On August 20, 2021, the Standing Committee of China’s National People’s Congress passed the Personal Information Protection Law (“PIPL”), which will take effect on November 1, 2021. We previously reported on this development here, when the law was in draft form. An unofficial translation of the newly enacted PIPL is available here and the Mandarin version of the PIPL is available here.[1]
The PIPL applies to “personal information processing entities (“PIPEs”),” defined as “an organisation or individual that independently determines the purposes and means for processing of personal information.” (Article 73). The PIPL defines “personal information” broadly as “various types of electronic or otherwise recorded information relating to an identified or identifiable natural person,” excluding anonymized information, and defines “processing” as “the collection, storage, use, refining, transmission, provision, public disclosure or deletion of personal information.” (Article 4).
The PIPL shares many similarities with the EU’s General Data Protection Regulation (the “GDPR”), including its extraterritorial reach, restrictions on data transfer, compliance obligations and sanctions for non-compliance, amongst others. The PIPL raises some concerns for companies that conduct business in China, even where such companies’ data processing activities take place outside of China, and the consequences for failing to comply could potentially include monetary penalties and companies being placed on a government blacklist.
Below, we describe the companies subject to the PIPL, key features of the PIPL, and highlight critical issues for companies operating in China in light of this important legislative development.
I. Which Companies are Subject to PIPL?
- The PIPL applies to cross-border transmission of personal information and applies extraterritorially. Where PIPEs transmit personal information to entities outside China, they must inform the data subjects of the transfer, obtain their specific consent to the transfer, and ensure that the data recipients satisfy standards of personal information protection similar to those in the PIPL.The PIPL applies to organisations operating in China, as well as to foreign organisations and individuals processing personal information outside China in any one of the following circumstances: (1) the organisation collects and processes personal data for the purpose of providing products or services to natural persons in China; (2) the data will be used in analysing and evaluating the behaviour of natural persons in China; or (3) under other unspecified “circumstances stipulated by laws and administrative regulations” (Article 3). This is an important similarity between the PIPL and GDPR, as the GDPR’s data protection obligations apply to non-EU data controllers and processors that track, analyze and handle data from visitors within the EU. Similarly, under the PIPL, a foreign receiving party must comply with the PIPL’s standard of personal information protection if it handles personal information from natural persons located in China.
- The PIPL gives the Chinese government broad authority in processing personal information. State organisations may process personal information to fulfil statutory duties, but may not process the data in a way that exceeds the scope necessary to fulfil these statutory duties (Article 34). Personal information processed by state organisations must be stored within China (Article 36).
II. Key Features of PIPL
- The PIPL establishes guiding principles on protection of personal information. According to the PIPL, processing of personal information should have a “clear and reasonable purpose” and should be directly related to that purpose (Article 6). The PIPL requires that the collection of personal information be minimized and not excessive (Article 6), and requires PIPEs to ensure the security of personal information (Articles 8-9). To that end, the PIPL imposes a number of compliance obligations on PIPEs, including requiring PIPEs to establish policies and procedures on personal information protection, implement technological solutions to ensure data security, and carry out risk assessments prior to engaging in certain processing activities (Articles 51 – 59).
- The PIPL adopts a risk-based approach, imposing heightened compliance obligations in specified high-risk scenarios. For instance, PIPEs whose processing volume exceeds a yet-to-be-specified threshold must designate a personal information protection officer responsible for supervising the processing of personal data (Article 52). PIPEs operating “internet platforms” that have a “very large” number of users must engage an external, independent entity to monitor compliance with personal information protection obligations, and regularly publish “social responsibility reports” on the status of their personal information protection efforts (Article 58).The law mandates additional protections for “sensitive personal information,” broadly defined as personal information that, once disclosed or used in an illegal manner, could infringe on the personal dignity of natural persons or harm persons or property (Article 28). “Sensitive personal information” includes biometrics, religious information, special status, medical information, financial account, location information, and personal information of minors under the age of 14 (Article 28). When processing “sensitive personal information,” according to the PIPL, PIPEs must only use information necessary to achieve the specified purpose of the collection, adopt strict protective measures, and obtain the data subjects’ specific consent (Article 28-29).
- The PIPL creates legal rights for data subjects. According to the new law, PIPEs may process personal information only after obtaining fully informed consent in a voluntary and explicit statement, although the law does not provide additional details regarding the required format of this consent. The law also sets forth certain situations where obtaining consent is unnecessary, including where necessary to fulfil statutory duties and responsibilities or statutory obligations, or when handling personal information within a reasonable scope to implement news reporting, public opinion supervision and other such activities for the public interest (Articles 13-14, 17). Where consent is required, PIPEs should obtain a new consent where it changes the purpose or method of personal information processing after the initial collection (Article 14). The law also requires PIPEs to provide a convenient way for individuals to withdraw their consent (Article 15), and mandates that PIPEs keep the personal information only for the shortest period of time necessary to achieve the original purpose of the collection (Article 19).If PIPEs use computer algorithms to engage in “automated decision making” based on individuals’ data, the PIPEs are required to be transparent and fair in the decision making, and are prohibited from using automated decision making to engaging in “unreasonably discriminatory” pricing practices (Article 24, 73). “Automated decision-making” is defined as the activity of using computer programs to automatically analyze or assess personal behaviours, habits, interests, or hobbies, or financial, health, credit, or other status, and make decisions based thereupon (Article 73(2)).When individuals’ rights are significantly impacted by PIPEs’ automated decision making, individuals can demand PIPEs to explain the decision making and decline automated decision making (Article 24).
III. Potential Issues for Companies Operating in China
The passage of the PIPL and the uncertainty surrounding many aspects of the law creates a number of potential issues and concerns for companies operating in China. These include the following:
- Foreign organisations may be subject to the PIPL’s regulatory requirements. The PIPL applies to data processing activities, even where those activities take place outside of China, provided they are carried out for the purpose of conducting business in China or evaluating individuals’ behavior in the country. The law is currently silent on how close the nexus must be between the data processing and Chinese business activities. The law also mandates that data processing activities taking place outside of China are subject to the PIPL under “other circumstances stipulated by laws and administrative regulations.” At present there is no guidance as to what these circumstances will be.Foreign organisations subject to the PIPL will need to comply with requirements including security assessments, assigning local representatives to oversee data processing, and reporting to supervisory agencies in China, though the exact parameters of these requirements remain unclear (Articles 51–58).
- The PIPL creates penalties for organisations that fail to fulfil their obligations to protect personal information (Article 66). These penalties include disgorgement of profits and provisional suspension or termination of electronic applications used by PIPEs to conduct the unlawful collection or processing. Companies and individuals may be subject to a fine of not more than 1 million RMB (approximately $154,378.20) where they fail to remediate conduct found to be in violation of the PIPL, with responsible individuals subject to fines of 10,000 to 100,000 RMB (approximately $1,543.81 to $15,438.05).Companies and responsible individuals face particularly stringent penalties where the violations are “grave,” a term left undefined in the statute. In these cases, the PIPL allows for fines of up to 50 million RMB (approximately $7,719,027.00) or 5% of annual revenue, although the PIPL does not specify which parameter serves as the upper limit for the fines. Authorities may also suspend the offending business activities, stop all business activities entirely, or cancel all administrative or business licenses. Individuals responsible for “grave” violations may be fined between 100,000 and 1 million RMB (approximately $15,438.29 to $154,382.93), and may also be prohibited from holding certain job titles, including Director, Supervisor, high-level Manager or Personal Information Protection Officer, for a period of time. In contrast, fines for severe violations of the GDPR can be up to €20 million (approximately $23,486,300.00) or up to 4% of the undertaking’s total global turnover of the preceding fiscal year (whichever is higher).
- Foreign organisations may also be subject to consequences under the PIPL for violating Chinese citizens’ personal information rights or harming China’s national security or public interest. The state cybersecurity and informatization department may place offending organisations on a blacklist, resulting in restrictions on receiving personal information for blacklisted entities (Article 42). The PIPL does not provide clarity on what constitutes a violation of Chinese citizens’ personal information rights or what qualifies as harming China’s national security or public interest.
Companies operating in China should pay particular attention to the cross-border data transfer issues raised by the PIPL:
- Foreign organisations will need to disclose certain information when transferring personal information outside of China’s borders. Under the PIPL, PIPEs must obtain the data subject’s consent prior to transfer, although the required form and method of that consent is not clear (Article 39). Entities seeking to transfer data must also provide the data subject with information about the foreign recipient, including its name, contact details, purpose and method of the data processing, the categories of personal information provided and a description of the data subject’s rights under the PIPL (Article 39).
- Certain companies may need to undergo a government security assessment prior to cross-border data transfers. In addition to the consent and disclose requirements under Article 39, “critical information infrastructure operators” and PIPEs processing personal information in quantities exceeding government limits must pass a government security assessment prior to transferring data outside of China (Article 40). The term “critical information infrastructure operator” is not further defined within the PIPL, the term is, however, broadly defined within the newly passed Regulations on the Security and Protection of Critical Information Infrastructure (the “Regulations on Critical Information Infrastructure”), which come into effect on September 1, 2021 (the Mandarin version is available here). Under Article 2 of the Regulations on Critical Information Infrastructure, a “critical information infrastructure operator” is a company engaged in important industries or fields, including public communication and information services, energy, transport, water, finance, public services, e-government services, national defense and any other important network facilities or information systems that may seriously harm national security, the national economy and people’s livelihoods, or public interest in the event of incapacitation, damage or data leaks.The PIPL also does not specify the data thresholds beyond the quantities provided by the state cybersecurity and information department or the nature of the security assessment, nor does it reference any specific legislation issued by the state cybersecurity and informatization department for purposes of determining such data thresholds (Article 40).
- PIPEs outside China that conduct personal data processing activities for the purpose of conducting business in China or evaluating individuals’ behaviour in the country must establish an entity or appoint an individual within China to be responsible for personal information issues. Such foreign organisations must report the name of the relevant entity or the representative’s name and contact method to the departments fulfilling personal information protection duties, although the PIPL does not specify or name to which departments foreign organisations must report in such instances (Article 53).
- Companies and individuals may not provide personal information stored within China to foreign judicial or enforcement agencies, without prior approval of the Chinese government. As summarized in our prior client alert, the PIPL adds to a growing list of laws that restrict the provision of data to foreign judiciaries and government agencies, which could have a far-reaching impact on cross-border litigation and investigations. Chinese authorities will process requests from foreign judicial or enforcement agencies for personal information stored within China in accordance with applicable international treaties or the principle of equality and reciprocity (Article 41). The PIPL does not provide any guidance on how a company should seek approval if it wishes to export personal data in response to a request from a foreign government agency or a foreign court.
IV. Next Steps
The passage of the PIPL comes during a time where China has increased its regulatory scrutiny on technology companies and other entities with large troves of sensitive public information, and their data usage. Given the broad scope of the PIPL and its extraterritorial reach, organisations inside and outside of China will need to review their data protection and transfer strategies to ensure they do not run afoul of this network of legislation.
Even for companies that currently have GDPR compliance programs in place, the PIPL introduces new requirements not currently required under the GDPR. Examples of such requirements unique to the PIPL include, amongst others, establishing a legal entity within China and passing a security review prior to exporting personal data that reaches a certain undisclosed threshold. How the government enforces the statute and interprets its provisions remain to be seen, and a PIPL compliance program will likely require a nuanced understanding of Chinese cultural and business practices.
Companies operating in China should pay close attention to regulations, guidance documents and enforcement actions related to the PIPL as the Chinese government continues to bolster its data protection legal infrastructure, and seek guidance from knowledgeable counsel.
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[1] Please note that the discussion of Chinese law in this publication is advisory only.
This alert was prepared by Connell O’Neill, Kelly Austin, Oliver Welch, Ning Ning, Felicia Chen, and Jocelyn Shih.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Privacy, Cybersecurity and Data Innovation practice group, or the following authors:
Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com)
Connell O’Neill – Hong Kong (+852 2214 3812, coneill@gibsondunn.com)
Oliver D. Welch – Hong Kong (+852 2214 3716, owelch@gibsondunn.com)
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This edition of Gibson Dunn’s Federal Circuit Update summarizes new petitions for certiorari in cases originating in the Federal Circuit concerning the Patent Trial and Appeal Board’s NHK-Fintiv Rule. This Update also discusses recent Federal Circuit decisions. Notably, starting with the September 2021 court sitting, the court has now resumed in-person arguments.
Federal Circuit News
Supreme Court:
The Court did not add any new cases originating at the Federal Circuit.
Noteworthy Petitions for a Writ of Certiorari:
There are two new certiorari petitions currently before the Supreme Court concerning the Patent Trial and Appeal Board’s NHK-Fintiv Rule, under which the Board may deny institution of inter partes review proceedings when the challenged patent is subject to pending district court litigation.
- Apple Inc. v. Optis Cellular Technology, LLC (U.S. No. 21-118): “Whether the U.S. Court of Appeals for the Federal Circuit may review, by appeal or mandamus, a decision of the U.S. Patent & Trademark Office denying a petition for inter partes review of a patent, where review is sought on the grounds that the denial rested on an agency rule that exceeds the PTO’s authority under the Leahy-Smith America Invents Act, is arbitrary or capricious, or was adopted without required notice-and-comment rulemaking.”
- Mylan Laboratories Ltd. v. Janssen Pharmaceuticals, N.V. (U.S. No. 21-202): “Does 35 U.S.C. § 314(d) categorically preclude appeal of all decisions not to institute inter partes review?” 2. “Is the NHK-Fintiv Rule substantively and procedurally unlawful?”
The following petitions are still pending:
- Biogen MA Inc. v. EMD Serono, Inc. (U.S. No. 20-1604) concerning anticipation of method-of-treatment patent claims. Gibson Dunn partner Mark A. Perry is counsel for the respondent.
- American Axle & Manufacturing, Inc. v. Neapco Holdings LLC (U.S. No. 20-891) concerning patent eligibility under 35 U.S.C. § 101, in which the Court has invited the Solicitor General to file a brief expressing the views of the United States.
- PersonalWeb Technologies, LLC v. Patreon, Inc. (U.S. No. 20-1394) concerning the Kessler doctrine.
Upcoming Oral Argument Calendar
The court has now resumed in-person arguments for the September 2021 court sitting.
The list of upcoming arguments at the Federal Circuit is available on the court’s website.
Live streaming audio is available on the Federal Circuit’s new YouTube channel. Connection information is posted on the court’s website.
Key Case Summaries (August 2021)
Qualcomm Incorporated v. Intel Corporation (Fed. Cir. No. 20-1589): Intel petitioned for six inter partes reviews (IPRs) challenging the validity of a patent owned by Qualcomm. During the IPRs, neither party disputed that the challenged claims required signals that increased user bandwidth. The PTAB, however, construed the claims in a way that omitted any requirement that the signals increase bandwidth. Qualcomm appealed the PTAB’s decision and argued that it was not afforded notice and an opportunity to respond to the PTAB’s construction.
The Federal Circuit (Moore, C.J., joined by Reyna, J. and Stoll, J.) vacated and remanded the PTAB’s decisions. Although the PTAB may adopt a different construction from a disputed, proposed construction, the court held that the Board may not adopt a claim construction that diverges from an agreed-upon requirement for a term. Because neither party could have anticipated the PTAB’s deviation, especially where the International Trade Commission had adopted the increased bandwidth requirement, the court held that the Board needed to provide notice and an adequate opportunity to respond. Because all briefing included the increased bandwidth requirement, the court rejected Intel’s argument that Qualcomm was not prejudiced. The court also found that a single question relating to the bandwidth requirement at the PTAB hearing did not provide adequate notice. Finally, the court found that the ability to seek rehearing from the PTAB’s decision was not a substitute for notice and an adequate opportunity to respond.
Personal Web Technologies LLC v. Google LLC (Fed. Cir. No. 20-1543): PersonalWeb sued Google and YouTube (collectively, “Google”) in the Eastern District of Texas, asserting three related patents directed to data-processing systems. After the cases were transferred to the Northern District of California, that district court granted Google’s motion for judgment on the pleadings that the asserted claims were ineligible under 35 U.S.C. § 101.
The panel (Prost, J., joined by Lourie and Reyna, J.J.) affirmed. At step one, the panel agreed with the district court that the asserted claims are directed to a three-step process: “(1) using a content-based identifier generated from a ‘hash or message digest function,’ (2) comparing that content-based identifier against something else, [that is,] another content-based identifier or a request for data; and (3) providing access to, denying access to, or deleting data.” The panel held that this claimed process amounted to the abstract idea of using “an algorithm-generated content-based identifier to perform the claimed data-management functions.” The panel explained that these functions are ineligible mental processes. Pointing to its prior cases, the panel explained that each of the three functions—generating, comparing, and using content-based identifiers to manage data—are concepts the Federal Circuit previously described as abstract. At step two, the Court concluded that the alleged inventive concept—“making inventive use of cryptographic hashes”—is simply a restatement of the abstract idea itself. The panel agreed with the district court that “using a generic hash function, a server system, or a computer does not render these claims non-abstract,” and explained that each of the supposed improvement disclosed in the specification was likewise abstract.
GlaxoSmithKlein LLC v. Teva Pharmaceuticals USA, Inc. (Fed. Cir. No. 18-1976): GlaxoSmithKline (“GSK”) sued Teva in the District of Delaware. After a jury returned a verdict of induced infringement against Teva, the district court granted Teva’s renewed JMOL, holding that Teva could not induce infringement with its “skinny label” because that label carved out the patented use of carvedilol. The district court also held that GSK had failed to prove that Teva caused inducement because it did not show that it was Teva’s actions that actually caused doctors to directly infringe by prescribing generic carvedilol to treat CHF.
The panel majority (Moore, C.J., and Newman, J.) vacated the grant of the JMOL and reinstated the jury’s verdict of induced infringement, with Judge Prost dissenting. Teva petitioned for rehearing, which the panel granted. The panel issued a new decision, in which the same majority once more reinstated the jury’s verdict of induced infringement against Teva. The majority held that whether a carve-out indication instructs a patented use is a question of fact. Considering the evidence in the record, the majority concluded that substantial evidence supported the jury’s determination that Teva induced infringement by not effecting a section viii carve-out because Teva advertised its drug as a generic equivalent and thereby actively encouraged a patented therapeutic use. The majority warned that this was a decision based on a “narrow, case-specific review of substantial evidence,” and agreed with amici that a “generics could not be held liable for merely marketing and selling under a ‘skinny’ label omitting all patented indications, or for merely noting (without mentioning any infringing uses) that FDA had rated a product as therapeutically equivalent to a brand-name drug.”
Judge Prost dissented again, arguing that the majority’s decision weakens the section viii carve-out by creating confusion for generic companies as to when they may face liability. Judge Prost pointed out that GSK expressly told the FDA that only one use was patented, and so Teva carved out that use. Judge Prost also argued that the majority’s decision changes the law of inducement by blurring the line between merely describing an infringing use and actually encouraging, recommending, or promoting an infringing use. Judge Prost explained that unlike direct infringement, induced infringement requires a showing of intent, and argued that no such intent by Teva could be shown because by carving out the patented use, it was actually taking steps to avoid infringement.
Andra Group, LP v. Victoria’s Secret Stores, LLC (Fed. Cir. No. 20-2009): Andra Group sued several related Victoria’s Secret entities in the Eastern District of Texas. Three entities (“Non-Store Defendants”)—corporate parent L Brands, Inc., Victoria’s Secret Direct Brand Management, LLC, and Victoria’s Secret Stores Brand Management, Inc.—do not have any employees, stores, or any other physical presence in the Eastern District of Texas. The fourth entity (“Store Defendant”) operates retail stores in the Eastern District of Texas. The Non-Store Defendants moved to dismiss the infringement suit for improper venue, and the district court granted the motion. Andra Group appealed.
The Federal Circuit (Hughes, J., joined by Reyna, J. and Mayer, J.) affirmed. The court held that the Store Defendant’s retail stores were not a regular and established place of business of the Non-Store Defendants. The court noted that the evidence showed that the Non-Store Defendants did not have the right to direct or control the Store Defendant’s employees. The court also found that the Store Defendant’s acceptance of returns for merchandise purchased on the website (which was run by a Non-Store Defendant) was a discrete task insufficient to establish an agency relationship. The court also rejected Andra’s argument that the Non-Store Defendants ratified the Store Defendant’s retail stores as their own place of business. The court held that a defendant must actually engage in business from that location and simply advertising a place of business is not sufficient to make it a place of business.
Omni MedSci, Inc. v. Apple Inc. (Fed. Cir. No. 20-1715): In a patent infringement suit brought by Omni against Apple, Apple filed a motion to dismiss for lack of standing. Apple contended that the asserted patents were not owned by Omni, but by University of Michigan (“UM”). Dr. Islam, the named inventor, was employed by UM and had signed an employment agreement that stated, inter alia, that intellectual property developed using university resources “shall be the property of the University.” Dr. Islam took a leave of absence during which he filed multiple provisional patent applications, which ultimately issued as the asserted patents. Dr. Islam then assigned these patents to Omni. The district court determined that the provision in Dr. Islam’s employment agreement “was not a present automatic assignment of title, but, at most, a statement of a future intention to assign.” Apple requested the district court grant certification of the standing question to the Federal Circuit, which was granted.
The majority (Linn, J., joined by Chen, J.) affirmed, and agreed that Dr. Islam’s employment agreement did not constitute a present automatic assignment or a promise to assign in the future. The majority found that the agreement did not include language such as “will assign” or “agrees to grant and does hereby grant,” which have been previously held to constitute a present automatic assignment of a future interest. At most, UM’s agreement with phrases such as “shall be the property of the University” and “shall be owned as agreed upon in writing,” was a promise of a potential future assignment, not as a present automatic transfer. The majority also found a lack of present tense words of execution, such as “hereby grants and assigns,” supported its interpretation.
Judge Newman dissented. She reasoned that because the employment agreement necessarily applies only to future inventions, in which future tense is used, the future tense “shall be the property of the University” is appropriate, and should have vested ownership of the patents in the University. Thus, she concluded that Omni did not have standing to bring the infringement suit.
Campbell Soup Company v. Gamon Plus, Inc. (Fed. Cir. No. 20-2344): Gamon sued Campbell Soup and Trinity Manufacturing (together, “Campbell”) for infringing two design patents, the commercial embodiment of which was called the iQ Maximizer. Campbell petitioned for inter partes review on the grounds that Gamon’s patents would have been obvious over another design patent (“Linz”). The Patent Trial and Appeal Board concluded that Campbell failed to prove unpatentability based on Linz, reasoning that although Linz had the same overall visual appearance as the claimed designs, it was outweighed by objective indicia of nonobviousness. The Board presumed a nexus between those objective indicia and the claimed designs because it found that the iQ Maximizer was coextensive with the claims.
Campbell appealed, and the Federal Circuit (Moore, C.J., Prost and Stoll, JJ.) reversed. The Court held that substantial evidence supported the Board’s finding that Linz creates “the same overall visual appearance as the claimed design[s].” However, under the next step of the design patent obviousness analysis, the Court held that the Board failed to answer the question of “whether unclaimed features are ‘insignificant,’” and that “[u]nder the correct legal standard, substantial evidence does not support the Board’s finding of coextensiveness.” The Court wrote, “We do not go so far as to hold that the presumption of nexus can never apply in design patent cases. It is, however, hard to envision a commercial product that lacks any significant functional features such that it could be coextensive with a design patent claim.” Finally, the Court held that Gamon failed to show that the objective indicia are the “direct result of the unique characteristics of the claimed invention,” because, for example, characteristics of the iQ Maximizer that led to commercial success “were not new.”
Venue in the Western District of Texas:
In re: Hulu, LLC (Fed. Cir. No. 21-142): The panel (Taranto, Hughes, and Stoll, JJ.) granted Hulu’s petition, holding that Judge Albright clearly abused his discretion in evaluating Hulu’s transfer motion and denying transfer. In particular, the panel held that the district court at least erred in its analysis for each factor that it found weighed against transfer: (1) the availability of compulsory process to secure the attendance of witnesses; (2) the cost of attendance for willing witnesses; and (3) the administrative difficulties flowing from court congestion.
In re: Google LLC (Fed. Cir. No. 21-144): The panel (O’Malley, Reyna, and Chen, JJ.) denied Google’s petition because it did not “ma[k]e a clear and indisputable showing that transfer was required.” The district court had found that one or more Google employees in Austin, Texas were potential witnesses, and the panel was “not prepared on mandamus to disturb those factual findings.”
In re: Apple Inc. (Fed. Cir. No. 21-147): The panel (Reyna, Chen, and Stoll, JJ.) denied Apple’s petition because Apple did not show entitlement to the “extraordinary relief.” The panel did not, however, find that the district court’s analysis was free of error. For example, the panel explained, the district court “improperly diminished the importance of the convenience of witnesses merely because they were employees of the parties.”
In re: Dish Network L.L.C. (Fed. Cir. No. 21-148): The panel (O’Malley, Reyna, and Chen, JJ.) denied Dish’s petition but held that it “do[es] not view issuance of mandamus as needed here because” the panel was “confident the district court will reconsider its determination in light of the appropriate legal standard and precedent on its own.” The panel explained that, in light of In re Apple Inc., 979 F.3d 1332 (Fed. Cir. 2020), the district court erred in relying on Dish’s general presence in Western Texas without tying that presence to the events underlying the suit. The panel also explained that “[t]he need for reconsideration here” is additionally confirmed by In re Samsung Electronics Co., 2 F.4th 1371 (Fed. Cir. 2021), because the district court here improperly diminished the convenience of witnesses in the transferee venue because of their party status and by presuming they were unlikely to testify despite the lack of relevant witnesses in the transferor venue.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Federal Circuit. Please contact the Gibson Dunn lawyer with whom you usually work or the authors of this alert:
Blaine H. Evanson – Orange County (+1 949-451-3805, bevanson@gibsondunn.com)
Jessica A. Hudak – Orange County (+1 949-451-3837, jhudak@gibsondunn.com)
Please also feel free to contact any of the following practice group co-chairs or any member of the firm’s Appellate and Constitutional Law or Intellectual Property practice groups:
Appellate and Constitutional Law Group:
Allyson N. Ho – Dallas (+1 214-698-3233, aho@gibsondunn.com)
Mark A. Perry – Washington, D.C. (+1 202-887-3667, mperry@gibsondunn.com)
Intellectual Property Group:
Kate Dominguez – New York (+1 212-351-2338, kdominguez@gibsondunn.com)
Y. Ernest Hsin – San Francisco (+1 415-393-8224, ehsin@gibsondunn.com)
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© 2021 Gibson, Dunn & Crutcher LLP
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This week the UK Government published yet more updates on the application of the new National Security and Investment Act 2021 (NSI Act), which will come into effect on 4 January 2022.
Now seemed like a good time to take stock of all of the developments and guidance to date and to provide a helpful overview of the new regime, with all of the draft legislation and guidance in one place.
The big question is, what do companies need to take into account right now?
1. Background
In November last year, we reported on the UK Government’s announcement to overhaul the UK’s approach to foreign investment review and the introduction of its National Security and Investment Bill. The Bill received Royal Assent in April to become the NSI Act.
The NSI Act will introduce a new standalone hybrid regime of mandatory and voluntary notifications for certain acquisitions that could harm the UK’s national security. The regime also includes a Government power to call in any deal which raises a “national security risk”.
In late July 2021, the UK Government confirmed that the NSI Act will take effect from 4 January 2022 and also published four new pieces of guidance[1] as well as an updated draft of sector definitions for the mandatory notification regime under the NSI Act and a statement on how it proposes to exercise its new call-in powers.
This week the UK Government published a further updated draft of sector definitions for the mandatory notification regime and an explanatory note. Other than an amendment to state they will come into force on 4 January 2022, the draft definitions are in substantially the same form as the July draft. The Government also published draft regulations on monetary penalties under the NSI Act, together with an explanatory memorandum. These regulations are broadly in line with the rules for calculating penalties under the Enterprise Act 2002 (EA2002), but there are some differences.
2. Impact for companies
The introduction of the NSI Act forms part of a trend towards stricter control of foreign direct investment seen elsewhere in the world, including in the U.S. and in Europe. As far as foreign investment in the UK is concerned, the NSI Act will afford the UK Government one of the highest levels of scrutiny of any regime globally.
Although it is expected to be rare that a deal will be blocked (or require remedies) under the NSI Act, the impact for investors will be significant in terms of deal certainty and timeline.
The Government initially estimated that there will be 1,000–1,800 transactions notified each year, and 70 – 95 of those transactions are expected to be called in for a full national security assessment. This compares to a total of less than 25 transactions which have been reviewed by the Government since 2003 under the EA2002 public interest regime.[2] Since these estimates were made, the Government has increased the threshold for mandatory notification from the acquisition of 15% of shares or voting rights to 25%. Nonetheless, given the broad nature of the regime and the current uncertainty around its application, we would anticipate that a high number of notifications will be made, at least initially.
Faced with mandatory notification obligations in many cases, as well as severe criminal and civil consequences for non-compliance, companies must pay close attention to national security risks when investing in the UK.
3. What do companies need to consider right now?
Consider the existing public interest regime
Over the next four months, transactions which raise national security concerns are still subject to the existing public interest intervention regime under the EA2002 and, accordingly, parties should ensure their transaction documents adequately cater for both regimes. For example, in relation to conditions and the process and approach to preparing and securing relevant regulatory approvals.
The risk of intervention under the current regime is not theoretical. In the last few years, the numbers and the nature of intervention in UK transactions on public interest grounds has increased. In December 2019, the CMA issued a Public Interest Intervention Notice (PIIN) in relation to the proposed acquisition of Mettis Aerospace by Aerostar following which the parties decided not to proceed with the acquisition. In that same month the CMA issued a PIIN in relation to Gardener Aerospace’s proposed acquisition of Impcross Limited which was subsequently blocked.
More recently, in April of this year, Digital Secretary Oliver Dowden issued instructions in relation to the proposed acquisition of ARM Limited by NVIDIA Corporation. The Secretary of State for Business, Energy and Industrial Strategy (BEIS) is reported as taking an active interest in Parker-Hannafin’s proposed acquisition of British defence technology firm, Meggitt. In August of this year, Director of National Security & International, Jacqui Ward, issued a PIIN in relation to Cobham’s proposed acquisition of the defence aerospace and security solutions provider, Ultra Electronics plc.
Once the NSI Act enters into force, the existing national security ground under the EA2002 will be repealed. However, the public health, media plurality and financial stability heads of intervention will remain in place and apply in parallel after commencement of the new NSI Act regime.
Make a jurisdictional assessment
Parties who are currently contemplating a deal that will complete after the commencement date (4 January 2022) need to assess whether their deal falls within the new mandatory notification regime. If so, the deal will need to be notified to the Investment Security Unit (ISU) of the Secretary of State for BEIS before closing.
An acquisition which is subject to the mandatory notification regime will be void if is completed without notifying and gaining approval from the Government. In such cases, parties need to ensure that their transaction documents contain appropriate conditions and that the long stop date is sufficient. Parties will need to take account of the time-frames that the ISU has to (i) determine whether to accept or reject a notification, (ii) assess whether they wish to issue a call-in notice and (iii) make its substantive assessment of the transaction, if it decides to call-in or screen the transaction.
Assess the risk of retrospective call-in for deals between 12 November 2020 and 4 January 2022
The NSI Act affords BEIS the power to retrospectively call-in deals and carry out a full national security assessment. These retroactive call-in powers apply to deals closed between 12 November 2020 and commencement of the NSI Act on 4 January 2022 (the interim period). They do not apply to deals closed before 12 November 2020.
This means that for deals contemplated now, even if they will close before 4 January 2022, parties have to carry out a risk assessment of the likelihood that BEIS will use its call-in powers post 4 January.
The call-in powers may be exercised where the Government reasonably suspects that a “trigger event” (see below) has occurred and that the trigger event has given rise or may give rise to a national security risk. If a transaction that closed in the interim period would have fallen within the mandatory regime had the NSI Act been in force at the time, it could be a prime candidate for call-in by BEIS once the NSI Act commences.[3]
For deals which closed in the interim period but would not have been caught by the mandatory regime, parties will still need to consider whether their deal may reasonably be considered to raise national security concerns within the meaning of the NSI Act. And, as such, whether the deal is a likely candidate for call-in by BEIS.
The period during which the Government can call-in a deal is five years from completion. This period is reduced to six months from the date at which the BEIS becomes aware of the transaction. For deals closing during the interim period, the call-in power will be available for a five year period from the date of closing, or six months from 4 January, if the parties informed BEIS of the transaction during the transitional period.
This is important because parties to a transaction which closes during the interim period and which could reasonably be considered to give rise to a national security, should consider whether to discuss the transaction informally with the ISU. Making BEIS aware through consultation with the ISU would have the effect of shortening the window for call-in to six months from commencement of the Act. It may also help parties decide whether a voluntary notification would be prudent once the Act commences. Such an approach may be advantageous from a deal certainty view point, in particular in terms of mitigating buy-side transactional risk.
4. A quick recap on the rules
4.1 What type of transactions does the NSI Act apply to?
The NSI Act applies to acquisitions of control over qualifying entities or assets – this is called a “trigger event” – where BEIS reasonably suspects that there is a risk to national security as a result of the acquisition.
The definition of control under the NSI Act is broad and applies to the acquisition of more than 25%, 50% and 75% of votes or shares in a qualifying entity (or the acquisition of voting rights that allow the acquirer to pass or block resolutions governing the affairs of the entity). In addition, outside of the mandatory regime, BEIS will also be able to call-in or accept voluntary notifications in relation to transactions falling below this 25% threshold where there is “material influence”. This can mean acquisitions of shareholdings as low as 10-5%.[4]
A qualifying entity must be a legal person, that is not an individual. It must have a tie to the UK, either because it is registered in the UK or because it carries on activities in the UK or supplies goods or services to persons in the UK.
Acquisitions of qualifying assets such as land and IP may be subject to call-in or the voluntary regime (but not the mandatory regime).[5]
4.2 Mandatory notifications
Notifications will be mandatory for acquisitions of control over a qualifying entity active in 17 defined sectors designated as particularly sensitive for national security. These are wide-ranging: from energy, defence and transport to AI, quantum technologies, and satellite and space technologies.[6] In these sectors, such transactions must receive Government approval before completion and so the NSI Act has a suspensory effect.
Failure to notify under the mandatory regime will render completion of the acquisition void. There are also civil and criminal penalties for completing a notifiable acquisition without approval. Civil penalties can be up to 5% of the organization’s global turnover or £10 million (whichever is greater).[7]
The Government has engaged extensively with stakeholders on the mandatory sector definitions, since the publication of the first draft in November 2020. Throughout this process, the Government has refined and developed the proposed definitions. The latest set of definitions were published on 6 September and are set out in the draft notifiable acquisition regulation. These are broadly in line with what the Government has published previously. The Government has indicated that it will continue to refine its definitions, even after commencement of the NSI Act in January.
One important point in the guidance issued in July[8] is that a qualifying entity falls within a description of the 17 mandatory sectors only if it carries on the activity specified in the UK or supplies relevant goods or services in the UK.[9]
4.3 Call-in and voluntary notifications
Acquisitions of control over qualifying entities outside of the 17 mandatory regime sectors do not need to be notified. But, if the Government reasonably suspects that an acquisition has given rise to, or may give rise to, a risk to national security, it can be scrutinized by the Government using its call-in powers.
Given these expansive call-in powers, parties may decide to voluntarily notify their transactions where there is a perceived risk of call-in and a desire for deal certainty. A voluntary notification forces BEIS to decide within 30 business days whether to proceed with a review.
As noted above, the voluntary regime may also apply to asset acquisitions and to transactions falling below this 25% threshold where there is “material influence”.[10]
5. How to assess the call-in risk
The Government published a new draft statement in July, setting out how it expects to exercise the power to give a call-in notice. This is referred to as the draft statement for the purposes of section 3. The Government again consulted on this statement, with the consultation closing on 30 August.
Whilst qualifying acquisitions across the whole economy are technically in scope, the call-in power will be focussed on acquisitions in the 17 areas of the economy subject to mandatory notification and areas of the economy which are closely linked to these 17 areas. Acquisitions which occur outside of these areas are unlikely to be called in because national security risks are expected to occur less frequently in those areas. This is new compared to the previous statement of intent of policy, which split areas of the economy into three risk levels (core areas, core activities and the wider economy), and is a welcome clarification.
The risk factors have stayed largely the same as in previous iterations, with some tweaks. Essentially, to assess the likelihood of a risk to national security, the Secretary of State will consider three risk factors:
- Target risk: whether the target is being used, or could be used, in a way that poses a risk to national security. BEIS will consider what the target does, is used for, or could be used for, and whether that could give rise to a risk to national security. BEIS will also consider any national security risks arising from the target’s proximity to sensitive sites.
- Acquirer risk: whether the acquirer has characteristics that suggest there is, or may be, a risk to national security from the acquirer having control of the target. Characteristics include sector(s) of activity, technological capabilities and links to entities which may seek to undermine or threaten the interests of the UK. Threats to the interests of the UK include the integrity of democracy, public safety, military advantage and reputation or economic prosperity. Some characteristics, such as a history of passive or longer-term investments, may indicate low or no acquirer risk.
- Control risk: whether the amount of control that has been, or will be, acquired poses a risk to national security. A higher level of control may increase the level of national security risk.
The risk factors will be considered together, but an acquisition may be called in if any one risk factor raises the possibility of a risk to national security.
The same risk factors will be applied to qualifying acquisitions of assets as to qualifying acquisitions of entities.
At present there are no turnover or market share safe-harbours for investors (below which transactions would fall outside the scope of the NSI Act). The Government has, to date, firmly rejected calls from industry professionals and practitioners to introduce such a safe-harbour or exemption.
6. What’s next?
We expect the Government to publish final regulations and guidance as the year draws to an end. We do not expect the scope of the 17 sensitive sectors to change now, before the NSI Act comes into effect.
In the meantime, parties should consider the possible impact of the new regime on any proposed divestments or acquisitions which are in the mandatory sectors or which are not in one of these designated sectors but which may nonetheless give rise to national security concerns. The ISU has encouraged parties to contact them to discuss possible acquisitions and how the NSI Act may impact their transaction or their responsibilities.
More generally, the Government has emphasised that the UK remains open for investment and that the new regime aims to proportionately mitigate national security risks. It is keen to stress its ambition that the new regime will enable the fastest, most proportionate foreign investment screening in the world, while not undermining predictability and certainty.
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[1] (i) How to Prepare for the New NSIA Rules on Acquisitions; (ii) Application of the NSIA to People or Acquisitions Outside the UK; (iii) Guidance for the Higher Education & Research Intensive Sectors; and (iv) NSIA and Interaction with Other UK Regulatory Regimes.
[2] The Government’s powers to review transactions on public interest grounds are currently set out in the Enterprise Act 2002. The Government can issue a Public Interest Intervention Notice (PIIN) on certain strictly defined public interest considerations. It can only do so where a transaction meets the jurisdictional thresholds under the UK merger control rules (with limited exceptions).
[3] For such transactions, which were legitimately closed before commencement, the suspension obligation does not apply and there can be no fines for failing to notify.
[4] The Government has stated that any assessment of an acquisition of material influence under the NSI Act will follow the CMA’s guidance on material influence in a merger control context.
[5] The Government has indicated that investigations of asset acquisitions that are not linked to the 17 mandatory sectors are expected to be rare and, generally, the Secretary of State expects to call-in acquisitions of assets rarely and significantly less frequently than acquisitions of entities.
[6] The full list is: Advanced Materials, Advanced Robotics, Artificial Intelligence, Civil nuclear, Communications, Computing hardware, Critical suppliers to Government, Critical suppliers to the emergency services, Cryptographic Authentication, Data Infrastructure, Defence, Energy, Military and Dual-use, Quantum technologies, Satellite and space technologies, Synthetic biology, Transport.
[7] See draft regulations on monetary penalties and the accompanying explanatory memorandum published on 6 September 2021.
[8] See guidance referred to in item (i) in footnote 1.
[9] The guidance also the proposed Section 3 statement (see section 4 of this alert below) provides helpful examples and case studies of the types of entities and assets both in and outside of the UK which may fall within scope of the new regime.
Gibson Dunn’s lawyers are available to assist in addressing any questions that you may have regarding the issues discussed in this update. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition, Mergers and Acquisitions, or International Trade practice groups, or the authors:
Ali Nikpay – Antitrust and Competition (+44 (0) 20 7071 4273, anikpay@gibsondunn.com)
Deirdre Taylor – Antitrust and Competition (+44 (0) 20 7071 4274, dtaylor2@gibsondunn.com)
Selina S. Sagayam – International Corporate (+44 (0) 20 7071 4263, ssagayam@gibsondunn.com)
Attila Borsos – Competition and Trade (+32 2 554 72 11, aborsos@gibsondunn.com)
Mairi McMartin – Antitrust and Competition (+32 2 554 72 29, mmcMartin@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On 2 September 2021, the Court of Justice of the European Union (the “CJEU”) issued its ruling in Republic of Moldova v Komstroy[1] (the “Decision” or “Komstroy”) concluding that, as a matter of EU law, Article 26 of the Energy Charter Treaty (the “ECT”) is not applicable to “intra-EU” disputes (that is, disputes between an investor of an EU Member State on the one hand, and an EU Member State on the other).
The CJEU’s Decision largely follows the CJEU’s controversial reasoning in Achmea BV v Slovak Republic[2] (“Achmea”) (2018), which concerned a bilateral investment treaty (“BIT”) between two EU Member States (as opposed to a multilateral treaty such as the ECT). Achmea was addressed in a previous client alert here.[3]
Background
In October 2019, the Paris Court of Appeal (cour d’appel de Paris) made a request to the CJEU for a preliminary ruling addressing three questions.[4] These pertained to set-aside proceedings brought by Moldova in respect of an UNCITRAL arbitral award rendered against it for certain breaches of obligations under the ECT. Paris was the seat of the underlying arbitration.
The CJEU’s Decision
Only one of the three questions referred by the Paris Court of Appeal ultimately was addressed by the CJEU. That question asked the CJEU to determine whether the definition of “investment” in Article 1(6) of the ECT requires any economic contribution on the part of the investor in the host State. The Decision found, in essence, that an economic contribution was required in its view.
The CJEU also set out its views on whether Article 26 of the ECT is compatible with EU law insofar as it provides for arbitration between EU based investors and EU Member States.[5] This question was not referred by the Paris Court of Appeal, nor was it directly relevant to the questions before the CJEU (which concerned investments in a non-EU Member State (Moldova)). This separate question had been raised by the European Commission, together with certain EU Member States,[6] acting as interveners in the CJEU proceedings. The Decision indicates that intra-EU arbitration under the ECT is incompatible with EU law. The CJEU’s reasoning is summarised below.
First, following its reasoning in Achmea, the CJEU explained that in order to preserve the autonomy of EU law, as well as its effectiveness, national courts of EU Member States may make a preliminary reference to the CJEU pursuant to Article 267 of the Treaty on the Functioning of the European Union (the “TFEU”). This referral procedure was described as the “keystone” of the EU judicial system with the “objective of securing the uniform interpretation of EU law, thereby ensuring its consistency, its full effect and its autonomy”.[7]
Second, the CJEU reasoned that because the EU is a Contracting Party to the ECT, the ECT itself is a so-called “act of EU law”.[8] Having reached this conclusion, the CJEU then determined that because the ECT is an “act of EU law”, an ECT tribunal would necessarily be required to interpret, and even apply, EU law when deciding a dispute under Article 26.[9] This reasoning appears to be directly at odds with the CJEU’s Opinion 1/17, in which it accepted that CETA tribunals[10]– though standing outside the judicial system of the EU – could nonetheless interpret and apply the CETA itself without running afoul of EU law.[11] The Decision does not explain how CETA, to which the EU is also a party and must likewise be considered an “act of the EU” by the CJEU, can be compatible with EU law, but the ECT cannot. Likewise, the CJEU did not explain how its finding that the ECT is an “act of EU law” would not apply equally in the extra-EU context (i.e., where a dispute involves an EU Member State and an investor from a third State), leaving these questions unanswered.
Third, having found that an ECT tribunal would need to apply EU law on the basis that the ECT is an “act of EU law”, the CJEU then ascertained whether an ECT tribunal is situated within the judicial system of the EU such that a preliminary reference could be made to the CJEU to ensure the effectiveness of EU law.[12] In the CJEU’s view – in “precisely the same way” as in Achmea – ECT tribunals are outside the EU legal system, thus preventing effective control over EU law.[13] The CJEU found that the judicial review that arises in the context of EU-seated investor-state arbitration is limited since the referring court can only perform a review insofar as its domestic law permits.[14] In other words, according to the CJEU, the full effectiveness of EU law cannot be guaranteed.
Finally, given that commercial arbitration tribunals routinely interpret and apply EU law outside of the EU legal system (which could mean that any arbitration would be incompatible with EU law), the Decision attempts to distinguish investor-state arbitration from commercial arbitration. The distinction, according to the CJEU, is that commercial arbitration is different because it “originate[s] in the freely expressed wishes of the parties concerned”, whereas investor-state arbitration apparently is not based on the parties’ “freely expressed wishes”.[15] Unfortunately, however, the CJEU did not elaborate on its conclusion in this regard. That conclusion appears to be inconsistent with well-established principles of public international law, which confirm that States can (and must) enter into treaties such as the ECT of their own free will.
In light of the foregoing, the CJEU concluded that Article 26 of the ECT is incompatible with EU law insofar as it provides for arbitration between EU investors and EU Member States.[16]
Implications of the CJEU’s Decision
The ECT remains in force between all Contracting Parties, which includes all EU Member States, as well as the EU. Indeed, a modification of the ECT to remove its application as between EU Member States would require the participation not just of the EU and its Member States, but of all 53 Contracting Parties to the ECT. The CJEU’s Decision does not (and cannot) modify the express terms of the ECT itself.
To date, all ECT tribunals that have considered jurisdictional objections based on the intra-EU nature of the dispute have rejected the suggestion that the ECT does not apply on an intra-EU basis. That is unlikely to change in light of the Decision. Indeed, the CJEU did not offer any analysis under the Vienna Convention on the Law of Treaties (the “VCLT”), which governs the interpretation of the ECT. Nor did the CJEU address the substantial body of case law under the ECT on the interpretation of Article 26 of the ECT, all of which reaches the opposite conclusion to the CJEU. Those cases set forth what is now a well-established principle that EU law is not relevant to the question of jurisdiction under the ECT. Thus, the Decision (which is limited to an analysis under EU law) should have no bearing on an ECT tribunal’s jurisdiction.
Another implication of the Decision is that EU-based investors considering energy investments in EU Member States may now view these investments as more risky. First, the applicability of Article 26 to intra-EU disputes was not a question that was before the CJEU and it had no impact on the Komstroy case, which (paradoxically) did not involve an intra-EU dispute. The Decision provides scant and inconsistent reasoning and may therefore be considered to be based on political considerations rather than a sound and reasoned interpretation of the law. The Decision thus has the potential to undermine investor confidence in the EU judicial system and the rule of law within the EU.
Second, the CJEU’s Decision may create uncertainty regarding the extent of investor protection within the EU for energy investments as EU Member States may believe that they can (or must) disapply the ECT to investors from other EU Member States. This, of course, would make investments by EU investors into EU Member States both less attractive and more expensive (as it will drive up risk premiums). The CJEU’s decision may, therefore, undermine investor confidence at a time when the EU is seeking substantial private investment in its energy sector as part of its efforts to de-carbonise. In other words, the Decision ultimately could be an “own goal” for the EU and its Member States.
____________________________
[1] Judgment of the Court (Grand Chamber), Case C‑741/19, Republic of Moldova v Komstroy, a company the successor in law to the company Energoalians, ECLI:EU:C:2021:655, 2 September 2021 (the “Decision”), available here.
[2] Judgment of the Court (Grand Chamber), Case C‑284/16, Slowakische Republik (Slovak Republic) v Achmea BV, ECLI:EU:C:2018:158, 6 March 2018, available here.
[3] In short, in Achmea, the CJEU determined that arbitration provisions such as the one found in the intra-EU BIT at issue in that case (which, in contrast to the ECT, explicitly required a tribunal to consider EU law) are not compatible with EU law.
[4] Request for a preliminary ruling from the Cour d’appel de Paris, Case C-741/19, Republic of Moldova v Komstroy, a company the successor in law to the company Energoalians, 8 October 2019, available here.
[6] France, Germany, Spain, Italy, The Netherlands and Poland.
[10] I.e., tribunals established to hear disputes arising under the under the EU-Canada Comprehensive Economic and Trade Agreement (“CETA”).
[11] Opinion 1/17 of the Full Court (CETA), ECLI:EU:C:2019:341, 20 April 2019, ¶¶ 116-118, available here.
[12] See Article 267 TFEU (the preliminary reference procedure).
The following Gibson Dunn lawyers assisted in the preparation of this client update: Jeff Sullivan QC, Ceyda Knoebel, Stephanie Collins and Theo Tyrrell.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s International Arbitration, Judgment and Arbitral Award Enforcement or Transnational Litigation practice groups, or any of the following in London:
Cyrus Benson (+44 (0) 20 7071 4239, CBenson@gibsondunn.com)
Penny Madden QC (+44 (0) 20 7071 4226, PMadden@gibsondunn.com)
Jeff Sullivan QC (+44 (0) 20 7071 4231, Jeffrey.Sullivan@gibsondunn.com)
Ceyda Knoebel (+44 (0) 20 7071 4243, CKnoebel@gibsondunn.com)
Stephanie Collins (+44 (0) 20 7071 4216, SCollins@gibsondunn.com)
Theo Tyrrell (+44 (0) 20 7071 4016, TTyrrell@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
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1. |
INTRODUCTION |
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1.1 |
Singapore has become an increasingly popular destination for trust listings in the recent years. Real estate investment trusts (“REITs”), business trusts (“BTs”) and stapled trusts are some of the more popular vehicles that property players opt for to tap capital on Singapore Exchange Securities Trading Limited (the “SGX-ST”). |
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1.2 |
This primer provides an overview of the structure of such vehicles, the main regulations regulating them, the process to getting listed on the SGX-ST as well as the various ways of acquiring control of these vehicles post-listing. This primer also explores the lessons to be learnt from the controversy surrounding Eagle Hospitality Trust (“EHT”) and the failed merger between ESR REIT and Sabana REIT. |
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2. |
STRUCTURE |
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2.1 |
REIT |
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2.1.1 |
A REIT may generally be described as a trust that invests primarily in real estate and real estate-related assets with the view to generating income for its unitholders. | |||||||||
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2.1.2 |
It is constituted pursuant to a trust deed entered into between the REIT manager and the REIT trustee. | |||||||||
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2.1.3 |
The REIT manager manages the assets of the REIT while the REIT trustee holds the assets on behalf of the unitholders and generally helps to safeguard the interests of the unitholders. | |||||||||
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2.1.4 |
REITs are popular with investors as the income from the assets (after deducting trust expenses) is distributed to the unitholders at regular intervals. A REIT which distributes at least 90% of its taxable income to its unitholders in the same year in which the income is derived can enjoy tax transparency treatment under the Income Tax Act, Chapter 134 of Singapore. It is also not uncommon for REITs to pledge to distribute the entire of its annual distributable income in the initial period post-listing. | |||||||||
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2.1.5 |
The typical roles in a REIT structure are as follows: | |||||||||
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Typical REIT Structure |
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2.1.6 |
SGX-ST-listed REITs typically adopt an external management model where the REIT manager is owned by the sponsor of the REIT. This is in contrast to an internal management model (adopted by a majority of REITs in the United States of America) where the REIT manager is instead owned by the REIT itself. Proponents of an internal management model in Singapore argue that an internal management model avoids conflicts of interest and lowers the fees payable to the REIT manager (which ultimately translates to better returns for unitholders). The success of the Hong Kong-listed internally managed Link REIT, Asia’s largest REIT in terms of market capitalization, may bear testament to this. However, whether an internal management model takes off in Singapore remains to be seen. Singapore investors could well prefer sponsor participation due to the various advantages that a sponsor can bring, such as marketability, expertise, support and pipeline of assets. |
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2.2 |
BT |
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2.2.1 |
A BT is a trust that can generally engage in any type of business activity, including the management of real estate assets or the management or operation of a business. | |||||||
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2.2.2 |
It is constituted pursuant to a trust deed entered into by the trustee-manager, a single entity that has the dual responsibility of safeguarding the interests of the unitholders of the BT and managing the business conducted by the BT. | |||||||
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2.2.3 |
BTs, unlike companies, can make distributions out of operating cash flows (instead of profits). They suit businesses which involve high initial capital expenditures with stable operating cash flows, such as real estate assets. | |||||||
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2.2.4 |
Compared to REITs, BTs are also more lightly regulated and may therefore be preferred for their flexibility. Property BTs often also pledge to provide REIT-like distributions to the unitholders. | |||||||
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2.2.5 |
The typical roles in a BT structure are as follows: | |||||||
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Typical Property BT Structure |
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2.3 |
Stapled Trust |
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2.3.1 |
A stapled trust on the SGX-ST typically comprises a REIT and a BT. Pursuant to a stapling deed, units of the REIT and units of the BT are stapled together and cannot be traded separately. The REIT and the BT would continue to exist as separate structures, but the stapled securities would trade as one counter and share the same investor base. | |
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2.3.2 |
A stapled trust structure may be preferred when an issuer wishes to bundle two distinct (but related) businesses into a single tradeable counter. Such stapled trust structure is commonly adopted for hospitality assets which provide both a passive (through the receipt of rental income from the lease of such assets) and an active (through the management and operation of such assets) income stream. | |
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2.3.3 |
In such cases, the REIT will be constituted to hold the income-producing real estate assets and the BT will be constituted to either (a) be the master lessee of the real estate assets who will manage and operate these assets or (b) remain dormant and only step in as a “master lessee of last resort” to manage and operate these assets when there are no other suitable master lessees to be found. The presence of a BT also offers flexibility for the stapled trust to undertake certain hospitality and hospitality-related development projects, acquisitions and investments which may not be suitable for the REIT. | |
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2.3.4 |
Investors who value the business and income diversification may therefore find such a model attractive. | |
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2.3.5 |
The typical roles in a REIT and a BT have been discussed above. |
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Typical Stapled Trust Structure |
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3. |
REGULATIONS | ||||||||||||||||||||||||
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3.1 |
REIT | ||||||||||||||||||||||||
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3.2 |
BT | ||||||||||||||||||||
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3.3 |
Stapled Trust | ||||
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4. |
LISTING | ||||||||||||||||||||||||||||||||||||||||||||||||||||
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4.1 |
Due Diligence | ||||||||||||||||||||||||||||||||||||||||||||||||||||
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4.2 |
Listing Process | ||||||||||||||||||||||||||
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4.3 |
Prospectus | ||||||||||||||||||||||||||||||||||||||||||||||||
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4.4 |
Continuing Listing Obligations | ||||||||||||||||||||||||||||||||||||||||||||
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Post-listing, REITs, BTs and stapled trusts are subject to continuing listing obligations under the Listing Manual, such as the requirement to announce specific and material information, requirements relating to secondary offerings, interested person transactions and significant transactions, as well as requirements relating to circulars and annual reports. | |||||||||||||||||||||||||||||||||||||||||||||
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4.5 |
Case Study of EHT | ||||||||||||||||||||||||||||||||||||||||||||
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5. |
Acquiring Control of a REIT, BT or Stapled Trust | ||||||||||||||||||||||||||||||||||||||||||||
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5.1 |
An acquisition of all the units of a REIT or BT or all the stapled securities of a stapled trust listed on the SGX-ST (“Target Entity”) may be effected in various ways, such as a take-over offer, a trust scheme of arrangement (“Trust Scheme”) and a reverse take-over (“RTO”). | ||||||||||||||||||||||||||||||||||||||||||||
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5.2 |
Any merger or acquisition involving a Target Entity would be subject to the Listing Manual, the CIS Code (in the case of a REIT) and the Singapore Code on Take-overs and Mergers (the “Take-over Code”). The Take-over Code is enforced by the Securities Industries Council (the “SIC”), which is part of the MAS. | ||||||||||||||||||||||||||||||||||||||||||||
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5.3 |
Take-over Offer | ||||||||||||||||||||||||||||||||||||||||||||
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5.4 |
Trust Scheme | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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5.5 |
RTO | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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5.6 |
Which method to adopt? | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, or the authors of this primer in the firm’s Singapore office:
Robson Lee (+65.6507.3684, RLee@gibsondunn.com)
Kai Wen Chua (+65.6507.3658, KChua@gibsondunn.com)
Zan Wong (+65.6507.3657, ZWong@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
The UK’s Competition Appeal Tribunal (the CAT) has certified the first application for a collective proceedings order (CPO) on an opt-out basis in Walter Hugh Merricks CBE v Mastercard Incorporated & Ors.
In the UK, a CPO is pre-requisite for opt-out collective actions seeking damages for breaches of competition law. Opt-out means that an action can be pursued on behalf of a class of unnamed claimants who are deemed included in the action unless they have specifically opted out. Opt-out ‘US style’ class actions have the potential to be far more complex, expensive and burdensome than traditional named party litigation.
Opt-out class actions were introduced for the first time in the UK in 2015 (see our previous alert here). Almost six years on, last week’s judgment by the CAT is therefore an important procedural step towards the first opt-out class action damages award in the UK.
As had been expected, following the Supreme Court’s judgment in December 2020 (see our previous alert here) Mastercard did not resist certification outright. As a result, the CAT’s most recent judgment provides little further clarity on how the test set out in the Supreme Court’s judgment will be applied to future applications for a CPO. However, the CAT’s recent judgment did address certain interesting questions concerning suitability to act as a class representative, whether deceased persons could be included in the proposed class and the suitability of claims for compound interest. These are discussed in more detail below.
Background
In 2017, the CAT had originally refused to grant Mr. Merricks a CPO. However, in December 2020, in Merricks v Mastercard, the UK’s Supreme Court dismissed Mastercard’s appeal against the Court of Appeal’s judgment regarding the correct certification test and remitted the case back to the CAT for reconsideration. The judgment of the Supreme Court was of seminal importance because it provided much needed clarification as to the correct approach for the CAT to take when considering whether claims are suitable for collective proceedings (see our previous alert here).
Following the Supreme Court’s clarification, Mastercard no longer challenged eligibility for collective proceedings in the remitted proceedings before the CAT. However, the CAT was still required to consider: (i) the authorisation of Mr. Merricks as the class representative in light of developments since the CAT’s original judgment in 2017; (ii) whether Mr. Merricks was entitled to include deceased persons in the proposed class; and (iii) whether Mr. Merricks’ claim for compound interest was suitable to be brought in collective proceedings.
Although the CAT reaffirmed that Mr. Merricks was suitable to act as a class representative, it held that deceased persons could not be included in the proposed class and that the claim for compound interest was not suitable to brought in collective proceedings. Whilst this will significantly reduce the damages Mastercard will be required to pay should Mr. Merricks ultimately succeed at the substantive trial, the CAT’s judgment has still paved the way for what could be the largest award of damages in English legal history.
CAT Judgment (Walter Hugh Merricks CBE v MasterCard Incorporated & Ors [2021] CAT 28)
(i) Authorisation of the Class Representative
In relation to the suitability of Mr. Merricks to act as the class representative, two issues arose. The first related to written submissions filed by a proposed class member contending that it was not just and reasonable for Mr. Merricks to act as class representative as a result of Mr. Merricks’ handling of a historic complaint related to a property transaction involving the proposed class member. However, the CAT did not consider that this gave rise to any issue in terms of Mr. Merricks’ suitability to act as class representative.
The second related to the terms of a new litigation funding agreement (LFA) put in place by Mr. Merricks in order to document the replacement of the original funder following the CAT’s 2017 judgment. Here, the CAT made it clear that, even if no objections were raised about the terms of a LFA by a proposed defendant (i.e., Mastercard) “the Tribunal has responsibility to protect the interests of the members of the proposed class, and their interests are of course not necessarily aligned with the interests of Mastercard”.
The CAT therefore independently scrutinised the new LFA with particular focus on the provisions permitting the funder to terminate the new LFA where it ceases to be satisfied about the merits of the claims or believes that the proceedings are no longer commercially viable. The CAT was concerned that this gave the funder too broad a discretion to terminate and, during the course of the remitted hearing, it was agreed that the termination provisions would be amended to include a requirement that the funder’s views had to be based on independent legal and expert advice.
Mastercard’s only objection to the terms of the new LFA was that it had no rights to enforce the new LFA and, as such, Mastercard sought an undertaking from the funder to the CAT that it would discharge any adverse costs award that might be made against Mr. Merricks. The CAT agreed that such an undertaking should be given and directed the parties to agree the wording.
(ii) The Deceased Persons Issue
On remittal, Mr. Merricks wanted to include deceased persons within the proposed class definition and sought to amend the definition to include “persons who have since died”.
Whilst the CAT accepted that a class definition could include the representatives of the estates of deceased persons, section 47B of the Competition Act 1998 did not permit claims to be brought by deceased persons in their own right (as Mr. Merricks’ proposed amendment was seeking to do). In any event, the Tribunal held that Mr. Merricks’ application to amend the proposed class definition was not permissible as the limitation period had already expired.
(iii) The Compound Interest Issue
A claim for compound interest had been included in the Claim Form from the outset. It was alleged by Mr. Merricks that all class members will either have incurred borrowings or financing costs to fund the overcharge they suffered or have lost interest that they would otherwise have earned through deposit or investment of the overcharge, or some combination of the two.
The CAT held that the Canadian jurisprudence in relation to certification had been explicitly recognised by the Supreme Court in the context of the UK regime. As such, a “plausible or credible” methodology for calculating loss had to be put forward at the certification stage in order for a claim to be suitable for collective proceedings. In the case of Mr. Merricks’ claim for compound interest, the CAT held that no credible or plausible methodology had been put forward by Mr. Merricks to arrive at any estimate of the extent of the overcharge that would have been saved or used to reduce borrowings rather than spent, which is the essential basis for a claim to compound interest.
Comment
The CAT’s judgment in Merricks is significant because it is the first class action to be certified on an opt-out basis since the current regime was introduced in 2015.
The CAT’s approach to Mr. Merricks’ claim for compound interest and the requirement for a “plausible or credible” methodology is of particular interest in circumstances where the Supreme Court made it clear that there is only a very limited role for the application of a merits test at the certification stage.
The UK was comparatively slow to introduce a regime for opt-out proceedings in relation to competition law infringements and, since its introduction in 2015, the regime itself has taken some time to find its feet. But momentum has been building and there are now a large number of high value opt-out CPO applications awaiting determination by the CAT covering both follow-on claims and standalone claims. In the next few months, a number of judgments are expected in relation to applications that had been stayed pending the Supreme Court’s judgment in Merricks. These will not only provide greater clarity on the application of the Supreme Court’s judgment but also answer questions that, to date, have not been considered by the CAT. These include, for example, how a carriage dispute between two competing proposed class representatives should be resolved. There will also be significant attention paid to the procedures adopted by the CAT as Mr. Merricks’ claim progresses now that it moves beyond the certification stage.
It is increasingly clear that companies operating in the UK are now at greater risk of facing ‘US style’ class actions for breaches of competition law. In addition, for non-competition claims that fall outside the regime introduced in 2015, parallel developments in the courts raise the possibility of complex group actions. For example, in relation to alleged breaches of data protection laws, the highly anticipated Supreme Court judgment in Lloyd v Google LLC (expected in Autumn) will provide guidance on the potential for representative actions to proceed in England and Wales.
Gibson Dunn is currently instructed on a number of the largest CPO applications currently being heard by the CAT and is deeply familiar with navigating this developing regime.
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 Antitrust and Competition practice group, or the following authors in London and Brussels:
Ali Nikpay (+44 (0) 20 7071 4273, anikpay@gibsondunn.com)
Doug Watson (+44 (0) 20 7071 4217, dwatson@gibsondunn.com)
Mairi McMartin (+32 2 554 72 29, MMcMartin@gibsondunn.com)
Dan Warner (+44 (0) 20 7071 4213, dwarner@gibsondunn.com)
UK Competition Litigation Group:
Philip Rocher (+44 (0) 20 7071 4202, procher@gibsondunn.com)
Allan Neil (+44 (0) 20 7071 4296, aneil@gibsondunn.com)
Patrick Doris (+44 (0) 20 7071 4276, pdoris@gibsondunn.com)
Susy Bullock (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)
Deirdre Taylor (+44 (0) 20 7071 4274, dtaylor2@gibsondunn.com)
Gail Elman (+44 (0) 20 7071 4293, gelman@gibsondunn.com)
Camilla Hopkins (+44 (0) 20 7071 4076, chopkins@gibsondunn.com)
Kirsty Everley (+44 (0) 20 7071 4043, keverley@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On August 16, 2021, the U.S. Securities and Exchange Commission announced a settled enforcement action against Pearson plc, a U.K. educational publisher, for inadequate disclosure of a cyber intrusion. According to the settlement, following a cyberattack, which the SEC deemed to be material, Pearson failed to revise its periodic cybersecurity risk disclosure to reflect that it had experienced a material data breach. In addition, in a subsequent media statement, Pearson misstated the significance of the breach by minimizing its scope and overstating the strength of the company’s security measures. The settlement, in which Pearson agreed to pay a $1 million penalty, is the latest indication of the SEC’s continuing focus on cyber disclosures as an enforcement priority and an important signal to public companies that, particularly in the face of an environment of increasing cyberattacks, accurate public disclosure about cyber events and data privacy is critical. The SEC action also underscores the importance, as part of an overall cyber-incident response, of carefully making materiality judgments.
According to the SEC Order,[1] Pearson learned in March 2019 that a sophisticated attacker took advantage of a vulnerability in software that Pearson provided to 13,000 school, district, and university accounts to access and download user names and passwords that were protected with an outdated algorithm as well as more than 11 million rows of student data that included names, dates of birth, and email addresses. The software manufacturer had publicized the existence of the vulnerability in September 2018 and made a patch available at that time; however, Pearson did not install the patch until after learning about the breach in March 2019. Also, at that time, Pearson conducted an internal investigation and began notifying impacted customers in July 2019.
According to the SEC Order, Pearson determined that it was not necessary to issue a public disclosure of the incident. The company’s next report on Form 6-K contained the same data security risk disclosure that it had used in previous reports, stating that there was a “[r]isk” that “a data privacy incident or other failure to comply with data privacy regulations and standards and/or a weakness in information security, including a failure to prevent or detect a malicious attack on our systems, could result in a major data privacy or confidentiality breach causing damage to the customer experience and our reputational damage, a breach of regulations and financial loss” (emphasis added). Consistent with its past position that companies should not discuss risks as hypothetical if they have already materialized or are materializing,[2] the SEC viewed this statement as implying that no “major data privacy or confidentiality breach” had occurred, and determined it was therefore misleading.
A few days after it filed this Form 6-K, a journalist asked Pearson about the data breach. In response, Pearson provided a statement, which it later posted on its website, that the SEC also described as misleading. According to the SEC Order, the statement had been prepared months earlier and failed to disclose that the attacker had extracted data, not just accessed it; understated what types of data were taken; suggested that it was uncertain whether data had been taken, whereas Pearson by that time allegedly knew exactly what data had been extracted; did not state how many rows of data were involved; and stated that Pearson had “strict data protections” and had patched the vulnerability, even though Pearson had waited months to install the patch and had relied upon outdated software to encrypt passwords.
As a result of the foregoing statements, the SEC Order states that Pearson violated Sections 17(a)(2) and (a)(3) of the Securities Act, provisions which prohibit misleading statements or omissions in the context of a securities offering,[3] as well Section 13(a) of the Exchange Act. The SEC Order also finds that the conduct demonstrated that Pearson failed to maintain adequate disclosure controls and procedures in violation of Exchange Act Rule 13a-15(a).
The Pearson settlement reflects a number of instructive points. First, this settlement demonstrates the importance of carefully assessing the materiality of a cyberattack. Here, the SEC determined that the data breach was material based on, among other things, the company’s business and its user base, the nature and volume of the data exfiltrated, and the importance of data security to the company’s reputation, as reflected in the company’s existing risk disclosures. However, the order does not assert that there was any adverse impact on Pearson’s business as a result of the incident. In fact, Pearson’s subsequent filings on Form 20-F expressly stated that prior attacks “have not resulted in any material damage” to the business. Consulting with counsel in making materiality assessments can help mitigate the risk of the government second-guessing materiality judgments in hindsight. Second, this is the third recent enforcement case that the SEC has brought based on disclosures contained in reports that are “furnished,” not “filed” with the SEC and in media statements.[4] Third, this is the second enforcement case in which the SEC has found that a company’s disclosures regarding a cybersecurity incident reflected inadequate disclosure controls and procedures.[5] Collectively, these cases reiterate that the SEC is intensely focused on cybersecurity disclosure issues, that public companies should be mindful of SEC disclosure considerations when responding to or publicly commenting on a cybersecurity issue, and that companies should ensure that their disclosure controls and procedures appropriately support their cybersecurity response plans.
The Pearson settlement is the latest — and likely not the last — SEC cyber disclosure enforcement action. The SEC Enforcement Division has also taken an expansive look into cyber disclosures with a sweep related to how companies responded to the widely reported SolarWinds breach, where foreign hackers believed to be tied to Russia used SolarWinds’ software to breach numerous companies and government agencies.[6] The agency asked companies it believed were impacted to voluntarily furnish information about the attack, and offered immunity, under certain conditions, for potential disclosure failings.[7]
In addition, although SEC interpretive guidance on cybersecurity disclosures was issued in 2018,[8] additional disclosure rulemaking appears likely. According to the Unified Agenda of Regulatory and Deregulatory Actions (“Reg Flex Agenda”) made available in June 2021, the first reflecting Chair Gary Gensler’s agenda,[9] the SEC is considering whether to propose new rules to enhance issuer disclosure on “cybersecurity risk governance.”[10]
The possible new proposed rulemaking project and the increasing enforcement efforts are a clear signal of the SEC’s continuing focus on accurate cybersecurity disclosures and robust disclosure controls and procedures around cybersecurity. The recent increase in cyberattacks contributes to the focus, as does the apparent perception of a risk that companies may under-report data security incidents. The Pearson enforcement action makes plain that a company’s disclosure about the possible risk of a data breach will likely be insufficient — and even be viewed as misleading — if the company has in fact suffered a cyber breach that the SEC deems to be material. Moreover, the SEC’s actions reinforce the importance of having strong disclosure controls and procedures so that full information about data breaches and vulnerabilities are communicated to those making decisions about disclosures.
____________________
[1] In re Pearson plc, Release No. 33-10963 (Aug. 16, 2021), https://www.sec.gov/litigation/admin/2021/33-10963.pdf.
[2] See Gibson, Dunn & Crutcher, “Considerations For Preparing Your 2019 Form 10-K” (Jan. 13, 2020), https://www.gibsondunn.com/considerations-for-preparing-your-2019-form-10-k; Gibson, Dunn & Crutcher, “Considerations For Preparing Your 2020 Form 10-K” (Feb. 3, 2021), https://www.gibsondunn.com/considerations-for-preparing-your-2020-form-10-k.
[3] These violations, which the SEC Order notes do not require a showing of intent, appear to be premised on the fact that Pearson had employee benefit plan equity offerings on-going that were registered on a Form S-8.
[4] See also In re First American Financial Corp., Release No. 34-92176 (June 14, 2021), https://www.sec.gov/litigation/admin/2021/34-92176.pdf; The Cheesecake Factory Incorporated, Release No. 34-90565 (Dec. 4, 2020), https://www.sec.gov/litigation/admin/2020/34-90565.pdf (disclosure involved two “furnished” Form 8-Ks).
[5] In re First American Financial Corp., Release No. 34-92176 (June 14, 2021), https://www.sec.gov/litigation/admin/2021/34-92176.pdf. In the First American Financial Corp. case, the SEC Order alleged that company executives did not have full information about a cybersecurity vulnerability when the company issued a statement to a reporter and furnished a voluntary Form 8-K addressing the situation. Id.
[6] Katanga Johnson, “U.S. SEC probing SolarWinds clients over cyber breach disclosures -sources,” Reuters (June 22, 2021), https://www.reuters.com/technology/us-sec-official-says-agency-has-begun-probe-cyber-breach-by-solarwinds-2021-06-21.
[7] In the Matter of Certain Cybersecurity-Related Events (HO-14225) FAQs, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/enforce/certain-cybersecurity-related-events-faqs (last modified June 25, 2021).
[8] Commission Statement and Guidance on Public Company Cybersecurity Disclosures, 83 Fed. Reg. 8166 (Feb. 26, 2018), https://www.govinfo.gov/content/pkg/FR-2018-02-26/pdf/2018-03858.pdf.
[9] Press Release, U.S. Sec. & Exch. Comm’n, SEC Announces Annual Regulatory Agenda (June 11, 2021), https://www.sec.gov/news/press-release/2021-99.
[10] See Gibson, Dunn & Crutcher, “Back to the Future: SEC Chair Announces Spring 2021 Reg Flex Agenda” (June 21, 2021), https://www.gibsondunn.com/back-to-the-future-sec-chair-announces-spring-2021-reg-flex-agenda.
This alert was prepared by Alexander H. Southwell, Mark K. Schonfeld, Lori Zyskowski, Thomas J. Kim, Ron Mueller, Eric M. Hornbeck, and Terry Wong.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Privacy, Cybersecurity and Data Innovation, Securities Regulation and Corporate Governance, and Securities Enforcement practice groups, or the following authors:
Alexander H. Southwell – New York (+1 212-351-3981, asouthwell@gibsondunn.com)
Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com)
Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Eric M. Hornbeck – New York (+1 212-351-5279, ehornbeck@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On August 18, 2021, EPA released a final rule revoking tolerances for chlorpyrifos residues on food.[1] EPA took this action to “stop the use of the pesticide chlorpyrifos on all food to better protect human health, particularly that of children and farmworkers.”[2] The agency will also issue a Notice of Intent to Cancel under the Federal Insecticide, Fungicide, and Rodenticide Act to cancel registered food uses of the chemical associated with the revoked tolerances.
Chlorpyrifos is an “insecticide, acaricide and miticide used primarily to control foliage and soil-borne pests,” in a large variety of agricultural crops, including soybeans, fruit and nut trees, and other row crops.[3] EPA sets “tolerances,” which represent “the maximum amount of a pesticide allowed to remain in or on a food.”[4] Under the Federal Food, Drug, and Cosmetic Act (FFDCA), EPA “shall modify or revoke a tolerance if the Administrator determines it is not safe.”[5]
Yesterday’s revocation follows a recent order from the U.S. Court of Appeals for the Ninth Circuit instructing EPA to issue a final rule in response to a 2007 petition filed by the Pesticide Action Network North America and Natural Resources Defense Council requesting that EPA revoke all chlorpyrifos tolerances on the grounds that they were unsafe.[6] EPA previously responded to and denied the original petition and subsequent objections to its denial. A coalition of farmworker, environmental, health, and other interest groups then challenged the denials in court.[7] In April 2021, a split panel of the Ninth Circuit ruled that EPA’s failure either to make the requisite safety findings under the FFDCA or issue a final rule revoking chlorpyrifos tolerances was “in derogation of the statutory mandate to ban pesticides that have not been proven safe,” and ordered the agency to grant the 2007 petition, issue a final rule either revoking the tolerances or modifying them with a supporting safety determination, and cancel or modify the associated food-use registrations of chlorpyrifos.[8]
In response, EPA has granted the 2007 petition and issued a final rule that revokes all chlorpyrifos tolerances listed in 40 CFR 180.342.[9] In issuing this rule, EPA noted that, based on currently available information, it “cannot make a safety finding to support leaving the current tolerances” in place.[10] The final rule becomes effective 60 days after publication in the Federal Register, and the revocation of tolerances becomes effective six months thereafter.
EPA indicated it followed the Ninth Circuit’s instruction by issuing the rule under section 408(d)(4)(A)(i) of the FFDCA, which allows issuance of a final rule “without further notice and without further period for public comment.”[11] EPA indicated its intent to review comments on the previously issued proposed interim decision, draft revised human health risk assessment, and draft ecological risk assessment for chlorpyrifos.[12] The Agency also intends to review registrations for the remaining non-food uses of the chemical.[13]
Prior to EPA’s action, certain states including Hawaii, New York, and Oregon had restricted the sale or use of the pesticide.[14] California prohibited the sale, possession, and use of chlorpyrifos for nearly all uses by the end of 2020.[15]
_______________________
[1] U.S. EPA, Pre-Publication Notice of Final Rule re Chlorpyrifos (Aug. 18, 2021), https://www.epa.gov/system/files/documents/2021-08/pre-pub-5993-04-ocspp-fr_2021-08-18.pdf.
[2] U.S. EPA, News Releases from Headquarters, EPA Takes Action to Address Risk from Chlorpyrifos and Protect Children’s Health (Aug. 18, 2021), https://www.epa.gov/newsreleases/epa-takes-action-address-risk-chlorpyrifos-and-protect-childrens-health.
[3] https://www.epa.gov/ingredients-used-pesticide-products/chlorpyrifos.
[4] U.S. EPA, Regulation of Pesticide Residues on Food, https://www.epa.gov/pesticide-tolerances.
[5] See 21 U.S.C. § 346a(b)(2)(a)(i) (EPA “may establish or leave in effect a tolerance for a pesticide chemical residue in or on a food only if the Administrator determines that the tolerances is safe.”).
[6] Pre-Publication Notice of Final Rule re Chlorpyrifos at 6–7; League of United Latin Am. Citizens v. Regan, 996 F.3d 673 (9th Cir. 2021).
[7] Pre-Publication Notice of Final Rule re Chlorpyrifos at 7.
[8] League of United Latin Am. Citizens, 996 F.3d at 667, 703–04.
[9] Pre-Publication Notice of Final Rule re Chlorpyrifos at 8.
[11] League of United Latin Am. Citizens, 996 F.3d at 702; 21 U.S.C. § 346a(d)(4)(A)(1).
[12] U.S. EPA, EPA Takes Action to Address Risk from Chlorpyrifos and Protect Children’s Health.
[14] See Haw. S.B.3095 (Relating to Environmental Protection) (2018); N.Y. Dep’t of Environ. Conservation, Chlorpyrifos Pesticide Registration Cancellations and Adopted Regulation, https://www.dec.ny.gov/chemical/122311.html; O.A.R. 603-057-0545 (Permanent Chlorpyrifos Rule) (Dec. 15, 2020), available here.
[15] Cal. Dep’t of Pesticide Regulation, Chlorpyrifos Cancelation https://www.cdpr.ca.gov/docs/chlorpyrifos/index.htm.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Environmental Litigation and Mass Tort practice group, or the following authors:
Abbey Hudson – Los Angeles (+1 213-229-7954, ahudson@gibsondunn.com)
David Fotouhi – Washington, D.C. (+1 202-955-8502, dfotouhi@gibsondunn.com)
Joseph D. Edmonds – Orange County (+1 949-451-4053, jedmonds@gibsondunn.com)
Jessica M. Pearigen – Orange County (+1 949-451-3819, jpearigen@gibsondunn.com)
Please also feel free to contact the following practice group leaders:
Environmental Litigation and Mass Tort Group:
Stacie B. Fletcher – Washington, D.C. (+1 202-887-3627, sfletcher@gibsondunn.com)
Daniel W. Nelson – Washington, D.C. (+1 202-887-3687, dnelson@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
This client alert provides an overview of shareholder proposals submitted to public companies during the 2021 proxy season, including statistics and notable decisions from the staff (the “Staff”) of the Securities and Exchange Commission (the “SEC”) on no-action requests.
I. Top Shareholder Proposal Takeaways from the 2021 Proxy Season
As discussed in further detail below, based on the results of the 2021 proxy season, there are several key takeaways to consider for the coming year:
- Shareholder proposal submissions rose significantly. After trending downwards since 2016, the number of proposals submitted increased significantly by 11% from 2020 to 802.
- The number of social and environmental proposals also significantly increased, collectively overtaking governance proposals as the most common. Social and environmental proposals increased notably, up 37% and 13%, respectively, from 2020. In contrast, governance proposals remained steady in 2021 compared to 2020 and represented 36% of proposals submitted in 2021. Executive compensation proposal submissions also declined in 2021, down 13% from the number of such proposals submitted in 2020. The five most popular proposal topics in 2021, representing 46% of all shareholder proposal submissions, were (i) anti-discrimination and diversity, (ii) climate change, (iii) written consent, (iv) independent chair, and (v) special meetings.
- Overall no-action request success rates held steady, but the number of Staff response letters declined significantly. The number of no-action requests submitted to the Staff during the 2021 proxy season increased significantly, up 18% from 2020 and 19% from 2019. The overall success rate for no-action requests held steady at 71%, driven primarily by procedural, ordinary business, and substantial implementation arguments. However, the ongoing shift in the Staff’s practice away from providing written response letters to companies, preferring instead to note the Staff’s response to no-action requests in a brief chart format, resulted in significantly fewer written explanations, with the Staff providing response letters only 5% of the time, compared to 18% in 2020.
- Company success rates using a board analysis during this proxy season rose modestly, while inclusion of a board analysis generally remained infrequent. Fewer companies included a board analysis during this proxy season (down from 19 and 25 in 2020 and 2019, respectively, to 16 in 2021), representing only 18% of all ordinary business and economic relevance arguments in 2021. However, those that included a board analysis had greater success in 2021 compared to 2020, with the Staff concurring with the exclusion of five proposals this year where the company provided a board analysis, compared to four proposals in 2020 and just one proposal in 2019.
- Withdrawals increased significantly. The overall percentage of proposals withdrawn increased significantly to the highest level in recent years. Over 29% of shareholder proposals were withdrawn this season, compared to less than 15% in 2020. This increase is largely attributable to the withdrawal rates of both social and environmental proposals, which rose markedly in 2021 compared to 2020 (increasing to 46% and 62%, respectively).
- Overall voting support increased, including average support for social and environmental proposals. Average support for all shareholder proposals voted on was 36.2% in 2021, up from the 31.3% average in 2020 and 32.8% average in 2019. In 2021, environmental proposals overtook governance proposals to receive the highest average support at 42.3%, up from 29.2% in 2020. Support for social (non-environmental) proposals also increased significantly to 30.6%, up from 21.5% in 2020—driven primarily by a greater number of diversity-related proposals voted on with increased average levels of support. Governance proposals received 40.2% support in 2021, up from 35.3% in 2020. This year also saw a double-digit increase in the number of shareholder proposals that received majority support (74 in total, up from 50 in 2020), with an increasing number of such proposals focused on issues other than traditional governance topics.
- Fewer proponents submitted proposals despite the increase in the number of proposals. The number of shareholders submitting proposals declined this year, with approximately 276 proponents submitting proposals (compared to more than 300 in both 2020 and 2019). Approximately 41% of proposals were submitted by individuals and 21% were submitted by the most active socially responsible investor proponents. As in prior years, John Chevedden and his associates were the most frequent proponents (filing 31% of all proposals in 2021 and accounting for 75% of proposals submitted by individuals). This year also saw the continued downward trend in five or more co-filers submitting proposals—down to 35 in 2021, from 54 in 2020 and 58 in 2019.
- Proponents continued to use exempt solicitations. Exempt solicitation filings continued to proliferate, with the number of filings reaching a record high again this year and increasing 30% over the last three years.
- Amended Rule 14a-8 in Effect. With the amendments to Rule 14a-8 now in effect for meetings held after January 1, 2022, companies should revise their procedural reviews and update their deficiency notices accordingly. However, it remains to be seen whether the new rules will lead to a decrease in proponent eligibility or result in an increase in proposals eligible for procedural or substantive exclusion, based on the new ownership and resubmission thresholds. The SEC’s recently announced Reg Flex Agenda indicates that the SEC intends to revisit Rule 14a-8 as a new rulemaking item in the near term, putting into question the future of the September 2020 amendments.
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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following lawyers in the firm’s Securities Regulation and Corporate Governance practice group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Michael Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)
Lori Zyskowski – New York, NY (+1 212-351-2309, lzyskowski@gibsondunn.com)
Aaron Briggs – San Francisco, CA (+1 415-393-8297, abriggs@gibsondunn.com)
Courtney Haseley – Washington, D.C. (+1 202-955-8213, chaseley@gibsondunn.com)
Julia Lapitskaya – New York, NY (+1 212-351-2354, jlapitskaya@gibsondunn.com)
Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, ctillinghast@gibsondunn.com)
Geoffrey E. Walter – Washington, D.C. (+1 202-887-3749, gwalter@gibsondunn.com)
David Korvin – Washington, D.C. (+1 202-887-3679, dkorvin@gibsondunn.com)
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Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On August 5, 2021, U.S. Senate Finance Committee Chairman Ron Wyden (D-Oregon) and U.S. Senate Finance Committee member Sheldon Whitehouse (D-Rhode Island) introduced legislation entitled the “Ending the Carried Interest Loophole Act.”[1] According to a summary released by the Finance Committee, the legislation is intended to close “the entire carried interest loophole.” While this legislation is very similar to a previous proposal introduced by Chairman Wyden[2], this legislation appears to have a greater likelihood of passage given the Democratic party’s control of both chambers of Congress and the election of President Biden. The legislation may have an even greater chance of passage if it secures the support of moderate Democratic Senators who will be key to its passage through reconciliation, which is a technical procedure that would permit Democrats to pass the bill through a majority vote in the Senate.
The “Ending the Carried Interest Loophole Act” would require partners who hold carried interests in exchange for providing services to investment partnerships to recognize a specified amount of deemed compensation income each year regardless of whether the investment partnership recognizes income or gain and regardless of whether and when the service providers receive distributions in respect of their carried interests. This deemed compensation income would be subject to income tax at ordinary income rates and self-employment taxes.
This legislation goes well beyond many previously proposed bills that attempted to recharacterize certain future income from investment partnerships as ordinary income instead of capital gain. In addition, it would replace section 1061 of the Internal Revenue Code of 1986, as amended (the “Code”), which was enacted as part of the 2017 tax act,[3] and lengthened the required holding period from one year to three years for service providers to recognize long-term capital gain in respect of carried interests.
Current Treatment of “Carried Interest” Allocations
Under current law, a partnership generally can issue a partnership “profits interest” to a service provider without current tax. The service provider holds the interest as a capital asset, with both the timing of recognition and character of the partner’s share of profits from the partnership determined by reference to the timing of recognition and character of profits made by the partnership. Thus, if the partnership recognizes capital gain, the service provider’s allocable share of the gain generally would be capital gain and recognized in the same year as the partnership’s recognition of the capital gain. These partnership “profits interests” are referred to as “carried interests” in the private equity context, “incentive allocations” in the hedge fund context, or “promotes” in the real estate context. As noted above, Code section 1061 generally treats gain recognized with respect to certain partnership interests held for less than three years as short-term capital gain.
“Ending the Carried Interest Loophole Act”
The legislation introduced by Chairman Wyden and Senator Whitehouse generally would require a taxpayer who receives or acquires a partnership interest in connection with the performance of services in a trade or business that involves raising or returning capital and investing in or developing securities, commodities, real estate and certain other assets to recognize annually, on a current basis – (1) a “deemed compensation amount” as ordinary income and (2) an equivalent amount as a long-term capital loss.
The “deemed compensation amount” generally would equal the product of (a) an interest charge, referred to as the “specified rate,”[4] (b) the service provider’s maximum share of partnership profits, and (c) the partnership’s invested capital as of certain measurement dates.[5] Conceptually, the partnership is viewed as investing a portion of its capital on behalf of the service provider via an interest free loan to the service provider. The service provider is deemed to recognize ordinary self-employment income in an amount equal to the foregone interest, calculated at the “specified rate.” Although not clear, the “specified rate” appears designed to approximate the economics of the typical preferred return rate often paid to limited partners on their contributed capital before the service provider receives any distributions from the partnership.
The offsetting long-term capital loss appears to be a proxy for tax basis that is designed to avoid a “double-counting” of income when the service provider ultimately receives allocations of income from the partnership attributable to the sale or disposition of partnership assets (or income or gain attributable to the sale or disposition of the partnership interest itself).[6] The long-term capital loss generally would only be usable in the tax year of deemed recognition if the individual taxpayer recognizes other capital gain that is available to be offset (otherwise, the long-term capital loss would be available to be carried forward to subsequent tax years).
For example, if a service provider is entitled to receive up to 20 percent of an investment fund’s profits, the investment fund receives $1 billion in capital contributions, and the “specified return” for the tax year is 12 percent, the service provider’s “deemed compensation amount” for that tax year would be $24,000,000, and the service provider would recognize an offsetting long-term capital loss of $24,000,000. Assuming relevant income thresholds are already met and that the service provider has sufficient long-term capital gain in the year of inclusion against which the long-term capital loss may be offset, based on maximum individual rates under current law, the service provider would expect to incur an incremental U.S. federal income tax rate of 17% on the “deemed compensation amount” (that is, 37 percent ordinary income tax rate less the 20 percent long-term capital gain tax rate).[7] Any long-term capital gain recognized by the service provider in excess of the “deemed compensation amount” that is attributable to the sale or disposition of partnership assets (or income or gain attributable to the sale or disposition of the partnership interest itself) would be taxed at 20 percent (or 23.8 percent if the net investment income tax is applicable).
To prevent a work-around, the legislation also would apply to any service provider who has received a loan from the partnership, from any other partner of the partnership, or from any person related to the partnership or another partner, unless the loan is fully recourse or fully secured and requires payments of interest at a stated rate not less than the “specified return.”
Other Proposed Changes and Contrast with Recent Biden Proposal
Besides the current inclusion of “deemed compensation amounts” at ordinary income rates, the legislation would alter existing law in several ways. As background, current Code section 1061 generally requires a partnership to hold capital assets for three years in order for the related capital gain to be taxed at preferential long-term capital gain rates. Earlier this year, the Administration released its fiscal year 2022 Budget, including a Greenbook with detailed proposals for changes to the federal tax law.[8] Among other things, the Greenbook proposal would eliminate the ability for partners whose taxable income (from all sources) exceed $400,000 to recognize long-term capital gain with respect to these partnership “profits interests,” but partners whose taxable income do not exceed $400,000 would continue to be subject to Code section 1061.
Under the bill, Code section 1061 would be repealed. In other words, ordinary income treatment would apply regardless of holding period and regardless of the service provider’s level of taxable income. Second, like the Greenbook proposal, under this legislation – (1) the recharacterized amount would be treated as ordinary income rather than short-term capital gain (there is currently no rate differential, but there could be sourcing and other differences), and (2) the “deemed compensation amount” would be subject to self-employment tax.
In addition, this bill also would provide for a deemed election under Code section 83(b) in the event of a transfer of a partnership interest in connection with the performance of services, unless the taxpayer makes a timely election to not have the deemed election apply. Unless a service provider elects out of the deemed election, the service provider would be required to recognize taxable income at the time of the transfer of a partnership interest in connection with the performance of services in an amount equal to the partnership interest’s fair market value. Importantly, fair market value for this purpose would equal the distributions that the service provider would receive in the event of a hypothetical liquidation of the partnership’s assets for cash (after satisfying applicable liabilities) at the time of transfer. This valuation methodology is broadly consistent with current law.
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[1] Ending the Carried Interest Loophole Act, S. 2617, 117th Cong. (2021).
[2] Ending the Carried Interest Loophole Act, S. 1639, 116th Cong. (2019).
[3] The 2017 tax act, commonly known as the Tax Cuts and Jobs Act, is formally titled “An act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” Pub. L. No. 115-97, 131 Stat. 2045.
[4] The “specified rate” for a calendar year means the par yield for “5-year High Quality Market corporate bonds” for the first month of the calendar year (currently 1.21%), plus 9 percentage points.
[5] According to a summary prepared by the Senate Finance Committee, the legislation is not intended to treat an applicable percentage as higher in a given taxable year due to the application of a “catch-up” provision in the partnership agreement. In addition, a partner’s “invested capital” is intended to equal the partner’s book capital account maintained under the regulations under Code section 704(b) with certain modifications, including that invested capital is to be calculated without regard to untaxed gain and loss resulting from the revaluation of partnership property.
[6] Even though the long-term capital loss may be used to offset other capital gain income of the service provider, the legislation would still fulfill its intended purpose of ensuring that the “deemed compensation amount” is subject to tax at ordinary income rates.
[7] For simplicity, we have omitted self-employment tax from the computation of the “deemed compensation amount” and omitted net investment income tax from the offsetting capital loss benefit on the assumption that these will generally offset.
[8] The proposed changes are described here: https://www.gibsondunn.com/biden-administration-releases-fiscal-year-2022-budget-with-greenbook-and-descriptions-of-proposed-changes-to-federal-tax-law/.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Tax practice group, or the following authors:
Evan M. Gusler – New York (+1 212-351-2445, egusler@gibsondunn.com)
Jennifer L. Sabin – New York (+1 212-351-5208, jsabin@gibsondunn.com)
Michael J. Desmond – Los Angeles/Washington, D.C. (+1 213-229-7531, mdesmond@gibsondunn.com)
Pamela Lawrence Endreny – New York (+1 212-351-2474, pendreny@gibsondunn.com)
Eric B. Sloan – Co-Chair, New York (+1 212-351-2340, esloan@gibsondunn.com)
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224 /+1 212-351-2344), jtrinklein@gibsondunn.com)
Daniel A. Zygielbaum – Washington, D.C. (+1 202-887-3768, dzygielbaum@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On July 28, 2021, the proxy advisory firm Institutional Shareholder Services (“ISS”) opened its Annual Benchmark Policy Survey (available here), covering a broad range of topics relating to non-financial environmental, social and governance (“ESG”) performance metrics, racial equity, special purpose acquisition corporations (“SPACs”) and more. In addition, noting that climate change “has emerged as one of the highest priority ESG issues” and that “many investors now identify it as a top area of focus for their stewardship activities,” this year ISS also launched a separate Climate Policy Survey (available here) focused exclusively on climate-related governance issues.
The Annual Benchmark Policy Survey includes questions regarding the following topics for companies in the U.S. and will inform changes to ISS’s benchmark policy for 2022:
- Non-financial ESG performance metrics. Citing an “upward trend” of inclusion of non-financial ESG-related metrics in executive compensation programs, a practice ISS notes “appears to have been fortified by the recent pandemic and social unrest,” the survey asks whether incorporating such metrics into executive compensation programs is an appropriate way to incentivize executives. The survey then asks which compensation components (long-term incentives, short-term incentives, both, or other) are most appropriate for inclusion of non-financial ESG-related performance metrics.
- Racial equity audits. Noting increased shareholder engagement on diversity and racial equity issues in the wake of social unrest following the death of George Floyd and others, the survey asks whether and when companies would benefit from independent racial equity audits (under any set of circumstances, only depending on certain company-specific factors, or not at all). The survey then asks respondents who indicated that a company would benefit depending on company-specific factors which factors would be relevant, including, for example, whether the company has been involved in significant racial and/or ethnic diversity–related controversies or does not provide detailed workforce diversity statistics, such as EEO-1 type data.
- Virtual-only shareholder meetings. This year’s survey seeks information on the types of practices that should be considered problematic in a virtual-only meeting setting. This question follows a “vast majority” of investor respondents indicating last year that they prefer a hybrid meeting approach absent COVID-19-related health and social restrictions. Among the potentially problematic practices ISS identifies in the survey are: the inability to ask live questions at the meeting; muting of participants during the meeting; the inability of shareholders to change votes at the meeting; advance registration requirements or other unreasonable barriers to registration; preventing shareholder proponents from presenting and explaining a shareholder proposal considered at the meeting; and management unreasonably “curating” questions to avoid addressing difficult topics. The survey also asks what would be an appropriate way for shareholders to voice concerns regarding any such problematic practices, including casting votes “against” the chair of the board or all directors or engaging with the company and/or communicating concerns.
- CEO pay quantum and mid-cycle changes to long-term incentive programs. For companies in the U.S. and Canada, ISS’s quantitative pay-for-performance screen currently includes a measure that evaluates one-year CEO pay quantum as a multiple of the median of CEO peers. The survey asks whether this screen should include a longer-term perspective (e.g., three years). The survey also seeks respondents’ views on mid-cycle changes to long-term incentive programs for companies incurring long-term negative impacts from the pandemic. ISS noted that such changes were generally viewed by ISS and investors as problematic given the view that long-term incentives should not be adjusted based on short-term market disruptions (i.e., less than one year), but it acknowledged that some industries continue to experience significant negative impacts from the pandemic.
- Companies with pre-2015 poor governance provisions – multi-class stock, classified board, supermajority vote requirements. ISS’s policy since 2015 has been to recommend votes “against” directors of newly public companies with certain poor governance provisions, including multiple classes of stock with unequal voting rights and without a reasonable sunset, classified board structure, and supermajority vote requirements for amendments to governing documents. Companies that were publicly traded before the 2015 policy change, however, were grandfathered and so are not subject to this policy. The survey asks whether ISS should consider issuing negative voting recommendations on directors at companies maintaining these provisions regardless of when the company went public, and if so, which provisions ISS should revisit and no longer grandfather.
- Recurring adverse director vote recommendations – supermajority vote requirements. For newly public companies, ISS currently recommends votes on a case-by-case basis on director nominees where certain adverse governance provisions – including supermajority voting requirements to amend governing documents – are maintained in the years subsequent to the first shareholder meeting. The survey asks whether, if a company has sought shareholder approval to eliminate supermajority vote requirements, but the company’s proposal does not receive the requisite level of shareholder support, ISS should continue making recurring adverse director vote recommendations for maintaining the supermajority vote requirements, or whether a single or multiple attempts by the company to remove the supermajority requirement would be sufficient (and if multiple attempts are sufficient, how many).
- SPAC deal votes. ISS currently evaluates SPAC transactions on a case-by-case basis, with a main driver being the market price relative to redemption value. ISS notes that the redemption feature of SPACs may be used so long as the SPAC transaction is approved; however, if the transaction is not approved, the public warrants issued in connection with the SPAC will not be exercisable and will be worthless unless sold prior to the termination date. Acknowledging that investors may redeem shares (or sell them on the open market) if they do not like the transaction prospects, and noting that these mechanics may result in little reason for an investor not to support a SPAC transaction, the survey asks whether it makes sense for investors to generally vote in favor of SPAC transactions, irrespective of the merits of the target company combination or any governance concerns. The survey also asks what issues, “dealbreakers,” or areas of concern might be reasons for an investor to vote against a SPAC transaction.
- Proposals with conditional poor governance provisions. ISS notes that one way companies impose poor governance or structural features on shareholders is by bundling or conditioning the closing of a transaction on the passing of other voting items. This practice is particularly common in the SPAC setting where shareholders are asked to approve a new governing charter (which may include features such as classified board, unequal voting structures, etc.) as a condition to consummation of the transaction. In light of these practices, the survey asks about the best course of action for a shareholder who supports an underlying transaction where closing the transaction is conditioned on approval of other ballot items containing poor governance.
The Climate Policy Survey includes questions regarding the following topics and will inform changes to both ISS’s benchmark policy as well as its specialty climate policy for 2022:
- Defining climate-related “material governance failures.” The survey seeks input on what climate-related actions (or lack thereof) demonstrate such poor climate change risk management as to constitute a “material governance failure.” Specifically, the survey asks what actions at a minimum should be expected of a company whose operations, products or services strongly contribute to climate change. Among the “minimum actions” identified by ISS are: providing clear and appropriately detailed disclosure of climate change emissions governance, strategy, risk mitigation efforts, and metrics and targets, such as that set forth by the Task Force on Climate-Related Financial Disclosure (“TCFD”); declaring a long-term ambition to be in line with Paris Agreement goals for its operations and supply chain emissions (Scopes 1, 2 & 3 targets); setting and disclosing absolute medium-term (through 2035) greenhouse gas (“GHG”) emissions reductions targets in line with Paris Agreement goals; and reporting that demonstrates that the company’s corporate and trade association lobbying activities align with (or do not contradict) Paris Agreement goals. The survey also asks whether similar minimum expectations are reasonable for companies that are viewed as not contributing as strongly to climate change.
- Say on Climate. In 2021, some companies put forward their climate transition plans for a shareholder advisory vote (referred to as “Say on Climate”) or committed to doing so in the future. The survey asks whether any of the “minimum actions” (referred to above) could be “dealbreakers” for shareholder support for approval of a management-proposed Say on Climate vote. The survey then asks whether voting on a Say on Climate proposal is the appropriate place to express investor sentiment about the adequacy of a company’s climate risk mitigation, or whether votes cast “against” directors would be appropriate in lieu of, or in addition to, Say on Climate votes. Finally, the survey asks when a shareholder proposal requesting a regular Say on Climate vote would warrant support: never (because the company should decide); never (because shareholders should instead vote against directors); case-specific (only if there are gaps in the current climate risk mitigation plan or reporting); or always (even if the board is managing risk effectively, the vote is a way to test efficacy of the company’s approach and promote positive dialogue between the company and its shareholders).
- High-impact companies. Noting that Climate Action 100+ has identified 167 companies that it views as disproportionately responsible for GHG emissions, the survey asks whether under ISS’s specialty climate policy these companies (or a similar list of such companies) should be subject to a more stringent evaluation of indicators compared to other companies that are viewed as having less of an impact on climate change.
- Net Zero initiatives. Citing increased investor interest in companies setting a goal of net zero emissions by 2050 consistent with a 1.5°C scenario (“Net Zero”), the survey asks whether the specialty climate policy should assess a company’s alignment with Net Zero goals. The survey also asks respondents to rank the importance of a number of elements in indicating a company’s alignment with Net Zero goals, including: announcement of a long-term ambition of Net Zero GHG emissions by 2050; long-term targets for reducing its GHG emissions by 2050 on a clearly defined scope of emissions; medium-term targets for reducing its GHG emissions by between 2026 and 2035 on a clearly defined scope of emissions; short-term targets for reducing its emissions up to 2025 on a clearly defined scope of emissions; a disclosed strategy and capital expenditure program in line with GHG reduction targets in line with Paris Agreement goals; commitment and disclosure showing its corporate and trade association lobbying activities align with Paris Agreement goals; clear board oversight of climate change; disclosure showing the company considers impacts from transitioning to a lower-carbon business model on its workers and communities; and a commitment to clear and appropriately detailed disclosure of its climate change emissions governance, strategy, risk mitigation efforts, and metrics and targets, such as that set forth by the TCFD framework.
While the two surveys cover a broad range of topics, they do not necessarily address every change that ISS will make in its 2022 proxy voting policies. That said, the surveys are an indication of changes ISS is considering and provide an opportunity for interested parties to express their views. Public companies and others are urged to submit their responses, as ISS considers feedback from the surveys in developing its policies.
Both surveys will close on Friday, August 20, at 5:00 p.m. ET. ISS will also solicit more input in the fall through regionally based, topic-specific roundtable discussions. Finally, as in prior years, ISS will open a public comment period on the major final proposed policy changes before releasing its final 2022 policy updates later in the year. Additional information on ISS’s policy development process is available at the ISS policy gateway (available here).
The following Gibson Dunn lawyers assisted in the preparation of this client update: Elizabeth Ising, Lori Zyskowski, and Cassandra Tillinghast.
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, eising@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Ron Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Michael Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)
Lori Zyskowski – New York, NY (+1 212-351-2309, lzyskowski@gibsondunn.com)
Aaron Briggs – San Francisco, CA (+1 415-393-8297, abriggs@gibsondunn.com)
Courtney Haseley – Washington, D.C. (+1 202-955-8213, chaseley@gibsondunn.com)
Julia Lapitskaya – New York, NY (+1 212-351-2354, jlapitskaya@gibsondunn.com)
Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, ctillinghast@gibsondunn.com)
Executive Compensation and Employee Benefits Group:
Stephen W. Fackler – Palo Alto/New York (+1 650-849-5385/+1 212-351-2392, sfackler@gibsondunn.com)
Sean C. Feller – Los Angeles (+1 310-551-8746, sfeller@gibsondunn.com)
Krista Hanvey – Dallas (+ 214-698-3425, khanvey@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Colorado Department of Labor and Employment (“CDLE”) has released new guidance on the Equal Pay for Equal Work Act (“EPEW”), taking a much harder line on Colorado employers whose remote job postings exclude Colorado applicants. Previously, some employers tried to avoid the most challenging aspects of the EPEW’s compensation-and-benefits posting requirements by stating that remote positions could be performed from anywhere but Colorado.
On July 21, 2021, the CDLE issued new guidance clarifying that all Colorado employers’ postings for remote jobs must comply with the EPEW’s compensation-and-benefits posting requirements, even if the postings state that the position cannot be performed in or from Colorado. See CDLE Interpretive Notice & Formal Opinion #9 (“INFO #9”). The CDLE also announced that it was sending “Compliance Assistance Letters” to all Colorado employers with remote job postings that exclude Colorado applicants and that do not include the compensation-and-benefits information required by the EPEW. See CDLE Compliance Assistance Letter (the “Letter”). The Letter gives such employers until August 10, 2021, to advise the CDLE by what date their covered job postings will include the compensation-and-benefits information the EPEW requires.
Finally, the CDLE also provided minor updates to its guidance about the compensation-and-benefits information the EPEW requires. The CDLE clarified that covered job postings need only provide a brief general description of the position’s benefits, but cannot use “open-ended” phrases such as “etc.” or “and more” to describe the position’s benefits. The CDLE also explained that, while employers can post a good-faith compensation range, the range’s bottom and top limits cannot be left unclear or open-ended. Additionally, the CDLE noted that the compensation posting requirements do not apply to “Help Wanted” signs or similar communications that do not refer to any specific positions for which the employer is hiring. Finally, the CDLE noted that job postings need not include the employer’s name to comply with the compensation posting requirements, if the employer wants to be discrete in its external job posting process.
This guidance indicates the CDLE’s “officially approved opinions and notices to employers … as to how [the CDLE] applies and interprets various statutes and rules.” INFO #9. It is not binding, for example, on a court of law. Moreover, although the prior lawsuit challenging the EPEW’s posting requirements and other “transparency rules” was voluntarily dismissed after the Colorado federal district court denied the plaintiff’s motion for a preliminary injunction, it is possible that the CDLE’s tough new stance on postings for remote jobs will lead to new challenges to these requirements.
This Client Alert expands on these issues, first addressing the CDLE’s new guidance regarding job posting requirements for remote jobs, then discussing the Compliance Assistance Letters the CDLE sent employers excluding Colorado applicants from remote jobs, and finally providing further detail on INFO #9’s updates regarding the compensation-and-benefits information the EPEW requires.
The EPEW’s Posting Requirements
The EPEW covers all public and private employers that employ at least one person in Colorado. Under the EPEW’s compensation-and-benefits posting requirements, employers are required to “disclose in each posting for each job the hourly or salary compensation, or a range of the hourly or salary compensation, and a general description of all of the benefits and other compensation to be offered to the hired applicant.” C.R.S. § 8-5-201(2). This requirement does not reach postings for “jobs to be performed entirely outside Colorado.” 7 CCR 1103-13 (4.3)(B).
Additionally, the EPEW also requires employers to “make reasonable efforts to announce, post, or otherwise make known all opportunities for promotion to all current employees on the same calendar day and prior to making a promotion decision.” C.R.S. § 8-5-201(1). This requirement applies broadly and includes only a few, very narrow exceptions.
The EPEW Posting Requirements Apply to Remote Jobs, Even If the Job Posting Excludes Colorado Applicants
The CDLE’s newly revised guidance states that the EPEW applies to “any posting by a covered employer for either (1) work tied to Colorado locations or (2) remote work performable anywhere, but not (3) work performable only at non-Colorado worksites.” INFO #9. The posting requirements’ “out-of-state exception … applies to only jobs tied to non-Colorado worksites (e.g., waitstaff at restaurant locations in other states), but not to remote work performable in Colorado or elsewhere.” Id. (emphasis added). Thus, a “remote job posting, even if it states that the employer will not accept Colorado applicants, remains covered by the [EPEW’s] transparency requirements.” Id.
The CDLE Sent “Compliance Assistance Letters” to Employers Excluding Coloradans from Remote Jobs
Consistent with INFO #9’s guidance regarding remote jobs, the CDLE announced it was sending a “Compliance Assistance Letter” to “all covered employers with remote job postings lacking pay disclosure and excluding Coloradans.” Compliance Assistance Letter. The Letter explained that, for “any employer with any Colorado staff,” “[r]emote jobs are clearly covered by the [EPEW’s] pay disclosure requirement, regardless of an employer’s expressed intent not to hire Coloradans.” Thus, “when employers covered by the [EPEW] post remote jobs covered by the Act, declaring a preference not to hire Coloradans does not eliminate the Act’s pay disclosure duty.”
The Letter goes on to provide general, high-level guidance on how to comply with the EPEW’s compensation-and-benefits posting requirements, including the following:
- “The required pay information can be brief,” such as just saying “$50,000 – $55,000, health insurance, and IRA.”
- “No special form, or format” of posting “is required — as long as the posting includes the required pay and benefits information.”
- “Pay information can be included or linked in a posting, if the employer prefers.”
- A “flexible” compensation range “from the lowest to the highest the employer genuinely may offer for that particular position can be posted.”
- An “out-of-range offer is allowed if the range was a good-faith expectation, but then unanticipated factors required higher or lower pay.”
- “The employer’s name need not be included [in the posting], if it wants discretion and is posting in a third-party site or publication.”
This guidance largely conforms to the CDLE’s prior guidance on these issues.
The CDLE Has Not Imposed Any Penalties … Yet
Consistent with its prior public stances, the CDLE indicated that it is currently focused on compliance through education, rather than fines. The Letter notes that, thus far, all of the employers that the CDLE has contacted about EPEW violations have agreed to fix their postings “promptly,” and the CDLE “happily exercised its discretion to waive all potential fines in each case, believing each employer to have acted in good faith.”
In addition, the CDLE stated that it is first sending the Compliance Assistance Letter to each employer excluding Colorado applicants from remote jobs, “rather than immediately launching investigations of each” employer. The Letter also offers these employers “individualized advice” from the CDLE by phone or email about how to comply with the EPEW posting requirements. Finally, the CDLE gives each employer who receives the Letter until “Tuesday, August 10, 2021, to indicate by what date all covered job postings will include the required pay and benefits disclosures.”
Additional CDLE Guidance Regarding the Required Contents of Job Postings
In addition to explaining the posting requirements for remote jobs, the CDLE provided a few other clarifications of its prior EPEW guidance:
- In providing the required “general description of all of the benefits the employer is offering for the position,” employers “cannot use an open-ended phrase such as ‘etc.,’ or ‘and more.’” INFO #9. However, consistent with its prior guidance, employers can simply say something brief like “$50,000 – $55,000, health insurance, and IRA.” Compliance Assistance Letter.
- Employers continue to be allowed to post a good-faith compensation range (which employers may ultimately depart from, in limited circumstances). INFO #9. But the compensation range’s “bottom and top cannot be left unclear with open-ended phrases such as ‘[$]30,000 and up’ (with no top of the range), or ‘up to $60,000’ (with no bottom of the range).”
- The compensation posting requirements do not apply to “Help Wanted” signs or “similar communication indicating only generally, without reference to any particular positions, that an employer is accepting applications or hiring.” INFO #9. In contrast, a job posting that must comply with the compensation-and-benefits posting requirements is “any written or printed communication (whether electronic or hard copy) that the employer has a specific job or jobs available or is accepting job applications for a particular position or positions.”
- Job postings need not include the employer’s name, if the employer “wants discretion and is posting in a third-party site or publication — as long as the posting includes the required pay and benefits information.” Compliance Assistance Letter. The Letter does not clarify whether a no-name posting would also comply with the EPEW’s promotion posting requirements, or just the compensation posting requirements.
Key Takeaways
This new guidance indicates that the CDLE is focused on foreclosing the methods that some employers were using to try to avoid the more challenging aspects of the EPEW’s compensation-and-benefits posting requirements. In contrast, little of the new CDLE guidance relates to the EPEW’s internal, promotion posting requirements (which in some ways may be even more challenging for Colorado employers).
Finally, the CDLE continues to indicate that it is focused on encouraging EPEW compliance through education, rather than fines, at least for now. Nonetheless, given the CDLE’s (and the public’s) continued scrutiny of compliance with this law, employers with any Colorado employees should ensure that their job postings are compliant as soon as possible. In particular, whether or not they have yet received a Compliance Assistance Letter from the CDLE, employers that had been relying on excluding Colorado applicants from remote jobs should revise their job postings to bring them into compliance with the EPEW, as interpreted by the CDLE.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Labor and Employment practice group, or the following authors:
Jessica Brown – Denver (+1 303-298-5944, jbrown@gibsondunn.com)
Marie Zoglo – Denver (+1 303-298-5735, mzoglo@gibsondunn.com)
Please also feel free to contact any of the following practice leaders:
Labor and Employment Group:
Katherine V.A. Smith – Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)
Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
This edition of Gibson Dunn’s Federal Circuit Update discusses recent Federal Circuit decisions concerning pleading requirements, obviousness, and more Western District of Texas venue issues. Also this month, the U.S. Senate voted to confirm Tiffany P. Cunningham to be United States Circuit Judge for the Federal Circuit and Federal Circuit Judge Kathleen O’Malley announced her retirement.
Federal Circuit News
Supreme Court:
The Court did not add any new cases originating at the Federal Circuit.
The following petitions are still pending:
- Biogen MA Inc. v. EMD Serono, Inc. (U.S. No. 20-1604) concerning anticipation of method-of-treatment patent claims. Gibson Dunn partner Mark A. Perry is counsel for the respondent.
- American Axle & Manufacturing, Inc. v. Neapco Holdings LLC (U.S. No. 20‑891) concerning patent eligibility under 35 U.S.C. § 101, in which the Court has invited the Solicitor General to file a brief expressing the views of the United States.
- PersonalWeb Technologies, LLC v. Patreon, Inc. (U.S. No. 20-1394) concerning the Kessler
Other Federal Circuit News:
On July 19, 2021, the U.S. Senate voted to confirm Tiffany P. Cunningham as United States Circuit Judge for the Federal Circuit by a vote of 63-33. Judge Cunningham was a partner at Perkins Coie LLP and was previously a partner at Kirkland & Ellis LLP. Ms. Cunningham is a graduate of Harvard Law School and she earned a Bachelor of Science in chemical engineering from the Massachusetts Institute of Technology. Ms. Cunningham clerked for Judge Dyk of the Federal Circuit.
Federal Circuit Judge Kathleen O’Malley announced her plans to retire from the bench on March 11, 2022. Judge O’Malley was appointed to the Federal Circuit by President Obama in 2010. Prior to her elevation to the Federal Circuit, Judge O’Malley was appointed to the U.S. District Court for the Northern District of Ohio by President Clinton in 1994.
Upcoming Oral Argument Calendar
The list of upcoming arguments at the Federal Circuit is available on the court’s website.
Live streaming audio is available on the Federal Circuit’s new YouTube channel. Connection information is posted on the court’s website.
The court will resume in-person arguments starting with the September 2021 court sitting.
Key Case Summaries (July 2021)
Bot M8 LLC v. Sony Corporation of America (Fed. Cir. No. 20-2218): Bot M8 LLC (“Bot M8”) sued Sony Corporation of America (“Sony”) for infringement of various patents. The district court sua sponte directed Bot M8 to file an amended complaint requiring Bot M8 to specify how every element of every claim is infringed and to reverse engineer the PS4 (the accused product) if it was able to. Bot M8 agreed to do so. After Bot M8 filed its First Amended Complaint (“FAC”), Sony filed a motion to dismiss, which the court granted. In a discovery hearing two days later, Bot M8 raised for the first time that in order to reverse engineer the PS4 and view the underlying code, it would have to “jailbreak” the system, which is a violation of the Digital Millennium Copyright Act (“DMCA”) and other anti-hacking statutes. In response, Sony gave Bot M8 permission to jailbreak the system. Bot M8 then sought leave of the court to file its Second Amended Complaint (“SAC”). The court denied Bot M8’s request citing lack of diligence. Bot M8 appealed the district court’s dismissal.
The panel (O’Malley, J., joined by Linn and Dyk, J.J.) affirmed-in-part, reversed-in-part, and remanded, holding that the district court was correct in dismissing two of the patents, but that it required “too much” with respect to the other two patents. The panel reaffirmed that “[a] plaintiff is not required to plead infringement on an element-by-element basis.”
For the first two patents, the panel affirmed the district court finding it did not err in dismissing the claims for insufficiently pleading a plausible claim because (1) the factual allegations were inconsistent and contradicted infringement, and (2) the allegations were conclusory. With respect to the second two patents, the panel reversed the district court determining that Bot M8 had supported its “assertions with specific factual allegations” and that the district court “demand[ed] too much” by dismissing these claims. The panel also affirmed the district court’s decision to deny Bot M8’s motion for leave to amend for lack of diligence. The panel noted that although it may have granted Bot M8’s motion if deciding it in the first instance, it found no abuse of discretion. While the district court should not have required reverse engineering of Sony’s products, Bot M8 waived its objections by telling the court it was happy to undertake the exercise. Moreover, Bot M8 failed to raise any concerns regarding its ability to reverse engineer the PS4 under the DMCA until after the court had issued its decision on Sony’s motion to dismiss.
Chemours Company v. Daikin Industries (Fed. Cir. No. 20-1289): The case involved two IPR final written decisions of the PTAB, which determined that claims directed to a polymer with a high melt flow rate are obvious. The Board relied on a prior art patent (“Kaulbach”) that disclosed a lower melt flow rate and a “very narrow molecular weight distribution.” The Board concluded that a POSA would be motivated to increase Kaulbach’s melt flow rate to the claimed range, even though doing so would broaden molecular weight distribution.
A majority of the panel (Reyna, J., joined by Newman, J.) reversed, holding that Kaulbach taught away from broadening molecular weight distribution and that, therefore, the Board’s proposed modification would necessarily alter Kaulbach’s inventive concept. Judge Dyk dissented in part on this issue, arguing that Kaulbach did not teach away from broadening molecular weight distribution, but only offered better alternatives. According to Judge Dyk, the Court’s precedent makes clear that an inferior combination may still be used for obviousness purposes. Judge Dyk also noted that increasing Kaulbach’s melt flow rate to the claimed range would not have necessarily broadened the molecular weight distribution beyond levels Kaulbach taught were acceptable.
In the unanimous part of the opinion, the panel also rejected the Board’s commercial success analysis, holding that the Board made three errors. First, the panel held that the Board erred by concluding that there could be no nexus between the claimed invention and the alleged commercial success because all elements of the challenged claims were present in Kaulbach or other prior art. The Court explained that where an invention is a unique combination of known elements, “separate disclosure of individual limitations . . . does not negate a nexus.” Next, the Court disagreed with the Board’s decision to require market share data, holding that sales data alone may be sufficient to show commercial success. Lastly, the Court rejected the Board’s finding that the proffered commercial success evidence was weak because the patents at issue were “blocking patents.” The Court held that “the challenged patent, which covers the claimed invention at issue, cannot act as a blocking patent.”
In re: Uber Technologies, Inc. (Fed Cir. No. 21-150) (nonprecedential): Uber sought a writ of mandamus ordering the United States District Court for the Western District of Texas to transfer the underlying actions to the United States District Court for the Northern District of California. The panel (Dyk, J., joined by Lourie and Reyna, J.J.) granted the petition. Gibson Dunn is counsel for Uber.
The panel explained that it had recently granted mandamus to direct the district court to transfer in two other actions filed by the plaintiffs asserting infringement of two of the same patents against different defendants, in In re Samsung Electronics Co., Nos. 2021-139, -140 (see our June 2021 update). In that case, the Federal Circuit rejected the district court’s determination that the plaintiffs’ actions could not have been brought in the transferee venue because the presence of the Texas plaintiff “is plainly recent, ephemeral, and artificial—just the sort of maneuver in anticipation of litigation that has been routinely rejected.” Noting that the district court itself recognized that the issues presented here are identical to those in plaintiffs’ other cases, the panel held that, as in Samsung, the district court erred in concluding that Uber had failed to satisfy the threshold question for venue.
With respect to the district court’s analysis of the traditional public and private factors, the court explained that this case involved very similar facts to those in Samsung, where the Court found that the district court erred by 1) “giving little weight to the presence of identified party witnesses in the Northern District of California despite no witness being identified in or near the Western District of Texas”; 2) “simply presuming that few, if any, party and non-party identified witnesses will likely testify at trial despite the defendants’ submitting evidence and argument to the contrary”; and 3) finding that “there was a strong public interest in retaining the case in the district based on Ikorongo’s other pending infringement action against Bumble Trading, LLC.” The court concluded that there was no basis for a disposition different from the one reached in Samsung. It noted that the reasons for not finding that judicial economy to override the clear convenience of the transferee venue apply with even more force here, given that the court had already directed the Samsung and LG actions to be transferred to Northern California in In re Samsung. The panel also found that the district court clearly erred in negating the transferee venue’s strong local interest by relying merely on the fact that the plaintiffs alleged infringement in the Western District of Texas.
In re: TCO AS (Fed. Cir. No. 21-158) (nonprecedential): NCS Multistage, Inc., a Canadian corporation, and NCS Multistage LLC, its Houston, Texas based subsidiary, sued TCO AS, a Norwegian company, for patent infringement in the Western District of Texas. TCO moved to transfer the case to the Southern District of Texas pursuant to 28 U.S.C. § 1404(a). The district court denied the motion, finding that TCO had failed to show the transferee venue was clearly more convenient.
TCO petitioned for a writ of mandamus, which the Federal Circuit (Taranto, Hughes, Stoll, JJ.) denied. Stressing the “highly deferential standard” for resolving a mandamus petition, the Federal Circuit could not “say that TCO has a clear and indisputable right to relief, particularly in light of the fact that several potential witnesses are located out-side of the proposed transferee venue, including some in the Western District of Texas, and the fact that the only party headquartered in the proposed transferee venue elected to litigate this case in the Western District of Texas.”
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Federal Circuit. Please contact the Gibson Dunn lawyer with whom you usually work or the authors of this alert:
Blaine H. Evanson – Orange County (+1 949-451-3805, bevanson@gibsondunn.com)
Jessica A. Hudak – Orange County (+1 949-451-3837, jhudak@gibsondunn.com)
Please also feel free to contact any of the following practice group co-chairs or any member of the firm’s Appellate and Constitutional Law or Intellectual Property practice groups:
Appellate and Constitutional Law Group:
Allyson N. Ho – Dallas (+1 214-698-3233, aho@gibsondunn.com)
Mark A. Perry – Washington, D.C. (+1 202-887-3667, mperry@gibsondunn.com)
Intellectual Property Group:
Kate Dominguez – New York (+1 212-351-2338, kdominguez@gibsondunn.com)
Y. Ernest Hsin – San Francisco (+1 415-393-8224, ehsin@gibsondunn.com)
Josh Krevitt – New York (+1 212-351-4000, jkrevitt@gibsondunn.com)
Jane M. Love, Ph.D. – New York (+1 212-351-3922, jlove@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On July 28, 2021, certain Democratic members of Congress, primarily in response to the $4.325 billion contribution made by the Sackler family to fund the settlement underpinning Purdue Pharma’s chapter 11 plan, introduced the Nondebtor Release Prohibition Act of 2021 (the “NRPA”), which proposes to amend the Bankruptcy Code to (i) prohibit the use of non-consensual third party releases in chapter 11 plans, (ii) limit so-called “Section 105” injunctions to stay lawsuits against third parties to a period no greater than 90 days after the commencement of a bankruptcy case, and (iii) provide a ground for dismissing a bankruptcy case commenced by a debtor that was formed within 10 years prior to such case via a divisional merger that separated material assets from liabilities.
The proposed elimination of the important bankruptcy tools of non-consensual third party releases and Section 105 injunctions – each of which is extraordinary in nature and only permitted in the rarest of circumstances – is a blunt force measure that threatens to vitiate the longstanding bankruptcy policy of favoring settlements over interminable value-destructive litigation. Moreover, the loss of these tools may cause inequitable disruption in currently pending cases and stymie the implementation of critical creditor-supported strategies to resolve the most difficult cases going forward. Additionally, while the disincentive against divisional mergers would affect a far more limited set of cases, it appears that the harm raised by some divisional mergers that are followed by bankruptcy may be adequately addressed through clarifying the applicability of fraudulent transfer law to challenge these transactions.
I. Bankruptcy Tools Impacted by the Proposed Legislation
At the heart of corporate chapter 11 bankruptcies are an array of tools that serve to preserve the value of a debtor’s estate for the benefit of all stakeholders. Certain tools promote the “breathing spell” necessary for a debtor to formulate and propose a plan, while others, such as the power to reject executory contracts, allow debtors to restructure their operations to emerge from bankruptcy stronger and with greater prospects to succeed than when it filed for bankruptcy.
a. Non-Consensual Third Party Releases
Non-consensual releases of third parties are not common and typically arise as a provision in a chapter 11 plan in which the release of the applicable third party in question is essential to a reorganization in light of, among other considerations, the identity of interest of such third party and the debtor and the substantial economic contribution made to the chapter 11 plan by such third party.
Section 105 of the Bankruptcy Code is often cited as a statutory basis for such releases. Section 105 permits a bankruptcy court to “issue any order, process or judgment that is necessary or appropriate to carry out the provisions” of the Bankruptcy Code.
These releases are distinct from voluntary releases that are commonly featured in corporate chapter 11 plans, whereby creditors are given an opportunity to “opt out” of such releases. A key contextual distinction between these two types of releases is that in the rarer instances in which non-consensual third party releases are sought, the economic contribution of the released third party is so substantial and vital to a chapter 11 plan as to require as a condition to such contribution that all claims against such third party be released, without regard to whether a subset of holdout creditors desire not to provide the release.
Currently, there is a federal circuit split among the courts that have ruled on the permissibility of non-consensual third party releases in connection with a chapter 11 plan. Notably, the Ninth and Tenth Circuits prohibit such releases, while the Second, Third, Fourth, Sixth, Seventh, and Eleventh Circuits permit such releases, with the Fifth Circuit taking a more restrictive approach short of a flat prohibition.
In the circuits where non-consensual third party releases are permitted, a debtor must satisfy a high evidentiary bar to obtain approval of such releases. The factors a bankruptcy court must consider in such circuits include (i) the identity of interests between the debtor and the third party, such that a suit against the non-debtor is akin to a suit against the debtor due to, for example, an indemnity obligation that may deplete the debtor’s assets; (ii) whether the non-debtor has contributed substantial assets to the reorganization; (iii) whether the release is essential to reorganization; (iv) whether the impacted classes of claims have overwhelmingly accepted the plan in question; and (v) whether the bankruptcy court has made a record of specific factual findings to support such releases.
The application of this standard typically requires the released third party to make a substantial financial contribution to a chapter 11 plan, which, in turn, has received extensive creditor support. In essence, these releases serve as an integrated component of a comprehensive economic settlement of claims accepted widely by the creditor body and without which a debtor likely could not reorganize.
Notably, the American Bankruptcy Institute’s exhaustive 2014 report and recommendations on bankruptcy reform recommended the use of non-consensual third party releases based on a consideration of the above-referenced fact-intensive standard and discouraged the imposition of a blanket prohibition against such releases.
b. Injunctions Against Third-Party Lawsuits
Similar to non-consensual third party releases, bankruptcy courts have used their authority under Section 105 of the Bankruptcy Code to preliminarily stay lawsuits against third parties in furtherance of the debtor’s reorganizational efforts. These injunctions constitute extraordinary relief and thus are not routine in corporate chapter 11 cases.
When such injunctions are requested, a debtor must satisfy a multi-factor standard that in most jurisdictions requires consideration of the likelihood of a successful reorganization, the balance of harms, and the public interest in the injunction. These injunctions are typically limited to 60 to 90 days, but have been of longer duration in certain limited cases. For example, the Section 105 injunction in the Purdue Pharma case enjoining litigation against the Sacklers has persisted for a longer period given the central role such injunction has played in fostering the global multi-billion dollar settlement that was ultimately reached.
II. Commentary
While the NRPA may be the product of valid frustrations some parties may have experienced in certain contentious and emotionally charged bankruptcy cases, its passage will likely do more harm than good.
Implicit in the testimony supporting passage of the NRPA is the premise that litigation against third parties should be preserved in all cases despite substantial creditor support that may otherwise exist for the settlement of such claims and the resulting emergence of the debtor from chapter 11. Eliminating the judicial discretion available in certain jurisdictions to implement this tool and elevating the rights of holdout creditors in its stead could lead to value-destructive liquidation outcomes in difficult cases that could otherwise be salvaged through settlements supported by a supermajority of the creditor body that include non-consensual releases of contributing third parties.
The NRPA’s policy preference for preserving litigation claims against third parties who may play a role in plan formulation means that, in cases where a financial contribution is no longer viable due to such mandatory preservation of litigation claims, tort claimants may receive less of a recovery than they would have under the current state of the law and possibly no recovery at all in many cases.
When viewed against the backdrop of current complex chapter 11 practice, this proposed legislation is misguided and elevates the interests of a minority of creditors in contravention of the vaunted bankruptcy principle of binding intransigent holdout creditors through supermajority support for a chapter 11 plan.
Moreover, the bankruptcy tool of preliminary “Section 105” injunctions similarly must satisfy a high evidentiary bar, and bankruptcy courts in practice do not grant these injunctions lightly. These injunctions, which stay suits against individuals and entities that are vital to ongoing reorganization efforts, serve a valuable function in providing the debtor with a limited temporal window within which to negotiate comprehensive settlements with protected parties and, thereby, maximize the chances of a successful reorganization. These injunctions are usually relatively short in duration and subject to dissolution in the event the ultimate reorganization purpose underpinning them is no longer being served.
The NRPA’s disincentivizing of divisional mergers, such as are available under Texas law, is a creative attempt at curbing a perceived abuse in a limited subset of cases. Contrary to the rhetoric of the bill’s supporters, such divisional mergers, which are actually more akin to reverse mergers, are not exclusively followed by bankruptcy and have independent purposes under state law, which include providing a measure of successor liability protection to entities implementing such mergers.
Notably, a divisional merger is not the only means of corporate separation. Companies frequently separate assets and liabilities in corporate “spinoffs” and “splitoffs.” Indeed, when these types of separation transactions are followed by bankruptcy, they have frequently come under vigorous attack. In such cases, fraudulent transfer law has played a vital role in preserving the claims related to such transactions, either as a means of fostering settlement (e.g, Peabody Energy’s spinoff of Patriot Coal) or through post-confirmation litigation (e.g., Kerr-McGee’s spinoff of Tronox, which resulted in fraudulent transfer litigation that led to a multi-billion dollar damages award). In order to neuter any argument that a divisional merger is immune from fraudulent transfer law, clarifying language to the Bankruptcy Code to that effect may be a more direct solution than permitting dismissal of any case filed by a debtor within 10 years of its formation via divisional merger.
Procedurally, the NRPA still needs to move through the Congressional committee process and, based on the current composition of the Senate, will ultimately require some measure of Republican support in order to become law.
Gibson Dunn lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors:
Michael J. Cohen – New York (+1 212-351-5299, mcohen@gibsondunn.com)
Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com)
Matthew J. Williams – New York (+1 212-351-2322, mjwilliams@gibsondunn.com)
Please also feel free to contact the following practice leaders:
Business Restructuring and Reorganization Group:
David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com)
Scott J. Greenberg – New York (+1 212-351-5298, sgreenberg@gibsondunn.com)
Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
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On July 23, 2021, the California Office of Environmental Health Hazard Assessment (OEHHA) released an Initial Statement of Reasons (ISOR) and proposed text for new regulations concerning safe harbor warnings under California’s Safe Drinking Water and Toxics Enforcement Act of 1986 (Proposition 65) for consumer products containing the herbicide, glyphosate. Glyphosate is the active ingredient in Monsanto Company’s Roundup, which is used worldwide in agriculture and other applications.
Proposition 65 generally requires consumer products sold in California to bear a warning label if they expose consumers to chemicals listed by the state as causing cancer or reproductive or developmental toxicity. Glyphosate was added to the list of chemicals causing cancer in 2017 based on the International Agency for Research on Cancer (IARC)’s determination that it is a “probable” human carcinogen.[1]
Despite glyphosate’s listing as a carcinogen under Proposition 65, the issue of glyphosate’s carcinogenicity has proven highly controversial, with major public authorities on carcinogens reaching conflicting conclusions. US EPA, for example, has concluded that glyphosate is “not likely to be carcinogenic to humans.”[2] A number of recent high-profile personal injury actions against Monsanto have resulted in massive jury verdicts for plaintiffs who claimed that exposure to glyphosate in Roundup caused their cancers.[3]
Monsanto’s legal challenge to glyphosate’s addition to the Proposition 65 list was unsuccessful,[4] but, in June 2020, the U.S. District Court for the Eastern District of California issued a permanent injunction against enforcement of Proposition 65 warnings for glyphosate.[5] The court held that the standard safe harbor warning language—including that glyphosate is “known to the State of California to cause cancer”—violated glyphosate sellers’ First Amendment rights against compelled speech, because it would force them to take one side of a controversial issue, despite “the great weight of evidence indicating that glyphosate is not known to cause cancer.”[6]
The ISOR for the proposed regulations discusses the scientific and legal controversy surrounding glyphosate,[7] which has plainly motivated and shaped the text of the proposed regulations. Indeed, the new warning language proposed for glyphosate appears crafted to avoid the First Amendment problems that gave rise to the preliminary injunction in Wheat Growers, though the ISOR notes that the injunction remains in effect, so “no enforcement actions can be taken against businesses who do not provide warnings for significant exposures to [glyphosate].”[8] The ISOR further explains that glyphosate presents “an unusual case because several regulatory agencies did not reach a similar conclusion as IARC,” and, therefore, “[t]he standard Proposition 65 safe harbor warning language . . . is not the best fit in this situation.”[9]
OEHHA proposes to add section 25607.49 to title 27 of the California Code of Regulations, which would provide:
(a) A warning for exposure to glyphosate from consumer products meets the requirements of this subarticle if it is provided using the methods required in Section 25607.48 and includes the following elements:
(1) The symbol required in Section 25603(a)(1)
(2) The words “CALIFORNIA PROPOSITION 65 WARNING” in all capital letters and bold print.
(3) The words, “Using this product can expose you to glyphosate. The International Agency for Research on Cancer classified glyphosate as probably carcinogenic to humans. Other authorities, including USEPA, have determined that glyphosate is unlikely to cause cancer, or that the evidence is inconclusive. A wide variety of factors affect your personal cancer risk, including the level and duration of exposure to the chemical. For more information, including ways to reduce your exposure, go to www.P65Warnings.ca.gov/glyphosate.”
(b) Notwithstanding subsection (a), and pursuant to Section 25603(d), where the warning is provided on the product label, and the label is regulated by the United States Environmental Protection Agency under the Federal Insecticide, Fungicide, and Rodenticide Act, Title 40 Code of Federal Regulations, Part 156; and by the California Department of Pesticide Regulation under Food and Agricultural Code section 14005, and Cal. Code Regs., title 3, section 6242; the word ATTENTION” or “NOTICE” in capital letters and bold type may be substituted for the words “CALIFORNIA PROPOSITION 65 WARNING.”
Section 25607.48 would also be added to make clear that the warning must be provided using a method listed in Section 25602.
Adoption of these regulations may trigger an effort to alter or lift the Wheat Growers injunction, though the district court rejected several alternative warning formulations that are similar to OEHHA’s current proposal.[10] If the injunction is modified, businesses involved in distribution, sale, or use of glyphosate-containing products in California would not be required to use the new warning language, since it is merely a safe harbor, but doing so would be sufficient to avoid violation of Proposition 65’s warning requirement.[11]
OEHHA’s announcement, the proposed text of the new regulations, and the ISOR are linked below. OEEHA will receive public comments on the proposed regulations until September 7, 2021.:
__________________________
[1] https://oehha.ca.gov/proposition-65/chemicals/glyphosate
[2] https://www.epa.gov/ingredients-used-pesticide-products/glyphosate
[3] See, e.g., Hardeman v. Monsanto Co, No. 16-cv-00525-VC (E.D. Cal. filed Feb. 1, 2016); Pilliod v. Monsanto Co., No. RG17862702, JCCP No. 4953 (Cal. Super. Ct. Alameda Cty. filed Jun 2, 2017).
[4] Monsanto Co. v. Office of Environmental Health Hazard Assessment, 22 Cal. App. 5th 534 (2018).
[5] Nat’l Ass’n of Wheat Growers v. Becerra, 468 F. Supp. 3d 1247, 1266 (E.D. Cal. 2020) (on appeal to the Ninth Circuit Court of Appeals, Case No. 20-16758).
[7] Initial Statement of Reasons, July 23, 2021, at pp. 5-6, 12.
[10] Wheat Growers, 468 F. Supp. 3d at 1262-63.
[11] Cal. Health & Safety Code § 25249.6
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Environmental Litigation and Mass Tort practice group, or the following authors:
Abbey Hudson – Los Angeles (+1 213-229-7954, ahudson@gibsondunn.com)
Alexander P. Swanson – Los Angeles (+1 213-229-7907, aswanson@gibsondunn.com)
Please also feel free to contact the following practice group leaders:
Environmental Litigation and Mass Tort Group:
Stacie B. Fletcher – Washington, D.C. (+1 202-887-3627, sfletcher@gibsondunn.com)
Daniel W. Nelson – Washington, D.C. (+1 202-887-3687, dnelson@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
One of the most common provisions in an acquisition agreement is the “effect of termination” provision. As its name implies, the provision expresses the agreement of the parties regarding what, if any, liability each party will have to the other after the agreement is terminated. It is common for the provision to state that, if the agreement is terminated, neither party will have any liability to the other except with respect to certain other provisions of the agreement, such as the confidentiality, governing law, interpretive and other boilerplate provisions, that are necessary to maintain the confidentiality of each party’s information after the agreement is terminated and to maintain the governing terms of the agreement in the event of a post-termination contractual dispute or a dispute regarding the validity of the termination itself. It is also common for the effect of termination provision to include a carve-out stating that termination of the agreement will not relieve the parties from certain pre-termination breaches of the agreement.
The scope of the pre-termination breaches subject to the carve-out typically is, and should be, scrutinized in transactions in which there is significant risk of the deal being terminated, such as due to a failure to receive regulatory approval or a debt financing failure. For example, in transactions in which the buyer is a financial sponsor and is relying on the availability of debt financing to pay the purchase price, the seller typically wants to ensure that, if the buyer fails to close the acquisition when required by the agreement, it has the ability to (i) keep the agreement in place and seek specific performance of the agreement to force the buyer to close, which may be limited to circumstances in which the buyer’s debt financing is available (i.e., a synthetic debt financing condition), or (ii) terminate the agreement and recover damages, often in the form of a reverse termination fee, from the buyer. The effect of termination provision should not purport to foreclose recovery of the reverse termination fee, which in some transactions serves as liquidated damages and a cap on the buyer’s liability for pre-termination breaches. In other transactions, the effect of termination provision may also permit the seller to recover damages beyond or irrespective of a reverse termination fee, frequently limited to circumstances in which there was an “intentional” or “willful” pre-termination breach by the buyer of its obligations.
In an increasingly competitive M&A market, it has become more common for buyers to agree to bear regulatory approval risk and for financial buyers to agree to backstop payment of the entire purchase price with equity in lieu of the synthetic debt financing condition or reverse termination fee construct described above. In these contexts, continued and careful consideration of a buyer’s liability for pre-termination breaches of a purchase agreement is critical. The scope of liability for pre-termination breaches also deserves attention in light of the now widespread use of representation and warranty insurance and transaction structures in which sellers may not expect any liability for breaches of representations and warranties, absent fraud.
The following is a summary of issues for buyers and sellers to consider when negotiating these issues in light of current and evolving M&A market dynamics.
Defining the Appropriate Pre-Termination Breach Standard
Although it is common for the effect of termination provision to include a carve-out stating that termination of the agreement will not relieve the parties from pre-termination breaches of the agreement, the relevant standard for defining the scope of those pre-termination breaches is often inconsistent in practice. Some agreements define the standard as any pre-termination breach that is “intentional and willful,” “knowing and intentional,” “intentional,” “willful and material,” or “willful.” Sometimes these terms are defined, sometimes not. Sometimes the standard distinguishes breaches of covenants, on the one hand, from breaches of representations and warranties, on the other hand, and sometimes it does not. Finally, some agreements do not contain a specific standard and provide that “any” pre-termination breach is carved-out from the effect of termination provision.
This lack of uniformity, coupled with contending interpretations after a broken transaction, can lead to unpredictable or undesirable outcomes. For example, in Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008), the Delaware Court of Chancery interpreted a “knowing and intentional” breach of a merger agreement as a deliberate act that in and of itself is a breach of the agreement “even if breaching was not the conscious object of the act.” This could lead to an undesirable outcome for buyers, who are wary of unintentionally breaching their obligations to obtain regulatory approvals or debt financing that can be ripe for second-guessing in the context of a broken transaction. They should consider defining the standard to include only an action taken with the actual knowledge that the action would result in a breach of the agreement.
Sellers, on the other hand, should consider defining the standard to include specifically the failure of the buyer to close the transaction when required by the agreement or, if the transaction involves a reverse termination fee that does not serve as liquidated damages, the failure of the buyer to close the transaction if the debt financing is available. In transactions with a financial buyer, the importance of this issue and the relevant standard may be overlooked if there is a last minute change to a full equity backstop structure in lieu of a traditional reverse termination fee structure.
Distinguishing Breaches of Covenants from Breaches of Representations and Warranties
As stated earlier, effect of termination provisions often do not distinguish between liability for pre-termination breaches of covenants and breaches of representations and warranties. But if the parties have negotiated a “willful” breach or similar standard to define the scope of their liability for pre-termination breaches, what does it mean to “willfully” breach a representation and warranty? As the Delaware court did in Hexion, some may interpret the term “willful” to imply a deliberate action, which may better describe a breach of a covenant, rather than a breach of a representation or warranty. As a result, the parties should consider distinguishing breaches of covenants from breaches of representations and warranties when formulating the appropriate standard.
Aligning Expectations in Transactions with Representation and Warranty Insurance
In addition, in transactions involving representation and warranty insurance, it has become increasingly common for sellers to expect no liability for breaches of their representations and warranties in the purchase agreement, absent fraud. That expectation drives the parties to scrutinize the survival or non-survival of the representations and warranties if the transaction closes, but the parties may overlook the effect of termination provision, which would apply in a broken transaction. A seller who expects no liability for breaches of representations and warranties may insist that the effect of termination carve-out not only distinguish breaches of covenants from breaches of representations and warranties, but also provide that liability for pre-termination breaches of representations and warranties will be limited to only instances of fraud.
In summary, although the effect of termination provision may often be considered akin to boilerplate provisions in a contract, astute dealmakers should focus on the carve-outs and ensure that they best serve their client’s interests under the particular circumstances of the transaction.
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Mergers and Acquisitions or Private Equity practice groups, or the authors:
Robert B. Little – Dallas (+1 214-698-3260, rlittle@gibsondunn.com)
Joseph A. Orien – Dallas (+1 214-698-3310, jorien@gibsondunn.com)
Please also feel free to contact the following practice group leaders:
Mergers and Acquisitions Group:
Eduardo Gallardo – New York (+1 212.351.3847, egallardo@gibsondunn.com)
Robert B. Little – Dallas (+1 214-698-3260, rlittle@gibsondunn.com)
Saee Muzumdar – New York (+1 212.351.3966, smuzumdar@gibsondunn.com)
Private Equity Group:
Richard J. Birns – New York (+1 212-351-4032, rbirns@gibsondunn.com)
Scott Jalowayski – Hong Kong (+852 2214 3727, sjalowayski@gibsondunn.com)
Ari Lanin – Los Angeles (+1 310-552-8581, alanin@gibsondunn.com)
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Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On July 15, 2021, the California Supreme Court in Ferra v. Loews Hollywood Hotel, LLC adopted a new formula for calculating the one extra hour of premium pay that employees are owed if an employer fails to provide a compliant meal period or rest break. Specifically, the Court held that those premium payments must include the hourly value of any nondiscretionary earnings (such as a nondiscretionary bonuses), and cannot simply be paid an employee’s base hourly rate. This holding aligns the formula for calculating meal period and rest break premium payments with the formula for calculating overtime payments under California law.
The Ferra decision represents a change in the law, as the California Court of Appeal and several federal district courts had previously held that California Labor Code section 226.7’s use of the term “regular rate of compensation” meant that premium payments for failures to provide meal periods or rest breaks should be calculated using an employee’s base hourly rate. Despite this shift, however, the California Supreme Court held that its decision applies retroactively.
In light of Ferra, employers should take steps to evaluate whether their calculation of premium payments for the non-provision of meal periods and rest breaks includes nondiscretionary payments, as well as assess the impact of the decision on any pending meal period or rest break litigation.
Ferra Holds That Nondiscretionary Earnings Must Be Included in the Calculation of Meal Period and Rest Break Premiums
California courts have long held that premium wages for calculating overtime pay must factor in the hourly value of nondiscretionary earnings. At issue in Ferra was whether that same formula applied to premium payments that are owed to employees when an employer fails to provide a meal period or rest break. Specifically, the California Supreme Court answered the following question: “Did the Legislature intend the term ‘regular rate of compensation’ in Labor Code section 226.7, which requires employers to pay a wage premium if they fail to provide a legally compliant meal period or rest break, to have the same meaning and require the same calculations as the term ‘regular rate of pay’ under Labor Code section 510(a), which requires employers to pay a wage premium for each overtime hour?”
The California Supreme Court held that “regular rate of compensation” and “regular rate of pay” are interchangeable terms, and therefore “premium pay for a noncompliant meal, rest, or recovery period, like the calculation of overtime pay, must account for not only hourly wages but also other non-discretionary payments for work performed by the employee.”
The Court explained that, in enacting Labor Code section 226.7, the California Legislature did so with an understanding that the federal Fair Labor Standards Act’s use of the phrase “regular rate” has been “consistently understood . . . to encompass all nondiscretionary payments, not just base hourly rates.” With this context, the Court concluded that “regular rate” was the “operative term” in the statute, and that the modifiers “of pay” and “of compensation” were intended to be used interchangeably.
The Court also held that its decision applies retroactively, emphasizing that it had not previously issued a definitive decision on the issue.
Ferra’s Impact on Employers
Employers should review their how they are calculating any meal period or rest break premium payments to ensure that they include the value of any nondiscretionary earnings during the relevant pay period.
As for litigation regarding the improper calculation of meal period and rest break premiums, Ferra does not eliminate all defenses to such claims or ensure that class certification will be granted in such cases. While Ferra clarifies how meal period and rest break premiums must be calculated, it says nothing at all regarding whether or not such premiums are owed in the first place. This means, as Ferra itself recognized, that an “employer may defend against” a claim that it has failed to provide meal periods or rest breaks “as it has always done.” In other words, plaintiffs pursuing Ferra-based claims will still need to establish an entitlement to a premium in the first place, and under Brinker Restaurant Corp. v. Superior Court, 53 Cal. 4th 1004 (2012), this means plaintiffs must establish that a compliant meal period or rest break was not provided. And in a putative class action, plaintiffs must show that this threshold question can be resolved on a classwide basis.
Some plaintiffs may attempt to skip over this important threshold requirement by pointing to the fact that an employer voluntarily made meal period or rest break premium payments, and argue that such payments are evidence that they were not provided with compliant breaks. But the fact that an employer may have made a meal period or rest break premium is not dispositive evidence that a compliant meal period or rest break was not provided. Employers often pay such premiums proactively and out of an abundance of caution, even where a premium was not in fact due. In other words, employers do not need to concede that the payment of a premium establishes that an employee was entitled to it. And this will mean that, in many cases, determining whether a compliant meal period or rest break was provided, and thus whether a premium was owed in the first, is a question that is not capable of classwide resolution.
Moreover, even if a plaintiff can show that they were entitled to a meal period or rest break premium, they must also prove that they earned a form of nondiscretionary pay during that same pay period that must be included in calculating the amount of the premium under Ferra. Whether a particular payment was discretionary or nondiscretionary is also often a highly fact-dependent inquiry, and thus may not be suitable for resolution on a classwide basis.
This alert was prepared by Jason Schwartz, Michele Maryott, Katherine Smith, Brad Hamburger, Lauren Blas, Megan Cooney, Katie Magallanes, Amber McKonly, Nick Thomas, Nick Barba, and Rebecca Lamp.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these matters. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment practice group, or the following authors:
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com)
Michele L. Maryott – Orange County (+1 949-451-3945, mmaryott@gibsondunn.com)
Katherine V.A. Smith – Co-Chair, Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, bhamburger@gibsondunn.com)
Lauren M. Blas – Los Angeles (+1 213-229-7503, lblas@gibsondunn.com)
Megan Cooney – Orange County (+1 949-451-4087, mcooney@gibsondunn.com)
Katie Magallanes – Orange County (+1 949-451-4045, kmagallanes@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On July 13, 2021, the Securities and Exchange Commission (“SEC”) announced a partially settled enforcement action against a Special Purpose Acquisition Company (“SPAC”), the SPAC sponsor and the CEO of the SPAC, as well as the proposed merger target and the former CEO of the target for misstatements in a registration statement and amendments concerning the target’s technology and business risks.[1] As of the date of the enforcement action, the registration statement had not been declared effective and the proxy statement/prospectus had not been mailed to the SPAC shareholders. This action is notable because the allegations against the SPAC, its sponsor and its CEO are premised on a purported negligent deficiency in their due diligence, which failed to uncover alleged misrepresentations and omissions by the target and its former CEO. This action has important implications for SPACs, their sponsors and executives for their diligence on proposed acquisition targets.
Overview of the Action
In a settled administrative order, in which the respondents neither admit nor deny the allegations, the Commission alleged that disclosures contained in a Form S-4 filed by the SPAC were inaccurate because they both overstated the commercial viability of the target’s key product, and understated the risk pertaining to the target’s former CEO and a previous regulatory action regarding national security.
The settled administrative action against the target and the civil complaint against its former CEO, who is a Russian national, are premised on allegations of fraud: specifically, that the target and its former CEO (1) misrepresented that the target had “successfully tested” its key technology, when in fact a prior test did not meet criteria for success; and (2) omitted or made misstatements concerning the U.S. government’s concerns with national security and foreign ownership risks posed by the target CEO including concerns related to his affiliation with the target.
The target consented to a settlement finding a violation of the anti-fraud provisions of the securities laws, including Section 10(b) of the Securities Exchange Act and agreeing to pay a penalty of $7 million. In the separate civil complaint against the target’s former CEO, the Commission alleges violations of the same anti-fraud provisions.
Of greater significance is the settled action against the SPAC, its sponsor and CEO, which is premised on allegations of negligence in the conduct of their due diligence on the target, which failed to uncover the misrepresentations by the target and its former CEO and thus resulted in those misstatements or omissions being repeated in the proxy materials, even though those proxy materials had not yet been mailed to shareholders. The settled order alleges that: (1) although the SPAC engaged a technology consulting firm to conduct diligence on the target’s technology, the SPAC did not ask the consulting firm to review the target’s prior product test; and (2) although the SPAC was aware that the U.S. government had previously ordered the target CEO to divest from another unrelated technology company, and requested documentation from the target relating to the order, and was falsely told by the target that it did not have such documents, the SPAC nevertheless proceeded with the executing the merger agreement and filing the registration statement.
The SPAC, its sponsor and its CEO consented to violations (or causing violations) of the negligence-based anti-fraud provisions, including those relating to proxy solicitations – Sections 17(a)(3) of the Securities Act and 14(a) of the Securities Exchange Act and Rule 14a-9. The SPAC agreed to pay a penalty of $1 million and the CEO agreed to pay a penalty of $40,000. The SPAC’s sponsor also agreed to forfeit 250,000 of its founder shares in the event the merger receives shareholder approval. The SPAC and the target also agreed to offer PIPE investors in the SPAC the opportunity to terminate their subscription agreement.
Key Takeaways — Implications for SPAC and Acquiror Diligence
This latest enforcement action comes on the heels of a string of pronouncements by senior SEC officials earlier this year concerning the risks posed by the explosion of SPAC initial public offerings in 2020 and early 2021, including a potential misalignment of interests and incentives between SPAC sponsors and shareholders.[2]
In the press release announcing this enforcement action, SEC Chairman Gary Gensler took the unusual step of providing comments that echoed the concerns of senior officials and sent a clear message that even when the SPAC is “lied to” by the target, the SPAC and its executives are at risk for liability under the securities laws if their diligence fails to uncover misrepresentations or omissions by the target. Chairman Gensler stated, “This case illustrates risks inherent to SPAC transactions, as those who stand to earn significant profits from a SPAC merger may conduct inadequate due diligence and mislead investors. . . . The fact that [the target] lied to [the SPAC] does not absolve [the SPAC] of its failure to undertake adequate due diligence to protect shareholders. Today’s actions will prevent the wrongdoers from benefitting at the expense of investors and help to better align the incentives of parties to a SPAC transaction with those of investors relying on truthful information to make investment decisions.”
The SEC’s action has important implications for SPAC sponsors, as well as any acquiror conducting diligence on a prospective merger target.
- First, the SEC took action with respect to the initial Form S-4, filed on November 2, 2020, and two amendments, filed on December 14, 2020 and March 8, 2021, even though the Form S-4 has been subsequently amended (and presumably corrected) and has not yet been declared effective. The combined proxy statement/consent solicitation statement/prospectus contained in the Form S-4 has not yet been mailed to shareholders since it remains in preliminary form.
- Second, in view of the unusual posture of this case, it is clear that the SEC intends this to be a message case to SPAC sponsors on the level of scrutiny that will be imposed on their diligence of acquisition targets. Diligence should be reasonable under the circumstances. However, in an investigation, the government reviews the reasonableness of diligence with the dual benefits of hindsight and subpoena power not available to private enterprises engaged in commercial transactions. Moreover, the SEC is well-versed in conducting these types of investigations and the securities law provisions used here are the same well-established provisions used in typical negligent fraud actions filed by the Commission. Thus the lessons of this action are not limited to SPACs, but also apply to diligence conducted by any acquiror on a potential target where the merger will be subject to disclosure and shareholder approval.
- Third, when conducting diligence on potential targets, sponsors should keep in mind that, in the event a target’s business turns out not to be as represented, the reasonableness of the SPAC’s diligence may be reviewed under a harsh government spotlight. This action highlights the need for blank check companies and their founders to conduct and document thorough legal, financial and accounting due diligence review of potential targets, as well as industry-specific due diligence focused on a target’s business. Sponsors should also follow up appropriately on potential red flags identified during the due diligence process, including assessing the accuracy of, and basis for, factual statements about the target in public filings and investor materials and to identify risks related to the target’s business to investors. Ultimately, in the event open questions remain, sponsors will need to evaluate the feasibility of proceeding with a transaction or whether adequate disclosures can be made to address the attendant risks.
- Fourth, sponsors also may want to consider the inclusion of seller indemnification provisions or the use of representations and warranties insurance to protect the SPAC from losses resulting from the inaccuracy of the target’s representations and warranties in the acquisition agreement. Such provisions and the use of insurance are less typical in de-SPAC transactions than in traditional private M&A transactions. In fact, the SPAC in this Enforcement action and the target amended their merger agreement on June 29, 2021, among other things, to add a limited seller indemnity related to untrue statements of a material fact in the information provided by or on behalf of the target for inclusion in the SPAC’s SEC filings, or any omission of a material fact therein relating to the target.
- Fifth, this action is also notable for the SPAC sponsor’s agreement to forfeit a portion of its founder shares and the opportunity given to PIPE investors to terminate their subscription. These remedies may have been driven, in part, by the limited amount of cash working capital at the SPAC available for a settlement and also highlights the SEC’s desire to hold founders accountable for the actions of the SPAC, with such founder shares representing a significant value to a SPAC’s sponsor. Furthermore, the ability of PIPE investors to terminate their subscription agreements could meaningfully impact the SPAC’s ability to close its pending transaction without the additional financing to backstop potential redemptions by the SPAC’s public investors.
- Finally, this action is also notable because the SEC charged the SPAC, the SPAC sponsor and the CEO of the SPAC with violating the proxy rules, including Rule 14a-9, at the preliminary proxy statement stage. In other words, the SEC could have, but chose not to, simply allowed the SPAC to correct its misstatements and omissions in subsequent filings so that the definitive proxy statement that is mailed to SPAC shareholders is materially accurate.
The SEC’s decision to intervene in the middle of the de-SPAC process with an Enforcement action and a suite of remedial actions that includes requiring the target to engage an independent compliance consultant to conduct a comprehensive ethics and compliance program assessment of the target’s disclosure practices underscores the priority of the Enforcement Division’s continuing focus on SPACs.
________________________
[1] Press Release, Securities and Exchange Commission, SEC Charges SPAC, Sponsor Merger Target, and CEOs for Misleading Disclosures Ahead of Proposed Business Combination (July 13, 2021), available at https://www.sec.gov/news/press-release/2021-124.
[2] March 31, 2021 Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies, available at https://www.sec.gov/news/public-statement/division-cf-spac-2021-03-31.
March 31, 2021 Public Statement: Financial Reporting and Auditing Considerations of Companies Merging with SPACs, available at https://www.sec.gov/news/public-statement/munter-spac-20200331.
Apr. 8, 2021 Public Statement: SPACs, IPOs and Liability Risk under the Securities Laws, available at https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws
Apr. 12, 2021 Public Statement: Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”), available at https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs.
SEC Official Warns on Growth of Blank-Check Firms, Wall St. Journal (Apr. 7, 2021), available at https://www.wsj.com/articles/sec-official-warns-on-growth-of-blank-check-firms-11617804892.
Gibson, Dunn and Crutcher’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 Securities Enforcement, Securities Regulation and Corporate Governance, Capital Markets, or Mergers and Acquisitions practice groups, or the following authors:
Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com)
Evan M. D’Amico – Washington, D.C. (+1 202-887-3613, edamico@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Jonathan M. Whalen – Dallas (+1 214-698-3196, jwhalen@gibsondunn.com)
Tina Samanta – New York (+1 212-351-2469, tsamanta@gibsondunn.com)
Timothy M. Zimmerman – Denver (+1 303-298-5721, tzimmerman@gibsondunn.com)
© 2021 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
In the last several years, M&A transaction planners have become increasingly focused on cybersecurity, privacy, and data protection risks, as technology advances and the regulatory regimes evolve. This recorded webcast focuses on how to design and manage an effective cybersecurity and privacy diligence plan. A group of experts, including US and European cybersecurity, privacy, and data protection lawyers, as well as M&A lawyers, discuss, among other things:
- The principal risks under relevant U.S. and European law
- The impact of the target company’s industry sector on the scope of the exercise
- The role of the buyer’s and seller’s internal experts, as well as outside consultants.
- Red flags that suggest the possibility of significant issues
- Key practice pointers
View Slides (PDF)
PANELISTS:
Ahmed Baladi is a partner in the Paris office and Co-Chair of the firm’s Privacy, Cybersecurity and Data Innovation Practice Group. His practice focuses on a wide range of privacy and cybersecurity matters including compliance, investigations and procedures before data protection authorities. He also advises companies and private equity clients in connection with all privacy and cybersecurity aspects of their cross-border M&A transactions.
Stephen Glover is a partner in the Washington, D.C. office and a member of the firm’s Mergers and Acquisitions Practice Group. Mr. Glover has an extensive practice representing public and private companies in complex mergers and acquisitions, including SPACs, spin-offs and related transactions, as well as other corporate matters. Mr. Glover’s clients include large public corporations, emerging growth companies and middle market companies in a wide range of industries. He also advises private equity firms, individual investors and others.
Saee Muzumdar is a partner in the New York office and a member of the firm’s Mergers and Acquisitions Practice Group. Ms. Muzumdar is a corporate transactional lawyer whose practice includes representing both strategic companies and private equity clients (including their portfolio companies) in connection with all aspects of their domestic and cross-border M&A activities and general corporate counseling.
Alexander H. Southwell is a partner in the New York office and Co-Chair of the firm’s Privacy, Cybersecurity and Data Innovation Practice Group. He is a Chambers-ranked former federal prosecutor and was named a “Cybersecurity and Data Privacy Trailblazer” by The National Law Journal. Mr. Southwell’s practice focuses on privacy, information technology, data breach, theft of trade secrets and intellectual property, computer fraud, national security, and network and data security issues, including handling investigations, enforcement defense, and litigation. He regularly advises companies and private equity firms on privacy and cybersecurity diligence and compliance.
Cassandra Gaedt-Sheckter is of counsel in the Palo Alto office where her practice focuses on data privacy, cybersecurity and data regulatory litigation, enforcement, transactional, and counseling representations. She has substantial experience advising companies on legal and regulatory compliance, diligence, and risks in transactions, particularly with respect to CCPA and CPRA as one of the leads of the firm’s CCPA/CPRA Task Force; GDPR; Children’s Online Privacy Protection Rules (COPPA); and other federal and state laws and regulations.
Vera Lukic is of counsel in the Paris office where her practice focuses on a broad range of privacy and cybersecurity matters, including assisting clients with multinational operations on their global privacy compliance programs, cross-border data transfers and data security issues, as well as representing clients in investigations, enforcement actions and litigation before the French data protection authority and administrative courts. She also regularly advises on data privacy aspects of M&A transactions, including with respect to carve-out and transition issues.
Lisa Zivkovic, Ph.D is an associate in the New York Office. She is a member of the Firm’s Privacy, Cybersecurity and Data Innovation, Technology Transactions, and Litigation practices groups. Ms. Zivkovic’s doctorate is a comparative history of data privacy in the US and European Union. She advises a wide range of clients, including technology, financial services, data aggregation and analytics, vehicle, and telematics companies, on new and complex legal and policy issues regarding global data privacy, cybersecurity, artificial intelligence, Internet of Things, and big data.
MCLE CREDIT INFORMATION:
This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hours, of which 1.0 credit hours may be applied toward the areas of professional practice requirement.
This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an affirmation form prior to watching the archived version of this webcast. Please contact CLE@gibsondunn.com to request the MCLE form.
Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 hours.
California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.
Today, July 9, 2021, President Biden issued a sweeping Executive Order directing federal regulatory agencies to take a variety of steps that, if completed and upheld by the courts, would effect a sea change in the government’s regulation of businesses’ competitive practices.[1]
The Executive Order itself will have little immediate impact on regulated parties, although its tenor and objectives send an important message about the Administration’s perception of the business climate and enforcement priorities. The Order’s principal purpose is to set in motion a variety of proceedings before regulatory agencies. Interested parties will often (but not always) have the opportunity to participate in notice and comment rulemaking before the agencies. If the agencies exceed their statutory authority or fail to follow proper regulatory procedures, their actions typically will be subject to challenge in the courts.
General Overview of the Executive Order
The Executive Order is expansive—addressing 72 initiatives involving more than a dozen federal agencies. The Order’s premise is that the size and consolidation of American businesses has restricted competition and harmed consumers and workers. A White House “fact sheet” accompanying the Order expresses concern that “[f]or decades, corporate consolidation has been accelerating,” including in healthcare, financial services, agriculture, and other sectors.[2] The Order asserts this has resulted in higher prices and lower wages, along with reduced “growth and innovation.” In the technology sector, the Order states, “a small number of dominant Internet platforms use their power to exclude market entrants, to extract monopoly profits, and to gather intimate personal information that they can exploit for their own advantage.” “When past presidents faced similar threats from growing corporate power,” the accompanying fact sheet says, “they took bold action,” such as trust-busting by Theodore Roosevelt and “supercharged antitrust enforcement” under Franklin Roosevelt. The fact sheet then lays out the “decisive,” “whole-of-government effort” directed by President Biden in the Order.
The Order addresses matters as diverse as the cost of hearing aids, airline payments for delayed baggage, the price of beef, and international shipping fees. It “directs” executive branch agencies like the Department of Transportation (“DOT”) to take certain action and “encourages” independent agencies like the Federal Trade Commission (“FTC”) to consider others. Nonetheless, independent agencies like the FTC should be expected to pursue each of the actions the Order identifies. Indeed, some of the initiatives outlined in the Order relate to matters for which agencies are already engaging in rulemakings.
Initiatives in the Order include:
Agriculture
- The Order directs the United States Department of Agriculture (“USDA”) to consider issuing new rules regulating competition in the farming industry.
- The Order “encourages” the Federal Trade Commission (“FTC”) to address restrictions on third-party repair or self-repair, such as restrictions prohibiting farmers from repairing their own tractors.
Healthcare
- The Order encourages the FTC to consider a rule addressing agreements in the prescription drug industries, such as settlements of patent litigation to delay the market entry of generic drugs or biosimilars.
- The Order directs the United States Department of Health and Human Services (“HHS”) to consider issuing proposed rules allowing hearing aids to be sold over the counter.
Labor Markets
- The Order encourages the FTC “to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”
- The Order encourages the FTC to consider a rule addressing occupational licensing restrictions.
- The Order encourages the FTC and the Department of Justice (“DOJ”) to revise existing antitrust guidance to “better protect workers from wage collusion.”
Merger Review
- The Order encourages the FTC and DOJ “to review the horizontal and vertical merger guidelines and consider whether to revise those guidelines.”
Technology
- The Order encourages the FTC to consider a rule addressing data collection and surveillance practices.
- The Order encourages the FTC to consider a rule addressing “unfair competition in major Internet marketplaces.”
Transportation
- The Order directs the DOT to “publish for notice and comment a proposed rule requiring airlines to refund baggage fees when a passenger’s luggage is substantially delayed and other ancillary fees when passengers pay for a service that is not provided.”
- The Order encourages the Federal Maritime Commission to consider a rule “to improve detention and demurrage practices and enforcement of related Shipping Act prohibitions.”
Next Steps, and Implications for Our Clients
The Order is a significant and bold pronouncement of the Administration’s position on competition matters and business practices generally. However, its ultimate importance will depend principally on agencies’ success in implementing the changes the Order identifies. Many of the changes sought by the Order will require notice and comment rulemaking, a process that often takes years. In rulemakings, agencies must conduct appropriate analyses; draft and issue a proposed rule; invite and consider the public’s comments on the proposal; and then revise and finalize the rule in light of those comments and the evidence in the record. A hasty, sloppy rule—or one that gives insufficient attention to important problems identified by commenters, such as the absence of statutory authority or constitutional problems—is legally vulnerable.
Agencies must base and justify their regulatory action on their own statutory authority; the Order is not a basis for an agency to take actions that are not statutorily authorized by Congress.
Companies concerned about specific directives in the Order should begin making plans now to ensure those concerns are amply documented before the agency when rulemaking proceedings begin. Substantial, evidence-based rulemaking comments—whether submitted directly by a company, or by a trade association—are often very helpful to agencies in identifying changes they should make to their initial proposals. And, if those comments are ignored, they can provide a strong foundation for a successful legal challenge.
Focus on the FTC
The FTC will be responsible for some of the Order’s most significant directives. For the FTC to simultaneously address such a large number of competition initiatives would be a historical novelty—the FTC has only issued one competition rule in its entire history.[3] That rule was issued in the 1960s, never enforced, and later withdrawn.[4]
Procedurally, the FTC recently streamlined its rulemaking procedures and gave the Chair more control over the process.[5] FTC Commissioner Wilson, who dissented from the procedural changes, expressed concern that they compromised the impartiality of the rulemaking process and unduly limited public input. And substantively, while any rulemaking must be based on a factual record, several of the initiatives outlined in the Order appear inconsistent with longstanding FTC enforcement policy and governing law. For example, the fact sheet accompanying the Order objects that “rapid[] consolidation” in the shipping industry has resulted in 10 shippers controlling 80% of the market. But under the long-standing Horizontal Merger Guidelines of the Department of Justice and Federal Trade Commission that are cited regularly by the courts, such a market likely would be considered “unconcentrated.”[6] To the extent the FTC takes actions that conflict with courts’ interpretation of antitrust law, or that constitute a significant and unexplained deviation from existing enforcement policies, its initiatives may be subject to legal challenge.
Similarly, while the fact sheet accompanying the Order suggests the FTC is to “ban” non-compete agreements, such a sweeping rule by the agency likely would be invalidated in court. The Order therefore more modestly encourages the agency to “curtail” non-compete “clauses” and agreements “that may unfairly limit worker mobility”; still, even a rule adopting this narrower approach would be subject to legal challenge, particularly if not drawn with great care and precision. Indeed, given that many states already require non-compete agreements to be reasonable in their scope, it is unclear how—if at all—a federal effort to curtail such agreements that “unfairly” limit worker mobility would change the legal landscape.
Expansive rulemaking could also expose the FTC to legal challenges under the constitutional “nondelegation doctrine,” which limits the extent to which Congress may delegate lawmaking power to administrative agencies. Although the nondelegation doctrine has seldom been invoked by the Supreme Court since the New Deal Era, in 2019 five Supreme Court justices expressed interest in reviving the doctrine.[7] Those five justices constitute a majority of the current Supreme Court. The FTC Act, which delegates to the FTC the authority to regulate “unfair” behavior, may be susceptible to a challenge on the grounds that Congress must provide concrete guidance to cabin the FTC’s exercise of its delegated power.
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[1] Executive Order on Promoting Competition in the American Economy (July 9, 2021), https://www.whitehouse.gov/briefing-room/presidential-actions/2021/07/09/executive-order-on-promoting-competition-in-the-american-economy/.
[2] FACT SHEET: Executive Order on Promoting Competition in the American Economy, (July 9, 2021), https://www.whitehouse.gov/briefing-room/statements-releases/2021/07/09/fact-sheet-executive-order-on-promoting-competition-in-the-american-economy/.
[3] FTC Commissioner Noah Joshua Phillips, Non-Compete Clauses in the Workplace: Examining Antitrust and Consumer Protection Issues, (Jan. 9, 2021), available here.
[4] Id.
[5] Statement of FTC Commissioner Rebecca Kelly Slaughter (July 1, 2021), available here.
[6] U.S. Dept. of Justice and the Federal Trade Commission, Horizontal Merger Guidelines, (Aug. 19, 2010), https://www.ftc.gov/sites/default/files/attachments/merger-review/100819hmg.pdf (explaining that a Herfindahl-Hirschman Index of less than 1500 is “[u]nconcentrated”).
[7] Gundy v. United States, 139 S. Ct. 2116 (2019) (Gorsuch J., dissenting) (joined by Chief Justice Roberts and Justice Thomas); Id. at 2131 (Alito, J., concurring); Paul v. United States, 140 S. Ct. 342 (2019) (Kavanaugh, J., concurring in denial of certiorari).
The following Gibson Dunn attorneys assisted in preparing this client update: Eugene Scalia, Helgi Walker, Rachel Brass, Kristen Limarzi, Michael Perry, Stephen Weissman, Jason Schwartz, Katherine Smith, and Chad Squitieri.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following in the firm’s Administrative Law and Regulatory, Antitrust and Competition or Labor and Employment practice groups.
Administrative Law and Regulatory Group:
Eugene Scalia – Washington, D.C. (+1 202-955-8543,escalia@gibsondunn.com)
Helgi C. Walker – Washington, D.C. (+1 202-887-3599, hwalker@gibsondunn.com)
Antitrust and Competition Group:
Rachel S. Brass – San Francisco (+1 415-393-8293, rbrass@gibsondunn.com)
Kristen C. Limarzi – Washington, D.C. (+1 202-887-3518, klimarzi@gibsondunn.com)
Michael J. Perry – Washington, D.C. (+1 202-887-3558, mjperry@gibsondunn.com)
Stephen Weissman – Washington, D.C. (+1 202-955-8678, sweissman@gibsondunn.com)
Labor and Employment Group:
Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)
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