

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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 in Brussels:

Peter Alexiadis (+32 2 554 7200, [email protected])
David Wood (+32 2 554 7210, [email protected])
Iseult Derème (+32 2 554 72 29, [email protected])

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On 15 December 2020, the Ruler of Dubai issued Decree No. (33) of 2020 which updates the law governing unfinished and cancelled real estate projects in Dubai (the “Decree”).

The Decree creates a special tribunal (the “Tribunal”) for liquidation of unfinished or cancelled real estate projects in Dubai and settlement of related rights which will replace the existing committee (the “Committee”) set up in 2013 for a similar purpose. The Tribunal will be authorised to review and settle all disputes, grievances and complaints arising from unfinished, cancelled or liquidated real estate projects in Dubai, including the disputes that remain unresolved by the Committee. The Tribunal will have wide-ranging powers, including, the ability to form subcommittees, appoint auditors and issue orders to the trustees of the real estate project’s escrow accounts in all matters related to the liquidation of unfinished or cancelled real estate projects in Dubai and determine the rights and obligations of investors and purchasers.

The Decree streamlines the process for resolving disputes, grievances and complaints relating to unfinished and/or cancelled real estate projects in Dubai by granting the Tribunal jurisdiction over all unfinished or cancelled disputes relating to real estate projects in Dubai and prohibiting all courts in Dubai, including the DIFC Courts from accepting any disputes, appeals or complaints under the jurisdiction of the Tribunal – thereby creating a more efficient route for resolution. The implementation of the Decree will be of interest to clients who have transactions related to unfinished and cancelled real estate projects in Dubai and may lead to the resolution / completion of projects that have stalled in Dubai.

The Decree also details the responsibilities and obligations of the Real Estate Regulatory Agency (“RERA”) related to supporting the Tribunal in performing its duties and responsibilities set out in the Decree. For example, RERA will be required to prepare detailed reports about unfinished and cancelled real estate projects in Dubai and provide its recommendations to the Tribunal to assist the Tribunal in settling disputes under its jurisdiction.

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Gibson Dunn’s Middle East practice focuses on regional and global multijurisdictional transactions and disputes whilst also acting on matters relating to financial and investment regulation. Our lawyers, a number of whom have spent many years in the region, have the experience and expertise to handle the most complex and innovative deals and disputes across different sectors, disciplines and jurisdictions throughout the Middle East and Africa.

Our corporate team is a market leader in MENA mergers and acquisitions as well as private equity transactions, having been instructed on many of the region’s highest-profile buy-side and sell-side transactions for corporates, sovereigns and the most active regional private equity funds. In addition, we have a vibrant finance practice, representing both lenders and borrowers, covering the full range of financial products including acquisition finance, structured finance, asset-based finance and Islamic finance. We have the region’s leading fund formation practice, successfully raising capital for our clients in a difficult fundraising environment.

For further information, please contact the Gibson Dunn lawyer with whom you usually work, or the following authors in the firm’s Dubai office, with any questions, thoughts or comments arising from this update.

Aly Kassam (+971 (0) 4 318 4641, [email protected])

Galadia Constantinou (+971 (0) 4 318 4663, [email protected])

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On December 11, 2020, the FDA granted Emergency Use Authorization for the Pfizer/BioNTech COVID-19 vaccine candidate.[1] That vaccine, which appears to be more than 90% effective in preventing the virus’s spread,[2] will likely soon be joined by other candidates, such as a similarly effective vaccine developed by Moderna.[3]

With their blazing-fast production time and extraordinary efficacy, the COVID-19 vaccines are among our most impressive recent medical achievements. They may also be the most controversial. Despite near-universal healthcare consensus as to the vaccines’ safety and efficacy, early polling suggests deep skepticism, with many in the population indicating that, if offered the vaccine, they will refuse.[4] And in a time of endemic disinformation and controversy, this resistance may only deepen.

Given the choice, employers might prefer to stay on the sidelines in an effort to avoid the coming “vaccine wars.” Like it or not, however, America’s workplaces will be on the front lines and likely will find themselves caught between public health imperatives, liability fears, and a restive workforce. And while current guidance indicates that employers generally can mandate employee vaccination (subject to religious and medical exceptions), unless the Occupational Safety & Health Administration (OSHA) or other authority requires them to do so, employers will face strong and countervailing pressures in deciding whether or how to implement such policies.

This Client Alert offers a “Playbook” for employers to navigate these choppy waters. Below we set out key considerations, both for employers who want or ultimately may be required to pursue a mandatory vaccination program and for employers who wish to encourage voluntary compliance.

Each employment context, of course, will differ. A mandatory vaccination policy that works well for a close-quarters or contact-heavy workplace, such as a healthcare facility or even a meatpacking plant, might be too heavy handed for a low-contact team of remote computer coders. Likewise, different states, cities, and industries may adopt very different workplace vaccination rules, creating a thicket of regulation (this Alert limits its scope to nationally applicable federal regulation, but state and local rules may differ). Despite this variation, though, there are nevertheless strategies and insights that can offer guidance.

I. Deciding Who Decides: Should Employers Mandate Vaccination?

As a threshold question, employers will need to decide whether to require employees to be vaccinated or instead to make vaccination voluntary. Below are some key considerations in making this choice.

A. Why Require the Vaccine?

Protecting Workplace and Community Health: In the absence of a regulatory requirement, the single most important reason for a workplace vaccine mandate is that it will protect workers’ health and lives. Each COVID-19 vaccine authorized for emergency use will have been found by the FDA to be “safe and effective,” and that authorization will have been supported by the Vaccines and Related Biological Products Advisory Committee (VRBPAC), an FDA advisory panel of outside scientific and public health experts that has independently reviewed the data.[5] The upshot is that, based on the best evidence available, the vaccines now being rolled out will protect the health and lives of employees, customers, and communities.

To be sure, vaccinations will not ensure everyone’s safety: we do not yet have long-term data on the duration of immunity, even the most effective vaccine candidates will protect no more than 90 to 95% of patients, and bona fide medical or religious reasons mean that some individuals cannot be vaccinated. Accordingly, even in the best-case scenario, a significant minority of the population will still be exposed and dependent upon the development of herd immunity to protect them. But these caveats should not distract from this reality: by an order of magnitude, COVID-19 vaccines will be our most effective medical strategy to prevent transmission of the virus and save lives.

Ensuring Vaccines Become Vaccinations: These powerful health benefits, however, will only be realized if workers actually get the vaccine. In other words, as public health experts have noted, we must “turn vaccines into vaccinations.”[6] Here, a mandatory approach may be important because voluntary vaccine programs have often had relatively low compliance, even in industries like healthcare,[7] and even for vaccines that have been the subject of massive “persuasion” campaigns (such as for the flu).[8] Given the amount of disinformation surrounding the coronavirus in general and vaccines in particular, such opt-in rates may, without a mandate, be even lower here. Put another way, a mandatory vaccine policy likely will be vastly more successful than a voluntary one at ensuring workers actually get protected.

Reducing Costs of Absences, Lost Productivity, and Long-Run Medical Care: Because a mandatory vaccination program creates a more vaccinated workforce, it also can significantly reduce workplace costs. Vaccinated workers will be less likely to fall ill to COVID-19, impose fewer costs from absences or lost productivity, require fewer instances of acute medical care, and impose lower long-term health costs. This last point is an important one: COVID-19 might be best known for short-term (and often horrific) acute consequences, but its long-term health impacts are poorly understood, yet believed to be significant for some.[9] Therefore, the virus may lead to worker illness and impairment that can span for months or even years. A higher vaccination rate is likely to curb each of these costs.

Getting and Staying Open: A mandatory vaccination approach also makes it more likely that a business can open and stay open. Even if there are no medical consequences, a single positive COVID-19 test can lead an employer to fully stop operations, particularly in industries like dining and hospitality.[10] A highly vaccinated workplace reduces the likelihood of such stoppages. At the same time, high vaccination rates can accelerate a “return to normal” by making it safer for the workforce to return to the office or otherwise resume normal operations, and by creating a safer environment for customers.

Defend Against Civil Liability for COVID-19 Cases: Further, and especially as vaccination rates increase, an un- or under-vaccinated workforce may pose a liability risk, as individuals infected on premises look to pin the blame on employers.

Under tort law principles employers that fail to take reasonable care to protect employees (or, for that matter, vendors, visitors, customers, or others on premises) risk liability. Applying this concept, individuals who become sick based on alleged on-premises exposure can argue (and in some cases have argued) that a business’s negligent safety practices (whether related to personal protective equipment (PPE), vaccines, cleaning, or anything else) caused their illness.

For employees themselves, such COVID-19 suits are likely to be limited by workers’ compensation statutes. As we noted in a previous Client Alert, companies are already seeing lawsuits seeking relief from employee injuries ranging from wrongful workplace exposure to COVID-19 to wrongful death from COVID-19.[11] In many cases, damages related to on-the-job COVID-19 exposure (or subsequent illness) will be considered occupational injuries and so are very likely covered under the relevant state’s workers’ compensation statutes. But employees’ lawyers will no doubt argue that this bar may not provide full protection, as evidenced by extensive (and so far, unsuccessful) efforts by federal lawmakers to provide businesses with greater immunity from employee COVID-19 claims,[12] as well as by a surge of interest in drafting (potentially unenforceable) employee COVID-19 liability waivers.[13]

More importantly, workers’ compensation statutes do not account for other stakeholders who may claim COVID-19 damages from exposure to an unvaccinated workforce. This includes suits by contractors, vendors, visitors, or customers—particularly in contact-intensive industries like education, lodging, hospitality, healthcare, or fitness where PPE may not provide sufficient protection.

A mandatory vaccination policy reduces these risks. First, and most obviously, mandatory vaccination makes it less likely individuals get sick in the first place, and therefore less likely anyone suffers legally actionable damages. Separately, the adoption and implementation of a mandatory vaccine plan can itself be important evidence of the high standard of care a company provided for those on premises, which also may be important in beating back potential liability.

Unless a broad liability shield is enacted by Congress, civil suits for COVID-19 infection damages, whether by employees, contractors, visitors, or customers, will remain a threat for the foreseeable future, and mandatory vaccination could be a key tool to address it.

Potential Protection Against Enforcement Action: Apart from civil liability from private plaintiffs, businesses without vaccine mandates could confront regulatory risk as well. Under OSHA’s “general duty” clause, for instance, employers are required to furnish each employee with a workplace free from recognized hazards that could cause serious harm.[14] While current OSHA guidance suggests this “general duty” can be satisfied by measures like PPE or distancing,[15] in the longer-run the agency might take the position that a robust vaccination program is required and that workplaces without such policies are not safe. This may be particularly true for healthcare and other industries where social distancing or similar measures may not be viable.

Further, even if OSHA does not enforce the “general duty” clause in this way, private litigants, unions, or others may seize on this language to argue that employers without mandatory vaccination policies are not providing a safe workplace.

B. Why Make the Vaccine Optional?

Employee Morale and Retention: Any “mandate,” as opposed to an optional program, would need to be carefully messaged and framed to the workforce. If the purposes behind the requirement are not explained (and even if they are), it may become a source of employee discontent or dissatisfaction. Day-to-day, such a requirement may lead employees opposed to the vaccine to view the company more negatively, and to respond accordingly.

Even with excellent messaging and buy-in, it is likely that some portion of the workforce, out of “anti-vaccine” belief, political views, or other reasons, will refuse to get the vaccine, and at the extreme may choose separation of employment rather than being vaccinated. And laws like the National Labor Relations Act (NLRA) could arguably protect various forms of employee protest as to the requirement, such as through social media campaigns.

Administrative Ease: Even for “mandatory” vaccines, by law those with medical conditions or sincerely held religious beliefs that preclude vaccination are entitled to make exemption requests and to seek appropriate reasonable accommodation (both possibilities discussed in detail below).  Given the controversy around the vaccine, many workers may try to claim such exemptions. Without thoughtful processes, this could put Human Resources (HR) at risk of being overwhelmed by needing to decide, on a case-by-case basis, who qualifies for an exemption. In a voluntary program, by contrast, no (or much less) formal process is needed.

Less Liability Risk for Discrimination Claims: On this point, individuals who seek an exemption but are denied may pursue legal claims, such as on the grounds that they were unlawfully discriminated against under the Americans with Disabilities Act (ADA) based on a medical condition their employer did not treat with sufficient seriousness,[16] or under Title VII of the Civil Rights Act[17] for their religious beliefs. Careful applications of the exemption process will minimize this risk, but cannot eliminate it.

Potentially Less Necessary to Certain Industries: Finally, while in some industries, like healthcare or personal services, close contact is unavoidable, in others, it is less of a concern. For workplaces that do not require close contact, and so can more effectively avoid or mitigate the potential spread of the virus on-site, a vaccine mandate might be unnecessary.

II. Playbook For Employer Vaccine Policies

As the above shows, employers may have sound safety, business, and legal reasons to pick either a mandatory or a voluntary approach to a COVID-19 vaccine. But without attention to risk points, either approach can run into trouble. Here are ways to minimize the danger, no matter which approach employers take.

A. Assess the Right to Require Vaccinations

An employer’s first step is to confirm its right to require vaccinations. For obvious reasons, this is important to workplaces that want to mandate vaccines. But even workplaces that want to pursue voluntary vaccination policies may want to confirm this information, both because conditions may change over time, and also because, even if employers do not make vaccination a condition of employment, they may want to make it a condition for certain employment activities.

For most private-sector U.S. employers, current law suggests vaccinations can likely be required as a condition of employment for at-will employees. In the context of the H1N1 flu, for example, OSHA guidance indicates that, so long as a private employer makes appropriate religious and medical exceptions, an employer may require vaccination as a condition of employment.[18] Historically such guidance was directed toward medical care facilities. Given the EEOC’s finding that COVID-19 constitutes a “direct threat” to workplace health at this time,[19] however, there is good reason to believe the EEOC would similarly view COVID-19 vaccine mandates as permissible.

That said, a given workplace may be subject to special conditions, so it is important to assess, at the outset, whether a vaccination requirement would be permissible. One example is if a collective bargaining agreement (CBA) governs the terms of employment, in which case it may speak to vaccine requirements.[20] Further, if employees are not at-will, but rather work under a contract, that contract may dictate whether a vaccine can be required.

Likewise, while to date no state or local law or regulation appears to impose any general bar to private employers requiring vaccination, the situation at the federal, state, and local level is evolving rapidly,[21] so employers should obtain legal advice and ensure no new rule (or relevant agency guidance or court decision) has changed the landscape before getting started.

B. Make a Plan to Process Exemption Requests

Even if employers choose to “mandate” a vaccine, they must still be prepared to provide legally required exceptions for employees who (1) cannot take the vaccine due to a medical disability or (2) seek an exemption from the vaccine based on sincerely held religious beliefs. Virtually all employers must comply with these important legal protections. But employers should also recognize that they can structure such requests, and the resulting accommodations, in a way that satisfies the law while ensuring that those who are not truly motivated by such concerns, but instead merely would prefer to be unvaccinated, do not take advantage of them.

1. Medical Exemptions

For medical reasons, some individuals may be unable to safely take the vaccine. We know, for example, that the vaccine should not be administered to individuals with a known history of a severe allergic reaction to any component of the vaccine. Under the ADA, if an employee claims to require an exemption based on a “disability,” [22] a workplace must engage in an “interactive process” with that individual to arrive, if possible, at a “reasonable accommodation” (which, potentially, would relieve the employee from having to get the vaccine).

Employee requests for medical exemptions should be treated like any other ADA request for accommodation. However, if employers are concerned that vaccine qualms will lead to insincere accommodation requests, there are steps they can take. First, the ADA permits requests for reasonable documentation of the disability, which an employer can enforce.[23]

Second, workers with disabilities do not have the right to the accommodation of their choice, but rather to a “reasonable accommodation,” viz, one that “reasonably” accommodates their disability, and that does not impose an “undue hardship” on an employer.[24] For example, employees who cannot be vaccinated do not necessarily need to be offered the “accommodation” of simply not receiving the vaccine but then otherwise resuming work as normal, nor must they be offered the accommodation of continuing to work from home after their colleagues have returned to work. Rather, under appropriate circumstances, an employer might instead require unvaccinated employees to attend work, but continue to distance and wear masks and PPE, even after vaccinated employees may in the future be permitted to halt such measures.[25]

Other possible accommodations may include shifting unvaccinated workers to other workplace roles or positions, relocating work sites within a building, or requiring that employees work remotely even if they want to return. This process will typically require a case-by-case assessment of the relevant facts.

In sum, employers should recognize that the ADA does not create an automatic right for anyone to “opt-out” of the vaccine, but only a right to a fair interactive process that leads to a reasonable accommodation.

2. Religious Exemptions

The second major category for possible exemptions are accommodation requests based on sincerely held religious beliefs or religion-like philosophical systems.[26] Under Title VII, such beliefs must be taken into account, and if it would not pose “undue hardship,” a reasonable accommodation must be granted.

Compared to medical exemption requests, Title VII religious accommodation requests are (1) easier to establish, with employees permitted to substantiate the “sincerity” of their beliefs with little documentation; but (2) less demanding on employers, in that the accommodations granted need only be provided if they would impose “de minimis” burdens on the employer. Both of these distinctions are relevant to any COVID-19 vaccination mandate.

On the “sincerity” of the religious belief at issue, the EEOC has noted that an employer is entitled to “make a limited inquiry into the facts and circumstances of the employee’s claim that the belief or practice at issue is religious and sincerely held, and gives rise to the need for the accommodation.”[27] That said, an employee can provide sufficient proof of sincerity by a wide variety of means, including “written materials or the employee’s own first-hand explanation,” or verification of “others who are aware of the employee’s religious practice or belief.”[28] Beyond that, probing the “sincerity” of a religious belief is risky business. So to the extent employees provide such substantiation, and even if their interpretation of a religious tenet differs from that religion’s mainstream, employers would be wise, at that point, to accept it.

However, the EEOC has further made clear that employers are only obligated to accommodate “religious” beliefs or comprehensive religious-type philosophical systems, as opposed to other strongly held types of beliefs. For instance, there is no legal requirement to accommodate political, scientific, or medical views, or isolated ideas (such as “vaccines are dangerous”).[29]

Given these principles, workplaces with vaccine mandates may want to create standardized Title VII exemption-request forms that (1) expressly state and remind employees that political, social, scientific, or other non-religious views are not sufficient justification and that it is not appropriate to request a Title VII exemption on those grounds, but that (2) otherwise permit employees to explain, in their own words, their religious or religious-type beliefs and why those beliefs prevent vaccination. As noted, however, to the extent an employee then completes the form and provides such an explanation, the explanation generally should be credited.

However, for the accommodation itself, as in the ADA context, even a sincere religious exception does not guarantee the right to be accommodated, but only the right to a process that may, if legally required, lead to an accommodation. And unlike the medical context, where the “undue hardship” an employer must show to deny accommodation is a “significant difficulty or expense,”[30] in the Title VII context “undue burden” is defined to require only a showing of more than a “de minimis” cost on the business.[31]

Accordingly, in addition to requiring unvaccinated employees to keep using PPE and other measures even after the rest of the workforce returns to normal, an employer likely has much more latitude to indicate that, where the risk of non-vaccination imposes burdens on the company, non-vaccination will not be allowed.[32]

C. Build Buy-In and Plan for Conflict Diffusion

Even with the legal authority to impose a mandate, employers that go this route still must be sure to build employee buy-in for compliance. This is particularly important in light of concerns regarding how a vaccine requirement might impact employee morale or office culture.

The more a workforce understands why the employer chose a mandate, and the more they have the chance to feel “heard” on the subject, the less friction there will be (and the fewer workers will attempt to claim potentially unneeded exemptions). Best practices for building buy-in include:

• Informing employees of the policy change in advance, so that they can meaningfully share their views.
• Clear communication as to the purpose of the requirement: employee safety and allowing a return to normal.
• Tying the vaccine mandate to concrete and visible changes (e.g., once the vaccine is in place, re-open formerly closed off recreation areas or office space).
• Providing accurate and reader-friendly information on the vaccine. Given the amount of mis- or disinformation available, employers and HR in particular will play a key educational role.

On this point, given the incendiary rhetoric around vaccines and strong beliefs held by individuals on many topics related to vaccination, it is possible that the accommodation process, if not carefully handled, could lead to workplace tension. Workplaces should be aware of this risk and ensure that at no time does it rise to the level of impermissible discrimination or a hostile workplace.

D. Minimize (and if Possible, Eliminate) Vaccination Costs to Employees

As a further way to ensure buy-in, whether for a mandatory or a voluntary program, employers should consider as many steps as possible to reduce the cost to employees of getting the vaccine. The medicine itself will be provided, free of charge, by the federal government.[33] But unless already covered by employee insurance, employees may still be charged an “administrative fee.”[34] Employers should consider covering those or other incidental costs, even if otherwise “out of plan” for workers.

Another “cost” to employees is that of time—such as the time to travel off-site to get a vaccine. Contracting with a third-party provider to conduct on-site vaccination can help reduce this cost and may provide further liability protection.

Finally, for the small minority of workers who experience symptoms or bad reactions to the vaccine, employers should consider adopting a permissive approach to allowing (or extending further) paid sick leave to the extent necessary, even if a worker might otherwise not be entitled to it.

As shown above, such measures, while they may not be legally required in certain circumstances (depending on wage-hour and sick leave laws, among other things), are likely to be critical to increase and encourage buy-in.

E. Take a Thoughtful Approach to Continued PPE and Distancing Requirements

One common question will be whether a vaccination policy can or should supplant mask requirements, distancing, and other measures. Because the vaccines are not one-hundred percent effective, and because it is unknown if vaccinated individuals can still spread the virus, there is no guarantee that even a vaccinated employee will be fully protected. Further, employers should also be mindful of the safety of individuals who, for medical or religious reasons, are unable to be vaccinated. Finally, even the most optimistic projections indicate that, for at least some period of time, there will not be enough vaccines to cover everyone in the workforce.[35] Each of these considerations suggests that, at least in the short term, policies like masks and social distancing may still be needed.

In the long run, however, providing the prospect of a return to relative normal for those who are vaccinated could be a powerful force toward boosting morale and commitment to a vaccination program, and toward getting greater employee buy-in.

F. Be Aware of Labor Law Issues

One further area to be aware of in rolling out a vaccine policy is the possibility of concerted labor action. Section 7 of the NLRA protects certain “concerted activity” regarding working conditions,[36] which might extend to protests or other labor action regarding a vaccine policy. Crucially, however, the NLRA does not protect non-compliance with workplace safety rules (such as employees attempting to style refusal to be vaccinated as a legally protected labor protest).[37] Further, to the extent there is a risk of labor activity against a vaccine mandate, employers should be aware that there is a countervailing risk of labor activity for a mandate, such as strikes by employees who refuse to come to work until their colleagues have been vaccinated.

G. Don’t Lean Too Hard (or Perhaps at All) on Waivers

Finally, for those employees who, whether by choice or a valid exemption, are not vaccinated, some employers are considering requiring a waiver indicating that the employee understands the medical risks of this decision and accepts any associated risk. Given the limitations on the enforceability and permissibility of such waivers, however, a robust disclosure may be a better format. OSHA, for instance, has long required an attestation for employees in the context of bloodborne pathogen vaccines acknowledging their understanding of the risks should they not be vaccinated.[38] Seeing the risks of declining the vaccine clearly laid out in writing may, at the margin, increase buy-in.

That said, as a liability protection device, there is reason to be skeptical about such disclosures or waivers. In many jurisdictions, courts will find that employee liability waivers for workplace illnesses and injuries are not enforceable or even permissible, given the perceived imbalance of bargaining power or the operation of state workers’ compensation laws (which in some cases are read to preclude such waivers).[39] Accordingly, while it may make sense to provide certain disclosures to unvaccinated employees, an actual waiver of liability may be prohibited or unenforceable.

* * *

As noted at the outset, no one size fits all, especially given the different levels of risk of infection spread in different industries and workplaces, as well as the fast-evolving legislative and regulatory environment around COVID-19. If your company is considering rolling out a vaccination program in your workplace, or otherwise has any questions on approaching the pandemic and return-to-work operations, Gibson Dunn’s Labor and Employment Group can offer assistance.

___________________

   [1]   Jessica Glenza, “FDA approves Pfizer/BioNTech coronavirus vaccine for emergency use in US,” The Guardian (Dec. 11, 2020), available at https://www.theguardian.com/world/2020/dec/11/fda-approves-pfizer-biontech-covid-19-coronavirus-vaccine-for-use-in-us.

   [2]   Lauran Neergaard & Linda A. Johnson, “Pfizer says COVID-19 vaccine is looking 90% effective,” Associated Press (Nov. 10, 2020), available at https://apnews.com/article/pfizer-vaccine-effective-early-data-4f4ae2e3bad122d17742be22a2240ae8.

   [3]   Denise Grady, “Early Data Show Moderna’s Coronavirus Vaccine Is 94.5% Effective,” N.Y. Times (Nov. 16, 2020), available at https://www.nytimes.com/2020/11/16/health/Covid-moderna-vaccine.html.

   [4]   See, e.g., RJ Reinhart, “More Americans Now Willing to Get COVID-19 Vaccine,” Gallup (Nov. 17, 2020), available at https://news.gallup.com/poll/325208/americans-willing-covid-vaccine.aspx (survey indicating that, as of late November, 42% of Americans would not agree to be vaccinated against COVID-19, up from 34% in July); Bill Hutchinson, “Over half of NYC firefighters would refuse COVID-19 vaccine, survey finds,” ABC News (Dec. 7, 2020), available at https://abcnews.go.com/Health/half-nyc-firefighters-refuse-covid-19-vaccine-survey/story?id=74582249.

   [5]   For an accessible introduction to this process, see FDA, “Vaccine Development – 101,” available at https://www.fda.gov/vaccines-blood-biologics/development-approval-process-cber/vaccine-development-101.

   [6]   See, e.g., Testimony to the Subcomm. on Oversight and Investigation of the H. Comm. on Energy and Commerce 1 (Sept. 30, 2020) (statement of Ashish K. Jha, Dean of Brown University School of Public Health), available at https://docs.house.gov/meetings/IF/IF02/20200930/111063/HHRG-116-IF02-Wstate-JhaA-20200930.pdf.

   [7]   See, e.g., Carla Black et al., CDC, Health Care Personnel and Flu Vaccination, Internet Panel Survey, United States, November 2017 (2017), available at https://www.cdc.gov/flu/fluvaxview/hcp-ips-nov2017.htm (noting a 60-70% flu vaccination rate among healthcare personnel).

   [8]   See, e.g., CDC, Flu Vaccination Coverage, United States, 2019–20 Influenza Season (Oct. 1, 2020), available at https://www.cdc.gov/flu/fluvaxview/coverage-1920estimates.htm.

   [9]   See, e.g., Rita Rubin, As Their Numbers Grow, COVID-19 ‘Long Haulers’ Stump Experts, J. of Am. Med. (Sept. 23, 2020), available at https://jamanetwork.com/journals/jama/fullarticle/2771111 (noting scientific studies estimating that approximately 10% of people who have had COVID-19 experience long-term symptoms, from fatigue to joint pain, and that these effects manifested even in individuals who were not initially seriously ill).

   [10]   See, e.g., “Some Savannah restaurants close due to positive COVID-19 cases,” WTOC (June 19, 2020), available at https://www.wtoc.com/2020/06/24/some-savannah-restaurants-close-due-positive-covid-cases/.

   [11]   See, e.g., Jean Casarez, “Wrongful death lawsuit filed against long-term care facility over staffer’s Covid‑19 death,” CNN (July 10, 2020), available at https://www.cnn.com/2020/07/10/us/wrongful-death-lawsuit-care-facility/index.html.

   [12]   See, e.g., Eli Rosenberg et al., “Senate stimulus negotiators try to reach deal on whether companies can be sued over virus outbreaks,” Wash. Post (Dec. 8, 2020), available at https://www.washingtonpost.com/business/2020/12/08/stimulus-negotiations-liability-shield/.

   [13]   See discussion infra.

   [14]   29 U.S.C. § 654.

   [15]   See generally U.S. DOL, OSHA Report 4045-06 2020, Guidance on Returning to Work (2020), available at https://www.osha.gov/Publications/OSHA4045.pdf.

   [16]   42 U.S.C. § 12112 (barring discrimination on the basis of a “disability”). Because “disability,” as defined in the ADA and further defined in subsequent ADAAA, includes any “physical or mental impairment that substantially limits one or more major life activities of [an] individual,” id. § 12102, employees who do not wish to be vaccinated may argue that they have a disability that prevents them from being vaccinated.

   [17]   Id. § 2000e-2 (prohibiting discrimination on the basis of an “individual’s race, color, religion, sex, or national origin”).

   [18]   See, e.g., OSHA, Standards Interpretation of Nov. 9, 2009, available at https://www.osha.gov/laws-regs/standardinterpretations/2009-11-09 (“[A]lthough OSHA does not specifically require employees to take the vaccines, an employer may do so”).

   [19]   EEOC, What You Should Know About COVID-19 and the ADA, the Rehabilitation Act, and Other EEO Laws (Sept. 8, 2020), available at https://www.eeoc.gov/wysk/what-you-should-know-about-covid-19-and-ada-rehabilitation-act-and-other-eeo-laws (“An employer may exclude those with COVID-19, or symptoms associated with COVID-19, from the workplace because, as EEOC has stated, their presence would pose a direct threat to the health or safety of others.”).

   [20]   Note, however, that to the extent OSHA or state regulators ultimately require, as a generally applicable workplace safety rule, that certain workplace vaccination policies be put into place, such health and safety rules would likely trump contrary (that is, more permissive) CBA terms. See discussion infra; see also United Steelworkers of America v. Marshall, 647 F.2d 1189, 1236 (D.C. Cir. 1980) (noting duty to bargain with unions over safety and health matters does not excuse employers from complying with OSHA safety standards); Paige v. Henry J. Kaiser Co., 826 F.2d 857, 863 (9th Cir. 1987) (same, as applied to California’s state-level OSHA equivalent).

   [21]   See, e.g., Joe Sonka, “Kentucky legislator pre-files bill prohibiting colleges from mandating vaccines,” Louisville Courier J. (Dec. 4, 2020), available at https://www.courier-journal.com/story/news/politics/ky-general-assembly/2020/12/04/kentucky-bill-would-prohibit-colleges-mandating-covid-19-vaccine/3827327001/.

   [22]   See 42 U.S.C. §12102 (defining “disability” to include any “physical or mental impairment that substantially limits one or more major life activities of [an] individual.”).

   [23]   See EEOC, Enforcement Guidance on Reasonable Accommodation and Undue Hardship under the ADA, EEOC-CVG-2003-1, Oct. 17, 2002 (“May an employer ask an individual for documentation when the individual requests reasonable accommodation? . . . Yes. When the disability and/or the need for accommodation is not obvious, the employer may ask the individual for reasonable documentation about his/her disability and functional limitations.”).

   [24]   See id.

   [25]   For analysis of an analogous question, see, for example, EEOC v. Baystate Med. Ctr., Inc., No. 3:16-cv-30086, Dkt. No. 125 (D. Mass. June 15, 2020) (Order upholding policy that required unvaccinated healthcare workers to, as a condition of employment, wear masks even though vaccinated colleagues were not required to) [Order text accessible via PACER and CM/ECF and partially reprinted at Vin Gurrieri, “EEOC Religious Bias Suit Over Hospital Worker Firing Tossed,” Law360 (June 16, 2020), available at https://www.law360.com/articles/1283456/eeoc-religious-bias-suit-over-hospital-worker-firing-tossed]; see also Holmes v. Gen. Dynamics Mission Sys., Inc., No. 19-1771, 2020 WL 7238415, at *3 (4th Cir. Dec. 9, 2020) (suggesting that as “long as [a workplace safety] requirement is valid, any employee who is categorically unable to comply . . . will not be considered a ‘qualified’ individual for ADA purposes,” and so may independently be denied a particular requested accommodation on such basis) (internal punctuation and citation omitted).

   [26]   Specifically, EEOC guidance indicates such protections extend to “[r]eligious beliefs include theistic beliefs (i.e. those that include a belief in God) as well as non-theistic ‘moral or ethical beliefs as to what is right and wrong which are sincerely held with the strength of traditional religious views.’” EEOC, Questions and Answers: Religious Discrimination in the Workplace, EEOC-NVTA-2008-2 (July 22, 2008), available at https://www.eeoc.gov/laws/guidance/questions-and-answers-religious-discrimination-workplace/.

   [27]    Id.

   [28]   See EEOC, Section 12 Religious Discrimination, EEOC-CVG-2008-1 (July 22, 2008), available at https://www.eeoc.gov/laws/guidance/section-12-religious-discrimination.

   [29]   Id.

   [30]   See EEOC, Enforcement Guidance on Reasonable Accommodation and Undue Hardship under the ADA, EEOC-CVG-2003-1 (Oct. 17, 2002), available at https://www.eeoc.gov/laws/guidance/enforcement-guidance-reasonable-accommodation-and-undue-hardship-under-ada.

   [31]   EEOC, Questions and Answers: Religious Discrimination in the Workplace, EEOC-NVTA-2008‑2 (July 22, 2008), available at https://www.eeoc.gov/laws/guidance/questions-and-answers-religious-discrimination-workplace/.

    [32]   See, e.g., Robinson v. Children’s Hosp. Bos., No. CV 14-10263-DJC, 2016 WL 1337255, at *10 (D. Mass. Apr. 5, 2016) (finding that for Title VII purposes, healthcare worker’s requested accommodation of non‑vaccination based on religious beliefs would have imposed “undue hardship” on employer and so did not need to be granted).

   [33]   Andrea Kane, “Federal government says it will pay for any future coronavirus vaccine for all Americans,” CNN (Oct. 28, 2020), available at https://www.cnn.com/2020/10/28/health/cms-medicare-covid-vaccine-treatment/index.html.

   [34]   Katie Connor, “Coronavirus vaccines may be free, but you could still get a bill. What we know,” CNET (Dec. 7, 2020), available at https://www.cnet.com/personal-finance/coronavirus-vaccines-may-be-free-but-you-could-still-get-a-bill-what-we-know/.

   [35]   Noah Higgins-Dunn, “Trump COVID Vaccine Chief Says Everyone in U.S. could be vaccinated by June,” CNBC (Dec. 1, 2020), available at https://www.cnbc.com/2020/12/01/trump-covid-vaccine-chief-says-everyone-in-us-could-be-immunized-by-june.html.

   [36]   29 U.S.C. § 157.

   [37]   See, e.g., Board Opinion, NLRB Case No. 12-CA-196002, Argos USA LLC d/b/a Argos Ready Mix, LLC and Construction and Craft Workers Local Union No. 1652, Laborers’ International Union of North America, AFL‒CIO, Cases 12–CA–196002 and 12–CA–203177 (Feb. 5, 2020), at 4, available at https://apps.nlrb.gov/link/document.aspx/09031d4582f8f960 (finding, in the context of cellphone-while-driving rules, that workplace rules that “ensure the safety of [workers] and the general public” do not interfere with the exercise of Section 7 rights).

   [38]   See, e.g., OSHA Standard 1910.1030 App A – Hepatitis B Vaccine Declination (requiring workers who opt out of the bloodborne pathogen vaccine to attest that they understand the medical risks of declining a vaccine should they decide to do so).

   [39]   See, e.g., Richardson v. Island Harvest, Ltd., 166 A.D.3d 827, 828-29 (N.Y. App. Div. 2018) (reasoning that employers and employees are in unequal bargaining positions, and that therefore prospective liability waivers for negligent employer conduct would be held unenforceable).

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

Jessica Brown – Denver (+1 303-298-5944, [email protected])
Lauren Elliot – New York (+1 212-351-3848, [email protected])
Daniel E. Rauch – Denver (+1 303-298-5734 , [email protected])

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

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

© 2023 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice. Please note, prior results do not guarantee a similar outcome.

On December 4, 2020, the Securities and Exchange Commission (“SEC”) announced its first enforcement action against a public company for misleading disclosures about the financial effects of the pandemic on the company’s business operations and financial condition. In a settled administrative order, the Commission found that disclosures in two press releases by The Cheesecake Factory Incorporated violated Section 13(a) of the Exchange Act and Rules 13a-11 and 12b-20 thereunder. Without admitting the findings in the order, the company agreed to pay a $125,000 penalty and to cease-and-desist from further violations.[1] In March 2020, the SEC’s Division of Enforcement formed a Coronavirus Steering Committee to oversee the Division’s efforts to actively look for Covid-related misconduct.

The Company’s Form 8-Ks

On March 23, 2020, the company furnished a Form 8-K to the Commission, disclosing, among other things, that it was withdrawing previously-issued financial guidance due to economic conditions caused by Covid-19. As an exhibit to the Form-8-K, the company included a copy of its press release providing a business update regarding the impact of Covid-19. The press release announced that the company was transitioning to an “off-premise” model (i.e., to-go and delivery) that would enable the company to continue to “operate sustainably.” This press release did not elaborate on what “sustainably” meant. The release also disclosed a $90 million draw down on the company’s revolving credit facility, and stated that the company was “evaluating additional measures to further preserve financial flexibility.”

On March 27, 2020, in response to media reports, the company filed another Form 8-K, disclosing that it was not planning to pay rent in April and that it was in discussion with landlords regarding its rent obligations, including abatement and potential deferral. The company also disclosed that as of April 1, it had reduced compensation for executive officers, its Board of Directors, and certain employees, and that it furloughed approximately 41,000 employees.

On April 3, 2020, the company furnished another Form 8-K to the Commission that attached a copy of an April 2, 2020 press release. This press release provided a preliminary Q1 2020 sales update, which reflected the impact of Covid-19. The release stated that “the restaurants are operating sustainably at present under this [off-premise] model.”

The SEC found that the March 23 and April 3 Form 8-Ks – but not the March 27 Form 8-K – were materially misleading.

What the Company Did Not Disclose

The company’s disclosures on March 23 and April 3 did not disclose:

1. a March 18, 2020 letter from the company to its restaurants’ landlords stating that it was not going to pay its rent for April 2020;
2. that the company was losing $6 million in cash per week;
3. that it had only approximately 16 weeks of cash remaining even after the $90 million revolving credit facility borrowing; and
4. that it was excluding expenses attributable to corporate operations from its claim of sustainability.

The SEC’s Findings

The SEC found that the company’s March 23 and April 3, 2020 Forms 8-K were materially false and misleading in violation of Section 13(a) of the Exchange Act and Rules 13a-11 and 12b-20 thereunder. These sections require that every issuer of a security registered pursuant to Section 12 of the Exchange Act file with the Commission accurate and current information on its Form 8-K, including material information necessary to make the required statements made in the reports not misleading.

Observations and Takeaways

Although this is the first enforcement action against a public company based on disclosures about the financial effects of the pandemic, the findings against the company are fairly unusual.

Two observations:

• First, the SEC’s order focuses on two press releases included as exhibits in Form 8-Ks that are deemed to be “furnished,” and not “filed,” under the Exchange Act. Specifically, one was filed under Item 7.01 and the other under Item 2.02. Because these Form 8-Ks are not deemed to be “filed” for purposes of Section 18 of the Exchange Act, there is no private right of action under Section 18 that can arise in connection with these Form 8-Ks. So, although “furnishing” reports results in lower liability exposure, it does not mean that the SEC cannot take enforcement action if it believes the disclosure is misleading.
• Second, the language at issue in the two Form 8-Ks is the word of the moment, “sustainably,” as in “operating sustainably.” It should be noted that, nine months after the disclosures were made, the company remains in business (and did not file for bankruptcy) and, in fact, as of the close of trading on December 4, 2020, its stock price closed near the high of the 52-week range. The concept of sustainability is generally thought to encompass the concept of over the long- or longer term, so it is not self-evident that these disclosures were materially misleading.

Some takeaways:

• In using the word “sustainably” without further qualification or explanation, issuers run the risk of being misunderstood. Sustainably in what sense (as a synonym for liquidity?) or to which degree? Over what period of time? It is not self-evident what sustainability entails.
• Where the subject matter involves the impact of Covid, the Commission’s order certainly demonstrates its willingness to take action even if, at worst, the disclosure at issue is vague or unclear. This was not a case in which the company claimed it had no liquidity issues when, in fact, it was experiencing significant liquidity issues. Put another way, this case raises the question as to whether Covid disclosures are attracting greater scrutiny than other corporate disclosures in the current climate.
• To state the obvious, the Commission brought this action for a reason: to underscore the importance of carefully drafted disclosures with respect to the impact of Covid on issuers’ results of operations, financial condition and liquidity; and to signal its willingness to take action if issuers’ Covid-related disclosures are not carefully drafted. A quote from the SEC Chair in the press release announcing this action is a further indication of the importance the SEC is placing on this area of enforcement.[2]

_______________________

  [1]   Order Instituting Cease-and-Desist Proceedings, Securities Exchange Act of 1934 Release No. 90565 at 4 (Dec. 4, 2020).

  [2]   Press Release, Securities and Exchange Commission, SEC Charges The Cheesecake Factory For Misleading COVID-19 Disclosures (Dec. 4, 2020), available at https://www.sec.gov/news/press-release/2020-306.

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Securities Enforcement or Securities Regulation and Corporate Governance practice groups, or the following authors:

Thomas J. Kim – Washington, D.C. (+1 202-887-3550, [email protected])
Mark K. Schonfeld – New York (+1 212-351-2433, [email protected])
Barry R. Goldsmith – New York (+1 212-351-2440, [email protected])
Richard W. Grime – Washington, D.C. (+1 202-955-8219, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
James J. Moloney – Orange County, CA (+ 949-451-4343, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Lauren Myers – New York (+1 212-351-3946, [email protected])

Please also feel free to contact the practice group leaders:

Securities Enforcement Practice Group Leaders:
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])

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
James J. Moloney – Orange County, CA (+ 949-451-4343, [email protected])
Lori Zyskowski – New York, NY (+1 212-351-2309, [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 two most influential proxy advisory firms—Institutional Shareholder Services (“ISS”) and Glass, Lewis & Co. (“Glass Lewis”)—recently released their updated proxy voting guidelines for 2021. The key changes to the ISS and Glass Lewis policies are described below along with some suggestions for actions public companies should take now in light of these policy changes and other developments. An executive summary of the ISS 2021 policy updates is available here and a more detailed chart showing additional updates to its voting policies and providing explanations for the updates is available here. The 2021 Glass Lewis Guidelines are available here and the 2021 Glass Lewis Guidelines on Environmental, Social & Governance Initiatives are available here.

ISS 2021 Voting Policy Updates

On November 12, 2020, ISS released updates to its proxy voting guidelines for shareholder meetings held on or after February 1, 2021. This summary reviews the major policy updates that apply to U.S. companies, which are used by ISS in making voting recommendations on director elections and company and shareholder proposals at U.S. companies.

ISS plans to issue a complete set of updated policies on its website in December 2020. ISS also indicated that it plans to issue updated Frequently Asked Questions (“FAQs”) on certain of its policies in December 2020, and it issued a set of preliminary FAQs on the U.S. Compensation Policies and the COVID-19 Pandemic in October 2020, which are available here. In January 2021, ISS will evaluate new U.S. shareholder proposals that are anticipated for 2021 and update its voting guidelines as necessary.

1. Director Elections

Board Racial/Ethnic Diversity

While ISS has not previously had a voting policy regarding board racial or ethnic diversity, ISS noted that many investors have shown interest in seeing this type of diversity on public company boards, especially in light of recent activism seeking racial justice. In its annual policy survey administered in the summer of 2020, ISS reported that almost 60% of investors indicated that boards should aim to reflect a company’s customer base and the broader societies in which companies operate by including directors drawn from racial and ethnic minority groups, and 57% of investors responded that they would also consider voting against members of the nominating committee (or other directors) where board racial and ethnic diversity is lacking.

Under ISS’s updated policy, at companies in the Russell 3000 or S&P 1500 indices:

• For the 2021 proxy season, the absence of racial/ethnic diversity on a company’s board will not be a factor in ISS’s voting recommendations, but will be highlighted by ISS in its research reports to “help investors identify companies with which they may wish to engage and foster dialogue between investors and companies on this topic.” ISS will only consider aggregate diversity statistics “if specific to racial and/or ethnic diversity.”
• For the 2022 proxy season, ISS will generally recommend votes “against” the chair of the nominating committee (or other directors on a case-by-case basis) where the board has no apparent racially or ethnically diverse members. Mitigating factors include the presence of racial and/or ethnic diversity on the board at the preceding annual meeting and a firm commitment to appoint at least one racially and/or ethnically diverse member within a year.

ISS highlighted several factors in support of its new policy, including obstacles to increasing racial and ethnic diversity on boards (citing studies conducted by Korn Ferry and the “Black Corporate Directors Time Capsule Project”), new California legislation, AB 979, to promote the inclusion of “underrepresented communities” on boards, recent comments by SEC Commissioner Allison Lee in support of strengthened additional guidance on board candidate diversity characteristics, diversity-related disclosure requirements and SEC guidance, and investor initiatives focused on racial/ethnic diversity on corporate boards.

Board Gender Diversity

ISS announced a policy related to board gender diversity in 2019, and provided a transitional year (2020) for companies that previously had no female directors to make a commitment to add at least one female director by the following year. In its recent policy updates, ISS removed the transition-related language, as the transition period will end soon. After February 1, 2021, ISS will recommend votes “against” the chair of the nominating committee (or other directors on a case-by-case basis) at any company that has no women on its board except in situations where there was at least one woman on the board at the previous annual meeting, and the board commits to “return to a gender-diverse status” by the next annual meeting.

Material Environmental & Social Risk Oversight Failures

Under extraordinary circumstances, ISS recommends votes “against” directors individually, committee members, or the entire board, in the event of, among other things, material failures of risk oversight. Current ISS policy cites bribery, large or serial fines or sanctions from regulatory bodies, significant adverse legal judgments or settlements, or hedging of company stock as examples of risk oversight failures. The policy updates add “demonstrably poor risk oversight of environmental and social issues, including climate change” as an example of a board’s material failure to oversee risk. ISS previously noted in its proposed policy updates that this policy is intended for directors of companies in “highly impactful sector[s]” that are “not taking steps to reduce environmental and social risks that are likely to have a large negative impact on future company operations” and is “expected to impact a small number of directors each year.”

“Deadhand” or “Slowhand” Poison Pills

ISS generally recommends votes case-by-case on director nominees who adopted a short-term poison pill with a term of one year or less, depending on the disclosed rationale for the adoption and other relevant factors. Noting that the unilateral adoption of a poison pill with a “deadhand” or “slowhand” feature is a “material governance failure,” ISS will now also generally recommend votes “against” directors at the next annual meeting if a board unilaterally adopts a poison pill with this feature, whether the pill is short-term or long-term and even if the pill itself has expired by the time of that meeting.

ISS explains that a deadhand pill provision is “generally phrased as a ‘continuing director (or trustee)’ or ‘disinterested director’ clause and restricts the board’s ability to redeem or terminate the pill” and “can only be redeemed if the board consists of a majority of continuing directors, so even if the board is replaced by shareholders in a proxy fight, the pill cannot be redeemed,” and therefore, “the defunct board prevents [the redemption]” of the pill. Continuing directors are defined as “directors not associated with the acquiring person, and who were directors on the board prior to the adoption of the pill or were nominated by a majority of such directors.” A slowhand pill is “where this redemption restriction applies only for a period of time (generally 180 days).”

Classification of Directors as Independent

While there are several changes to ISS’s policy, the primary change is to limit the “Executive Director” classification to officers only, excluding other employees. According to ISS, this change will not result in any vote recommendation changes under its proxy voting policy, but may provide additional clarity for institutional holders whose overboarding policies apply to executive officers.

2. Other Board-Related Proposals

Board Refreshment

Previously, ISS generally recommended votes “against” proposals to impose director tenure and age limits. Under the updated policy, ISS will now take a case-by-case approach for tenure limit proposals while continuing to recommend votes “against” age-limit proposals. With respect to management proposals for tenure limits, ISS will consider the rationale and other factors such as the robustness of the company’s board evaluation process, whether the limit is of sufficient length to allow for a broad range of director tenures, whether the limit would disadvantage independent directors compared to non-independent directors, and whether the board will impose the limit evenly, and not have the ability to waive it in a discriminatory manner. With respect to shareholder proposals for tenure limits, ISS will consider the scope of the proposal and whether there is evidence of “problematic issues” at the company combined with, or exacerbated by, a lack of board refreshment.

ISS noted that the board refreshment is “best implemented through an ongoing program of individual director evaluations, conducted annually, to ensure the evolving needs of the board are met and to bring in fresh perspectives, skills, and diversity as needed,” but it cited the growing attention on board refreshment as a mechanism to achieve board diversity as an impetus for this policy change.

3. Shareholder Rights and Defenses

Exclusive Forum Provisions

Exclusive forum provisions in company governing documents historically have required shareholders to go to specified state courts if they want to make fiduciary duty or other intra-corporate claims against the company and its directors. In March 2020, a unanimous Delaware Supreme Court confirmed the validity of so-called “federal forum selection provisions”—provisions that Delaware corporations adopt in their governing documents requiring actions arising under the Securities Act of 1933 (related to securities offerings) to be filed exclusively in federal court. Noting that the benefits of eliminating duplicative litigation and having cases heard by courts that are “well-versed in the applicable law” outweigh the potential inconvenience to plaintiffs, ISS updated its policy to recommend votes “for” provisions in the charter or bylaws (and announced it would not criticize directors who unilaterally adopt similar provisions) that specify “the district courts of the United States” (instead of particular federal district court) as the exclusive forum for federal securities law claims. ISS will oppose federal exclusive forum provisions that designate a particular federal district court. ISS also updated its policy on state exclusive forum provisions. At Delaware companies, ISS will generally support provisions in the charter or bylaws (and will not criticize directors who unilaterally adopt similar provisions) that select Delaware or the Delaware Court of Chancery. For companies incorporated in other states, if the provision designates the state of incorporation, ISS will take a case-by-case approach, considering a series of factors, including disclosure about harm from duplicative shareholder litigation.

Advance Notice Requirements

ISS recommends votes case-by-case on advance notice proposals, supporting those that allow shareholders to submit proposals/nominations as close to the meeting date as reasonably possible. Previously, to be “reasonable,” the company’s deadline for shareholder notice of a proposal/nomination had to be not more than 60 days prior to the meeting, with a submittal window of at least 30 days prior to the deadline. In its updated policy, ISS now considers a “reasonable” deadline to be no more than 120 days prior to the anniversary of the previous year’s meeting with a submittal window no shorter than 30 days from the beginning of the notice period (also known as a 90-120 day window). ISS notes that this is in line with recent market practice. This policy applies only in limited situations where a company submits an advance notice provision for shareholder approval.

Virtual Shareholder Meetings

In light of the ongoing COVID-19 pandemic and other rule changes regarding shareholder meeting formats, ISS has added a new policy under which it will generally recommend votes “for” management proposals allowing for the convening of shareholder meetings by electronic means, so long as they do not preclude in-person meetings. Companies are encouraged to disclose the circumstances under which virtual-only meetings would be held, and to allow for comparable rights and opportunities for shareholders to participate electronically as they would have during an in-person meeting. ISS will recommend votes case-by-case on shareholder proposals concerning virtual-only meetings, considering the scope and rationale of the proposal and concerns identified with the company’s prior meeting practices.

4. Social and Environmental Issues

Mandatory Arbitration of Employment Claims

The new policy on mandatory arbitration provides that ISS will recommend votes case-by-case on proposals requesting a report on the use of mandatory arbitration on employment-related claims, taking into account the following factors:

• The company’s current policies and practices related to the use of mandatory arbitration agreements on workplace claims;
• Whether the company has been the subject of recent controversy, litigation, or regulatory actions related to the use of mandatory arbitration agreements on workplace claims; and
• The company’s disclosure of its policies and practices related to the use of mandatory arbitration agreements compared to its peers.

ISS added this policy because proposals on mandatory arbitration have received increased support from shareholders, and ISS clients have expressed interest in a specific policy on this topic.

Sexual Harassment

ISS’s new policy on sexual harassment provides that ISS will recommend votes case-by-case on proposals requesting a report on actions taken by a company to strengthen policies and oversight to prevent workplace sexual harassment, or a report on risks posed by a company’s failure to prevent workplace sexual harassment. ISS will take into account the following factors:

• The company’s current policies, practices, and oversight mechanisms related to preventing workplace sexual harassment;
• Whether the company has been the subject of recent controversy, litigation, or regulatory actions related to workplace sexual harassment issues; and
• The company’s disclosure regarding workplace sexual harassment policies or initiatives compared to its industry peers.

Similar to the new policy on mandatory arbitration discussed above, ISS cited increasing shareholder support for sexual harassment proposals and client demand as reasons for establishing this new policy.

Gender, Race/Ethnicity Pay Gap

ISS recommends votes case-by-case on proposals requesting reports on a company’s pay data by gender or race/ethnicity, or a report on a company’s policies and goals to reduce any gender or race/ethnicity pay gaps. In its updated policy, ISS adds to the list of factors to be considered in evaluating these proposals “disclosure regarding gender, race, or ethnicity pay gap policies or initiatives compared to its industry peers” and “local laws regarding categorization of race and/or ethnicity and definitions of ethnic and/or racial minorities.” ISS notes that this change is to “highlight that some legal jurisdictions do not allow companies to categorize employees by race and/or ethnicity and that definitions of ethnic and/or racial minorities differ from country to country, so a global racial and/or ethnicity statistic would not necessarily be meaningful or possible to provide.”

Glass Lewis 2021 Proxy Voting Policy Updates

On November 24, 2020, Glass Lewis released its updated proxy voting guidelines for 2021. This summary reviews the major updates to the U.S. guidelines, which provides a detailed overview of the key policies Glass Lewis applies when making voting recommendations on proposals at U.S. companies and on environmental, social and governance initiatives.

1. Board of Directors

Board Diversity

Glass Lewis expanded on its previous policy on board gender diversity, under which it generally recommends votes “against” the chair of the nominating committee of a board that has no female members. Under its expanded policy:

• For the 2021 proxy season, Glass Lewis will note as a concern boards with fewer than two female directors.
• For the 2022 proxy season, Glass Lewis will generally recommend votes “against” the nominating committee chair of a board with fewer than two female directors; however, for boards with six or fewer members, Glass Lewis’s previous policy requiring a minimum of one female director will remain in place. Glass Lewis indicated that, in making its voting recommendations, it will carefully review a company’s disclosure of its diversity considerations and may refrain from recommending that shareholders vote against directors when boards have provided a sufficient rationale or plan to address the lack of diversity on the board.

In addition, Glass Lewis noted that several states have begun to address board diversity through legislation, including California’s legislation requiring female directors and directors from “underrepresented communities” on boards headquartered in the state. Under its updated policy, Glass Lewis will now recommend votes in accordance with board composition requirements set forth in applicable state laws when they come into effect.

Disclosure of Director Diversity and Skills

Beginning with the 2021 proxy season, Glass Lewis will begin tracking the quality of disclosure regarding a board’s mix of diverse attributes and skills of directors. Specifically, Glass Lewis will reflect how a company’s proxy statement presents: (i) the board’s current percentage of racial/ethnic diversity; (ii) whether the board’s definition of “diversity” explicitly includes gender and/or race/ethnicity; (iii) whether the board has adopted a policy requiring women and minorities to be included in the initial pool of candidates when selecting new director nominees (also known as the “Rooney Rule”); and (iv) board skills disclosure. Glass Lewis reported that it will not be making voting recommendations solely on the basis of this assessment in 2021, but noted that the assessment will “help inform [its] assessment of a company’s overall governance and may be a contributing factor in [its] recommendations when additional board-related concerns have been identified.”

Board Refreshment

Previously, Glass Lewis articulated in its policy its strong support of mechanisms to promote board refreshment, acknowledging that a director’s experience can be a valuable asset to shareholders, while also noting that, in rare circumstances, a lack of refreshment can contribute to a lack of board responsiveness to poor company performance. In its updated policy, Glass Lewis reiterates its support of periodic board refreshment to foster the sharing of diverse perspectives and new ideas, and adds that, beginning in 2021, it will note as a potential concern instances where the average tenure of non-executive directors is 10 years or more and no new directors have joined the board in the past five years. Glass Lewis indicated that it will not be making voting recommendations strictly on this basis in 2021.

2. Virtual-Only Shareholder Meetings

Glass Lewis has removed its temporary exception to its policy on virtual shareholder meeting disclosure that was in effect for meetings held between March 30, 2020 and June 30, 2020 due to the emergence of COVID-19. Glass Lewis’s standard policy will be in effect, under which Glass Lewis will generally hold the governance committee chair responsible at companies holding virtual-only meetings that do not include robust disclosure in the proxy statement addressing the ability of shareholders to participate, including disclosure regarding shareholders’ ability to ask questions at the meeting, procedures, if any, for posting questions received during the meeting and the company’s answers on its public website, as well as logistical details for meeting access and technical support.

3. Executive Compensation

Short-Term Incentives

Glass Lewis has codified additional factors it will consider in assessing a company’s short-term incentive plan, including clearly disclosed justifications to accompany any significant changes to a company’s short-term incentive plan structure, as well as any instances in which performance goals have been lowered from the previous year. Glass Lewis also expanded its description of the application of upward discretion, including lowering goals mid-year and increasing calculated payouts, to also include instances of retroactively prorated performance periods.

Long-Term Incentives

With respect to long-term incentive plans, under its updated policy Glass Lewis has defined inappropriate performance-based award allocation as a criterion that may, in the presence of other major concerns, contribute to a negative voting recommendation. Glass Lewis will also review as “a regression of best practices” any decision to significantly roll back performance-based award allocation, which may lead to a negative recommendation absent exceptional circumstances. Glass Lewis also clarified that clearly disclosed explanations are expected to accompany long-term incentive equity granting practices, as well as any significant structural program changes or any use of upward discretion.

4. Environmental, Social & Governance Initiatives

Workforce Diversity Reporting

Glass Lewis has updated its guidelines to provide that it will generally recommend votes “for” shareholder proposals requesting that companies provide EEO-1 reporting. It also noted that, because issues of human capital management and workforce diversity are material to companies in all industries, Glass Lewis will no longer consider a company’s industry or the nature of its operations when evaluating diversity reporting proposals.

Management-Proposed E&S Resolutions

Glass Lewis will take a case-by-case approach to management proposals that deal with environmental and social issues, and will consider a variety of factors, including: (i) the request of the management proposals and whether it would materially impact shareholders; (ii) whether there is a competing or corresponding shareholder proposal on the topic; (iii) the company’s general responsiveness to shareholders and to emerging environmental and social issues; (iv) whether the proposal is binding or advisory; and (v) management’s recommendation on how shareholders should vote on the proposal.

Climate Change

Glass Lewis will no longer consider a company’s industry when reviewing climate reporting proposals, noting that because of the extensive and wide-ranging impacts climate change can have, it is an issue that should be addressed and considered by companies regardless of industry. As a result, under its new policy, Glass Lewis will generally recommend votes “for” shareholder proposals requesting that companies provide enhanced disclosure on climate-related issues, such as requesting that the company undertake a scenario analysis or report that aligns with the recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”). Glass Lewis explained that that while it is generally supportive of these types of proposals, it will closely evaluate them in the context of a company’s unique circumstances and when making vote recommendations will continue to consider: (i) how the company’s operations could be impacted by climate-related issues; (ii) the company’s current policies and the level and evolution of its related disclosure; (iii) whether a company provides board-level oversight of climate-related risks; (iv) the disclosure and oversight afforded to climate change-related issues at peer companies; and (v) if companies in the company’s market and/or industry have provided any disclosure that is aligned with the TCFD recommendations.

Glass Lewis’s updated policy also addresses its approach to proposals on climate-related lobbying. When reviewing proposals asking for disclosure on this issue, Glass Lewis will evaluate: (i) whether the requested disclosure would meaningfully benefit shareholders’ understanding of the company’s policies and positions on this issue; (ii) the industry in which the company operates; (iii) the company’s current level of disclosure regarding its direct and indirect lobbying on climate change-related issues; and (iv) any significant controversies related to the company’s management of climate change or its trade association memberships. Under its policy, while Glass Lewis will generally recommend that companies enhance their disclosure on these issues, it will generally recommend votes “against” any proposals that would require the company to suspend its memberships in or otherwise limit a company’s ability to participate fully in the trade associations of which it is a member.

Environmental and Social Risk Oversight

Glass Lewis has updated its guidelines with respect to board-level oversight of environmental and social issues. Under its existing policy, for large-cap companies and in instances where Glass Lewis identifies material oversight concerns, Glass Lewis will review a company’s overall governance practices and identify which directors or board-level committees have been charged with oversight of environmental and/or social issues. Under its updated policy:

• For the 2021 proxy season, Glass Lewis will note as a concern when boards of companies in the S&P 500 do not provide clear disclosure (in either the company’s proxy statement or governing documents such as committee charters) on board-level oversight of environmental and social issues.
• For the 2022 proxy season, Glass Lewis will generally recommend votes “against” the governance committee chair at S&P 500 companies without explicit disclosure concerning the board’s role in overseeing these issues.Glass Lewis clarified in its updated policy that, while it believes it is important that these issues are overseen at the board level and that shareholders are afforded meaningful disclosure of these oversight responsibilities, it believes that companies should determine the best structure for this oversight (which it noted may be conducted by specific directors, the entire board, a separate committee, or combined with the responsibilities of a key committee).

5. Other Changes

Glass Lewis’s 2021 voting policies also include the following updates:

1. Special Purpose Acquisition Companies (“SPACs”): New to its policy this year is a section detailing Glass Lewis’s approach to common issues associated with SPACs. Under its new policy, Glass Lewis articulates a generally favorable view of proposals seeking to extend business combination deadlines. The new policy also details Glass Lewis’s approach to determining independence of board members at a post-combination entity who previously served as executives of the SPAC, whom Glass Lewis will generally consider to be independent, absent any evidence of an employment relationship or continuing material financial interest in the combined entity.
2. Governance Following an IPO or Spin-Off. Glass Lewis clarified its approach to director recommendations on the basis of post-IPO corporate governance concerns. Glass Lewis generally targets the governance committee members for such concerns; however, if a portion of the governance committee members is not standing for election due to a classified board structure, Glass Lewis will expand its recommendations to additional director nominees, based on who is standing for election. Glass Lewis also clarified its approach to companies that adopt a multi-class share structure with disproportionate voting rights, or other anti-takeover mechanisms, preceding an IPO, noting it will generally recommend voting against all members of the board who served at the time of the IPO if the board: (i) did not also commit to submitting these provisions to a shareholder vote at the company’s first shareholder meeting following the IPO; or (ii) did not provide for a reasonable sunset of these provisions.
3. Board Responsiveness. Glass Lewis did not change its board responsiveness policy, but clarified its approach to assessing significant support for non-binding shareholder resolutions. Specifically, for management resolutions, Glass Lewis will note instances where a resolution received over 20% opposition at the prior year’s meeting and may opine on the board’s response to such opposition; however, in the case of majority-approved shareholder resolutions, Glass Lewis generally believes significant board action is warranted in response.

Recommended Actions for Public Companies

• Submit your company’s peer group information to ISS for the next proxy statement: As part of ISS’s peer group construction process, on a semiannual basis in the U.S., companies may submit their self-selected peer groups for their next proxy disclosure. Although not determinative, companies’ self-selected peer groups are considered in ISS’s peer group construction, and therefore it is highly recommended that companies submit their self-selected peer groups. Certain companies with annual meetings to be held between February 1, 2021 and September 15, 2021 may submit their self-selected peer groups through the Governance Analytics page on the ISS website from November 16, 2020 to December 4, 2020. The peer group should include a complete peer list used for benchmarking CEO pay for the fiscal year ending prior to the next annual meeting. Companies that have made no changes to their previous proxy-disclosed executive compensation benchmarking peers, or companies that do not wish to provide this information in advance, do not need to participate. For companies that do not submit changes, the proxy-disclosed peers from the company’s last proxy filing will automatically be considered in ISS’s peer group construction process.
• Evaluate your company’s practices in light of the updated ISS and Glass Lewis proxy voting guidelines: Companies should consider whether their policies and practices, or proposals expected to be submitted to a shareholder vote in 2021, are impacted by any of the changes to the ISS and Glass Lewis proxy voting policies. For example, companies should consider whether their exclusive forum provisions or poison pills in the charter or bylaws contain any specific feature that would lead to adverse voting recommendations for directors by ISS or Glass Lewis.
• Assess racial/ethnic diversity on your board and consider enhancing related disclosures in the proxy statement: Companies should assess the composition of their board with respect to gender and racial/ethnic diversity, and consider whether any changes are needed to the board’s director recruitment policies and practices. Companies should also consider whether their diversity disclosures in the proxy statements or other public filings are adequate. To facilitate this assessment and support enhanced public disclosures, companies should consider asking their directors to self-identify their diverse traits in their upcoming director and officer questionnaires. As also noted by ISS, investors, too, are increasingly focused on racial/ethnic diversity. California recently passed the new board racial/ethnic diversity bill that expands upon the 2018 gender diversity bill, and the Illinois Treasurer launched a campaign representing a coalition of state treasurers and other investors in October 2020 asking Russell 3000 companies to disclose the race/ethnicity and gender of their directors in their 2021 proxy statements. In August 2020, State Street sent a letter to the board chairs of its U.S. portfolio companies, informing them that starting in 2021, State Street will ask companies to provide “specific communications” to shareholders regarding their diversity strategy and goals, measures of the diversity of the employee base and the board, goals for racial and ethnic representation at the board level and the board’s role in oversight of diversity and inclusion. In addition, earlier this week, Nasdaq filed a proposal with the SEC to adopt new listing rules related to board diversity and disclosure. The proposed rules would require most Nasdaq-listed companies to publicly disclose statistical information in a proposed uniform format on the company’s board of directors related to a director’s self-identified gender, race, and self-identification as LGBTQ+ and would also require such Nasdaq-listed companies “to have, or explain why they do not have, at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+.”
• Consider enhancing board oversight and disclosures on environmental and social matters: Although ISS noted that its update related to material environmental and social risk oversight failures is expected to affect a small number of directors in certain high-risk sectors, it is notable that ISS explicitly adds environmental and social risk oversight as an area where it will hold directors accountable. Also, institutional investors continue to focus on these issues in their engagements with companies and voice their concerns at companies that lag behind on this front. For example, BlackRock recently reported that, during the 2020 proxy season, it took actions against 53 companies for their failure to make sufficient progress regarding climate risk disclosure or management, either by voting against director-related items (such as director elections and board discharge proposals) or supporting certain climate-related shareholder proposals. Regardless of sector or industry, companies should evaluate whether their board has a system that properly enables them to oversee how the company manages environmental and social risks and establishes policies aligned with recent developments.

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work in the Securities Regulation and Corporate Governance and Executive Compensation and Employee Benefits practice groups, or any of the following practice leaders and members:

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, [email protected])
Ron Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Michael Titera – Orange County, CA (+1 949-451-4365, [email protected])
Lori Zyskowski – New York, NY (+1 212-351-2309, [email protected])
Aaron Briggs – San Francisco, CA (+1 415-393-8297, [email protected])
Courtney Haseley – Washington, D.C. (+1 202-955-8213, [email protected])
Julia Lapitskaya – New York, NY (+1 212-351-2354, [email protected])
Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, [email protected])

Executive Compensation and Employee Benefits Group:
Stephen W. Fackler – Palo Alto/New York (+1 650-849-5385/+1 212-351-2392, [email protected])
Sean C. Feller – Los Angeles (+1 310-551-8746, [email protected])
Krista Hanvey – Dallas (+ 214-698-3425, [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.

Announcements

On November 30, 2020, ICE Benchmark Administration (“IBA”), the administrator of LIBOR, with the support of the Federal Reserve Board and the UK Financial Conduct Authority, announced plans to consult on specific timing for the path forward to cease the publication of USD LIBOR. In particular, IBA plans to consult on ceasing the publication of USD LIBOR on December 31, 2021 for only the one week and two month USD LIBOR tenors, and on June 30, 2023 for all other USD LIBOR tenors (i.e., overnight, one month, three month, six month and 12 month tenors). This announcement is significant as regulators had indicated that all USD LIBOR tenors would cease to exist or become non-representative at the end of 2021. This proposal significantly lengthens the transition period to June 30, 2023 for most legacy contracts, allowing time for many contracts to mature before USD LIBOR ceases to exist. Legacy contracts with maturities beyond June 30, 2023 would still need to be amended to incorporate appropriate fallback provisions to address the ultimate cessation of USD LIBOR.

This announcement follows on the heels of IBA’s November 18^th announcement that it plans to consult on ceasing publication of all GBP, EUR, CHF and JPY LIBOR settings after December 31, 2021. IBA plans to close the consultation for feedback on both proposals by the end of January 2021. IBA noted that any publication of the overnight and one, three, six and 12 month USD LIBOR settings based on panel bank submissions beyond December 31, 2021 will need to comply with applicable regulations, including as to representativeness.

Concurrently, a statement by the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation included supervisory guidance that encourages banks to stop new USD LIBOR issuances by the end of 2021, noting that entering into new USD LIBOR-based contracts creates safety and soundness risks.

The regulators and IBA make clear that these announcements should not be read as an index cessation event for purposes of contractual fallback language (i.e., they should not be read to say that LIBOR has ceased, or will cease, to be provided permanently or indefinitely or that it is not, or no longer will be, representative). IBA will need to receive feedback on the consultation and will make separate announcement(s) regarding the cessation dates once final. Accordingly, the IBA proposal is not final and is subject to the feedback on the consultation.

The Alternative Reference Rates Committee (the “ARRC”) also released a statement in support of the announcements, expressing that the developments “would support a smooth transition for legacy contracts by allowing time for most to mature before USD LIBOR is proposed to cease, subject to consultation outcomes.” The ARRC further stated that “these developments align with the ARRC’s transition efforts, and will accelerate market participants’ use of the Secured Overnight Financing Rate (SOFR), the ARRC’s preferred alternative to USD LIBOR.”

Impact

If commonly used USD LIBOR tenors continue to be published and remain representative until June 30, 2023, this will provide an extra 18 months for the completion of the LIBOR transition process beyond what was previously expected. Fallback provisions in existing contracts using these USD LIBOR tenors would not be triggered until June 30, 2023, when, under the proposal, LIBOR would ultimately cease to exist. This will also allow additional time for the development of a forward-looking version of SOFR (“Term SOFR”), which could further ease the transition.

Counterparties with existing loans, derivatives and other contracts that mature prior to June 30, 2023 and reference most USD LIBOR rates would not need to incorporate fallback amendments, since these contracts will terminate before the transition. Additionally, with respect to derivatives and loans that reference USD LIBOR and have maturities beyond June 30, 2023, counterparties are likely to consider delaying adoption of fallback amendments because there no longer is an immediate threat of application of the fallback, yet uncertainty remains as to the extent of the mismatch between the ARRC-recommended fallback provisions for loans (Term SOFR, if available, or, otherwise, daily simple SOFR) and the ISDA 2020 IBOR Fallbacks Protocol for derivatives (SOFR compounded in arrears).

Furthermore, counterparties may opt to wait and see how the market develops before amending legacy contracts, especially given uncertainty around the appropriate adjustment to contractually specified spreads over the reference rate when adopting SOFR in place of LIBOR.

Although certain tenors of USD LIBOR may continue to be published until mid-2023, banks have now been advised, for safety and soundness concerns, not to enter into any new contracts that reference LIBOR after December 31, 2021. This will result in a longer period during which banks and other market participants will have both LIBOR loans and swaps and SOFR loans and swaps. Banks and other market participants should consider the operational and pricing impacts of maintaining products based on both benchmarks and confirm whether they have any contracts that reference one week or two month USD LIBOR, which are expected to be discontinued after December 31, 2021.

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

Andrew L. Fabens – New York (+1 212-351-4034, [email protected])
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Ben Myers – London (+44 (0) 20 7071 4277, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
John J. McDonnell – New York (+1 212-351-4004, [email protected])

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

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

Derivatives Group:
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])

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])
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, [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 European Commission (Commission) has launched a centralized complaints system through which EU-registered companies, industry associations, trade unions and NGOs can report market access barriers or breaches by third countries of their ‘trade and sustainable development’ (TSD) commitments or commitments undertaken under the EU’s Generalised Scheme of Preferences (GSP).[1]

The centralized complaints system[2] forms part of the Commission’s increased efforts in strengthening the enforcement and implementation of trade agreements that the EU has concluded with third countries and follows the appointment in July 2020 of the first Chief Trade Enforcement Officer (CTEO).[3]

The stated objective of the centralized complaints system is to establish a more accessible, responsive, and structured process for handling complaints by the Commission’s Directorate General for Trade (DG Trade).

The centralized complaints system does not create an obligation for the Commission to pursue each and every complaint and provides for no deadlines for the Commission to act. Complainants will be informed as to whether the complaint leads to an enforcement action. If the Commission decides to take action, it will communicate an action plan and indicative timeline to the complainant. The Commission will prioritize the treatment of complaints on the basis of objective criteria such as the likelihood of resolving the issue, the legal basis, and the economic/systemic impact of market access barriers and the seriousness of the violation of the TSD and GSP commitments.

The entry into force of this new complaints mechanism is accompanied by the Commission’s Operating Guidelines[4] as well as the Commission’s Working Approaches[5] which set out the ways in which the different elements of the EU’s recent enforcement efforts are meant to operate together.

A. Market access barriers complaints

• This type of complaint relates to the reporting of market access barriers which may include the imposition of standards and other technical requirements, the restriction to foreign participation in a services sector, quantitative restrictions related to imports, lack of transparency of national trade regulation, unfair application of customs formalities and procedures, unreasonable labelling, marking and packaging requirements etc.
• Market access barriers complaints may be lodged by EU Member States, entities registered within the EU, industry associations of EU companies, associations of EU employers, and trade unions or trade union associations formed in accordance to the laws of any EU Member State.
• Complainants will have to demonstrate that the market access barrier directly concerns them.

B. Complaints regarding TSD/GSP commitments

• This type of complaint relates to the reporting of breaches of commitments made by third countries in trade agreements with the EU or by third countries benefitting from the EU’s General Scheme of Preferences.
• Recent EU trade agreements contain rules on trade and sustainable development, in the form of trade and sustainable development commitments. TSD commitments are for instance included in the 2017 EU-Canada Comprehensive Economic and Trade Agreement (CETA)[6] as well as in the EU-Georgia Association Agreement of 2014,[7] among many.[8]
• The EU’s General Scheme of Preferences removes import duties from products coming into the EU market from vulnerable developing countries. The GSP offers: (i) a partial or full removal of customs duties on two third of tariff lines for low and lower-middle income countries, such as India, Indonesia, Kenya, Nigeria etc.; (ii) 0% tariffs for vulnerable low and lower-middle income countries that implement 27 international conventions related to human rights, labour rights, protection of the environment and good governance, such as Pakistan, Philippines, Sri Lanka etc.; (iii) a duty-free, quota-free access for all products except arms and ammunition for least developed countries such as Afghanistan, Ethiopia, Mali etc.
• TSD/GSP complaints may be lodged by citizens of any EU Member State, EU Member States, entities having their registered office, central administration or principal place of business within the EU, industry associations of EU companies, associations of EU employers, trade unions or trade union associations formed in accordance with the laws of any EU Member State and NGOs formed in accordance with the laws of any EU Member State. Importantly, complainants will need to disclose if they are acting exclusively on their own behalf or if they are representing other interests as well.
• Complainants will have to provide details of the impact and seriousness of the alleged breach in addition to the description of the factual and legal elements.

Beyond the Complaint Mechanism

The centralized complaints system is part of the Commission’s broader enforcement toolkit. The Commission will continue with the overall monitoring of trade barriers and how third countries implement their TSD/GSP commitments. In this, the Commission relies on its network of delegations and on information provided by Member States.

It remains to be seen how many formal complaints will be lodged by the various stakeholders and how many complaints DG Trade will be willing to formally pursue. If sufficient resources are dedicated at DG Trade to reviewing and effectively pursuing stakeholders’ complaints, the centralized complaints system could play an important role in the Commission’s wider push for reaffirming the EU’s economic interest with major trading partners; together with bolder trade defence enforcement[9] and the proposed new mechanism to control foreign State subsidies in the EU.[10]

_______________________

[1]  Official Press Release available at: https://trade.ec.europa.eu/doclib/press/index.cfm?id=2213.

[2]  The complaint forms are accessible at: https://trade.ec.europa.eu/access-to-markets/en/contact-form.

[3]  For more information on the CTEO’s competences please refer to: https://ec.europa.eu/trade/trade-policy-and-you/contacts/chief-trade-enforcement-officer/.

[4]  For the full text of the Commission’s Operating Guidelines of 16 November 2020, please refer to: https://trade.ec.europa.eu/doclib/docs/2020/november/tradoc_159074.pdf.

[5]  For the full text of the Commission’s Working Approaches of 16 November 2020, please refer to: https://trade.ec.europa.eu/doclib/docs/2020/november/tradoc_159075.pdf.

[6]  Chapter 22 of the CETA contains provisions on sustainable development. With this Chapter, both sides agree to ensure economic growth supports their social and environmental goals. The chapter also creates a Joint Committee on Trade and Sustainable Development, and commits both sides to promoting forums with interest groups.

[7]  Chapter 13 of the EU-Georgia Association Agreement contains commitments on sustainable development   relating to sustainable management of forests and trade in forest and fish products, the conservation and the sustainable use of biological diversity etc.

[8]  For a full list of EU trade agreements which include rules on trade and sustainable development, please refer to: https://ec.europa.eu/trade/policy/policy-making/sustainable-development/.

[9]  Gibson Dunn Client Alert of 24 June 2020, regarding the European Commission’s imposition of countervailing duties on imports from Egypt for subsidies provided by China, available at: https://www.gibsondunn.com/european-commission-imposes-countervailing-duties-on-imports-from-  egypt-for-subsidies-provided-by-china/.

[10]  Gibson Dunn Client Alert of 18 June 2020, regarding the European Commission’s White Paper on Foreign Subsidies, available at: https://www.gibsondunn.com/european-commission-publishes-white-paper-on-foreign-subsidies-political-power-meets-legal-ambiguity/.

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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, any member of the firm’s International Trade practice group, or the following authors:

Attila Borsos – Brussels (+32 2 554 72 11, [email protected])
Vasiliki Dolka – Brussels (+32 2 554 72 01, [email protected])
Kirsty Everley – London (+44 (0)20 7071 4043, [email protected])

International Trade Group:

Europe and Asia:
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)20 7071 4276, [email protected])
Sacha Harber-Kelly – London (+44 (0)20 7071 4205, [email protected])
Penny Madden – London (+44 (0)20 7071 4226, [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])
Fang Xue – Beijing (+86 10 6502 8687, [email protected])
Qi Yue – Beijing – (+86 10 6502 8534, [email protected])

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])

© 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 Commodity Futures Trading Commission (“CFTC” or the “Commission”) recently announced that its Division of Enforcement (the “Division”) issued new guidance to its staff when considering a recommendation that the Commission recognize a respondent’s cooperation, self-reporting, or remediation in an enforcement order (the “Guidance”).[1] The Guidance represents the latest step in the Commission’s ongoing efforts to provide clarity and transparency regarding the Division’s practices and procedures.

Prior Advisories on Cooperation, Self-Reporting and Remediation Remain in Effect

The Guidance explicitly states that it does not change how the Division evaluates self-reporting, cooperation, or remediation, nor how the Division considers reductions in penalties in connection with self-reporting, cooperation, or remediation.[2] Rather, these evaluations are guided by factors described in prior advisories published by the Division (the “Advisories”)[3] and set forth in the agency’s Enforcement Manual,[4] which continue to remain in effect.

While the Advisories remain in effect, they are not binding on Division staff. Instead, they emphasize the discretionary nature of both the Division’s evaluation of cooperation and its resulting recommendations.[5] Moreover, the Advisories caution that they “should not be read as requiring the Division staff to recommend, or the Commission to impose or authorize, a reduction of sanctions based on the presence or absence of particular cooperation factors.”[6] Thus, in certain circumstances, and at the discretion of the Division staff, cooperation, self-reporting, and/or remediation may result in a recommendation of recognition and of reduced sanctions in a Commission enforcement order.[7] The Advisories do note, however, that—at the far end of the self-reporting/cooperation/remediation spectrum—“if a company or individual self-reports, fully cooperates, and remediates, the Division will recommend that the Commission consider a substantial reduction from the otherwise applicable civil monetary penalty.”[8] However, where an individual or company did not self-report but otherwise fully cooperated and remediated deficiencies, the Advisories provide that the Division may recommend a reduced civil monetary penalty.[9]

The New Guidance: Clarity on When and How

The Guidance builds upon the Advisories by providing transparency and clarity regarding “when and how” the Division will recommend that assessments relating to self-reporting, cooperation, or remediation be reflected and recognized by the CFTC in its enforcement orders.[10] To achieve this objective, the Guidance sets forth the following four scenarios and the corresponding level of recognition and penalty reduction (if any) to be recommended by the Division.

Scenario	Degree of Self-Reporting, Cooperation and Remediation	Recognition/ Penalty	Enforcement Order Language
1	None	No Recognition in Enforcement Order	N/A
2	No Self-Reporting, But Cognizable Cooperation and/or Remediation	Recognition, But No Reduction in Penalty	“In accepting Respondent’s offer, the Commission recognizes the cooperation of [name of Respondent] with the Division of Enforcement’s investigation of this matter.   The Commission also acknowledges Respondent’s representations concerning its remediation in connection with this matter.”
3	No Self-Reporting, But Substantial Cooperation and/or Remediation	Recognition and Reduced Penalty	“In accepting Respondent’s Offer, the Commission recognizes the substantial cooperation of [name of respondent] with the Division of Enforcement’s investigation of this matter. The Commission also acknowledges Respondent’s representations concerning its remediation in connection with this matter. The Commission’s recognition of Respondent’s substantial cooperation and appropriate remediation is further reflected in the form of a reduced penalty.”
4	Self-Reporting, Substantial Cooperation and Remediation	Recognition and Substantially Reduced Penalty	“In accepting Respondent’s Offer, the Commission recognizes the self-reporting and substantial cooperation of [name of Respondent] in connection with the Division’s investigation of this matter. The Commission also acknowledges Respondent’s representations concerning its remediation in connection with this matter. The Commission’s recognition of Respondent’s self-reporting, substantial cooperation, and appropriate remediation is further reflected in the form of a substantially reduced penalty.”

By arranging the list of factors set forth in the Advisories into four typical combinations (scenarios), and noting when each particular combination should result in a specific recommendation to the Commission, the Guidance provides the Division’s staff with a clear roadmap for exercising its discretion under the Advisories. The Guidance also provides the staff with the exact language it should recommend be included by the Commission in an enforcement order to describe the nature and extent of a respondent’s self-reporting, cooperation, or remediation for each scenario. In addition, the Division’s recommendation to the Commission should include a description of the particular acts of cooperation, self-reporting, or remediation that should be included in the enforcement order. Significantly, the Guidance—unlike the Advisories—is binding on the Staff.[11]

Implications of the Guidance

The new Guidance has several important implications. First, the Guidance is an important contribution to the Commission’s initiative to provide consistency, transparency, and clarity to market participants regarding its enforcement actions. The CFTC published its first Enforcement Manual in May 2019, noting its core value of clarity.[12] On the heels of that publication, the Division issued new civil monetary penalty guidance and compliance program evaluation guidance in, respectively, May 2020 and September 2020.[13] In connection with these publications, the Commission has noted that clarity serves multiple purposes, including deterring misconduct and assisting respondents by enhancing predictability.[14] As explained by Chairman Tarbert, the new Guidance furthers these objectives “by ensuring the public understands the levels of recognition the CFTC may provide in its enforcement orders.”[15]

Second, the Guidance will facilitate consistent practices by the enforcement staff with regard to their recommendations for the recognition of cooperation, self-reporting, or remediation. The binding nature of the Guidance will help promote consistency in that the various geographic offices of the Division will now be required to interpret and apply the Advisories in accordance with the Guidance. Consistent practices by the enforcement staff will, in turn, enhance predictability. While the Commission will continue to exercise its independent judgment in determining when and how self-reporting, cooperation, or remediation should be recognized in its orders, market participants who are considering whether to negotiate a resolution of an enforcement investigation will benefit significantly from increased predictability by the staff.[16] Moreover, increased predictability will further incentivize self-reporting, cooperation, and remediation, which will advance some of the key goals of the Division’s enforcement program.

Finally, the Guidance—as well as enforcement orders issued by the Commission as a result of the Guidance—will be valuable reference points for market participants who are negotiating settlements with the Division. The Guidance, coupled with the Advisories, can be used by parties to frame arguments regarding the nature and extent of the credit they should receive for their self-reporting, cooperation, or remediation. Similarly, enforcement orders issued under the Guidance can be used as benchmarks when parties negotiate settlements. The Guidance’s requirements that staff recommendations include a description of the particular acts of self-reporting, cooperation, or remediation by the respondent and that proposed enforcement orders use uniform language for the recognition of such acts should foster benchmarking. Although parties can still use enforcement orders issued before the Guidance as reference points, such orders sometimes include disparate language to describe what are essentially the same levels of self-reporting, cooperation, or remediation. Going forward, it will be easier for parties to compare “apples to apples.”

In sum, although the Guidance has been issued by the Division for its staff, it will be beneficial both to market participants who are considering whether to self-report, cooperate, or remediate, and to parties who are considering whether to attempt to resolve an investigation being conducted by the Division.

 _____________________

[1]  CFTC Press Release No. 8296-20.

[2]  Memorandum from Vincent A. McGonagle, Acting Director, Division of Enforcement, to Division of Enforcement Staff, Recognizing Cooperation, Self-Reporting, and Remediation in Commission Enforcement Orders (Oct. 29, 2020) (the “Guidance”), at 1.

[3]  Enforcement Advisory: Cooperation Factors in Enforcement Division Sanction Recommendations for Individuals (Jan. 19, 2017) (the “Individual Cooperation Guidance”); Enforcement Advisory: Cooperation Factors in Enforcement Division Sanction Recommendations for Companies (Jan. 19, 2017) (the “Company Cooperation Guidance”); Enforcement Advisory: Updated Advisory on Self-Reporting and Full Cooperation (Sept. 25, 2017) (the “Updated Self-Reporting and Cooperation Guidance”).

[4]  See Commodity Futures Trading Commission, Enforcement Manual (2020).

[5]  See Individual Cooperation Guidance at 5; Company Cooperation Guidance at 5.

[6]  Updated Self-Reporting and Cooperation Guidance at 2.

[7]  Id. at 1, 5.

[8]  Updated Self-Reporting and Cooperation Guidance at 2.

[9]  Id.

[10]  Guidance at 1.

[11]  Guidance at 2.

[12]  CFTC Press Release No. 7925-19.

[13]  CFTC Press Release Nos. 8165-20 and 8235-20.

[14]  See CFTC Press Release No. 7925-19 (“Clarity and transparency in our policies should promote fairness, increase predictability, and enhance respect for the rule of law.”); CFTC Press Release No. 8165-20 (“Clarity about how our statutes and rules are applied is essential to deterring misconduct and maintaining market integrity.”); CFTC Press Release No. 8235-20 (“It’s in both the agency’s interest and the interest of compliance personnel that the Commission is clear about how and what we’ll evaluate.”).

[15]  CFTC Press Release No. 8296-20 (quoting Chairman Heath Tarbert); see also CFTC Press Release No. 8296-20 (“Providing clarity to market participants and the public is one of the CFTC’s core values. . . . Through this and the other public guidance, the division seeks consistency and transparency across CFTC enforcement actions.” (quoting Acting Director Vincent McGonagle)).

[16]  See Cooperation Recognition Guidance at 2, n.4.

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

Lawrence J. Zweifach – New York (+1 212-351-2625, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
Lauren M.L. Nagin – New York (+1 212-351-2365, [email protected])
Darcy C. Harris – New York (+1 212-351-3894, [email protected])

Derivatives Practice 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])
Arthur S. Long – New York (+1 212-351-2426, [email protected]).com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, [email protected])
Lawrence J. Zweifach – New York (+1 212-351-2625, [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 10 November 2020, the European Data Protection Board (EDPB) issued important new guidance on transferring personal data out of the European Economic Area (EEA). The guidance addresses a key question for many companies: how to transfer personal data out of the EEA to the United States or other countries not recognized by the European Commission as ensuring an adequate level of protection for personal data. The guidance thus begins to lessen some of the uncertainty caused by the Court of Justice of the European Union’s July 2020 ruling in the landmark Schrems II decision.

The EDPB’s guidance have been published for consultation by citizens and stakeholders until 21 December 2020, and may thus be subject to further changes or amendments. Although the guidance take the form of non-binding recommendations, companies that transfer personal data out of the EEA would be well-served to review their approach to such transfers in light of the EDPB guidance.

I. Context

As a reminder, under the EU’s omnibus privacy law, the General Data Protection Regulation (GDPR), a transfer of personal data out of the EEA may take place if the receiving country ensures an adequate level of data protection, as determined by a decision of the European Commission. In the absence of such an adequacy decision, the exporter may proceed to such data transfer only if it has put in place appropriate safeguards.

In the Schrems II ruling in July 2020, the CJEU invalidated the EU-U.S. Privacy Shield, which had been a framework used by companies transferring personal data from the EEA to the U.S. to provide reassurance that the data would be protected after the transfer. The CJEU’s decision allowed the use of the Standard Contractual Clauses, known as the “SCCs,” approved by the European Commission, to continue as another framework or method to cover such transfers. However, the CJEU required companies to verify, prior to any transfer of personal data pursuant to the SCCs, whether data subjects would be granted a level of protection in the receiving country essentially equivalent to that guaranteed within the EU, pursuant to the GDPR and the EU Charter of Fundamental Rights.[i]

The Court specified that the assessment of that level of protection must take into consideration both the contractual arrangements between the data exporter and the recipient and, as regards any access by the public authorities of the receiving country, the relevant aspects of the legal system of that third country.

Due to their contractual nature, SCCs cannot bind the public authorities of third countries, since they are not party to the contract. Consequently, under Schrems II, data exporters may need to supplement the guarantees contained in the SCCs with supplementary measures to ensure compliance with the level of protection required under EU law in a particular third country.

The EDPB issued on 10 November 2020 two sets of recommendations:

1. Recommendations 01/2020 on measures that supplement transfer tools to ensure compliance with the EU level of protection of personal data, which are aimed at providing a methodology for data exporters to determine whether and which additional measures would need to be put in place for their transfers; and
2. Recommendations 02/2020 on the European Essential Guarantees (EEG) for surveillance measures, which are aimed at updating the EEG[ii], in order to provide elements to examine whether surveillance measures allowing access to personal data by public authorities in a receiving country, whether national security agencies or law enforcement authorities, can be regarded as a justifiable interference.

II. Recommendations on how to identify and adopt supplementary measures

The EDPB describes a roadmap of the steps to adopt in order to determine if a data exporter needs to put in place supplementary measures to be able to legally transfer data outside the EEA.

Step 1 – Know your transfers. The data exporter should map all transfers of personal data to countries outside the EEA (and verify that the data transferred is adequate, relevant and limited to what is necessary in relation to the purposes for which it is transferred to and processed in the third country).

Step 2 – Verify the transfer tool on which the transfer relies. If the European Commission has already declared the country as ensuring an adequate level of protection for personal data, there is no need to take any further steps, other than monitoring that the adequacy decision remains valid.

In the absence of an adequacy decision, the data exporter and the data importer would need to rely on one of the transfer tools listed under Articles 46 of the GDPR (including the SCCs) for transfers that are regular and repetitive. Derogations provided for in Article 49 of the GDPR[iii] may be relied on only in some cases of occasional and non-repetitive transfers.

Step 3 – Assess if there is anything in the law or practice of the third country that may impinge on the effectiveness of the appropriate safeguards of the transfer tools relied on, in the context of the transfer (see section III below).

The recommendations specify that: (i) the data importer should be in a position to provide the relevant sources and information relating to the third country in which it is established and the laws applicable to it; and (ii) the data exporter may also refer to several sources of information (e.g., case law of the CJEU and of the European Court of Human Rights; adequacy decisions in the country of destination if the transfer relies on a different legal basis; national caselaw or decisions taken by independent judicial or administrative authorities competent on data privacy and data protection of third countries).

If the assessment reveals that the receiving country’s legislation impinges on the effectiveness of the transfer tool contained in Article 46 of the GDPR, Step 4 should be implemented[iv].

Step 4 – Identify and adopt supplementary measures to bring the level of protection of the data transferred up to the EU standard of “essential equivalence”.

Supplementary measures may have a contractual[v], technical[vi], or organizational[vii] nature—and combining diverse measures may enhance the level of protection and contribute to reaching EU standards.

The EDPB provides for:

1. Various examples of measures that are dependent upon several conditions being met in order to be considered effective (e.g., technical measures such as encryption or pseudonymization; contractual measures such as obligation to use specific technical measures, transparency obligations, obligations to take specific actions, empowering data subjects to exercise their rights; organizational measures such as internal policies for governance of transfers especially with groups of enterprises, transparency and accountability measures, organization methods and data minimization measures, adoption of standards and best practices); and
2. A non-exhaustive list of factors to identify which supplementary measures would be most effective: (a) format of the data to be transferred (i.e. in plain text, pseudonymized or encrypted); (b) nature of the data; (c) length and complexity of the data processing workflow, number of actors involved in the processing, and the relationship between them; (d) possibility that the data may be subject to onward transfers, within the same receiving country or even to other third countries.

The EDPB clarifies that certain data transfer scenarios may not lead to the identification of an effective solution to ensure an essentially equivalent level of protection for the data transferred to the third country. Therefore, in these circumstances, supplementary measures may not qualify to lawfully cover data transfers (e.g., where transfer to processors requires access to data in clear text or remote access to data for business purposes).

In addition, the EDPB specifies that contractual and organizational measures alone will generally not overcome access to personal data by public authorities of the third country. Thus, there will be situations where only technical measures might impede or render ineffective such access.

If no supplementary measure can ensure an essentially equivalent level of protection for a specific transfer, in particular if the law of the receiving country prohibits the application of the possible supplementary measures envisaged (e.g., prohibits the use of encryption) or otherwise prevents their effectiveness, the transfer should be avoided, suspended or terminated.

Step 5 – Implement procedural steps if effective supplementary measures have been identified[viii].

For example, this could consist of entering into an amendment to complete the SCCs to provide for the supplementary measures. When the SCCs themselves are modified or where the supplementary measures added “contradict” directly or indirectly the SCCs, the procedural step should consist in requesting the authorization from the competent supervisory authority.

Step 6 – Re-evaluate at appropriate intervals, i.e., monitor developments in the third country that could affect the initial assessment.

III. Recommendations on how to assess the level of protection of a third country (Step 3)

The “Recommendations 02/2020 on the European Essential Guarantees for surveillance measures” specify the four EEGs to be taken into consideration in assessing whether surveillance measures allowing access to personal data by public authorities in a receiving country (whether national security agencies or law enforcement authorities), can be regarded as a justifiable interference. Such EEGs should be seen as the essential guarantees to be found in the receiving country when assessing the interference (rather than a list of elements to demonstrate that the legal regime of a third country as a whole is providing an essentially equivalent level of protection):

1. Processing should be based on clear, precise and accessible rules;
2. Necessity and proportionality with regard to the legitimate objectives pursued must be demonstrated;
3. An independent oversight mechanism should exist; and
4. Effective remedies need to be available to the individual.

IV. Consequences

Many companies will likely continue to transfer personal data outside of the EEA on the basis of the transfer tools listed under Articles 46 of the GDPR (including the SCCs and binding corporate rules). Companies, in particular data exporters, must therefore document the efforts implemented in order to ensure that the level of protection required by EU law will be complied within the third countries to which personal data are transferred.

Such efforts should include, first, to assess whether the level of protection required by EU law is respected in the relevant third country and, if this is not the case, to identify and adopt supplementary measures (technical, contractual and/or organizational) to bring the level of protection of the data transferred up to the EU standard of “essential equivalence”. If no supplementary measure can ensure an essentially equivalent level of protection for a specific transfer, the transfer should be avoided, suspended or terminated.

It is difficult to predict how local supervisory authorities will assess compliance efforts or sanction non-compliant transfers. While the EDPB’s recommendations are to be implemented on a case-by-case basis based on the specifics of the concerned transfer, we may not exclude supervisory authorities to assess independently the level of protection of certain receiving countries and identifying relevant supplemental measures.

In addition, these recommendations raise sensitive issues with respect to Brexit, and come at a critical moment in the Brexit negotiations. The U.K. will, in the event of a “No-Deal” Brexit, become a third state from the end of the transition period on 31 December 2020, and there is unlikely to be, at least immediately, an adequacy decision in place in respect of the U.K. One might reasonably expect that, given its membership throughout the currency of the GDPR and the forerunner directive, an adequacy decision in favor of the U.K. would be rapidly forthcoming. While that would be a determination for the European Commission, the EDPB has expressed reservations, making specific reference to the October 2019 agreement between the U.K. and the U.S. on Access to Electronic Data for the Purpose of Countering Serious Crime, which, it says, “will have to be taken into account by the European Commission in its overall assessment of the level of protection of personal data in the UK, in particular as regards the requirement to ensure continuity of protection in case of “onward transfers” from the UK to another third country.” The EDPB has indicated that if the Commission presents an adequacy decision in favor of the U.K., it will express its own view in a separate opinion. Absent an adequacy decision, transfers from the EEA to the U.K. would fall to be treated in the same way as transfers to other third countries, requiring consideration of Articles 46 and 49, SCCs, supplementary measures, etc.

A separate question is how the U.K. will, post-Brexit transition, treat these recommendations from the EDPB, and the question of transfers to third countries generally (and to the U.S. specifically). It cannot be excluded that this may be among the first area in which we begin to see a limited divergence between EU and U.K. data privacy laws.

It is also worth noting that on 12 November 2020, the European Commission published a draft implementing decision on SCCs for the transfer of personal data to third countries along with a draft set of new SCCs[ix]. The new SCCs include several modules to be used by companies, depending on the transfer scenario and designation of the parties under the GDPR, namely: (i) controller-to-controller transfers, (ii) controller-to-processor transfers, (iii) processor-to-processor transfers and (iv) processor-to-controller transfers. These new SCCs also incorporate some of the contractual supplementary measures recommended by the EDPB as described above. They are open for public consultation until 10 December 2020 and the final new set of SCCs are expected to be adopted in early 2021. At this stage, the draft provides for a grace period of one year during which it will be possible to continue to use the old SCCs for the execution of contracts concluded before the entry into force of the new SCCs[x].

In light of the above, we recommend that companies currently relying on SCCs to consult with their data protection officer or counsel to evaluate tailored ways to document and implement the steps to be taken in order to minimize the risks associated with continued data transfers to non-EEA countries — particularly to the U.S.

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[i] The Charter of Fundamental Rights brings together all the personal, civic, political, economic and social rights enjoyed by people within the EU in a single text.

[ii] The European Essential Guarantees were originally drafted in response to the Schrems I judgment (CJEU judgment of 6 October 2015, Maximillian Schrems v Data Protection Commissioner, Case C‑362/14, EU:C:2015:650).

[iii] Under article 49.2 of the GDPR, a transfer to a third country or an international organization may take place only if the transfer is not repetitive, concerns only a limited number of data subjects, is necessary for the purposes of compelling legitimate interests pursued by the controller which are not overridden by the interests or rights and freedoms of the data subject, and the controller has assessed all the circumstances surrounding the data transfer and has on the basis of that assessment provided suitable safeguards with regard to the protection of personal data.

[iv] The CJEU held, for example, that Section 702 of the U.S. FISA does not respect the minimum safeguards resulting from the principle of proportionality under EU law and cannot be regarded as limited to what is strictly necessary. This means that the level of protection of the programs authorized by 702 FISA is not essentially equivalent to the safeguards required under EU law. As a consequence, if the data importer or any further recipient to which the data importer may disclose the data is subject to 702 FISA, SCCs or other Article 46 of the GDPR transfer tools may only be relied upon for such transfer if additional supplementary technical measures make access to the data transferred impossible or ineffective.

[v] Example of contractual measures: The exporter could add annexes to the contract with information that the importer would provide, based on its best efforts, on the access to data by public authorities, including in the field of intelligence provided the legislation complies with the EDPB European Essential Guarantees, in the destination country. This might help the data exporter to meet its obligation to document its assessment of the level of protection in the third country. Such measure would be effective if (i) the importer is able to provide the exporter with these types of information to the best of its knowledge and after having used its best efforts to obtain it, (ii) this obligation imposed on the importer is a mean to ensure that the exporter becomes and remains aware of the risks attached to the transfer of data to a third country.

[vi] Example of technical measures: A data exporter uses a hosting service provider in a third country to store personal data, e.g., for backup purposes. The EDPB considers that encryption measure provides an effective supplementary measure if (i) the personal data is processed using strong encryption before transmission, (ii) the encryption algorithm and its parameterization (e.g., key length, operating mode, if applicable) conform to the state-of-the-art and can be considered robust against cryptanalysis performed by the public authorities in the recipient country taking into account the resources and technical capabilities (e.g., computing power for brute-force attacks) available to them, (iii) the strength of the encryption takes into account the specific time period during which the confidentiality of the encrypted personal data must be preserved, (iv) the encryption algorithm is flawlessly implemented by properly maintained software the conformity of which to the specification of the algorithm chosen has been verified, e.g., by certification, (v) the keys are reliably managed (generated, administered, stored, if relevant, linked to the identity of an intended recipient, and revoked), and (vi) the keys are retained solely under the control of the data exporter, or other entities entrusted with this task which reside in the EEA or a third country, territory or one or more specified sectors within a third country, or at an international organization for which the Commission has established in accordance with Article 45 of the GDPR that an adequate level of protection is ensured.

[vii] Example of organizational measures: Regular publication of transparency reports or summaries regarding governmental requests for access to data and the kind of reply provided, insofar publication is allowed by local law. The information provided should be relevant, clear and as detailed as possible. National legislation in the third country may prevent disclosure of detailed information. In those cases, the data importer should employ its best efforts to publish statistical information or similar type of aggregated information.

[viii] It is worth noting that the EDPB indicates that it will provide more details “as soon as possible” on the impact of the Schrems II judgement on other transfer tools (in particular binding corporate rules and as hoc contractual clauses).

[ix] This set of new SCCs should be distinguished from the new draft of clauses published by the Commission on the same day which relates to Article 28.3 of the GDPR (also called SCCs by the Commission). This new draft of clauses will only be optional (the parties may choose to continue using their own data processing agreements) and is also subject to public consultation until 10 December 2020.

[x] Provided the contract remains unchanged, with the exception of necessary supplementary measures; on the contrary, in case of relevant changes to the contract or new sub-contracting, the old SCCs must be replaced by the new ones.

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The following Gibson Dunn lawyers prepared this client alert: Ahmed Baladi, Ryan T. Bergsieker, Patrick Doris, Kai Gesing, Alejandro Guerrero, Vera Lukic, Adelaide Cassanet, and Clemence Pugnet. Please also feel free to contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the Privacy, Cybersecurity and Consumer Protection Group:

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

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

United States
Alexander H. Southwell – Co-Chair, PCCP Practice, New York (+1 212-351-3981, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])
Matthew Benjamin – New York (+1 212-351-4079, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, [email protected])
Kristin A. Linsley – San Francisco (+1 415-393-8395, [email protected])
H. Mark Lyon – Palo Alto (+1 650-849-5307, [email protected])
Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Deborah L. Stein – Los Angeles (+1 213-229-7164, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, [email protected])
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, [email protected])

© 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 2013, California set hydrogen infrastructure targets to promote development and growth of the fuel cell electric vehicle (FCEV) and hydrogen fueling market.[1] Yesterday, the California Air Resources Board (CARB) released a draft annual report that analyzes the industry’s current status and near-term outlook, and recommends “actions necessary to maintain progress and enable continued future expansion.”[2]

Despite the COVID-19 pandemic, California’s hydrogen fueling network and the number of FCEVs on the road have continued to grow over the past year.[3] CARB concluded that the hydrogen fueling industry is “responding favorably” to California’s “maturing support systems.”[4] As of July 3, 2020, there were 42 open-retail stations, with five stations opened and nine newly funded this year.[5] The total network has reached 71 opened and planned projects across the State.[6] And the California Energy Commission is expected to announce the recipients of co-funding for new stations in the near future.[7]

Although growth projections have shifted back one year compared to prior estimate due to the pandemic, auto manufacturers nevertheless seem poised to accelerate production of FCEVs in tandem with projected fueling station development.[8] And deployment data suggests that FCEV technology has a shot at wide-spread consumer adoption based on similar trends for consumer acceptance of the current generation of battery electric vehicles.[9]

While California’s hydrogen fueling network has continued to advance and has become a priority among public and private stakeholders, CARB notes that progress must “not only continue[] but accelerate[]” in order to meet “State and industry targets for both zero-emission infrastructure development and [zero-emission vehicle] deployment.”[10] Although the State is on track to meet its AB 8 goals, “there is little room for station development delays.”[11] Specifically, the market needs “continued and coordinated industry and State support” to achieve economies of scale so that manufacturers will continue to produce FCEVs, and customer-facing costs will drop enough to make FCEV ownership possible for a broader swath of the California population.[12] CARB cites several “complementary factors” that are crucial to successful FCEV market growth: development of new supply chains and manufacturing capacity; increased consumer awareness and acceptance of FCEVs and hydrogen technology; expansion of the hydrogen fuel production network; and use of consumer incentives to make the technology more affordable.[13]

CARB recommends six specific priorities for industry development:

1. Use AB 8 and HRI program funding, and any other means available, to develop as many light-duty hydrogen fueling stations as possible through the end of the AB 8 program.
2. Appropriately balance the goals of developing stations in communities statewide and driving larger-capacity growth in highly developed local networks.
3. Continue to assess ongoing and projected development pace and quickly address bottlenecks as the technology transitions to a broader market.
4. Understand capacities and opportunities to reduce State funding and transition to a financially self-sufficient industry.
5. Expand upstream hydrogen supply to ensure fuel availability for customers as the market expands.
6. Encourage use of renewable hydrogen.[14]

CARB has solicited public and expert review of the draft report and will release a final revised report in 2021.

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[1]   Assembly Bill No. 8 (Statutes of 2013).

[2]   California Air Resources Board, 2020 Annual Evaluation of Fuel Cell Electric Vehicle Deployment & Hydrogen Fuel Station Network Development xiv.

[3]   Id. at xiii, 3.

[4]   Id. at xiii.

[5]   Id. at xv-xvi.

[6]   Id.

[7]   Id. at xiii, 4-8.

[8]   Id. at xvii-xxii.

[9]   Id. at xx-xxi.

[10]   Id. at xiii, 62.

[11]   Id. at xxi.

[12]   Id. at 62.

[13]   Id. at xiii-xiv.

[14]   Id. at 62-63.

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The following Gibson Dunn lawyers assisted in preparing this client update: Thomas Manakides, Abbey Hudson, Joseph Edmonds and Jessica Pearigen.

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

Stacie B. Fletcher – Co-Chair, Washington, D.C. (+1 202-887-3627, [email protected])
Daniel W. Nelson – Co-Chair, Washington, D.C. (+1 202-887-3687, [email protected])
Thomas Manakides – Orange County (+1 949-451-4060, [email protected])
Abbey Hudson – Los Angeles (+1 213-229-7954, [email protected])
Joseph D. Edmonds – Orange County (+1 949-451-4053, [email protected])
Jessica M. Pearigen – Orange County (+1 949-451-3819, [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 November 10, 2020, Governor Andrew Cuomo signed legislation that will expand First Amendment protections under New York’s anti-SLAPP law by providing new tools for defendants to challenge frivolous lawsuits. The bill was initially passed by the New York State Senate and Assembly on July 22, 2020. The bill amends and extends New York’s current statute (sections 70-a and 76-a the New York Civil Rights Law) addressing so-called strategic lawsuits against public participation (“SLAPPs”):[1] suits that seek to punish and chill the exercise of the rights of petition and free speech on public issues by subjecting defendants to expensive and burdensome litigation.[2] Prominent First Amendment and free speech advocates, including the Reporters Committee for Freedom of the Press,[3] Time’s Up Now,[4] the New York Civil Liberties Union,[5] and the Authors Guild[6] came out in its support, as did the Editorial Board of The New York Times.[7]

Anti-SLAPP laws currently exist in 30 states and the District of Columbia, yet despite being home to some of the world’s most prominent media and news organizations,[8] New York’s own anti-SLAPP law, enacted in 2008, has been narrowly limited to litigation arising from a public application or permit, often in a real estate development context.[9] The new law, sponsored by Senator Brad Hoylman and Assemblywoman Helene E. Weinstein, amends the civil rights law in several ways to expand and strengthen New York’s anti-SLAPP protections.

The following is a summary of the law’s changes, which take effect immediately upon enactment, and key continuing features:

• Expands the statute beyond actions “brought by a public applicant or permittee,” to apply to any action based on a “communication in a . . . public forum in connection with an issue of public interest” or “any other lawful conduct in furtherance of the exercise of the constitutional right of free speech in connection with an issue of public interest, or in furtherance of the exercise of the constitutional right of petition.”[10]
• Confirms that “public interest” should be construed broadly, including anything other than a “purely private matter.”[11]
• Requires courts to consider anti-SLAPP motions based on the pleadings and “supporting and opposing affidavits stating the facts upon which the action or defense is based.”[12]
• Provides that all proceedings—including discovery, hearings, and motions—shall be stayed while a motion to dismiss is pending, except that the court may order limited discovery where necessary to allow a plaintiff to respond to an anti-SLAPP motion.[13]
• Alters the formerly permissive standard (“may”) for awarding attorneys’ fees to provide that where the court grants such a motion, an award of fees and costs is mandatory: i.e., “costs and attorney’s fees shall be recovered.”[14]

While the amended statute provides welcome tools to defendants facing SLAPP suits, it remains to be seen how the revisions will function in practice. For example, while the revisions incorporate some of the key language and structure of California’s anti-SLAPP statute[15] —including a stay of discovery, and mandatory attorneys’ fees and costs to prevailing defendants—the proposed law preserves the standard for evaluating the merits: a motion to dismiss such an action “shall be granted” unless the plaintiff can show “that the cause of action has a substantial basis in law or is supported by a substantial argument for an extension, modification or reversal of existing law.”[16] In the context of the previous limited anti-SLAPP law, New York courts have interpreted that standard to impose a “heavy burden” on plaintiffs opposing anti-SLAPP motions,[17] requiring them to make an evidentiary showing of the facts supporting their claim and demonstrating that the defendant cannot establish a defense against it.[18] It will be up to courts to determine how that standard functions when applied to a broader range of cases, including defamation and other tort claims, that may present closer questions.

Separately, the status of the applicability of state anti-SLAPP statutes in federal court remains an open question, especially in light of the Second Circuit’s recent decision that California’s anti-SLAPP statute does not apply in federal court. La Liberte v. Reid, No. 19-3574, 2020 WL 3980223 (2d Cir. July 15, 2020). Whether New York’s revised anti-SLAPP law will be available to defendants in federal lawsuits in the Second Circuit is an open question that federal courts may soon need to confront.

Finally, courts will be asked to determine whether the revised statute is effective in currently pending actions, or if it will only have effect in actions filed after enactment. New York reserves this question as “a matter of judgment made upon review of the legislative goal,” based on “whether the Legislature has made a specific pronouncement about retroactive effect or conveyed a sense of urgency; whether the statute was designed to rewrite an unintended judicial interpretation; and whether the enactment itself reaffirms a legislative judgment about what the law in question should be.”[19] New York courts will likely conclude that the revised statute has “retroactive” effect and will apply in pending cases in light of the statute’s clear “remedial purpose.”[20] The legislature was careful to explain that the revisions intend to correct judicial “narrow[] interpret[ation]” of the existing anti-SLAPP statute and to remedy the courts’ “fail[ure] to use their discretionary power to award costs and attorney’s fees” in SLAPP suits, and that the revised statute “will better advance the purposes that the Legislature originally identified in enacting New York’s anti-SLAPP law.”[21] These factors all suggest that the revisions will take immediate effect in both pending and post-enactment lawsuits.

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

[2] Understanding Anti-SLAPP Laws, Reporters Committee for Freedom of the Press, https://www.rcfp.org/resources/anti-slapp-laws/ (last visited August 3, 2020).

[3] Reporters Committee supports legislation that would strengthen New York’s anti-SLAPP law, Reporters Committee for Freedom of the Press, https://www.rcfp.org/briefs-comments/rcfp-supports-ny-anti-slapp-bills/(last visited August 3, 2020).

[4] TIME’S UP (@TIMESUPNOW), Twitter, https://twitter.com/TIMESUPNOW/status/1286031156446728193 (last accessed August 3, 2020).

[5] Senator Brad Hoylman (@bradhoylman), Twitter, https://twitter.com/bradhoylman/status/1286002251685863424 (last accessed August 3, 2020).

[6] Authors Guild Signs Letter in Support of Anti-SLAPP Statute, Authors Guild, https://www.authorsguild.org/industry-advocacy/authors-guild-signs-letter-in-support-of-anti-slapp-statute/ (last accessed August 3, 2020).

[7] The Legal System Should Not Be a Tool for Bullies, N.Y. Times, https://www.nytimes.com/2020/07/17/opinion/new-york-slapp-frivolous-lawsuits.html.

[8] Id.

[9] 2020 N.Y. Senate Bill No. 52-A/Assembly Bill No. 5991A (July 22, 2020), https://www.nysenate.gov/legislation/bills/2019/s52/amendment/a.

[10] Id. (emphasis added).

[11] Id.

[12] Id.

[13] Id.

[14] Id. (emphasis added).

[15] Cal. Civ. Proc. Code § 425.16.

[16] 2020 N.Y. Senate Bill No. 52-A/Assembly Bill No. 5991A (July 22, 2020), https://www.nysenate.gov/legislation/bills/2019/s52/amendment/a (emphasis added).

[17] 161 Ludlow Food, LLC v. L.E.S. Dwellers, Inc., 107 N.Y.S.3d 618, at *4 (N.Y. Sup. Ct. 2018), aff’d, 176 A.D.3d 434 (1st Dep’t 2019).

[18] Edwards v. Martin, 158 A.D.3d 1044, 1048 (3d Dep’t 2018).

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

[20] In re Gleason (Michael Vee, Ltd.), 96 N.Y.2d 117, 122–23 (2001).

[21] 2020 N.Y. Senate Bill No. 52-A/Assembly Bill No. 5991A (July 22, 2020), https://www.nysenate.gov/legislation/bills/2019/s52/amendment/a.

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The following Gibson Dunn lawyers assisted in the preparation of this client update: Anne Champion, Nathaniel Bach, Connor Sullivan, Kaylie Springer, and Dillon Westfall.

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

Anne M. Champion – New York (+1 212-351-5361, [email protected])
Connor Sullivan – New York (+1 212-351-2459, [email protected])
Scott A. Edelman – Co-Chair, Media, Entertainment and Technology Practice, Los Angeles (+1 310-557-8061, [email protected])
Kevin Masuda – Co-Chair, Media, Entertainment and Technology Practice, Los Angeles (+1 213-229-7872, [email protected])
Nathaniel L. Bach – Los Angeles (+1 213-229-7241, [email protected])

This update provides an overview and summary of key class action developments during the third quarter of 2020 (July through September).

Part I discusses an important Second Circuit decision regarding claims for injunctive relief in false advertising class actions.

Part II describes an Eleventh Circuit opinion in which a divided panel held that 19th-century Supreme Court decisions prohibit the very common practice of providing incentive awards to class representatives.

Part III covers two decisions from the Ninth Circuit relating to the Class Action Fairness Act’s amount-in-controversy requirement.

I.   The Second Circuit Holds That It Is Improper to Certify an Injunctive-Relief Class of Past Purchasers of an Allegedly Falsely Advertised Product

In a very significant decision impacting false advertising class actions, the Second Circuit in Berni v. Barilla S.p.A., 964 F.3d 141 (2d Cir. 2020), held that district courts cannot certify a Rule 23(b)(2) injunctive-relief class of past purchasers of products that were allegedly falsely advertised.

Berni involved the allegation that boxes of pasta they had purchased were underfilled in violation of New York’s General Business Law § 349(a), which prohibits “[d]eceptive acts or practices in the conduct of any business, trade or commerce.” Id. at 144. The parties reached a settlement in which the defendant agreed, among other things, to include disclosures on its boxes regarding the amount of pasta contained in them. Id. The district court certified an injunctive-relief class for settlement purposes under Rule 23(b)(2) and entered final approval of the settlement. An objector appealed.

The Second Circuit held that the objector had standing to appeal even though he was not personally deceived by the packaging, id. at 145–46, and it then reversed the grant of class certification, holding that a Rule 23(b)(2) class may be certified only where the injunctive relief sought would be “proper for each and every member of the group of past purchasers.” Id. at 146. In this case, such relief would not be proper, according to the court, because past purchasers were under no obligation to buy the product again, and, even if they did, would already have the information they claimed to lack at the time of their initial purchase. As such, they were “not likely to encounter future harm of the kind that makes injunctive relief appropriate.” Id. at 147–48.

The Berni decision is a critical ruling in favor of class-action defendants, as it will prevent the certification of Rule 23(b)(2) classes in many, if not most, false advertising class actions within the Second Circuit. Coupled with the Ninth Circuit’s decision in Sonner v. Premier Nutrition Corp., 971 F.3d 834 (9th Cir. 2020), which upheld the dismissal of equitable claims when an adequate legal remedy exists, plaintiffs should face more challenges asserting Rule 23(b)(2) class actions in two of the busiest jurisdictions for these lawsuits.

II.   Relying on Longstanding Supreme Court Decisions, the Eleventh Circuit Rejects Incentive Awards for Class Representatives

The Eleventh Circuit caught the attention of practitioners this quarter on the permissibility of incentive payments for class representatives, which are almost customary in class settlements.

In Johnson v. NPAS Solutions, LLC, 975 F.3d 1244 (11th Cir. 2020), a putative class of consumers alleged that the defendant had violated the Telephone Consumer Protection Act, 47 U.S.C. § 227. The parties settled, and the district court eventually approved the settlement, overruling one class member’s objection that the class representative’s incentive award “contravened” the United States Supreme Court’s decisions in Trustees v. Greenough, 105 U.S. 527 (1882), and Central Railroad & Banking Co. v. Pettus, 113 U.S. 116 (1885), which are known for “establishing the rule . . . that attorneys’ fees can be paid from a common fund.” Johnson, 975 F.3d at 1250, 1255–56.

The frequency of class action “service awards” in modern practice did not persuade the majority of the Eleventh Circuit panel:

The class-action settlement that underlies this appeal is just like so many others that have come before it. And in a way, that’s exactly the problem. We find that, in approving the settlement here, the district court repeated several errors that, while clear to us, have become commonplace in everyday class-action practice . . . . We don’t necessarily fault the district court—it handled the class-action settlement here in pretty much exactly the same way that hundreds of courts before it have handled similar settlements. But familiarity breeds inattention, and it falls to us to correct the errors in the case before us.

Id. at 1248–49. The majority ruled that while Greenough and Pettus had permitted an award of class counsel’s fees, they had denied class representatives’ claims for a “salary” or “personal services” and for “private expenses” as “unsupported by reason or authority.” Id. at 1256–57. The majority held that incentive awards are “roughly analogous to a salary” and, “[i]f anything, . . . present even more pronounced risks than . . . salary and expense reimbursements” because they “promote litigation by providing a prize to be won.” Id. at 1257–58.

Judge Martin dissented and warned that the majority’s holding was unprecedented and would cause plaintiffs to “be less willing to take on the role of class representative in the future.” Id. at 1264.

III.   The Ninth Circuit Reverses Remand Orders in Two Class Action Fairness Act Cases

The Ninth Circuit issued two significant decisions in appeals involving remand orders under the Class Actions Fairness Act (“CAFA”) that will make it easier for defendants to establish the $5 million amount in controversy needed for removal under CAFA.

In Salter v. Quality Carriers, Inc., 974 F.3d 959 (9th Cir. 2020), the court held that plausible allegations of CAFA’s amount-in-controversy requirement are sufficient unless the plaintiff challenges the truth of those allegations. In Salter, the defendant removed an action brought by a putative class of truck drivers alleging that they were misclassified as independent contractors. To establish that the amount in controversy exceeded $5 million, the defendant relied on a declaration from its Chief Information Officer that stated he was familiar with the company’s record-keeping practices and that the company had deducted expenses totaling over $14 million from putative class members’ paychecks. Id. at 961–62. The district court determined that the declaration was conclusory and faulted the defendant for failing to attach the underlying business records, and remanded the action to state court. Id. at 962. Citing Dart Cherokee Basin Operating Co. v. Owens, 574 U.S. 81, 88–89 (2014), the Ninth Circuit vacated the remand order because the district court erred in refusing to accept the truth of the declaration. Salter, 974 F.3d at 964–65. Because the plaintiff did not make a factual attack on the truth of the declaration, and instead argued only that the declaration was insufficiently detailed and did not attach supporting data, the declaration’s conclusions should have been accepted as true. Id. at 965.

In Greene v. Harley-Davidson, Inc., 965 F.3d 767 (9th Cir. 2020), the Ninth Circuit held that punitive damages can be factored into the amount in controversy calculation under CAFA if there is a “reasonable possibility” of such damages. The defendant argued that a jury might award punitive damages on a 1:1 ratio with compensatory damages, as juries had done in other cases brought under California’s Consumers Legal Remedies Act. Id. at 770–71. The district court refused to include punitive damages in the amount-in-controversy calculation because the defendant did not “analogize or explain” how the cited cases “[we]re similar to the instant action.” Id. at 771. The Ninth Circuit reversed. It reasoned that the amount in controversy for purposes of CAFA is the “amount at stake in the underlying litigation,” which “refers to possible liability.” Id. at 772 (first emphasis in original, second emphasis added). A defendant could meet its burden to show possible liability by “cit[ing] a case based on the same or a similar statute in which the jury or court awarded punitive damages based on the punitive-compensatory damages ratio relied upon by the defendant in its removal notice.” Id. Because the defendant had cited four such cases, it met its burden. Id.

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The following Gibson Dunn lawyers contributed to this client update: Christopher Chorba, Theane Evangelis, Kahn Scolnick, Bradley Hamburger, Lauren Blas, Nathan Strauss, Vincent Eisinger, and Andrew Kasabian.

Gibson Dunn attorneys 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 Class Actions or Appellate and Constitutional Law practice groups, or any of the following lawyers:

Theodore J. Boutrous, Jr. – Co-Chair, Litigation Practice Group – Los Angeles (+1 213-229-7000, [email protected])
Christopher Chorba – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7396, [email protected])
Theane Evangelis – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7726, [email protected])
Kahn A. Scolnick – Los Angeles (+1 213-229-7656, [email protected])
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, [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 third quarter of 2020 saw a noticeable surge in Artificial Intelligence (“AI”)-related regulatory and policy proposals. The European Union (“EU”) has emerged as a pacesetter in AI regulation, taking significant steps towards a long-awaited comprehensive and coordinated regulation of AI at EU level—evidence of the European Commission’s (the “Commission”) ambition to exploit the potential of the EU’s internal market and position itself as a major player in sustainable technological innovation. In this update, we review some of the recent policy initiatives in the EU ahead of the Commission’s long-awaited legislative proposals expected in early 2021.

In the U.S., the third quarter of 2020 saw a number of bipartisan bills passed in the U.S. House of Representatives seeking to develop and refine U.S. national AI policy and adopt measures promoting the ethical and equitable use of AI technologies and consumer protection measures.

As global AI policy develops, we are observing some interesting themes emerging, one of which is stakeholders’ varying levels of comfort with the lack of a universal definition of AI. Some commentators have suggested that undue effort should not be expended on defining AI since it is a dynamic technology that will continue to change.[1] At the same time, global lawmakers are already reviewing and passing regulations that focus on certain categories of AI, often in the absence of clear definitions and delineations between certain AI applications that will impact the scope of regulation (see, e.g., the European Parliament’s discussion about a possible regulation of “all” AI applications, discussed further at I. below), creating legal uncertainty for regulators and businesses alike. We will continue to monitor these policy trends and provide a comprehensive analysis in our forthcoming 2020 Artificial Intelligence and Automated Systems Annual Legal Review.

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Table of Contents

EU Legislation & Policy

U.S. Federal Legislation & Policy

Intellectual Property

Autonomous Vehicles

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I.  EU LEGISLATION & POLICY

In past years, EU discussions about regulating AI technologies had been characterized by a restrictive “regulate first” approach.[2] However, the regulatory road map presented by the Commission in February under the auspices of its new digital strategy eschewed, for example, blanket technology bans and proposed a more nuanced “risk-based” approach to regulation, emphasizing the importance of “trustworthy” AI but also acknowledging the need for Europe to both remain innovative and competitive in a rapidly growing space and avoid fragmentation of the single market resulting from differences in national legislation. As discussed further below, there is some evidence of a growing dissonance between EU members with respect to the balance between technological innovation and risk, and a European consensus on a harmonized legal framework is far from realized.

The Commission’s “White Paper on Artificial Intelligence – A European approach to excellence and trust” (the “White Paper”) sets out a road map designed to balance innovation, ethical standards and transparency.[3] As noted in our client alert “EU Proposal on Artificial Intelligence Regulation Released,” the White Paper favors a risk-based approach with sector- and application-specific risk assessments and requirements, rather than blanket sectoral requirements or bans—earmarking a series of “high-risk” technologies for future oversight, including those in “critical sectors” and those deemed to be of “critical use.”[4] The Commission also released a series of accompanying documents: the “European Strategy for Data” (“Data Strategy”)[5] and a “Report on the Safety and Liability Implications of Artificial Intelligence, the Internet of Things and Robotics” (“Report on Safety and Liability”).[6]

While the Commission’s comprehensive legislative proposal is not anticipated before early 2021, the EU policy landscape remains dynamic. Companies active in AI should closely follow recent developments in the EU, given the proposed geographic reach of the future AI legislation, which is likely to affect all companies doing business in the EU.

A.  European Commission’s AI White Paper Consultation and “Inception Impact Assessment”

As we reported in our Artificial Intelligence and Automated Systems Legal Update (1Q20), in January 2020, the EC launched a public consultation period and requested comments on the proposals set out in the White Paper and the Data Strategy, providing an opportunity for companies and other stakeholders to provide feedback and shape the future EU regulatory landscape. The consultation closed on June 14. In July, the Commission published a summary report on the consultation’s preliminary findings.[7] Over 1,250 stakeholders from all over the world responded, providing feedback on the proposed policy and regulatory framework on AI. Respondents raised concerns about the potential for AI to breach fundamental rights or lead to discriminatory outcomes, but they were divided on whether new compulsory requirements should be limited to high-risk applications.

On the heels of the White Paper Consultation, the Commission launched an “Inception Impact Assessment” initiative for AI legislation in July, aiming to define the Commission’s scope and goals for AI legislation with a focus on ensuring that “AI is safe, lawful and in line with EU fundamental rights.”[8] The Commission’s road map builds on the proposals in the White Paper and provides more detail on relevant policy options and policy instruments, from a “baseline” policy (involving no policy change at the EU level) through various alternative options following a “gradual intervention logic,” ranging from a nonlegislative, industry-led, “soft law” approach (Option 1) through a voluntary labelling scheme (Option 2), to comprehensive and mandatory EU-level legislation for all or certain types of AI applications (Option 3), or a combination of any of the options above taking into account the different levels of risk that could be generated by a particular AI application (Option 4).[9] Another core question relates to the scope of the initiative, notably how AI should be defined (narrowly or broadly) (e.g., machine learning, deep neural networks, symbolic reasoning, expert systems, automated decision-making).

Substantively, the road map reiterates that the Commission is particularly concerned with a number of specific, significant AI risks that are not adequately covered by existing EU legislation, such as cybersecurity, the protection of employees, unlawful discrimination or bias, the protection of EU fundamental rights, including risks to privacy, and protecting consumers from harm caused by AI (both through existing and new product safety legislation). Continued focus remains on the need for legal certainty, both for businesses marketing products involving AI in the EU, and for market surveillance and supervisory authorities. The feedback period for the road map closed in September, and the completion of the Inception Impact Assessment is scheduled for December 2020. As noted, these policy proposals are intended to culminate in proposed regulation, which is expected to be unveiled by the Commission in the first quarter of 2021.

B.  European Parliament Votes on Proposals regarding the Regulation of Artificial Intelligence

Earlier this year, the European Parliament (the “Parliament”) set up a special committee to analyze the impact of artificial intelligence on the EU economy.[10] The new committee chair, Dragoș Tudorache, noted that “Europe needs to develop AI that is trustworthy, eliminates biases and discrimination, and serves the common good, while ensuring business and industry thrive and generate economic prosperity.”[11]

In April, the Parliament’s Legal Affairs Committee (“JURI”) published three draft reports to the Commission providing recommendations on a framework for AI liability, copyright protection for AI-assisted human creations, safeguards within the EU’s patent system to protect the innovation of AI developers, and AI ethics and “human-centric AI.”[12] The three legal initiatives, summarized in final reports and recommendations outlined in more detail below, were adopted by the plenary on October 20, 2020.[13]

1.  Report with Recommendations to the Commission on a Framework of Ethical Aspects of Artificial Intelligence, Robotics and Related Technologies

The legislative initiative urges the Commission to present a legal framework outlining the ethical principles and legal obligations to be followed when developing, deploying and using artificial intelligence, robotics and related technologies in the EU including software, algorithms and data, protection for fundamental rights. The initiative also calls for the establishment of a “European Agency for Artificial Intelligence” and a “European certification of ethical compliance.”[14]

The proposed legal framework is premised on several guiding principles, including “human-centric and human-made AI; safety, transparency and accountability; safeguards against bias and discrimination; right to redress; social and environmental responsibility; and respect for privacy and data protection.”[15] High-risk AI technologies, which include machine learning and other systems with the capacity for self-learning, should be designed to “allow for human oversight and intervention at any time, particularly where a functionality could result in a serious breach of ethical principles and could be dangerous.”[16] Some of the high-risk sectors identified are healthcare, public sector and finance, banking and insurance.

2.  Report with Recommendations to the Commission on a Civil Liability Regime for Artificial Intelligence

The Report calls for a future-oriented civil liability framework that makes front- and back-end operators of high-risk AI strictly liable for any resulting damage and provides a “clear legal framework [that] would stimulate innovation by providing businesses with legal certainty, whilst protecting citizens and promoting their trust in AI technologies by deterring activities that might be dangerous.”[17] While it does not take the position that a new EU liability regime is necessary, the Report identifies a gap in the existing EU product liability regime with respect to the liability of operators of AI-systems in the absence of a contractual relationship with potential victims, proposing a dual approach: (1) strict liability for operators of “high-risk AI-systems” akin to the owner of a car or pet; or (2) a presumption of fault towards the operator for harm suffered by a victim by a non-“high-risk” AI system, with national law regulating the amount and extent of compensation as well as the limitation period in case of harm caused by the AI-system.[18] Multiple operators would be held jointly and severally liable, subject to a maximum liability of €2 million. The Report defines criteria on which AI-systems can qualify as high-risk in the Annex, proposing that a newly formed standing committee, involving national experts and stakeholders, should support the Commission in its review of potentially high-risk AI-systems.

3.  Report on Intellectual Property Rights for the Development of Artificial Intelligence Technologies

The Report emphasizes that EU global leadership in AI requires an effective intellectual property rights (“IP”) system and safeguards for the EU’s patent system in order to protect and incentivize innovative developers, balanced with the EU’s ethical principles for AI and consumer safety.[19] Notably, the Report distinguishes between AI-assisted human creations and AI-generated creations, taking the position that AI should not have a legal personality and that ownership of IP rights should only be granted to humans. Where AI is used only as a tool to assist an author in the process of creation, the current IP legal framework should remain applicable. Nonetheless, the Report recommends that AI-generated creations should fall under the scope of the EU IP regime in order to encourage investment and innovation, subject to protection under a specific form of copyright.

C.  A Lack of Consensus between EU Members on the Balance to Be Struck between Innovation and Safety

Although the Commission is seeking to impose a comprehensive and harmonious framework for AI regulation across all member states, it is far from clear that consensus exists as to the scope of regulatory intervention. In October, 14 EU members (Denmark, Belgium, the Czech Republic, Finland, France, Estonia, Ireland, Latvia, Luxembourg, the Netherlands, Poland, Portugal, Spain and Sweden) published a joint position paper urging the Commission to espouse a “soft law approach” that takes into account the fast-evolving nature of AI technologies.[20] The paper calls for the adoption of “self-regulation, voluntary labelling and other voluntary practices as well as a robust standardisation process as a supplement to existing legislation that ensures that essential safety and security standards are met” to allow regulators to learn from technology and identify potential regulatory challenges without stymieing innovation.

This approach may be met with challenge from Germany, the current chair of the EU presidency, which has expressed concern over certain Commission proposals to apply restrictions on AI applications deemed to be of high-risk only, and would prefer a broader regulatory reach for technologies that would be subject to the new framework, as well as mandatory, detailed rules for data retention, biometric remote identification and human supervision of AI systems.[21]

On November 5, a 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 (defined in the report as “lernende Systeme” or “self-learning systems”) while acknowledging the risks they pose. 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.[22] 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. The committee was set up in late 2018 and comprises 19 members of the German parliament and 19 external experts. We will provide a more detailed analysis of the Committee’s final report in our forthcoming 2020 Artificial Intelligence and Automated Systems Annual Legal Review.

D.  UK ICO Guidance on AI and Data Protection

On July 30, 2020, the UK Information Commissioner’s Office (“ICO”) published its final guidance on Artificial Intelligence (the “Guidance”).[23] Intended to help organizations “mitigate the risks of AI arising from a data protection perspective without losing sight of the benefits such projects can deliver,” the Guidance sets out a framework and methodology for auditing AI systems and best practices for compliance with the UK Data Protection Act 2018 and data protection obligations under the EU’s General Data Protection Regulation (“GDPR”). The Guidance proposes a “proportionate and risk-based approach” and recommends an auditing methodology consisting of three key parts: auditing tools and procedures for use in audits and investigations; detailed guidance on AI and data protection; and a tool kit designed to provide further practical support to organizations auditing the compliance of their own AI systems (which is forthcoming). The guidance addresses four overarching principles:

1. Accountability and governance in AI—including data protection impact assessments (“DPIAs”), understanding the relationship and distinction between controllers and processors in the AI context, as well as managing, and documenting decisions taken with respect to competing interests between different AI-related risks (e.g., trade-offs);
2. Fair, lawful and transparent processing—including how to identify lawful bases (and using separate legal bases for processing personal data at each stage of the AI development and deployment process), assessing and improving AI system performance, mitigating potential discrimination, and documenting the source of input data as well as any inaccurate input data or statistical flaw that might impact the output of the AI system.
3. Data minimization and security—including guidance to technical specialists on data security issues common to AI, types of privacy attacks to which AI systems are susceptible, compliance with the principle of data minimization (the principle of identifying the minimum amount of personal data needed, and to process no more than that amount of information), and privacy-enhancing techniques that balance the privacy of individuals and the utility of a machine learning system during the training and inference stages.[24]
4. Compliance with individual data subject rights—including data subject rights in the context of data input and output of AI systems, rights related to automated decision, and requirements to design AI systems to facilitate effective human review and critical assessment and understanding of the outputs and limitations of AI systems.

The Guidance also emphasizes that data protection risks should be considered at an early stage in the design process (e.g., “safety by design”) and that the roles of the different parties in the AI supply chain should be clearly mapped at the outset. Of note is also the recommendation that training data be stored at least until a model is established and unlikely to be retrained or modified. The Guidance refers to, but does not provide guidance on, the anonymization or pseudonymization of data as a privacy-preserving technique, but notes that the ICO is currently developing new guidance in this field.[25]

The ICO encourages organizations to provide feedback on the Guidance to make sure that it remains “relevant and consistent with emerging developments.”

II.  U.S. FEDERAL LEGISLATION & POLICY

A.  AI in Government Act of 2020 (H.R. 2575)

First introduced by Rep. Jerry McNerney (D-CA) on May 8, 2019, the AI in Government Act of 2020 (H.R. 2575) was passed by the House on September 14, 2020 by voice vote.[26] The bill aims to promote the efforts of the federal government in developing innovative uses of AI by establishing the “AI Center of Excellence” within the General Services Administration (“GSA”), and requiring that the Office of Management and Budget (“OMB”) issue a memorandum to federal agencies regarding AI governance approaches. It also requires the Office of Science and Technology Policy to issue guidance to federal agencies on AI acquisition and best practices.

Senators Rob Portman (R-OH) and Cory Gardner (R-CO) are cosponsoring an identical bill, S. 1363, which was approved by the U.S. Senate Homeland Security and Governmental Affairs Committee in November 2019.[27] Sen. Portman described the bipartisan legislation, which remains pending in the Senate, as “the most significant AI policy change ever passed by Congress.”

B.  Consumer Safety Technology Act (H.R. 8128)

On September 29, the House passed the Consumer Safety Technology Act (H.R. 8128), previously named the “AI for Consumer Product Safety Act.” If enacted, the bill would direct the U.S. Consumer Product Safety Commission (“CPSC”) to establish a pilot program to explore the use of artificial intelligence for at least one of the following purposes: (1) tracking injury trends; (2) identifying consumer product hazards; (3) monitoring the retail marketplace for the sale of recalled consumer products; or (4) identifying unsafe imported consumer products. The bill has been referred to the Senate Committee on Commerce, Science, and Transportation.

C.  Bipartisan U.S. Lawmakers Introduce Legislation to Create a National AI Strategy

On September 16, 2020, Reps. Robin Kelly (D-Ill.) and Will Hurd (R-Texas), after coordination with experts and the Bipartisan Policy Center, introduced a concurrent resolution calling for the creation of a national AI strategy.[28] This Resolution proposes four pillars to guide the strategy:[29]

• Workforce: Fill the AI talent gap and prepare American workers for the jobs of the future, while also prioritizing inclusivity and equal opportunity;[30]
• National Security: Prioritize the development and adoption of AI technologies across the defense and intelligence apparatus;
• Research and Development: Encourage the federal government to collaborate with the private sector and academia to ensure America’s innovation ecosystem leads the world in AI; and
• Ethics: Develop and use AI technology in a way that is ethical, reduces bias, promotes fairness, and protects privacy.

D.  Artificial Intelligence Education Act

On September 24, 2020, Reps. Paul D. Tonko (D-NY) and Guy Reschenthaler (R-PA) introduced the Artificial Intelligence Education Act (H.R. 8390).[31] The bipartisan legislation would establish grant support within the National Science Foundation to fund the creation of easily accessible K-12 lesson plans for schools and educators.[32] The bill has been referred to the Committee on Science, Space, and Technology and the Committee on Education and Labor.

III.  INTELLECTUAL PROPERTY

A.  USPTO Releases Report on Artificial Intelligence and Intellectual Property Policy

On October 6, 2020, the U.S. Patent and Trademark Office (“USPTO”) published a report “Public Views on Artificial Intelligence and Intellectual Property Policy” (the “Report”).[33] The Report catalogs the roughly 200 comments received in response to the USPTO’s request for comments issued in October 2019 (as reviewed in our client alert USPTO Requests Public Comments On Patenting Artificial Intelligence Inventions).[34] The USPTO requested feedback on issues such as whether current laws and regulations regarding patent inventorship and authorship of copyrighted work should be revised to take into account contributions other than by natural persons.

A general theme that emerges from the report is concern over the lack of a universally acknowledged definition of AI, and a majority view that current AI (i.e., AI that is not considered to be artificial general intelligence, or “AGI”) can neither invent nor author without human intervention. The comments also suggested that existing U.S. intellectual property laws are “calibrated correctly to address the evolution of AI” (although commenters were split as to whether any new classes of IP rights would be beneficial to ensure a more robust IP system), and that “human beings remain integral to the operation of AI, and this is an important consideration in evaluating whether IP law needs modification in view of the current state of AI technology.”[35]

The key comments sound in eight categories:

1.  Elements of an AI Invention

AI has no universally recognized definition, but can be understood as computer functionality that mimics human cognitive functions, e.g., the ability to learn. AI inventions include inventions embodying an advance in AI itself (e.g., improved models or algorithms), inventions that apply AI to a field other than AI, and inventions produced by AI itself. The current state of the art is limited to ‘narrow’ AI, as opposed to artificial general intelligence akin to human intelligence.

2.  Conception and Inventorship

The vast majority of public commenters asserted that current inventorship law is equipped to handle inventorship of AI technologies and that the assessment of conception should remain fact-specific. The use of an AI system as a tool by a natural person does not generally preclude a natural person from qualifying as an inventor if he or she contributed to the conception of the claimed invention. Many commenters took issue with the premise that, under the current state of the art, AI systems were advanced enough to “conceive” of an invention. As one commenter put it, “the current state of AI technology is not sufficiently advanced at this time and in the foreseeable future so as to completely exclude the role of a human inventor in the development of AI inventions.”[36] Some commenters suggested that the USPTO should revisit the question when machines begin achieving AGI (i.e., when science agrees that machines can “think” on their own). A minority of commenters suggested that AGI was a present reality that needed to be addressed today.

3.  Ownership of AI Inventions

The vast majority of commenters stated that no changes should be necessary to the current U.S. law—that only a natural person or a company (via assignment) should be considered the owner of a patent or an invention. However, a minority of responses stated that while inventorship and ownership rights should not be extended to machines, consideration should be given to expanding ownership to a natural person who trains an AI process, or who owns/controls an AI system.

4.  Subject Matter Eligibility under 35 U.S.C. § 101

Many commenters asserted that there are no patent eligibility considerations unique to AI Inventions, and that AI inventions should not be treated any differently than other computer-implemented inventions. This is consistent with how the USPTO currently examines AI inventions today: claims to an AI invention that fall within one of the four statutory categories and are patent-eligible under the Alice/Mayo test[37] will be patent subject matter-eligible under 35 U.S.C. § 101. While some AI inventions may not pass muster under the subject matter eligibility analysis because they can be characterized as certain methods of organizing human activity, mental processes, or mathematical concepts, as one commenter noted, the complex algorithms that underpin AI inventions have the ability to yield technological improvements. In addition, claims directed to an abstract idea will still be patent-eligible if the additional claim elements, considered individually or as an ordered combination, amount to significantly more than the abstract idea so as to transform them into patent-eligible subject matter.

5.  Written Description and Enablement under 35 U.S.C. § 112(a)

The majority of commenters agreed that there are no unique disclosure considerations for AI inventions. One commenter stated that the principles set forth in the USPTO’s examiner training materials regarding computer-implemented inventions “are similarly applicable to AI-related inventions as to conventional algorithmic solutions.” However, some commenters indicated that there are significant and unique challenges to satisfying the disclosure requirements for an AI invention since even though the input and output may be known by the inventor, the logic in between is in some respects unknown. Commenters noted that proper enforcement of the description requirement is imperative for patent quality. USPTO takes the position that whether a specification provides enabling support for the claimed invention is “intensely fact-specific.”

Commenters suggest that there are differing views on the predictability of AI systems. One commenter stated that “most current AI systems behave in a predictable manner and that predictability is often the basis for the commercial value of practical applications of these technologies.” Others noted that some AI inventions may operate in a black box because there is an “inherent randomness in AI algorithms,” making it appropriate to “apply the written description requirement and the enablement factors from In re Wands.”[38]

Commenters presented differing views as to the predictability of AI inventions. Some explained that AI inventions generally behave predictably in their practical applications (that fact being a basis for their commercial value), whereas some AI inventions might be less predictable due to inherent randomness in their algorithms. This unpredictability may make it appropriate to consider established factors such as the level of predictability in the art, amount of direction provided by the inventor, existence of working examples, and quantity of experimentation necessary to make or use the invention based on the content of the disclosure.

6.  Level of Ordinary Skill in the Art

The USPTO noted that AI is capable of being applied to various disciplines, a tendency that requires an assessment of how it is affecting seemingly disparate fields of innovation since it may have “the potential to alter the skill level of the hypothetical ‘ordinary skilled artisan,’ thereby affecting the bar for nonobviousness.” Many commenters asserted that AI has the potential to affect the level of ordinary skill in an art and that the present legal framework for assessing the person of ordinary skill in the art is “adequate to determine the impact of AI-based tools in a given field.” However, commenters cautioned that widespread use of AI systems have not yet permeated all fields and discouraged the USPTO from declaring that the application of conventional AI is an exercise of ordinary skill in the art.

7.  Prior Art Considerations

The majority of commenters stated that there were no prior art considerations unique to AI inventions and that current standards were sufficient. However, some commenters indicated that there were prior art considerations unique to AI inventions, many of which focused on the proliferation of prior art, such as the generation of prior art by AI, and the difficulty in finding prior art, such as source code related to AI. Others indicated that while no prior art considerations unique to AI inventions currently existed, depending on how sophisticated AI becomes in the future, unique AI prior art could become relevant. Among all the responses, a common theme was the importance of examiner training and providing examiners with additional resources for identifying and finding AI-related prior art.

8.  New IP Protections for Data Protection and Other Issues

The USPTO noted that data protection under current U.S. law is limited in scope, and the U.S. does not currently have intellectual property rights protections solely focused on data for AI algorithms. In their responses to the question of whether any new forms of IP protections are needed for AI inventions, commenters noted the importance of “big data” in developing and training AI systems, but were equally divided between the view that new intellectual property rights were necessary to address AI inventions and the belief that the current U.S. IP framework was adequate to address AI inventions. Generally, however, commenters who did not see the need for new forms of IP rights suggested that developments in AI technology should be monitored to ensure needs were keeping pace with AI technology developments.

Those requesting new IP rights focused on the need to protect the data associated with AI, particularly in the context of machine learning systems. One opinion stated that companies that collect large amounts of data have a competitive advantage relative to new entrants to the market and that “[t]here could be a mechanism to provide access to the repositories of data collected by large technology companies such that proprietary rights to the data are protected but new market entrants and others can use such data to train and develop their AI.”[39] Commentators took the view that training data is currently protectable as a trade secret or, in the event that the training data provides some new and useful outcome, as a patent, but thought that there may be gaps in IP protection for trained models. Commenters did not provide concrete proposals on how any newly created IP rights should function, and many called on the USPTO to further consult the public on the issue. Commenters also stressed the need for examiner technical training and a call for memorializing guidance specific to AI for patent examiners.

Finally, in response to a question about whether policies and practices of other global patent agencies should inform the USPTO’s approach, there was a divide between commentators advocating for an evolution of global laws in a common direction, and those who cautioned against further attempts to harmonize international patent laws and procedures “because U.S. patent law is the gold standard.”[40]

We will continue to monitor developments in this space and report on any action USPTO may take in response to these comments.

IV.  AUTONOMOUS VEHICLES

A.  SELF-DRIVE Act Reintroduced in U.S. Congress

Federal regulation of autonomous vehicles had so far faltered in the new Congress, leaving the U.S. without a federal regulatory framework while the development of autonomous vehicle technology continues apace. However, on September 23, 2020, Rep. Bob Latta (R-OH) reintroduced the Safely Ensuring Lives Future Deployment and Research In Vehicle Evolution (“SELF DRIVE”) Act.[41] As we have addressed in previous legal updates,[42] the House previously passed the SELF DRIVE Act (H.R. 3388) by voice vote in September 2017, but its companion bill (the American Vision for Safer Transportation through Advancement of Revolutionary Technologies (“AV START”) Act (S. 1885)) stalled in the Senate.

The bill empowers the National Highway Traffic Safety Administration (“NHTSA”) with the oversight of manufacturers of Highly Automated Vehicles (“HAVs”) through enactment of future rules and regulations that will set the standards for safety and govern areas of privacy and cybersecurity relating to such vehicles. The bill also requires vehicle manufacturers to inform consumers of the capabilities and limitations of a vehicle’s driving automation system and directs the Secretary of Transportation to issue updated or new motor vehicle safety standards relating to HAVs.

One key aspect of the bill is broad preemption of the states from enacting legislation that would conflict with the Act’s provisions or the rules and regulations promulgated under the authority of the bill by the NHTSA. While state authorities would likely retain their ability to oversee areas involving human driver and autonomous vehicle operation, the bill contemplates that the NHTSA would oversee manufacturers of autonomous vehicles, just as it has with non-autonomous vehicles, to ensure overall safety. In addition, the NHTSA is required to create a Highly Automated Vehicle Advisory Council to study and report on the performance and progress of HAVs. This new council is to include members from a wide range of constituencies, including members of the industry, consumer advocates, researchers, and state and local authorities. The intention is to have a single body (the NHTSA) develop a consistent set of rules and regulations for manufacturers, rather than continuing to allow the states to adopt a web of potentially widely differing rules and regulations that may ultimately inhibit development and deployment of HAVs.

In a joint statement on the bill, Energy and Commerce Committee Republican Leader Rep. Greg Walden (R-OR) and Communications and Technology Subcommittee Republican Leader Rep. Bob Latta (R-OH) noted that “[t]here is a clear global race to AVs, and for the U.S. to win that race, Congress must act to create a national framework that provides developers certainty and a clear path to deployment.”[43] The bill has been referred to the House Energy and Commerce Committee and awaits further action.[44]

B.  European Commission Report on the Ethics of Connected and Automated Vehicles

In September 2020, the Commission published a report by an independent group of experts on the ethics of connected and automated vehicles (“CAVs”).[45] The report—which promotes the “systematic inclusion of ethical considerations in the development and use of CAVs”[46]—sets out twenty ethical recommendations on road safety, privacy, fairness, AI explainability, responding to dilemma situations, clear testing guidelines and standards, the creation of a culture of responsibility for the development and deployment of CAVs, auditing CAV algorithmic decision-making reducing opacity, as well as the promotion of data, algorithm and AI literacy through public participation. The report applies a “Responsible Research and Innovation” approach that “recognises the potential of CAV technology to deliver the […] benefits [reducing the number of road fatalities and harmful emissions from transport, improving the accessibility of mobility services]” but also incorporates a broader set of ethical, legal and societal considerations into the development, deployment and use of CAVs and to achieve an “inherently safe design” based on a user-centric perspective.[47] The report builds on the Commission’s strategy on Connected and Automated Mobility.[48]

C.  Proposed German Legislation on Autonomous Driving

The German government intends to pass a law on autonomous vehicles (“Gesetz zum autonomen Fahren”) by mid-2021.[49] The new law is intended to regulate the deployment of CAVs 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 intends to create, by the end of 2021, a “mobility data room” (“Datenraum Mobilität”), 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.[50] 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.

_____________________

   [1]   United States Patent and Trademark Office, Public Views on Artificial Intelligence and Intellectual Property Policy (Oct. 2020), at 2 (summarizing responses by stakeholders to the USPTO’s request for public comment), available at https://www.uspto.gov/sites/default/files/documents/USPTO_AI-Report_2020-10-07.pdf.

   [2]   H. Mark Lyon, Gearing Up For The EU’s Next Regulatory Push: AI, LA & SF Daily Journal (Oct. 11, 2019), available at https://www.gibsondunn.com/wp-content/uploads/2019/10/Lyon-Gearing-up-for-the-EUs-next-regulatory-push-AI-Daily-Journal-10-11-2019.pdf.

   [3]   EC, White Paper on Artificial Intelligence – A European approach to excellence and trust, COM(2020) 65 (Feb. 19, 2020), available at https://ec.europa.eu/info/sites/info/files/commission-white-paper-artificial-intelligence-feb2020_en.pdf.

   [4]   Id. Industries in critical sectors include healthcare, transport, police, recruitment, and the legal system, while technologies of critical use include such technologies with a risk of death, damage or injury, or with legal ramifications.

   [5]   EC, A European strategy for data, COM (2020) 66 (Feb. 19, 2020), available at https://ec.europa.eu/info/files/communication-european-strategy-data_en.

   [6]   EC, Report on the safety and liability implications of Artificial Intelligence, the Internet of Things and robotics, COM (2020) 64 (Feb. 19, 2020), available at https://ec.europa.eu/info/files/commission-report-safety-and-liability-implications-ai-internet-things-and-robotics_en.

   [7]   EC, White Paper on Artificial Intelligence: Public consultation towards a European approach for excellence and trust, COM (2020) (July 17, 2020), available at https://ec.europa.eu/digital-single-market/en/news/white-paper-artificial-intelligence-public-consultation-towards-european-approach-excellence.

   [8]   EC, Artificial intelligence – ethical and legal requirements, COM (2020) (June 2020), available at https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12527-Requirements-for-Artificial-Intelligence.

   [9]   Id.

[10]   European Parliament, Setting up a special committee on artificial intelligence in a digital age, and defining its responsibilities, numerical strength and term of office (June 18, 2020), available at https://www.europarl.europa.eu/doceo/document/TA-9-2020-0162_EN.html; the European Parliament is also working on a number of other issues related to AI, including: the civil and military use of AI (legal affairs committee); AI in education, culture and the audio-visual sector (culture and education committee); and the use of AI in criminal law (civil liberties committee).

[11]   European Parliament, News Report, AI rules: what the European Parliament wants (Oct. 21, 2020), available at https://www.europarl.europa.eu/news/en/headlines/society/20201015STO89417/ai-rules-what-the-european-parliament-wants.

[12]   European Parliament, Parliament leads the way on first set of EU rules for Artificial Intelligence (Oct. 20, 2020), available at https://www.europarl.europa.eu/news/en/press-room/20201016IPR89544/.

[13]   In addition, the Parliament announced that it had approved two separate legislative initiative reports calling on the Commission to address and tackle current shortcomings in the online environment in its Digital Services Act (“DSA”) package, due to be presented in December 2020. In particular, the Parliament noted that the EU aims to shape the digital economy at the EU level, as well as set the standards for the rest of the world. In addition, the Parliament outlined in its reports that all digital service providers established in non-EU must adhere to the DSA’s rules when their services are also aimed at consumers or users in the EU.

[14]   European Parliament, Report with recommendations to the Commission on a framework of ethical aspects of artificial intelligence, robotics and related technologies (2020/2012 (INL)) (Oct. 8, 2020), available at https://www.europarl.europa.eu/doceo/document/A-9-2020-0186_EN.pdf; European Parliament, Resolution of 20 October 2020 with recommendations to the Commission on a framework of ethical aspects of artificial intelligence, robotics and related technologies (2020/2012 (INL)) (Oct. 20, 2020), available at https://www.europarl.europa.eu/doceo/document/TA-9-2020-0275_EN.pdf.

[15]   Press Release, European Parliament, Parliament leads the way on first set of EU rules for Artificial Intelligence (Oct. 20, 2020), available at https://www.europarl.europa.eu/news/en/press-room/20201016IPR89544/.

[16]   Id.

[17]   Press Release, European Parliament, Parliament leads the way on first set of EU rules for Artificial Intelligence (Oct. 20, 2020), available at https://www.europarl.europa.eu/news/en/press-room/20201016IPR89544/.

[18]   European Parliament, Report with recommendations to the Commission on a civil liability regime for artificial intelligence (2020/2014 (INL)) (Oct. 5, 2020), available at https://www.europarl.europa.eu/doceo/document/A-9-2020-0178_EN.pdf; European Parliament, Resolution of 20 October 2020 with recommendations to the Commission on a civil liability regime for artificial intelligence (2020/2014 (INL)), available at https://www.europarl.europa.eu/doceo/document/TA-9-2020-0276_EN.pdf.

[19]   European Parliament, Report on intellectual property rights for the development of artificial intelligence technologies (2020/2015(INI)) (Oct. 2, 2020), available at https://www.europarl.europa.eu/doceo/document/A-9-2020-0176_EN.pdf; European Parliament, Resolution of 20 October 2020 on intellectual property rights for the development of artificial intelligence technologies (2020/2015(INI)) (Oct. 20, 2020), available at https://www.europarl.europa.eu/doceo/document/TA-9-2020-0277_EN.pdf.

[20]   Innovative And Trustworthy AI: Two Sides Of The Same Coin, Position paper on behalf of Denmark, Belgium, the Czech Republic, Finland, France, Estonia, Ireland, Latvia, Luxembourg, the Netherlands, Poland, Portugal, Spain and Sweden, available at https://em.dk/media/13914/non-paper-innovative-and-trustworthy-ai-two-side-of-the-same-coin.pdf; see also https://www.euractiv.com/section/digital/news/eu-nations-call-for-soft-law-solutions-in-future-artificial-intelligence-regulation/.

[21]   Stellungnahme der Bundesregierung der Bundesrepublik Deutschland zum Weißbuch zur Künstlichen Intelligenz – ein europäisches Konzept für Exzellenz und Vertrauen, COM (2020) 65 (June 29, 2020), available at https://www.ki-strategie-deutschland.de/files/downloads/Stellungnahme_BReg_Weissbuch_KI.pdf; see also Philip Grüll, Germany calls for tightened AI regulation at EU level, Euractiv (July 1, 2020), available at https://www.euractiv.com/section/digital/news/germany-calls-for-tightened-ai-regulation-at-eu-level/.

[22]   Deutscher Bundestag, Enquete-Kommission, Künstliche Intelligenz – Gesellschaftliche Verantwortung und wirtschaftliche, soziale und ökologische Potenziale, Kurzzusammenfassung des Gesamtberichts (Oct. 28, 2020), available at https://www.bundestag.de/resource/blob/801584/102b397cc9dec49b5c32069697f3b1e3/Kurzfassung-des-Gesamtberichts-data.pdf.

[23]   UK ICO, Guidance on AI and data protection (July 30, 2020), available at https://ico.org.uk/for-organisations/guide-to-data-protection/key-data-protection-themes/guidance-on-ai-and-data-protection/.

[24]   Examples of such privacy-enhancing techniques include perturbation or adding ‘noise’, synthetic data, and federated learning.

[25]   On the topic of data minimization, see further the European Data Protection Board’s (“EDPB”) Draft Guidelines on the Principles of Data Protection by Design and Default under Article 25 of the GDPR, adopted on October 20, 2020 after a public consultation and available here.

[26]   H.R. 2575, 116th Congress (2019-2020).

[27]   The Ripon Advance, GOP senators praise House passage of AI in Government Act (Sept. 16, 2020), available at https://riponadvance.com/stories/gop-senators-praise-house-passage-of-ai-in-government-act/?_sm_au_=iVV6kKLFkrjvZrvNFcVTvKQkcK8MG; Rob Portman, House Passes Portman, Gardner Bipartisan Legislation to Improve Federal Government’s Use of Artificial Intelligence (Sept. 14, 2020), available at https://www.portman.senate.gov/newsroom/press-releases/house-passes-portman-gardner-bipartisan-legislation-improve-federal?_sm_au_=iVV6kKLFkrjvZrvNFcVTvKQkcK8MG.

[28]   Robin Kelly, Kelly, Hurd Introduce Bipartisan Resolution to Create National Artificial Intelligence Strategy (Sept. 16, 2020), available at https://robinkelly.house.gov/media-center/press-releases/kelly-hurd-introduce-bipartisan-resolution-to-create-national-artificial?_sm_au_=iVV6kKLFkrjvZrvNFcVTvKQkcK8MG; H.Con.Res. 116, 116th Congress (2019-2020).

[29]   Bipartisan Policy Center, A National AI Strategy (Sept. 1, 2020), available at https://bpcaction.org/wp-content/uploads/2020/09/1-Pager-on-National-AI-Strategy-Resolution-.pdf?_sm_au_=iVV6kKLFkrjvZrvNFcVTvKQkcK8MG.

[30]   On September 10, the House Budget Committee held a hearing to discuss the impact of Artificial Intelligence on the U.S. economy, and specifically on what role technology should play in the country’s recovery post-COVID-19. Witness Darrell West, Ph.D., of Brookings Institution warned that the rapid integration of AI technologies developed in the private sector could affect the American workforce by causing job losses and job dislocation.

[31]   H.R. 8390, 116th Congress (2019-2020).

[32]   Paul D. Tonko, Tonko, Reschenthaler Introduce Artificial Intelligence Education Act (Sept. 24, 2020), available at https://tonko.house.gov/news/documentsingle.aspx?DocumentID=3142.

[33]   United States Patent and Trademark Office, USPTO releases report on artificial intelligence and intellectual property policy (Oct. 6, 2020), available at https://www.uspto.gov/about-us/news-updates/uspto-releases-report-artificial-intelligence-and-intellectual-property?_sm_au_=iVV6kKLFkrjvZrvNFcVTvKQkcK8MG.

[34]   United States Patent and Trademark Office, Public Views on Artificial Intelligence and Intellectual Property Policy (Oct. 2020), available at https://www.uspto.gov/sites/default/files/documents/USPTO_AI-Report_2020-10-07.pdf. On October 30, 2019, the USPTO also issued a request for comments on Intellectual Property Protection for Artificial Intelligence Innovation, on IP policy areas other than patent law. The October 2020 USPTO publication summarizes the responses by commentators at Part II from p. 19 of the Report onwards.

[35]   Id. at ii.

[36]   Id. at 5.

[37]   Alice Corp. Pty. Ltd. v. CLS Bank Int’l, 573 U.S. 208, 221 (2014); Mayo Collaborative Servs. v. Prometheus Labs., Inc., 566 U.S. 66 (2012).

[38]   In re Wands 858 F.2d 731 (Fed. Cir. 1988).

[39]   Supra, n.34, at 15.

[40]   Id. at 18.

[41]   H.R. __ 116th Congress (2019-2020).

[42]   For more information, please see our legal updates Accelerating Progress Toward a Long-Awaited Federal Regulatory Framework for Autonomous Vehicles in the United States and 2019 Artificial Intelligence and Automated Systems Annual Legal Review.

[43]   Energy & Commerce Committee Republicans, Press Release, E&C Republicans Continue Leadership on Autonomous Vehicles (Sept. 23, 2020), available at https://republicans-energycommerce.house.gov/news/press-release/ec-republicans-continue-leadership-on-autonomous-vehicles/.

[44] State regulatory activity has continued to accelerate, adding to the already complex mix of regulations that apply to companies manufacturing and testing HAVs. Over half of all U.S. states have enacted legislation related to autonomous vehicles; see further Nathan Benaich & Ian Hogarth, State of AI Report (Oct. 1, 2020), at 93, available at https://docs.google.com/presentation/d/1ZUimafgXCBSLsgbacd6-a-dqO7yLyzIl1ZJbiCBUUT4/edit#slide=id.g893233b74e_0_0; National Conference of State Legislatures, Autonomous Vehicles: Self-Driving Vehicles Enacted Legislation (Feb. 18, 2020), available at https://www.ncsl.org/research/transportation/autonomous-vehicles-self-driving-vehicles-enacted-legislation.aspx. As outlined in our 2019 Artificial Intelligence and Automated Systems Annual Legal Review, state regulations vary significantly. Also, in November 2020, Massachusetts voters are deciding on whether or not to add “mechanical” vehicle telematics data—real-time updates from a car’s sensors transmitted to an automaker’s private servers—to the list of information that Original Equipment Manufacturers (“OEMs”) have to share with independent mechanics under the state’s landmark “Right to Repair” law. Telematics data was purposefully excluded from the original 2013 law. If passed, the amendment would require automakers who want to do business in the state to make that data accessible through a smartphone app for owners starting in 2022. See Rob Stumpf, There’s Another Huge Right to Repair Fight Brewing in Massachusetts, The Drive (Oct. 13, 2020), available at https://www.thedrive.com/news/36980/theres-another-huge-right-to-repair-fight-brewing-in-massachusetts.

[45]   European Commission, Press Release, New recommendations for a safe and ethical transition towards driverless mobility, COM (2020) (Sept. 18, 2020), available at https://ec.europa.eu/info/news/new-recommendations-for-a-safe-and-ethical-transition-towards-driverless-mobility-2020-sep-18_en.

[46]   Id.

[47]   European Commission, Directorate-General for Research and Innovation, Independent Expert Report, Ethics of Connected and Automated Vehicles: Recommendations on road safety, privacy, fairness, explainability, and responsibility (Sept. 18, 2020), at 4, available here.

[48]   EC, Connected and automated mobility in Europe, COM(2020) (June 22, 2020), available at https://ec.europa.eu/digital-single-market/en/connected-and-automated-mobility-europe.

[49]   Bundesministerium für Verkehr und digitabe Infrastruktur, Gesetz zum autonomen Fahren (Oct. 2020), available at https://www.bmvi.de/SharedDocs/DE/Artikel/DG/gesetz-zum-autonomen-fahren.html; see also Josef Erl, Autonomes Fahren: Deutschland soll Weltspitze werden, Mixed.de (Oct. 31, 2020), available at https://mixed.de/autonomes-fahren-deutschland-soll-weltspitze-werden/.

[50]   Daniel Delhaes, Deutsche Autoindustrie erwägt, ihre Datenschätze zu bündeln, Handelsblatt (July 9, 2020), available at https://www.handelsblatt.com/technik/sicherheit-im-netz/autonomes-fahren-deutsche-autoindustrie-erwaegt-ihre-datenschaetze-zu-buendeln/26164062.html?ticket=ST-2824809-tuIGjXYQywf7MHzRurpa-ap4.

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The following Gibson Dunn lawyers prepared this client update: H. Mark Lyon, Frances Waldmann and Tony Bedel.

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 Artificial Intelligence and Automated Systems Group, or the following authors:

H. Mark Lyon – Palo Alto (+1 650-849-5307, [email protected])
Frances A. Waldmann – Los Angeles (+1 213-229-7914,[email protected])

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

Artificial Intelligence and Automated Systems Group:
H. Mark Lyon – Chair, Palo Alto (+1 650-849-5307, [email protected])
J. Alan Bannister – New York (+1 212-351-2310, [email protected])
Patrick Doris – London (+44 (0)20 7071 4276, [email protected])
Kai Gesing – Munich (+49 89 189 33 180, [email protected])
Ari Lanin – Los Angeles (+1 310-552-8581, [email protected])
Robson Lee – Singapore (+65 6507 3684, [email protected])
Carrie M. LeRoy – Palo Alto (+1 650-849-5337, [email protected])
Alexander H. Southwell – New York (+1 212-351-3981, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Michael Walther – Munich (+49 89 189 33 180, [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.

“As our planet increasingly faces the unpredictable consequences of climate change and resource depletion, urgent action is needed to adapt to a more sustainable model…To achieve more sustainable growth, everyone in society must play a role. The financial system is no exception. Re-orienting private capital to more sustainable investments requires a comprehensive rethinking of how our financial system works. This is necessary if the EU is to develop more sustainable economic growth, ensure the stability of the financial system, and foster more transparency and long-termism in the economy.” (Press release, European Commission: Sustainable Finance: Commission’s Action Plan for a greener and cleaner economy (8 March 2018)).

 

The European Commission’s Sustainable Finance Action Plan[1] (the “Action Plan”) proposed a package of measures including, amongst other initiatives, a regulation imposing sustainability-related disclosures on financial market participants (“SFDR”[2]) and a regulation to establish an EU-wide common language (or taxonomy) to identify the extent to which economic activities can be considered sustainable (the “Taxonomy Regulation”[3]). This briefing note provides an overview of the Taxonomy Regulation and the SFDR and discusses their impact on private fund managers, including non-EU managers who market their funds into the EU and/or the United Kingdom under the applicable national private placement regimes.

Each of the Taxonomy Regulation and the SFDR apply to “financial market participants”, a term which is broadly defined and includes (amongst others): (i) alternative investment fund managers (“AIFMs”); and (ii) MiFID[4] investment firms that provide portfolio management services, and to “financial products” made available by them. “Financial products” include (amongst other things) alternative investment funds (“AIFs”) managed by AIFMs and portfolios managed by MiFID firms.

The term “financial market participant” clearly includes AIFMs which are authorised under the AIFMD[5]. There is a lack of clarity for non-EU AIFMs in the text of both pieces of legislation. However, according to guidance on the Taxonomy Regulation, the disclosure requirements on financial market participants, which build on the obligations in the SFDR should “apply to anyone offering financial products in the European Union, regardless of where the manufacturer of such products is based”. Consequently, it is clear that the disclosure obligations will apply to non-EU AIFMs that market their AIFs into the EEA (and the UK) pursuant to the national private placement regimes under Article 42 of the AIFMD.

SUSTAINABLE FINANCE DISCLOSURE REGULATION

The aim of the SFDR is to introduce harmonised requirements in relation to the disclosures to end investors on the integration of sustainability risks, on the consideration of adverse sustainability impacts, on sustainable investment objectives or on the promotion of environmental and/or social characteristics, in investment decision-making.

Many of the framework requirements under the SFDR will apply from 10 March 2021, although some of the requirements for funds with sustainable investment as an objective or which promote environmental and/or social characteristics will come into force on 1 January 2022 and 1 January 2023. In addition to the framework requirements, the SFDR is to be supplemented by more detailed requirements set out in the regulatory technical standards (“RTS”) which are yet to be finalised. The RTS should have applied from 10 March 2021. However, the European Commission has recently, in a letter addressed to certain trade associations, confirmed that there will be a delay in the application of the RTS requirements, although no date has yet been announced for their future application (there is some expectation that the application date will be closer to 1 January 2022).

The European Commission has, however, made clear that all of the requirements and general principles contained in the SFDR itself will remain applicable to firms from 10 March 2021. Fund managers are, therefore, expected to take a principles-based approach to compliance with the SFDR and evidence this on a best efforts basis. It is considered by the European Commission that firms are already likely complying with certain product-level disclosure requirements as a result of existing sectoral legislation. This seems, however, to be an overly optimistic view, as (for example) much of the sectoral legislation does not go into the level of prescription set out in the SFDR.

The disclosures required by the SFDR include both manager-level disclosures (i.e. at the level of the AIFM or MiFID investment firm) and also product-level disclosures (i.e. at the level of the AIF or portfolio). The disclosures must be made in pre-contractual information to investors, in periodic investor reporting and publicly on the manager’s website. Importantly, the SFDR does not apply only to managers of AIFs or portfolios with a sustainable investment objective or promoting environmental and/or social characteristics. While there are enhanced disclosures for such AIFs/portfolios, the SFDR requires disclosures to be made by all in-scope “financial market participants”.

Manager-level disclosures

At the level of the manager, a financial market participant must disclose the following:

• Information on its website about its policies on the integration of sustainability risks into its investment decision-making processes – in order to comply, managers will need to ensure that they integrate an assessment of not only all relevant financial risks, but also all relevant sustainability risks that may have a material negative impact on the financial return of investments made, into their due diligence processes[6]. This will require firms to review all relevant investment decision-making processes and policies in order to understand how sustainability risks are currently integrated (if at all).
• Information on its website regarding its consideration (or not) of principal adverse impacts of investment decisions on sustainability factors – firms will need to make a commercial decision on whether or not they will consider the principal adverse impacts of investment decisions on sustainability factors. To the extent that a firm decides to consider such impacts, it will be required to publish a statement on its website on its due diligence policies with respect to those impacts. Those firms who choose not to consider adverse impacts of investment decisions on sustainability factors will be required to publish and maintain on their websites clear reasons for why they do not do so, including (where relevant) information as to whether and when they intend to consider such adverse impacts.[7]
• Information in remuneration policy and on its website as to how its remuneration policy is consistent with the integration of sustainability risks – firms will be required to revisit their existing remuneration policies and include in those policies and on their websites information on how the remuneration policies promote sound and effective risk management with respect to sustainability risks and how the structure of remuneration does not encourage excessive risk-taking with respect to sustainability risks and is linked to risk-adjusted performance.

Product-level disclosures

At the level of each AIF/portfolio (regardless of whether the AIF/portfolio has a sustainable investment objective or promotes environmental and/or social characteristics), the following must be disclosed:

• Information in pre-contractual disclosures to investors about the manner in which sustainability risks are integrated into investment decision-making and the likely impacts of sustainability risks on the returns of the AIF/portfolio – a financial market participant may decide at product-level that sustainability risks are not relevant to the particular AIF/portfolio. In such case, clear reasons must be given as to why they are not relevant.
• Information in pre-contractual disclosures to investors as to whether and how the particular AIF/portfolio considers principal adverse impacts on sustainability factors (by 30 December 2022) – a financial market participant may decide not to consider principal adverse impacts of their investment decisions on sustainability factors at the level of the AIF/portfolio. In which case, clear reasons must be provided as to why they are not taken into account.
• Information in periodic reports on principal adverse impacts on sustainability factors (from 1 January 2022).

For an AIFM, the pre-contractual disclosures mean the disclosures which an AIFM is required to make to investors before they invest in an AIF pursuant to Article 23 of the AIFMD and the periodic reports mean the annual report which is required to be produced pursuant to Article 22 of the AIFMD. In the context of a MiFID investment firm, the pre-contractual disclosures mean the information that is required to be provided to a client before providing services pursuant to Article 24(4) of MiFID. The periodic reports for MiFID firms refer to the reports required to be provided to clients pursuant to Article 25(6) of MiFID.

Disclosures for sustainable products

The SFDR identifies that products with “various degrees of ambition” have been developed to date. Therefore, the SFDR draws a distinction between financial products which have a sustainable investment objective and those which promote environmental and/or social characteristics. Different disclosure requirements apply to each.

Products promoting environmental and/or social characteristics

In relation to financial products promoting environmental and/or social characteristics (provided that the investee companies in which investments are to be made follow good governance practices[8]) (“Article 8 AIFs/portfolios”), the following must be disclosed at product level in the investor pre-contractual disclosures:

• information on how those characteristics are met;
• where an index has been designated as a reference benchmark, information on whether and how the index is consistent with those characteristics; and
• information as to where than index can be found.

Information is also required in the periodic reports for the AIF/portfolio on the extent to which the environmental or social characteristics are met. As this information relates to complete financial years, this requirement will apply from 1 January 2022.

In addition, this information must be published and maintained on the manager’s website together with information on the methodologies used to assess, measure and monitor the environmental and/or social characteristics, including data sources, screening criteria for the underlying assets and the relevant sustainability factors used to measure the environmental or social characteristics.

Products with a sustainable investment objective

In the case of an AIF/portfolio with a sustainable investment objective (“Article 9 AIFs/portfolios”) where an index has been designated as a reference benchmark, product-level pre-contractual disclosures must include:

• information on how the designated index is aligned with the investment objective; and
• an explanation as to why and how the designated index aligned with the objective differs from a broad market index.

Where no index has been designated, pre-contractual disclosures will include an explanation of how the sustainable investment objective is to be attained. Where the AIF/portfolio has a reduction in carbon emissions as its objective, the information to be disclosed must include the objective of low carbon emission exposure in view of achieving the long-term global warming objectives of the Paris Agreement.

Information is also required to be disclosed in the periodic reports for the AIF/portfolio on: (i) the overall sustainability-related impact of the AIF/portfolio by means of relevant sustainability indicators; and (ii) where an index is designated as a reference benchmark, a comparison between the overall sustainability-related impact with the impacts of the designated index and of a broad market index through sustainability indicators.

In addition, this information must be published and maintained on the manager’s website together with information on the methodologies used to assess, measure and monitor the impact of the sustainable investments selected for the AIF/portfolio, including data sources, screening criteria for the underlying assets and the relevant sustainability factors used to measure the environmental or social characteristics.

TAXONOMY REGULATION

The Taxonomy Regulation establishes an EU-wide classification system to provide a common language (i.e. taxonomy) to define environmentally sustainable economic activities. It also sets out six environmental objectives, including climate change mitigation, climate change adaption and transition to a circular economy and provides that for an economic activity to be environmentally sustainable it must make a “substantial contribution” to at least one of the environmental objectives and not cause any significant harm to any of the others.

The Taxonomy Regulation also amends the SFDR in certain respects as regards disclosures required for financial products that have a sustainable investment objective or promote environmental characteristics and requires negative disclosure for those AIFs/portfolios which do not have such objectives/characteristics.

An economic activity is considered to be environmentally sustainable for the purposes of the Taxonomy Regulation if:

1) it makes a “substantial contribution” to one or more of the six environmental objectives;

2) it does “no significant harm” to any of the six environmental objectives;

3) it is carried out in accordance with certain minimum safeguards[9]; and

4) it complies with technical screening criteria[10].

The six environmental objectives are:

• climate change mitigation;
• climate change adaptation;
• sustainable use and protection of water and marine resources;
• transition to a circular economy;
• pollution prevention and control; and
• protection and restoration of biodiversity and ecosystems.

The Annex to this alert provides an overview of what “substantial contribution” and “significant harm” means for each of the six environmental objectives.

Amendments to the SFDR

The Taxonomy Regulation makes certain amendments to the SFDR in relation to the pre-contractual and periodic reporting requirements for Article 8 AIFs/portfolios and Article 9 AIFs/portfolios where they invest in an economic activity that contributes to one or more of the environmental objectives set out in the Taxonomy Regulation. Additional pre-contractual and periodic disclosures are required for such products, including: information on the environmental objective(s) which is contributed to and a description of how and to what extent the investments are in economic activities that qualify as environmentally sustainable under the Taxonomy Regulation.

The Taxonomy Regulation also makes changes for other financial products too which are neither an Article 8 AIF/portfolio or Article 9 AIF/portfolio by requiring a negative disclosure using the following words: “The investments underlying this financial product do not take into account the EU criteria for environmentally sustainable economic activities.”

The amendments made to the SFDR by the Taxonomy Regulation will apply from 1 January 2022 in some cases and 1 January 2023 in others, depending on which environmental objective is contributed to by the AIF/portfolio.

BREXIT: IMPACT IN THE UK

The UK left the EU in January 2020 and the agreed transition period will expire on 31 December 2020. As the disclosure obligations under the SFDR and the Taxonomy Regulation will not apply until after the end of the transition period, they do not form part of the so-called “retained EU law” in the UK from 1 January 2021. In relation to the Taxonomy Regulation, for example, the UK government has stated that it will retain the taxonomy framework, including the high level environmental objectives, however the Regulation’s disclosure requirements will not form part of this (given that they are set to apply as from a date post-transition period). As the delegated legislation containing the technical standards has not, so far, been published by the European Commission, the government has not yet been in a position to comment as to the extent of the UK’s alignment with the EU on this after the transition period[11].

Also, with regard to the SFDR, the Financial Services (Miscellaneous Amendments) (EU Exit) Regulations 2020 provide that the SFDR will continue to apply in part in the UK when the Brexit transition period ends, with key omissions relating, for example, to the upcoming technical standards and financial product-specific disclosure requirements.

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ANNEX

 

Environmental objective	“Substantial contribution”	“Significant harm”[12]
Climate change mitigation	The process of holding the increase in the global average temperature to below 2°C and pursuing efforts to limit it to 1.5°C above pre-industrial levels, as set out in the Paris Agreement.   The economic activity will substantially contribute to the stabilisation of greenhouse gas concentrations in the atmosphere, including through process or product innovation by, for example: improving energy efficiency; increasing clean or climate neutral mobility; or establishing energy infrastructure that enables the decarbonisation of energy systems.	Significant greenhouse gas emissions.
Climate change adaptation	The process of adjustment to actual and expected climate change and its impacts. Broadly, this includes substantially reducing the risk of the adverse impact, or substantially reducing the adverse impact, of the current and expected future climate on (i) other people, nature or assets; or (ii) the economic activity itself, in each case without increasing the risk of an adverse impact on other people, nature and assets.	An increased adverse impact of the current and expected climate on people, nature and assets.
Sustainable use and protection of water and marine resources	The activity substantially contributes to achieving the good status of water bodies or marine resources, or to preventing their deterioration, through certain means, including, for example, through improving water management and efficiency.	Detriment to the good status, or where relevant the good ecological potential, of water bodies, including surface waters and groundwaters, or to the good environmental status of marine waters.
Transition to a circular economy	Maintaining the value of products, materials and other resources in the economy for as long as possible, enhancing their efficient use in production and consumption. The activity substantially contributes to the circular economy by (among other things): improving the efficiency in the use of natural resources; increasing the recyclability of products; and preventing or reducing waste generation.	Significant inefficiencies in the use of materials and the direct or indirect use of natural resources such as non-renewable energy sources, raw materials, water and land in one or more stages of the life-cycle of products, including in terms of durability, reparability, upgradability, reusability or recyclability of products. Significant increase in the generation, incineration or disposal of waste, with the exception of incineration of non-recyclable hazardous waste. Where long term disposal of waste may cause significant and long-term harm to the environment.
Pollution prevention and control	The economic activity will substantially contribute to the protection and restoration of biodiversity and ecosystems by, for example, sustainable agricultural practices, sustainable forest management and nature and biodiversity conservation.	Detriment to a significant extent to the good condition and resilience of ecosystems or where that activity is detrimental to the conservation status of habitats and species, including those of community interest.
Protection and restoration of biodiversity and ecosystems	The economic activity will substantially contribute to the protection and restoration of biodiversity and ecosystems by, for example, sustainable agricultural practices, sustainable forest management and nature and biodiversity conservation.	Detriment to a significant extent to the good condition and resilience of ecosystems or where that activity is detrimental to the conservation status of habitats and species, including those of community interest.

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   [1]   Communication from the Commission to the European Parliament, the European Council, the Council, the European Central Bank, the European Economic and Social Committee and the Committee of the Regions – Action Plan: Financing Sustainable Growth, 8 March 2018

   [2]   Regulation (EU) 2020/852 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector

   [3]   Regulation (EU) 2019/2088 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088

   [4]   Markets in Financial Instruments Directive (Directive 2014/65/EU)

   [5]   Alternative Investment Fund Managers Directive (Directive 2011/61/EU)

   [6]   Recital 12 SFDR.

   [7]   Note that large financial market participants (broadly, those with an average number of 500 employees during the financial year) will not have the option. From 30 June 2021 they must consider adverse impacts of their investment decisions on sustainability factors.

   [8]   “Good governance practices” is not defined in the SFDR. It is clear from the text that the European legislators intended it to be interpreted widely. Examples of good governance practices include: sound management structures, employee relations, remuneration of staff and tax compliance.

   [9]   OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights.

[10]   These technical screening criteria will be established by the European Commission in accordance with the provisions of the Taxonomy Regulation.

[11]   Letter from John Glen, Economic Secretary to the Treasury, to Sir William Cash, Chair of the European Scrutiny Committee: 9355/18: Proposal for a Regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment (28 May 2020)

[12]   Further details regarding “no significant harm” to be set out in the technical screening criteria.

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

Michelle M. Kirschner (+44 (0)20 7071 4212, [email protected])

Chris Hickey (+44 (0)20 7071 4265, [email protected])

Martin Coombes (+44 (0)20 7071 4258, [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 October 23, 2020, the UK Serious Fraud Office published a new chapter from its internal Operational Handbook, which it describes as “comprehensive guidance on how we approach Deferred Prosecution Agreements (DPAs), and how we engage with companies where a DPA is a prospective outcome.”

At the time of its publication, the Director of the SFO, Lisa Osofsky, remarked, “Publishing this guidance will provide further transparency on what we expect from companies looking to co-operate with us.” Director Osofsky’s full remarks are here: https://www.sfo.gov.uk/2020/10/23/serious-fraud-office-releases-guidance-on-deferred-prosecution-agreements/.

The 2020 DPA Guidance (“the Guidance”) is here: https://www.sfo.gov.uk/publications/guidance-policy-and-protocols/sfo-operational-handbook/deferred-prosecution-agreements/.

In Director Osofsky’s remarks, it is worth observing that she states “DPAs require the company to admit to the misconduct, pay a financial penalty and agree to adhere to conditions set out by the prosecutor to ensure future co-operation and compliance.”

In fact, the underlying statute that created DPAs is clear that a party need not admit guilt[1] and the new Guidance, when addressing the content of the Statement of Facts, also makes plain it is not necessary.[2] There has therefore been no change in the law or the SFO’s requirements with respect to completing a DPA.

The Guidance contains very little new content compared with what is already set out in the DPA Code of Practice (published in January 2014),[3] which is referenced almost 100 times in the Guidance. It should not be forgotten that the DPA Code of Practice remains in force and is the lead document for consideration, with its publication and consideration required by law and it having been laid before Parliament.[4]

So what is new?

1. The Guidance contains a section on “Parallel Investigations” with other agencies that counsels the prosecutor to ensure that they coordinate early with other agencies and de-conflict. The purpose of the Guidance is to facilitate smooth and expeditious investigations that do not prejudice one another. Whilst this detail is not in the DPA Code of Practice, it is covered extensively in other prosecution guidance.[5]
2. There is a section in the Guidance on the naming of individuals in the Statement of Facts that accompanies the DPA and contains a description of the conduct. The Guidance counsels the prosecutor to consider redaction or anonymization. In practice, this has been the case for the majority of Statements of Fact agreed to date; alternatively, publication has been delayed until the conclusion of the trial of individuals to avoid prejudice to their trials.
3. Under “Corporate compliance programmes,” the prosecutor is counselled when requiring remediation terms to consider whether it is necessary and proportionate to require the company to adopt the use of data analytics to test compliance controls and behaviour.
4. The section on “Monitors” is interesting for what it does not say, rather than what it does say. It does not repeat the guidance provided in the DPA Code of Practice that “An important consideration for entering into a DPA is whether [the Company] already has a genuinely proactive and effective corporate compliance programme. The use of monitors should therefore be approached with care.” The language in the DPA Code of Practice signals a presumption that those offered a DPA are unlikely to be required to have a monitor in place. Rarely will a term requiring a monitor be consistent with the DPA Code of Practice and therefore meet the statutory requirement for terms to be “fair, reasonable and proportionate.”[6]
5. On “Sale or merger” the Guidance suggests that DPAs should include a term that requires the consent of the SFO to such a sale or merger. This is new but so far has not featured as a term in any of the DPAs agreed to date.[7] Prior DPAs make it a requirement to make it a term of a subsequent sale or merger that the acquirer be bound by the terms of the DPA.
6. The section on “Compensation” provides more detail than the DPA Code of Practice. However, it does no more than rehearse the well-established criminal law principles that determine when compensation should be sought and awarded, and which have been applied by the Court in prior DPAs.
7. Under a heading enticingly titled “Calculating the profits to be disgorged,” the Guidance disappoints in saying only that “Calculating the profits achieved on account of the relevant conduct may not be a straightforward exercise; and it may be helpful to obtain accountancy expertise.”
8. The last four DPA’s have imposed an obligation to self-report serious new misconduct that becomes known during the term of the DPA. In a section of the Guidance headed “Compliance with terms,” it states that “If any suspected wrongdoing relating to the Company is self-reported, or is otherwise discovered, during the term of the DPA, the prosecutor should consider what if any impact such conduct has on the Company’s obligations under the DPA, the SFO’s investigation of the Company [sic].” If a company self-reports pursuant to a term in a DPA, it will not be in breach. But if it were discovered that the company failed to self-report, that may, subject to the rules of evidence, be treated by the SFO as a breach. Further, the self-reporting or discovery of new serious misconduct has the potential for the SFO to seek a variation of the terms of the DPA in order to amend or supplement its terms.[8]

The commission of a further serious offence, let alone the suspicion of one during the term of a DPA, would not amount to a breach of a DPA without an express term to that affect. To date, no DPA has contained such a term. In most instances, it would be impractical given the length of time it typically takes to investigate and prosecute new cases. By the time the SFO established that an offence had been committed, the DPA will likely have expired. Any breach proceedings in respect of the DPA must commence during the term of the DPA.[9] A term that would make it possible to breach a DPA in the event of an unproven suspicion would arguably not be fair, reasonable and proportionate.

Self-Reporting

Self-reporting features in a non-exhaustive list of public interest factors in the DPA Code of Practice that point in favour of a DPA instead of prosecution. Each of the specified public interest factors along with others that might be case-specific are to be balanced by the prosecutor in exercising their discretion whether to conclude a case by way of a DPA.[10] It has always been the case that self-reporting is not essential, albeit a factor that will carry considerable weight. This was affirmed in the January 2020 Airbus DPA where the court said “…there is no necessary bright line between self-reporting and co-operation.” If it were unclear, the Guidance now makes this plain at footnote 15, which provides, “[t]he failure of a Company to self-report is not a bar to DPA negotiations per se but must be considered as a factor when assessing whether a DPA is in the public interest.” [11]

The Guidance also makes clear that a self-report does not have to be immediate by stating, “Voluntary self-reporting suspected wrongdoing within a reasonable time of those suspicions coming to light is an important aspect of co-operation.” This mirrors the language in the DPA Code of Practice, so it also does not mark a change in policy.[12]

Conclusion

The Guidance does not materially assist companies to understand what the SFO expects in terms of co-operation beyond what was previously published. Those aspects of the Guidance that are not already in the DPA Code of Practice are found in alternative guidance or in prior DPAs, are matters of procedure addressed specifically to prosecutors or are light on detail.

Consistent with Director Osofsky’s commendation of the SFO’s most recent DPA for having “real teeth,”[13] the Guidance suggests that the SFO is considering seeking increasingly onerous terms in DPAs. The challenge for the SFO will be that, should it continue down such a track, the incentives that a DPA is designed to offer will be diminished, ultimately disincentivizing the co-operation they are designed to encourage.

______________________

[1] Crime and Courts Act 2013, Schedule 17, paragraph 5(1). See also DPA Code of practice, paragraph 6.3 which confirms guilt need not be admitted but the contents and meaning of key documents referred to in the Statement of Facts will require admission.

[2] “There is no requirement for formal admissions of guilt in respect of the offences charged on the indictment.” Guidance, section “Statement of Facts”

[3] https://www.cps.gov.uk/sites/default/files/documents/publications/dpa_cop.pdf.

[4] Crime and Courts Act 2013, Schedule 17, paragraph 6.

[5] Such as the Director of Public Prosecutions’ “Guidance on the handling of cases where the jurisdiction to prosecute is shared with prosecuting authorities overseas,” (https://www.cps.gov.uk/publication/directors-guidance-handling-cases-where-jurisdiction-prosecute-shared-prosecuting ), “Annex A – Eurojust Guidelines For Deciding ‘Which Jurisdiction Should Prosecute?’”
(https://www.eurojust.europa.eu/sites/default/files/Publications/Reports/2016_Jurisdiction-Guidelines_EN.pdf)
and the “Agreement for Handling Criminal Cases with Concurrent Jurisdiction between the United Kingdom and the United States of America.”
(https://www.cps.gov.uk/sites/default/files/documents/legal_guidance/Agreement-handling-criminal-cases-concurrent-jurisdiction-UK-USA.pdf).

[6] Crime and Courts Act 2013, Schedule 17, paragraphs 7(1)(b) and 8(1)(b).

[7] At the time of writing there remains an unpublished DPA in respect of Airline Services Limited.

[8] See also Crime and Courts Act 2013, Schedule 17, paragraph 10.

[9] Crime and Courts Act 2013, Schedule 17, paragraph 9(1).

[10] DPA Code of Practice, paragraphs 2.6 and 2.8.

[11] See also SFO v Airbus SE, January 31, 2020 at paragraph 68.

[12] DPA Code of Practice, paragraph 2.8.2 i.

[13] Future Challenges in Economic Crime: A View from the SFO, Royal United Services Institute, October 8, 2020, (https://www.sfo.gov.uk/2020/10/09/future-challenges-in-economic-crime-a-view-from-the-sfo/).

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This client alert was prepared by Sacha Harber-Kelly and Steve Melrose.

Mr. Harber-Kelly is a former prosecutor at the SFO and was appointed to lead the SFO’s engagement in the cross-governmental working group which devised the DPA legislative framework, and subsequently appointed to draft the DPA Code of Practice, which sets out how prosecutors will operate the DPA regime.

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you would like to discuss this alert in detail, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following members of the firm’s UK disputes practice.

Philip Rocher (+44 (0)20 7071 4202, [email protected])
Patrick Doris (+44 (0)20 7071 4276, [email protected])
Sacha Harber-Kelly (+44 (0)20 7071 4205, [email protected])
Charles Falconer (+44 (0)20 7071 4270, [email protected])
Allan Neil (+44 (0)20 7071 4296, [email protected])
Steve Melrose (+44 (0)20 7071 4219, [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 29 September 2020, the European Commission (“Commission”) issued its first report on concomitant minority shareholdings by institutional investors in companies active in the same market (“Common Shareholdings”)(“Report”).[1] The findings of the 320 page Report were drawn upon lessons learned from five sectors which are considered by the Commission to be relatively concentrated, namely: Oil & Gas, Electricity, Mobile Telecoms, Trading Platforms, and Beverages.

The Report was triggered by the identification of an increasing number of Common Shareholdings in recent years. For instance, in 2014, 60% of U.S. public firms had a shareholder that held at least 5% both in the firm itself and in a competitor.[2] In Europe, Common Shareholdings with at least 5% participation concerned 67% of listed companies in 2016.[3]

Traditionally, Common Shareholdings have not been an antitrust issue as institutional investors usually held small minority stakes, falling far below the level necessary to give them the ability to exercise control, and implemented passive investment strategies. However, in recent years, Common Shareholdings have attracted the attention of antitrust enforcement agencies in Europe and the U.S.[4], given that fund managers have accumulated more substantial shareholdings, together with the related voting rights, in a large number of firms that are often direct competitors.

A number of economists have also raised concerns about this perceived concentration of power, the influence that could be exerted over the management of the companies affected, and the potential incentives to collude amongst the investors.

Overview of the competition assessments made thus far

To date, empirical research on the competitive effects of Common Shareholdings has been focused on the U.S. Specifically, two major studies of the retail banking and airline sectors have concluded that Common Shareholdings in those sectors were associated with higher prices (for banking deposit services and airline tickets respectively) and accordingly may have had a detrimental effect on competition.[5] Following the publication of those studies, the U.S. Federal Trade Commission held a hearing on Common Shareholdings in December 2018.[6]

In the EU, the Commission has examined the potential effects of Common Shareholdings in two recent merger cases: Dow/DuPont[7] and Bayer/Monsanto.[8] As a result of high levels of Common Shareholdings, the Commission concluded that the usual market share indicators (including the HHI Index) were likely to underestimate the level of market concentration, which would lead it to “underestimate the expected non-coordinated effects of the Transaction”.[9] The Commission’s analysis noted in particular that Common Shareholdings may reduce the likelihood of companies to invest in R&D efforts where this would harm the interests of competing firms held in the same institutional investor portfolio.[10] In addition, the Commission observed that passive investors “exert influence on individual firms with an industry-wide perspective”, and also that dispersed ownership exaggerates that influence.[11]

In 2018, Commission Vice-President Margrethe Vestager indicated that the Commission would be looking “carefully” at the prevalence of Common Shareholdings in the EU.[12] Consistent with this approach, the German Monopolies Commission also concluded in a lengthy report that institutional investors may have the means to influence certain of their portfolio companies’ decisions and recommended that the issue receive more attention at EU level.[13] In early 2019, the European Parliament’s Economic and Monetary Affairs Committee agreed to commission research to examine the prevalence of Common Shareholdings in the EU.

The Report’s findings

The Report sets out evidence on the presence and extent of Common Shareholdings across the EU and its possible anticompetitive effects, without putting forward any concrete policy proposals. Its main findings are as follows:

• More than two-thirds of all listed firms active in the EU (67%) are cross-held by Common Shareholdings of at least 5% in each company.
• Portfolios of Common Shareholdings continue to be especially large – in some cases including between 30% to 40% of active companies – in the electricity, financial instruments, telecommunications, and beverage sectors.
• Despite the wide presence of Common Shareholdings, a causal link with competitive outcomes is still challenging, not least because of the definition of the relevant market, the measurement of the Common Shareholding itself, the choice of an appropriate competition indicator (market dominance, concentration levels), or data availability at firm or product level.
• The Report introduces a detailed study of the beverages sector, concluding that a 2009 merger between two institutional investors may have had an effect on the margins of the beverage firms in their portfolios.
• Nonetheless, the Report stresses that more detailed analysis is needed in specific cases regarding the precise causal link between a given Common Shareholding and any actual impact on competition.

Takeaway

As was clear from the Commission’s Dow/DuPont and Bayer/Monsanto merger Decisions, Common Shareholdings are likely to become a more established element in the Commission’s scrutiny of mergers, particularly in concentrated markets.

Following the publication of the Report, in cases where it believes that market shares and other traditional analytical tools underestimate the effect of a concentration the Commission may be inclined to argue that a material impact on competition is more likely where a Common Shareholding is present. This could result in even more complex merger review procedures, potentially including a review of investment histories and strategies.

The Report shows, however, that there are no hard and fast theories of harm of Common Shareholdings. We are currently none the wiser as to whether the Commission will seek to build such an analysis into its existing “coordinated effects”[14] theories or as part of a broader analysis in so-called “gap” cases.[15] It is, therefore, unlikely that the Commission will rely solely on Common Shareholdings to veto a merger. Nonetheless, it is likely that the Commission will view Common Shareholding as an “element of context” capable of magnifying anticompetitive concerns raised by other elements of the investigation.

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[1] Full report available here. The Report was undertaken by the Finance & Economy Unit of the Commission’s Joint Research Centre at the request of the Commission’s Directorate-General for Competition, as part of a project reviewing “Possible anti-competitive effects of common ownership”.

[2] See OECD, ‘Common Ownership by Institutional Investors and its Impact on Competition’, Background Note by the Secretariat, 5-6 December 2017, p. 13, available at: https://one.oecd.org/document/DAF/COMP(2017)10/en/pdf.

[3] Common Shareholding Report, op. cit., at p. 2.

[4] OECD Background Note, op. cit., at p. 13.

[5] Jose Azar, Sahil Raina and Martin C Schmalz, ‘Ultimate Ownership and Bank Competition’, May 2019; Jose Azar, Martin C Schmalz and Isabel Tecu, ‘Anticompetitive Effects of Common Ownership’, Journal of Finance 28(4), 2018.

[6] FTC Hearing #8: Competition and Consumer Protection in the 21st Century, 6 December 2018, transcript available here.

[7] Case M.7932 Dow/DuPont.

[8] Case M.8084 Bayer/Monsanto.

[9] Case M.7932 Dow/DuPont, Annex 5, paras. 4 and 81; Case M.8084 Bayer/Monsanto, para. 229.

[10] Case M.7932 Dow/DuPont, Annex 5

[11] Case M.7932 Dow/DuPont, Annex 5, para. 7.

[12] Full speech accessible at: https://wayback.archive-it.org/12090/20191129215248/https://ec.europa.eu/commission/commissioners/2014-2019/vestager/announcements/competition-changing-times-0_en; see also https://globalcompetitionreview.com/dg-comp-looking-common-ownership-says-vestager.

[13] Full report available here.

[14] Coordinated effects occur where as a result of the merger, the merging parties and their competitors will successfully be able to coordinate their behaviour in an anti-competitive way, for example by tacit or explicit collusion.

[15] Mergers in oligopolistic markets which the Commission believes would significantly lessen competition without creating or strengthening a dominant position in the marketplace.

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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 Antitrust and Competition practice group or the following authors in Brussels:

Jens-Olrik Murach (+32 2 554 7240, [email protected])
David Wood (+32 2 554 7210, [email protected])
Peter Alexiadis (+32 2 554 7200, [email protected])

Antitrust and Competition Group in Europe:

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])

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])

© 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.

California’s housing shortage continues as the state grapples with the COVID-19 pandemic.  In an effort to mitigate delays in housing production throughout the state, California Governor Gavin Newsom recently signed into law Assembly Bill 1561 (“AB 1561”), which extends the validity of certain categories of residential development entitlements.  Devised as a remedy for impediments to housing development as a result of interruptions in planning, financing, and construction due to the pandemic, AB 1561 helps cities and counties that would otherwise need to devote significant resources to addressing individual permit extensions on a case-by-case basis.

AB 1561 adds a new section to the state’s Government Code, Section 65914.5, that extends the effectiveness of “housing entitlements” that were (a) issued and in effect prior to March 4, 2020 and (b) set to expire prior to December 31, 2021.  All such qualifying housing entitlements will now remain valid for an additional period of eighteen (18) months.

Section 65914.5 broadly defines a “housing entitlement” to include any of the following:

1. A legislative, adjudicative, administrative, or any other kind of approval, permit, or other entitlement necessary for, or pertaining to, a housing development project issued by a state agency;
2. An approval, permit, or other entitlement issued by a local agency for a housing development project that is subject to the Permit Streamlining Act (Cal. Gov. Code § 65920 et seq);
3. A ministerial approval, permit, or entitlement by a local agency required as a prerequisite to the issuance of a building permit for a housing development project;
4. Any requirement to submit an application for a building permit within a specified time period after the effective date of a housing entitlement described in numbers 1 and 2 above; and
5. A vested right associated with an approval, permit, or other entitlement described in numbers 1 through 4 above.

Notably, specifically excluded from the definition of a “housing entitlement” are: (a) development agreements authorized pursuant to California Government Code Section 65864; (b) approved or conditionally approved tentative maps which were previously extended for at least eighteen (18) months on or after March 4, 2020 pursuant to Government Code Section 66452.6; (c) preliminary applications under SB 330 (the Housing Crisis Act of 2019); and (d) applications for development approved under SB 35 (Cal. Gov. Code § 65913.4).

Further, housing entitlements which were previously granted an extension by any state or local agency on or after March 4, 2020, but before the effective date of AB 1561 (i.e. September 28, 2020), will not be further extended for an additional 18-month period so long as the initial extension period was for no less than eighteen (18) months.

The definition of a “housing development project” is broad and includes any of the following: (x) approved or conditionally approved tentative maps, vesting tentative maps, or tentative parcel maps for Subdivision Map Act compliance (Cal. Gov. Code § 66410 et seq); (y) residential developments; and (z) mixed-use developments in which at least two-thirds (2/3rds) of the square footage of the development is designated for residential use.  For purposes of calculating the square footage devoted to residential use within a mixed-use development, the calculation must include any additional density, floor area, and units, and any other concession, incentive, or waiver of development standards obtained under California’s Density Bonus Law (Cal. Gov. Code § 65915); however, the square footage need not include any underground space such as a basement or underground parking garage.

AB 1561 makes clear that while the extension provision of Section 65914.5 applies to all cities, including charter cities, local governments are not precluded from further granting extensions to existing entitlements.

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Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. For additional information, please contact any member of Gibson Dunn’s Real Estate or Land Use Group, or the following authors:

Doug Champion – Los Angeles (+1 213-229-7128, [email protected])
Amy Forbes – Los Angeles (+1 213-229-7151, [email protected])
Ben Saltsman – Los Angeles (+1 213-229-7480, [email protected])
Matthew Saria – Los Angeles (+1 213-229-7988, [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 widespread economic uncertainty caused by COVID-19 poses distinct challenges for buyers and sellers seeking to identify M&A opportunities, as companies evaluate the impact of the pandemic on their businesses to date, and seek to predict its future impact. Continued volatility in the financial markets and the lack of visibility into how the pandemic will affect the global economy in the near or longer term, as well as the pace and scope of economic recovery, introduce elements of conjecture into the valuation process. Securing financing for a transaction is also likely to be difficult, as traditional credit providers may be reluctant to lend, particularly to borrowers in sectors that have been more severely impacted by the crisis.

Buyers and sellers struggling with these challenges may find that stock-for-stock mergers offer an attractive option. Transactions based on stock consideration can enable the parties to sidestep some of the difficulties involved in agreeing on a cash price for a target, by instead focusing on the target’s and the buyer’s relative valuations. In addition, using stock as consideration allows buyers to conserve cash and increase closing certainty by eliminating the need to obtain financing to complete a transaction.

The extent and duration of COVID-19’s impact on M&A activity, and whether companies will trend toward stock-for-stock mergers in lieu of cash acquisitions, remains unclear. However, recent stock-for-stock deal announcements such as Analog Devices’s $21 billion acquisition of Maxim Integrated Products, Just Eat Takeaway’s $7.3 billion acquisition of Grubhub, Uber’s $2.65 billion acquisition of Postmates, Chevron’s $5 billion acquisition of Noble Energy, Clarivate plc’s $6.8 billion acquisition of CPA Global and Builders FirstSource’s $2.46 billion acquisition of BMC Stock Holdings suggest that companies may be more inclined to opt for stock-for-stock mergers against the backdrop of continued valuation and financing risks.

While stock-for-stock mergers may help parties address certain issues posed by the current climate, these transactions also raise concerns that do not arise in cash acquisitions. In particular, a company contemplating a stock-for-stock merger should consider the following:

Valuation issues. Setting the exchange ratio in a stock-for-stock merger requires the parties to determine their relative valuations, which, at first blush may seem easier than agreeing on a direct value for the target in a cash merger. However, stock-for-stock mergers do not eliminate difficult valuation issues, particularly if the parties are in different industries or at different stages of their development. The pandemic is likely to make valuation issues even more challenging if the parties have been impacted in dissimilar ways or levels of severity by the effects of COVID-19, or if the parties have different outlooks regarding the pace and scope of their respective recoveries.

The parties must also determine if a control premium is appropriate, and the size of any premium. A target will generally seek a premium to its current market value for a sale of control, and the demand for a premium may become more forceful if the target believes that its shares are undervalued due to general market or industry conditions. The buyer may resist this demand, arguing that the shares are not undervalued, and that in a stock-for-stock deal, unlike a cash deal, the target’s stockholders will have an ongoing equity stake in the combined company enabling them to benefit from any merger gains. In most cases, however, the buyer accepts the target’s arguments and agrees to build a premium into the exchange ratio.

Not every stock-for-stock transaction will include a premium, however. In a deal that the parties characterize as a merger of equals, the parties may agree that a premium will not be paid because neither party is acquiring control. They reason that the two companies’ respective stockholders should benefit pro rata from gains realized by the combined company, and set the exchange ratio so that it simply reflects the companies’ relative valuations.

Decisions regarding whether a premium is appropriate and the size of the premium will be carefully scrutinized by stockholders, activists and plaintiffs’ lawyers. As a result, the parties should be prepared to defend their deal based on the companies’ relative valuations, the prospects of the post-merger business and applicable factors impacting industry or stock market conditions generally.

Fixed vs floating exchange ratios. Stock-for-stock deals are structured using either a fixed exchange ratio or a floating exchange ratio. Fixed exchange ratios are based on the relative market values of the buyer and the target; floating exchange ratios are designed to ensure that target stockholders receive buyer shares with a specified dollar value. Floating exchange ratio deals do not present the same advantages as fixed exchange ratio deals in today’s environment. The parties cannot simply assess relative market values, but instead must determine a fixed value per target share, which is a difficult exercise when markets are volatile and forecasting future performance is difficult. But if the target successfully demands that its stockholders receive a specified price, the buyer may acquiesce, reasoning that a floating exchange ratio deal remains attractive because it can avoid using cash, reduce financing risk and increase closing certainty.

Collars and walk-away rights. Using stock consideration poses certain risks. When the exchange ratio floats, the buyer takes the risk that its stock price falls between signing and closing, forcing it to issue more shares at closing and diluting its existing stockholders; when the exchange ratio is fixed, the buyer takes the risk that its stock price rises between signing and closing and it overpays for the target. The target’s risks run in the opposite direction: it takes the risk that the buyer’s stock price falls between signing and closing when the exchange ratio is fixed, or that the buyer’s stock price rises between signing and closing when the exchange ratio floats, and, in each case, that its stockholders feel they have received insufficient value.

Pandemic-related market volatility and uncertainty about the pace of economic recovery may make parties more sensitive to the risks of using stock consideration. To address these risks, parties to a stock-for-stock merger may consider using mechanisms that were not commonly used before the pandemic: collars and/or walk-away rights based on stock price.

Collars provide a hedge against significant fluctuations in the buyer’s stock price between signing and closing by establishing upper and lower limits on the number of buyer shares and/or the value of the consideration that will be required to be delivered to target stockholders. A collar assures each party that the merger consideration and dilutive effect of the transaction will remain within negotiated parameters.

To further mitigate risk, the buyer and target may include a “walk-away” right for one or both of the parties if the value of the buyer’s stock drops below a designated threshold (walk-away rights are rarely triggered by increases in the buyer’s stock price). This right may be structured as either a closing condition or termination right (with or without associated termination fees). If the walk-away provisions are used together with a collar, the walk-away price may be set at, below or above the level of the collar’s “floor.” Like collars, the parties have broad flexibility to craft the walk-away provisions to achieve their desired results. For example, if the exchange ratio is fixed, the agreement may provide that if the buyer’s stock price falls below the negotiated threshold: the buyer may elect to “top-up” the consideration either through cash or shares, otherwise, the target can walk away, or that the target may choose to either walk away or require the buyer to issue more shares by flipping to a floating exchange ratio.[1]

Walk-away rights have not been used frequently in the past, in part, because a board of directors considering whether or not to exercise a walk-away right is in a difficult position. Issues a board must resolve include: should the board undertake a new analysis of the fairness of the transaction, including obtaining an updated fairness opinion? If the company’s stockholders have already approved the merger, how should this affect the answers to these questions? Board decisions regarding walk-away rights are likely to be subject to the same scrutiny, second-guessing and challenges as the board’s decision to approve the merger. If the board chooses not to exercise a walk-away right, and the merger ultimately turns out badly for the company’s stockholders, will the directors be sued? If the board does exercise a walk-away right and, in hindsight, it appears that the merger would have benefitted the company’s stockholders, will the directors be sued?

As noted above, collars and walk-away rights were not common pre-pandemic, and we have not noted a significant increase in their use in recent months. However, parties may consider using these somewhat unusual features in response to these highly unusual times.

Fiduciary duty issues for boards. The COVID-19 pandemic may place additional pressure on a board’s decision to approve a business combination (or to exercise a walk-away right). In Delaware, a stock-for-stock merger in which no single person or “group” will control the combined company is generally not subject to the value maximization imperative of a sale of control or to enhanced judicial scrutiny under Revlon Inc. v. MacAndrews & Forbes Holdings, Inc. If the target does not have a controlling stockholder, and a majority of its directors are disinterested, the decision to merge should be entitled to the protection of the business judgement rule. As a result, the directors should have broad discretion to approve a stock-for-stock merger that the board believes in good faith is in the best interests of the company and its stockholders.

Even if Revlon duties do not apply, the target board is likely to feel significant pressure to make the best deal possible under the circumstances. The board’s decision to combine is highly likely to be second-guessed under any circumstances, and even more so if the transaction is undertaken during a period of perceived overall economic risk. The board must assess whether it makes sense to combine at this time despite the current difficulty in projecting the companies’ respective future recovery, growth and prospects. Target stockholders may criticize the board for selling too low if the buyer is seen as taking advantage of the target’s falling stock price. If the company believes it has a solid plan for recovery, it must consider whether the company will be better off on a standalone basis, or if the combination will bolster its recovery. Before approving the merger, the board should be comfortable that it can defend its decision that the merger is in the company’s best interests.

Governance issues. Because target stockholders will have a stake in the combined company post-closing, the parties to a stock-for-stock merger are more likely to be sensitive to governance and social issues than they would be in a cash merger. The relevant issues include, among others, the composition of the combined company board and senior management team and the name of the combined company. Negotiations of these issues can be tricky, particularly in a deal that the parties consider a merger of equals, where there is likely to be even more intense focus on who serves in management roles at the combined company. The current economic crisis may raise the stakes riding on the outcome of the governance negotiations, particularly if the parties’ respective management teams have different strategies for dealing with the pandemic and its consequences. Enforcing post-closing agreements on these matters is also difficult. To address post-closing enforcement concerns, the parties may consider expressly including their agreement on governance matters in the combined company’s charter, to be effective as of the closing, and requiring supermajority board and/or stockholder approvals to amend the relevant charter provisions.

COVID-related deal terms. Deal negotiators should consider whether and how the merger agreement terms, such as representations, MAE definitions and post-signing covenants, should be revised as a result of the pandemic. Please refer to Gibson Dunn’s Client Alert entitled “M&A Amid the Coronavirus (COVID-19) Crisis: A Checklist”[2] for a detailed discussion of these issues. Most stock-for-stock transactions will contain certain reciprocal provisions, including representations and interim operating covenants. In considering whether to make COVID-specific revisions to these provisions, a party should either be prepared to accept the same terms for itself, or justify why reciprocity is not appropriate. Negotiations on these points may also be complicated by situations where the parties’ operating results and/or stock prices have not been similarly impacted by the crisis.

Diligence. The target’s diligence of the buyer in a cash merger is typically limited to assessing the buyer’s ability to perform its obligations under the transaction agreements. However, because the target’s stockholders will receive the buyer’s stock in a stock-for-stock merger, the target is more likely to comprehensively diligence the buyer. The mutual diligence effort in a stock-for-stock merger may lengthen the timeline, and increase the complexity and expense of the transaction.

Buyer Stockholder Approval. The buyer’s stockholders may be required to approve certain stock-for-stock mergers, e.g., if the buyer has to amend its charter to authorize the issuance of additional securities to be issued in the merger, if the buyer is one of the merging parties or if required by securities exchange listing rules because the transaction represents a change of control of the buyer or requires the issuance of securities representing twenty percent or more of the buyer’s outstanding common stock or voting power. The requirement to obtain buyer stockholder approval may reduce closing certainty, lengthen the timeline, and increase the complexity and expense of the transaction.

Mixed cash-stock deals. Some parties may consider mergers in which the consideration consists of a mix of cash and stock. While the use of stock may make it easier to finance and close the transaction, the use of stock will also introduce the valuation and other issues discussed in this Client Alert.

Scrutiny. As noted above, the parties to a business combination transaction undertaken in the current environment should expect the deal terms and business rationale to be placed under a microscope. As a result of the uneven M&A activity during the pandemic, every new deal that is announced receives significant attention. The parties should anticipate close scrutiny of the transaction, particularly by stockholder activists and plaintiffs’ firms, and develop their deal announcement and communications plans accordingly.

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[1]   The March 2020 merger agreement between Provident Financial Services, Inc. and SB One Bancorp provides a current example of a walk-away right. The agreement provides for a fixed exchange ratio. However, SB One may terminate the agreement if the value of Provident Financial’s stock drops (i) by over 20% between signing and the date the last regulatory approval for the transactions is obtained and (ii) by more than the drop in the average of the NASDAQ Bank Index closing prices over the same period less 20%. If SB One exercises this termination right, Provident Financial has the option to increase the merger consideration, in cash, by the amount necessary to cause either of these conditions not to be met. As a result, SB One stockholders are assured that the dollar value of the merger consideration they receive will not fall below a minimum amount.

[2]   Originally published March 18, 2020 and available at https://www.gibsondunn.com/ma-amid-the-corona-virus-covid-19-crisis-a-checklist/; updated version available at https://advance.lexis.com/api/permalink/930c7ac9-3d37-4ff9-82dd-39e19a994dce/?context=1000522.

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 outbreak. For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team.

Gibson Dunn’s lawyers regularly counsel strategic and private equity buyers and sellers on the legal issues raised by this pandemic in the M&A context. Please also feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Mergers and Acquisitions or Private Equity practice groups, or the authors:

Stephen I. Glover – Washington, D.C. (+1 202-955-8593, [email protected])

Eduardo Gallardo – New York, New York (+1 212.351.3847, [email protected])

Alisa Babitz – Washington, D.C. (+1 202-887-3720, [email protected])

Marina Szteinbok – New York, New York (+1 212-351-4075, [email protected])

Ann-Marie Harrelson – Washington, D.C. (+1 202-887-3683, [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.

Hong Kong Court Refused to Grant a Wholesale Recognition of Right to Marry for Same-Sex Couples

Two judgments were handed down by the Court of First Instance (CFI) of the High Court of Hong Kong on 18 September 2020 concerning two separate judicial review applications seeking to advance the equality of rights of members of the LGBT community. The CFI granted the relief sought concerning certain statutes on intestacy and inheritance in one of these two cases (please see our Client Alert “Hong Kong Case Update: Ng Hon Lam Edgar v Secretary for Justice”), but it rejected the declaratory relief seeking the recognition of same-sex marriage in Hong Kong generally in the case Sham Tsz Kit v Secretary for Justice [2020] HKCFI 2411 (Sham case), which judgment (Judgment) we will discuss in this Client Alert.

It appears that whilst the Hong Kong court is prepared to consider whether certain specific statute or policy of the government may constitute unlawful discrimination on the basis of sexual orientation, it is not prepared to grant a wholesale recognition to same-sex marriage under the laws of Hong Kong at this stage.

BACKGROUND

Mr Sham, a male Hong Kong permanent resident, and his same-sex partner got married in the United States in November 2013. The applicant submitted that they would have married in Hong Kong if the laws had allowed it. He contended that it was highly unfair and discriminatory against same-sex couples that the current Hong Kong law does not recognize same-sex marriage, thereby depriving same-sex couples of the rights and benefits currently enjoyed by opposite-sex couples.[1]

On 22 November 2018, he commenced a judicial review application to challenge the constitutionality of two statutory provisions, namely s 4 of the Marriage Ordinance (Cap 181) and s 20(1)(d) of the Matrimonial Causes Ordinance (Cap 179).[2]

Mr Sham put forward three alternative grounds of judicial review:

• Ground 1: the “exclusion of same-sex couples from the institution of marriage constitutes a violation of the right to equality” as protected under the Hong Kong Bill of Rights (BOR) and the Basic Law (BL).
• Ground 2: “the laws of Hong Kong, in so far as they do not allow same-sex couples to marry and fail to provide any alternative means of legal recognition of same-sex partnerships” constitute a violation of the right to privacy and the right to equality as protected by the BOR and/or the BL.
• Ground 3: “the laws of Hong Kong, in so far as they do not recognize foreign same-sex marriages, constitute a violation of the right to equality” as protected under the BOR and the BL.[3]

Since another case, MK v Government of the HKSAR [2019] 5 HKLRD 259 (MK case), raised the same or similar issues under Grounds 1 and 2, the court stayed the proceedings of the Sham case pending the determination of the MK case.

On 18 October 2019, the court dismissed the judicial review made in the MK case, which effectively ruled against Grounds 1 and 2, holding that:

• It is not a violation of any constitutional rights for same-sex couples to be denied the right of marriage under the laws of Hong Kong.
• The government is subject to no positive legal obligation to provide an alternative legal framework giving same-sex married couples the same rights and benefits enjoyed by opposite-sex married couples.[4]

In view of the determination of the MK case, the court lifted the stay of proceedings in the Sham case in so far as it applies to Ground 3 on 22 November 2019. It was argued in support of Ground 3 in the trial that, the recognition by the laws of Hong Kong of foreign opposite-sex marriages but not foreign same-sex marriages constitutes differential treatment on the prohibited ground of sexual orientation, and the differential treatment is not justified as it does not pass the four-step justification test.[5]

THE DECISION

In determining the Sham case, the CFI adopted the two-stage approach endorsed by the Court of Final Appeal (CFA) of Hong Kong in two recent decisions, Leung Chun Kwong v Secretary for Civil Service (2019) 22 HKCFAR 127 (Leung case) and QT v Director of Immigration (2018) 21 HKCFAR 324 (QT case). Please see our Client Alert “Hong Kong Case Update: Ng Hon Lam Edgar v Secretary for Justice” for an explanation of the two-stage approach.

The CFI held that:

• Whether foreign opposite-sex marriages and foreign same-sex marriages are relevant comparators depends on the subject matter being considered and the relevant context. It cannot be said in a vacuum, and there is no general rule, that the two groups of persons in foreign opposite-sex marriages and foreign same-sex marriages are in an analogous or a comparable position.[6]
• Similarly, whether any differential treatment is based on a prohibited ground and whether such differential treatment (if any) can be justified upon an analysis through the four-step justification test depends on specific facts and context.[7]

The CFI therefore rejected the general declaration sought that the non-recognition of foreign same-sex marriages under Hong Kong law violates the constitutional right to equality. Upon the invitation of the applicant’s Counsel, (so as to allow any appeal to be pursued on all grounds in one-go), the CFI also lifted the stay of proceedings in so far as it relates to Grounds 1 and 2 of the judicial review and dismissed them for the reasons given in the MK case.[8]

COMMENT

As with the decision made the MK case (which followed, inter alia, the CFA decisions in the Leung case and the QT case), the CFI endorsed in the Sham case that whilst the right to marriage of opposite-sex couples is protected by the constitution, no such protection is accorded to same-sex couples. Same-sex marriages remain invalid marriages in Hong Kong as the law stands now.

It is apparent that the Hong Kong court is open to consider challenges against specific legislation, or policies or decisions of the government or other public bodies on the ground of unlawful discrimination based on sexual orientation.[9] In fact, the CFI pointed out in the Judgment, some specific government policies and/or statutes may be held unconstitutional upon challenge.[10] However, the court is not prepared to grant a general declaration to the effect that same-sex marriages have the same legal recognition as opposite-sex marriages regardless of the subject matter under consideration and the relevant context.[11]

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   [1]   §§ 4-6, the Judgment.

   [2]   § 7, the Judgment.

s 40 of the Marriage Ordinance (Cap 181) states that “(1) Every marriage under this Ordinance shall be a Christian marriage or the civil equivalent of a Christian marriage. (2) The expression Christian marriage or the civil equivalent of a Christian marriage (基督敎婚禮或相等的世俗婚禮) implies a formal ceremony recognized by the law as involving the voluntary union for life of one man and one woman to the exclusion of all others.”

s 20(1)(d) of the Matrimonial Causes Ordinance (Cap 179) provides that “A marriage which takes place after 30 June 1972 shall be void on any of the following grounds only – (d)     that the parties are not respectively male and female.”

   [3]   § 8, the Judgment.

   [4]   § 10, the Judgment.

   [5]   §§ 11 and 12, the Judgment. Please see our Client Alert “Hong Kong Case Update: Ng Hon Lam Edgar v Secretary for Justice” for an explanation of the four-step justification test.

   [6]   §§ 21 and 22, the Judgment.

   [7]   §§ 23 to 25, the Judgment.

   [8]   §§ 27 and 28, the Judgment.

   [9]   See § 57 of the judgment of the MK case.

   [10]   § 26, the Judgment.

   [11]   § 26, the Judgment.

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

Brian Gilchrist (+852 2214 3820, [email protected])

Elaine Chen (+852 2214 3821, [email protected])

Alex Wong (+852 2214 3822, [email protected])

Celine Leung (+852 2214 3823, [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.

With talk about a second Coronavirus wave gathering pace, the German Ministry of Justice and Consumer Protection (Bundesministerium der Justiz und für Verbraucherschutz) is proposing to extend the temporary COVID-19-related legislation of March 2020 significantly simplifying the passing of shareholders’ resolution, including, in particular, the possibility to hold virtual-only shareholders’ meetings. The extension is proposed in unchanged form for another year until the end of 2021. A respective draft regulation has been published at short notice on 18 September 2020 and stakeholders are invited to submit their comments until 25 September 2020.

While the legislation of March 2020 was well received in the rise of the COVID-19 crisis the reactions to an extension were mixed so far. Criticism focuses on the significant restrictions of shareholders’ rights by this legislation (e.g. no right to ask questions or to counter-motions in real time, wide discretion of the management with respect to answering submitted questions, only limited appeal right etc.). This was raised not only by shareholders’ activists but also by various parliament members including prominent experts of the ruling coalition.

In the reasons of the draft regulation, the ministry strongly emphasizes that companies should only hold virtual-only meetings if actually required in the individual circumstances due to the pandemic. In addition, the ministry encourages the corporations in question to handle the Q&A process as shareholder-friendly as technically possible, including allowing for questions in real- time, if they decide to hold a virtual meeting.

The time window to debate the proposal is extremely short. The new shareholders’ meeting season is already approaching quickly, starting as early as in January/February 2021 for companies with business years ending on 30 September 2020. While the Ministry of Justice and Consumer Protection is authorized to extend the period of application of the legislation for another year without any modifications, modifications in substance would require the involvement of parliament and are thus deemed rather unlikely. If the proposal is adopted, it would be up to the corporations themselves to take the ministry’s appeal seriously and to make use of the virtual format in a responsible and shareholder-friendly manner.

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The following Gibson Dunn lawyers have prepared this client update: Ferdinand Fromholzer, Silke Beiter, Johanna Hauser.

Gibson Dunn’s lawyers in the two German offices in Munich and Frankfurt are available to assist you in addressing any questions you may have regarding the issues discussed in this update.

For further information, please feel free to contact the Gibson Dunn lawyer with whom you usually work, or the three authors:

Ferdinand Fromholzer (+49 89 189 33 170, [email protected])
Silke Beiter (+49 89 189 33 170, [email protected])
Johanna Hauser (+49 89 189 33 170, [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.