On June 11, 2021, the Second Circuit issued its decision in 1-800 Contacts, Inc. v. FTC,[1] an appeal of an administrative litigation brought by the Federal Trade Commission against 1-800 Contacts. The decision—which rejected the FTC’s claim that several trademark settlements by 1-800 Contacts violated the antitrust laws —found that the trademark settlement agreements at issue were “typical” and procompetitive, and provides crucial guidance for parties considering settling trademark disputes. The decision also has broader implications for antitrust claims involving the enforcement of intellectual property rights and will likely serve as an important precedent in such cases. From a substantive trademark perspective, the decision also confirms that the law over the use of another party’s trademarks as search engine keywords remains “unsettled.”
The FTC’s Case Against 1-800 Contacts
The FTC’s case challenged thirteen agreements that 1-800 Contacts had signed with competitors to settle trademark infringement claims where it alleged that those competitors’ online advertisements infringed 1-800 Contacts’ trademarks.[2] The settlements restricted competitors’ use of search advertising by requiring them (1) to refrain from bidding on 1-800 Contacts’ trademarks in search-engine auctions, and (2) to affirmatively bid on negative keywords that would prevent their ads from being displayed when a consumer searched for a 1-800 Contacts trademark. The FTC alleged that these agreements restricted competition in violation of Section 5 of the FTC Act because they “prevent[ed] [1-800 Contacts’] competitors from disseminating ads that would have informed consumers that the same contact lenses were available at a cheaper price from other online retailers,” and reduced “price competition in search advertising auctions.”[3] An Administrative Law Judge (ALJ) upheld the FTC’s case, and the Commission affirmed the ALJ’s decision, classifying the agreements in question as “inherently suspect” under the antitrust laws.[4]
The Second Circuit’s Decision
1-800 Contacts appealed the Commission’s decision to the Second Circuit, and the appeals court reversed. As an initial matter, the court agreed with the FTC that trademark settlements are not categorially immune from antitrust scrutiny.[5] Consistent with FTC v. Actavis,[6] the Second Circuit held that trademark settlements can, under certain circumstances, violate the antitrust laws. But the court rejected the Commission’s characterization of the trademark settlements as “inherently suspect” and its application of a truncated rule of reason analysis.[7] Because trademark settlements have “cognizable procompetitive justifications” and have not “been widely condemned” by courts, the court found that application of the full rule of reason approach was required.[8]
The court found that 1-800 Contacts had shown that its settlements had procompetitive justifications. The court reasoned that the “[t]he protection of [1-800 Contacts’] trademark interests constitutes a valid procompetitive justification,”[9] that “agreements to protect trademark interests are ‘common, and favored, under the law,’” and that courts “should ‘presume’ that trademark settlement agreements are procompetitive.”[10] In response to the FTC’s claim that these procompetitive justifications did not justify the restrictions in the settlements because those benefits could be achieved through a “less restrictive alternative,” the court adopted a very narrow view of that doctrine. In language deferential to the settling parties, the court held that “what is ‘reasonably necessary’” to achieve the procompetitive benefits of protecting a trademark interest “is likely to be determined by competitors during settlement negotiations.”[11] The court then found that the FTC’s proposed alternative—a “disclosure requirement”—was not shown to be a less restrictive alternative because, among other things, the FTC failed to address the practical difficulties with its proposal, e.g., how the disclosure requirement could be enforced.[12] As a result, the court found that the FTC’s proposed alternative might not as be as effective in promoting the “parties’ ability to protect and enforce their trademarks.”[13] The court, accordingly, found that the FTC failed to show that the settlement agreements violated the antitrust laws and ordered the FTC’s case dismissed.
Practical Implications for Trademark Settlements
The 1-800 Contacts decision has numerous practical implications for parties seeking to settle trademark disputes and otherwise protect their trademark interests. The decision provides some very useful guidance on how companies may settle trademark disputes with minimal antitrust risk, but companies should continue to take care to consider antitrust concerns in crafting such settlements. While the court dismissed the FTC’s case against 1-800 Contacts, it did find that trademark settlements can raise antitrust issues in certain circumstances. Overall, there are several key takeaways from the decision, including:
- The Second Circuit decision includes language that is deferential to the settling parties in trademark disputes. As a result, the FTC and private plaintiffs will face significant hurdles if they attempt to bringing new antitrust cases challenging trademark settlements. Notably, a respondent in an FTC administrative proceeding can appeal an adverse decision in any Circuit in which the respondent does business,[14] which means that the Second Circuit’s decision will effectively set the legal standard for any future FTC administrative enforcement actions.
- While the Second Circuit did not expressly define the situations in which a trademark settlement might raise greater antitrust risk, it did mention an agreement entered “under duress” “between parties with unequal bargaining power” as a potential example of where a trademark settlement might be entitled to lesser deference in an antitrust challenge.[15]
- The court also left open the possibility that the requirement that competitors use negative keywords could be higher risk than agreements not to bid on each other’s trademarks. The court stated that it had “no reason to consider” the issue of whether the requirement to use negative keywords went “beyond any legitimate claim of trademark infringement” because the FTC had not made a finding of anticompetitive effects specific to “this narrow aspect of the settlement agreements.”[16]
- The court stated that the merits of the trademark claims that led to the settlement agreements in the 1-800 Contacts case were “unsettled.”[17] Although the court’s overall holding implies that courts will be reluctant to second guess the merits of a claim that the parties have elected to settle, aggressive antitrust plaintiffs will likely continue to argue that a lower level of deference should apply if the trademark claims are extremely weak.
- The decision’s reasoning also appears to extend to agreements between competitors that do not arise out of pending trademark infringement litigation. While the FTC had argued that one of the agreements was particularly suspect because the parties’ agreement to limit their bidding on trademark terms was not based on an asserted infringement claim, the court found that the FTC had not offered “direct evidence differentiating” that agreement from the others and that the court did not need to do so in its decision because “protecting trademarks is a valid procompetitive justification for the restrictions.”[18]
Given the risk that regulators or private plaintiffs will continue to pursue similar claims, it remains crucial for companies considering settling trademark disputes with restrictions on search advertising to analyze the antitrust risk of such arrangements.
Broader Implications for Other Types of IP Enforcement and Settlements
The decision also has important implications for non-trademark cases. The court found, as noted, that protecting one’s intellectual property rights constitutes a legitimate business interest that can justify restrictions on an allegedly infringing party’s conduct in a settlement agreement. Although the decision emphasizes the unique features of trademarks, its reasoning is likely to apply, at least to some extent, to antitrust claims challenging settlements of other types of IP disputes. For example, we expect that this decision will be cited by parties in antitrust cases based on alleged reverse-payment settlement agreements in the pharmaceutical industry. Similarly, the court’s narrow interpretation of the “less restrictive alternative” doctrine is also likely applicable outside of the trademark context. For that doctrine to apply, the court required the plaintiff to do more than just speculate about potentially less restrictive alternatives: the plaintiff “needs to show more than the mere possibility” of a less restrictive alternative.[19] And the court also stated that not any proposed alternative will do—the proposed alternative must be practical to apply, as well as “substantially less restrictive” than the arrangement challenged.[20]
Finally, the decision in 1-800 Contacts also serves as a reminder that, in an era in which commentators are encouraging more aggressive and novel antitrust enforcement, the federal judiciary remains the ultimate arbiter of federal antitrust policy. Enforcers seeking to expand the scope of U.S. antitrust law must do more than bring novel cases—they must also prove their cases with hard facts in a court of law.
* Gibson Dunn partner Howard S. Hogan served as an expert witness for 1-800 Contacts in this case, and offered the opinion that the settlement agreements at issue were standard trademark settlements, as courts continue to determine the bounds of trademark claims arising from the use of trademarks as search engine keywords.
____________________________
[1] — F.3d —, 2021 WL 2385274 (2d Cir. June 11, 2021).
[7] 1-800 Contacts, 2021 WL 2385274, at *7. The “inherently suspect” framework is also known as the “abbreviated rule of reason analysis” or a “quick-look” approach. Id. at *6 (quoting Cal. Dental Ass’n v. FTC, 526 U.S. 756, 770 (1999)).
[10] Id. at *9 (first quoting Clorox, 117 F.3d at 55; and then quoting id. at 60).
[11] Id. at *10 (quoting United States v. Brown Univ., 5 F.3d 658, 679 (3d Cir. 1993)).
[13] Id. The panel also held that the FTC failed to offer “direct” evidence of anticompetitive effects. Id. at *8.
[15] 1-800 Contacts, 2021 WL 2385274, at *10 n.14.
[19] Id. at *11 (emphasis added).
[20] Id. (quoting Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and Their Application ¶ 1502 (3rd & 4th eds., 2019 Cum. Supp. 2010-2018)).
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition, Intellectual Property, Fashion, Retail and Consumer Products, or Media, Entertainment and Technology practice groups, or the authors:
Eric J. Stock – New York (+1 212-351-2301, estock@gibsondunn.com)
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Stephen Weissman – Washington, D.C. (+1 202-955-8678, sweissman@gibsondunn.com)
Michael J. Perry – Washington, D.C. (+1 202-887-3558, mjperry@gibsondunn.com)
Please also feel free to contact the following U.S. practice leaders:
Antitrust and Competition Group:
Rachel S. Brass – San Francisco (+1 415-393-8293, rbrass@gibsondunn.com)
Stephen Weissman – Washington, D.C. (+1 202-955-8678, sweissman@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)
Fashion, Retail and Consumer Products Group:
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Media, Entertainment and Technology Group:
Scott A. Edelman – Los Angeles (+1 310-557-8061, sedelman@gibsondunn.com)
Kevin Masuda – Los Angeles (+1 213-229-7872, kmasuda@gibsondunn.com)
Benyamin S. Ross – Los Angeles (+1 213-229-7048, bross@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 June 3, 2021, the United States Court of Appeals for the Second Circuit issued an important decision dismissing a lawsuit by the New York State Department of Financial Services (“DFS”), which was challenging the authority of the federal Office of the Comptroller of the Currency (“OCC”) to grant special purpose national bank (“SPNB”) charters.[1] Such non-depository charters have attracted the attention of financial technology (“fintech”) companies. The decision reversed a holding of the United States District Court for the Southern District of New York that had placed greater power in state regulators’ hands in holding that the OCC lacked such authority because such non-depository institutions are not engaged in the “business of banking.” The Second Circuit’s decision, which was based on threshold standing and ripeness grounds, maintains ambiguity in the federal-state balance with respect to regulation of SPNBs and threatens to narrow DFS’s regulatory and supervisory reach over cutting-edge financial products and services, which the agency has sought to expand in recent years.
DFS Challenges Special Purpose National Bank Charters
The lawsuit centered around the National Bank Act of 1864, which provides for OCC regulation and supervision of federally chartered national banks in their “business of banking.” The statute provides that if “it appears that [an entity applying for a federal banking charter] is lawfully entitled to commence the business of banking,” the Comptroller shall “give to such association a certificate . . . that such association has complied with all the provisions required to be complied with before commencing the business of banking, and that such association is authorized to commence such business.[2] Once a bank receives a federal charter,
It shall have power . . . [t]o exercise . . . all such incidental powers as shall be necessary to carry on the business of banking; by discounting and negotiating promissory notes, drafts, bills of exchange, and other evidences of debt; by receiving deposits; by buying and selling exchange, coin, and bullion; by loaning money on personal security; and by obtaining, issuing, and circulating notes . . . .[3]
In 2003, the OCC amended federal regulations to provide for authority to issue SPNB charters, or charters for a national bank that engages in a limited range of banking activities, “including one of the core banking functions [i.e., paying checks or lending money], but does not take deposits.”[4] In amending these regulations, the OCC thus asserted that it had authority to charter entities that pay checks or lend money, among other activities, but that do not receive deposits. These regulations, however, were largely ignored until then-Comptroller of the Currency Thomas Curry announced in late 2016 that the OCC would consider such charters for fintech firms.[5]
This announcement met vigorous resistance by DFS, New York’s chief financial regulator. According to DFS, the decision to issue federal SPNB charters would lead to a preemption of state law for newly chartered entities and would reduce “critical financial protections” provided in New York, weakening the state’s “regulatory controls on usury, payday loans, and other predatory lending practices.”[6] DFS also claimed it would lose revenue from assessments levied against fintech companies that do not take deposits, because such companies, which are currently governed primarily by state law, could convert to a federal charter.[7]
In 2017, DFS challenged the OCC’s regulatory regime, but that lawsuit was dismissed for lack of standing and ripeness.[8] In 2018, the OCC announced that it would accept applications for SPNB charters under the new regulation.[9] Soon thereafter, the OCC allegedly invited “Fintech startup companies to come to [its] office in New York to discuss . . . the new [SPNB] charter.”[10] Fintech companies are “non-bank companies that leverage recent technological innovations to provide financial services and/or products to customers in new ways,” such as mobile payment services, distributed ledger technology, marketplace lending, and crowdfunding sites.[11] DFS responded to the OCC’s efforts by bringing an action against the OCC in the United States District Court for the Southern District of New York, claiming among other things that the OCC exceeded its authority under the National Bank Act by authorizing itself to grant SPNB charters to institutions that do not accept deposits and that the OCC’s regulation is null and void.[12]
The District Court’s Decision
The District Court set aside the OCC’s decision to accept SPNB charter applications and held that the OCC had exceeded its authority under the National Bank Act. In particular, the District Court found that the term the “business of banking” in the statute unambiguously requires receiving deposits as an aspect of the banking business.[13] In reaching that conclusion, the District Court looked to the statute’s text, framework, and history, as well as the history of federal banking law, the long history of the OCC not asserting charting power over special purpose institutions, and the “dramatic disruption of federal-state relationships in the banking industry” sought by the OCC on “a question of deep economic and political significance.”[14]
Following that ruling, the parties submitted proposed judgments setting aside the OCC’s regulation “with respect to all fintech applicants seeking a national bank charter that do not accept deposits,” but the OCC sought a narrower judgment setting aside the regulation only as to fintech companies that “have a nexus to New York State, i.e., applicants that are chartered in New York or that intend to do business in New York (including through the internet) in a manner that would subject them to regulation by DFS.”[15] The District Court rejected the OCC’s proposal and set aside the regulation regardless of fintech companies’ location nationwide.[16]
The Second Circuit’s Ruling
Last week, the Second Circuit reversed the district court’s judgment and instructed the court to dismiss the case without prejudice. The Court concluded that DFS’s claims were unripe and without standing because DFS failed to allege that the OCC’s decision caused it to suffer an actual or imminent injury.[17] Having determined that the case was not justiciable, the Court did not address the District Court’s holding on the merits that the “business of banking” under the federal banking statute unambiguously requires receipt of deposits.[18]
The Court concluded that DFS lacked standing because its concerns about the effects of preemption were “too speculative,” given that the OCC’s actions would not implicate such concerns until the OCC received an SPNB charter application from or granted such a charter to a non-depository fintech that would otherwise be subject to DFS’s jurisdiction.[19] As the Court explained, there is “currently no non-depository fintech that can claim federal preemption engaging in any practice that may give rise to the regulatory harms that DFS alleges, such as charging interest rates that exceed New York’s statutory cap.”[20] The Court was likewise unpersuaded that DFS faced a “substantial risk” of losing revenue acquired through annual assessments under New York law.[21] The Court explained that DFS has “yet to lose out on any revenue acquired through its assessments . . . because the OCC has not received, let alone approved, an application for an SPNB charter from a non-depository fintech within DFS’s jurisdiction.”[22] The Court declined to “decide the precise point at which DFS’s claims may become justiciable in the future,” whether it be when a non-depository fintech formally applies for an SPNB charter, when the OCC grants such an application, or some other time.[23]
Conclusion
This decision represents a setback for DFS and other state regulators who may perceive the OCC’s assertion of authority over non-depository institutions as an incursion into an area that has traditionally fallen within the states’ ambit. Indeed, as New York’s primary financial regulator, DFS has jurisdiction over approximately 1,500 financial institutions and 1,800 insurance companies, and it supervises approximately $7 trillion in assets across the insurance, banking, and financial services industries.[24]
The OCC’s ability to press forward with fintech companies is of special concern to DFS, which has been actively flexing authority in recent years with respect to contemporary trends in financial services, implementing new initiatives designed to foster innovation in a wide range of services and products, such as cryptocurrencies, while also focusing on consumer protection and bringing fintechs within an expanded regulatory scheme.[25] The future of regulation over these cutting-edge industries, many of which have close connections to New York, could be impacted by the Second Circuit’s ruling.
The effects of the decision, however, should not be overstated. The Court of Appeals made clear that it expressed no opinion on the ultimate issue of whether the OCC has authority to grant national bank charters to non-depository institutions, and it likewise expressed no view on whether the OCC’s amended regulation (if unlawful) must be set aside only as to companies applying within a particular jurisdiction such as New York or more broadly nationwide. These important issues are likely to be resolved through future litigation, and indeed, a similar case is pending in the United States District Court for the District of Columbia.[26] In addition, the new Acting Comptroller of the Currency, Michael Hsu, a longtime member of the supervisory staff of the Federal Reserve Board, has indicated that he intends to take a close look at whether to continue some of the OCC’s initiatives launched under the Trump Administration.[27]
__________________________
[1] See Lacewell v. Office of Comptroller of Currency, — F.3d —, 2021 WL 2232109 (2d Cir. June 3, 2021).
[2] 12 U.S.C. § 27(a) (emphasis added).
[3] Id. § 24 (Seventh) (emphasis added).
[4] Lacewell, 2021 WL 2232109, at *2 (quoting 12 C.F.R. § 5.20(e)(1)(i)); see Vullo v. Office of Comptroller of Currency, 378 F. Supp. 3d 271, 279 (S.D.N.Y. 2019), rev’d, Lacewell, 2021 WL 2232109.
[5] See “Remarks By Thomas J. Curry Comptroller of the Currency Regarding Special Purpose National Bank Charters for Fintech Companies,” Georgetown University Law Center (December 2, 2016), available at https://www.occ.gov/news-issuances/speeches/2016/pub-speech-2016-152.pdf.
[6] Lacewell, 2021 WL 2232109, at *8; see Vullo, 378 F. Supp. 3d at 286.
[7] Lacewell, 2021 WL 2232109, at *8, *11; see Vullo, 378 F. Supp. 3d at 286.
[8] Vullo, 378 F. Supp. 3d at 280.
[10] Lacewell, 2021 WL 2232109, at *4.
[11] Vullo, 378 F. Supp. 3d at 378 n.2; see Lacewell, 2021 WL 2232109, at *3.
[12] Vullo, 378 F. Supp. 3d at 278, 280.
[14] Id. at 292-98 (emphasis added).
[15] Lacewell, 2019 WL 6334895, at *1 (S.D.N.Y. Oct. 21, 2019), rev’d, Lacewell, 2021 WL 2232109.
[24] See N.Y. Dep’t of Fin. Servs., About Us, https://www.dfs.ny.gov/our_mission; Vullo, 378 F. Supp. 3d at 278.
[25] See, e.g., Mylan L. Denerstein, Akiva Shapiro & Seth M. Rokosky, New York State Dep’t of Fin. Servs. Roundup (2021), https://www.gibsondunn.com/wp-content/uploads/2021/02/NY-Department-of-Financial-Services-Round-Up-February-2021.pdf; Denerstein, Shapiro & Rokosky, Webcast: Recent Developments at the New York State Dep’t of Fin. Servs. (2020), https://www.gibsondunn.com/webcast-recent-developments-at-the-new-york-state-department-of-financial-services/; Denerstein, Shapiro & Rokosky, New York State Dep’t of Fin. Servs. Roundup (2020), https://www.gibsondunn.com/wp-content/uploads/2020/02/NY-Department-of-Financial-Services-Round-Up-February-2020.pdf.
[26] See, e.g., Press Release, “Conference of State Banking Supervisors Files New Complaint Against OCC,” December 22, 2020, available at https://www.csbs.org/newsroom/csbs-files-new-complaint-against-occ.
[27] See, e.g., Statement of Michael J. Hsu, Acting Comptroller of the Currency, Committee on Financial Services, United States House of Representatives, May 19, 2021 (Hsu Statement).
Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work, or the authors:
Mylan L. Denerstein – Co-Chair, Public Policy Practice, New York (+1 212-351-3850, mdenerstein@gibsondunn.com)
Akiva Shapiro – New York (+1 212-351-3830, ashapiro@gibsondunn.com)
Seth M. Rokosky – New York (+1 212-351-6389, srokosky@gibsondunn.com)
Please also feel free to contact the following leaders and members of the firm’s Financial Institutions practice group:
Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@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.
Pearl of Wisdom
The DIFC Court of Appeal in Lahelalahela V Lameezlameez [2020] DIFC CA 007 found that the Riyadh Convention[1] is not a part of DIFC Law, and in any event provides a non-exclusive service regime. To the extent Pearl Petroleum[2] found to the contrary, it was wrongly decided. The DIFC Court can therefore order alternative service or dispense with service in respect of a receiving party domiciled in a Riyadh Convention state. This will come as a great relief to DIFC Court practitioners who have been grappling with Pearl Petroleum and the significant hurdles it created for service of DIFC Court documents in the GCC Region. The Court of Appeal also provided welcome clarity on the implementation of international agreements to which the UAE is a party into DIFC Law, finding that obligations in such agreements are not automatically a part of DIFC Law where they relate to civil and commercial matters. This is an important development with wide-ranging implications for the source and content of DIFC Law, as well as for the enforcement of DIFC-seated arbitrations. Gibson, Dunn & Crutcher, with lead Counsel Tom Montagu-Smith-QC, acted for the successful Claimant at first instance and Respondent on appeal.
Background
The Claimant obtained a monetary award in DIFC-seated arbitration proceedings against the Defendant, and later successfully obtained (ex parte) a DIFC Court order recognising and enforcing the award (the “Enforcement Order”). Pursuant to RDC 43.70 and the terms of the Enforcement Order, the Enforcement Order could not be enforced until after it had been served on the Defendant.
The Defendant company is registered in Erbil, in the Republic of Iraq, which, along with the UAE, is a signatory to the Riyadh Convention. Article 6 of the Riyadh Convention sets out a method of service (“Convention Service”), which applies where the sender and recipient are both resident in a signatory state to the Riyadh Convention (a “Convention State”).[3] Unlike diplomatic service, Convention Service operates directly between a sending court (in this case the DIFC Court) and a receiving court (in this case the local Erbil Court).
The Claimant attempted Convention Service. The local court in Erbil refused to serve the Enforcement Order and stated (wrongly) that the Riyadh Convention did not apply. The Claimant then obtained (ex parte) an order for alternative service from the DIFC Court (the “Service Order”). Upon being served with the Service Order, the Defendant applied for it to be set aside. The principal argument by the Defendant was that Pearl Petroleum correctly found that the Riyadh Convention, where applicable, is part of DIFC law and provides an exclusive and mandatory service regime, and the DIFC Court does not have the power to order alternative service or dispense with service.
The Claimant argued that Pearl Petroleum was distinguishable, and in any event wrongly decided because the Riyadh Convention is not binding on the DIFC Court. At first instance, H.E. Justice Shamlan Al Sawalehi (“Justice Al Sawalehi”) found for the Claimant on both these grounds. As the first instance decision conflicted with Pearl Petroleum, permission to appeal was granted, and a hearing occurred before the Court of Appeal in February 2021, with the Court of Appeal issuing its decision on 9 May 2021.
Pearl Petroleum
In Pearl Petroleum, the DIFC Court set aside an order for alternative service of a recognition and enforcement order. The alternative service order had been initially granted ex parte on the basis that service under the Riyadh Convention would very likely be stymied by the award-debtor, the Kurdistan Regional Government. The DIFC Court held that, by virtue of Article 5 of UAE Federal Law No. 8 of 2004 (“Article 5”)[4], treaties which form part of the law of the UAE are binding in the DIFC. Importantly, the Court found that, not only was the Riyadh Convention applicable in the DIFC, but the service regime in Article 6 of the Riyadh Convention was mandatory and exclusive. That is, there was no scope to circumvent the terms of the Riyadh Convention by an order for alternative service or to dispense with service altogether so that the Riyadh Convention was not engaged.
The effect of Pearl Petroleum was that, if the Court of a Convention State refuses or fails to serve a DIFC Court recognition and enforcement order pursuant to the Convention Service regime, the recognition and enforcement order will never become enforceable; similarly draconian implications applied to the service of other court documents. The obvious problem that this gave DIFC Court users was exacerbated by the fact that the Riyadh Convention is of broad application throughout the GCC region.
Justice Al Sawalehi’s Decision
At first instance, Justice Al Sawalehi held that Pearl Petroleum was distinguishable, as, unlike in Pearl Petroleum, service had been attempted but failed in the present case. In the alternative, His Honour found that Pearl Petroleum was wrongly decided and the DIFC Court was not bound to follow the Riyadh Convention at all.
The present case distinguished from Pearl Petroleum
In Pearl Petroleum, the claimant had not actually attempted service in accordance with the Riyadh Convention – instead, alternative service had been sought on the basis that interference with service by the Defendant was highly likely. Justice Al Sawalehi considered this to be a critical distinction and confined the ration in Pearl Petroleum accordingly. That is, Pearl Petroleum, properly interpreted, held that where a document in DIFC Court proceedings is required to be served on a defendant in a Convention State, it must first be attempted to be served by Convention Service, but after this attempt, the Court is empowered to order alternative service or dispense with it altogether.
Pearl Petroleum wrongly decided
Justice Al Sawalehi also found that, even if Pearl Petroleum was not distinguishable, it was in any event wrong on a more fundamental basis – i.e. the Riyadh Convention was not binding in the DIFC at all. There are two ‘avenues’ by which the Riyadh Convention could ‘automatically’[5] apply in the DIFC: (1) Article 5; and (2) Article 3(2) of the UAE Federal Law No. 8 of 2004, which provides that financial Free Zones “shall…be subject to all Federal laws, with the exception of Federal civil and commercial laws” (“Article 3(2)”).
Regarding Article 5, His Honour found that it placed an obligation on “financial free zones”, which meant the DIFC executive (i.e. the Ruler, the President of the DIFC and the DIFC Authority), but not the DIFC Courts. To the contrary, Article 30 of the DIFC Court Law[6] provides a mandatory, exhaustive list of the law that can be applied by the DIFC Court. UAE Federal law is not mentioned. Therefore, the DIFC Court shall not apply UAE Federal law unless either: (1) it is agreed by the parties, or (2) it is incorporated into DIFC domestic law by express enactment. There was no such party agreement, and His Honour found that the Riyadh Convention had not been incorporated into DIFC Law, notwithstanding Article 42(1) of the DIFC Arbitration Law[7] and Article 24(2) of the DIFC Court Law[8]. As such, Article 5 was not binding on the DIFC Court.
His Honour also grappled with the slightly different question of whether the Riyadh Convention applied to the DIFC Court, not by virtue of Article 5, but by virtue of Article 3(2). The Riyadh Convention is not only an international treaty to which the UAE is party (thus potentially triggering Article 5, were it to apply), but it is also incorporated directly into UAE Federal law by way of Federal Decree No. 53 of 1999 (the “Decree”). If the Riyadh Convention (as converted to Federal Law by the Decree) was not a civil or commercial law, it would therefore apply to the DIFC by virtue of Article 3(2). The Defendant argued that the Riyadh Convention was procedural law, not civil or commercial law, and thus applied in the DIFC. Justice Al Sawalehi rejected this, finding that Article 6 fell under the rubric of civil and commercial law in Article 3(2), and was thus precluded from application in the DIFC.
The Appeal
The Defendant appealed, and the hearing occurred in February 2021 before Chief Justice Zaki Azmi, Justice Wayne Martin, and Justice Sir Richard Field. The two[9] key issues on appeal were:
- Do the terms of the Riyadh Convention form part of DIFC Law such that they must be applied by the DIFC Court?
- If the answer to (1) is yes, is the service regime in the Riyadh Convention exclusive, such that the DIFC Court cannot either order alternative service or dispense with service?
(1) Is the Riyadh Convention part of DIFC Law?
The Court of Appeal answered this question in the negative, which was sufficient to dismiss the Appeal. Like the Court of First Instance, the focus of the Court of Appeal was on whether the Riyadh Convention was ‘automatically’ a part of DIFC Law (and therefore binding on the DIFC Court), by virtue of Article 5 and/or Article 3(2).
Article 5
Regarding Article 5, the Court of Appeal found:
(a) Article 5 imposes obligations upon the “Financial Free Zones”. On the proper construction of Article 5, “Financial Free Zones” does not include the DIFC Courts. This was for the following reasons:
|
i. | A “Financial Free Zone” is defined by Article 1 to be the corporate body created when a Federal Decree is issued in accordance with Article 2[10] of UAE Federal Law No. 8 of 2004. The DIFC Court is not such a corporate entity[11]. Rather, the combined effect of Federal Law No. 8 of 2004 and Federal Decree No. 35 of 2004 was to create a corporate entity known as the Dubai International Financial Centre. It is this entity that is the subject of Article 5. |
|
ii. | There is an important distinction between the obligation of courts to apply the domestic law of the jurisdiction, and the obligation of States to comply with their international agreements. The Defendant/Appellant’s reliance on Article 5 elided this distinction. |
|
iii. | Article 5 is intended to ensure that the relevant corporate body which is delegated executive power by the State exercises such power in a manner which does not put the State in breach of its international agreements. In other words, Article 5 functions as a constraint on the exercise of executive power; it cannot be taken to import all obligations imposed under all treaties to which the UAE is a party into the domestic law of each Financial Free Zone. |
|
iv. | Indeed, Articles 3 and 7(3)[12] of UAE Federal Law No. 8 of 2004 are the provisions concerned with the laws applicable in Financial Free Zones, not Article 5. |
|
v. | The exercise of judicial authority within a Financial Free Zone is left to be dealt with by laws issued by the relevant Emirate pursuant to Article 7(3). It is impossible to construe the reference in Article 5 to the “Financial Free Zones” to include whatever myriad arrangements might be made with respect to the exercise of judicial authority within the various Emirates within which such Zones might be created. |
The crux of the above is that Article 5 does not provide that international agreements to which the UAE is party apply automatically within the DIFC. Subject to Article 3(2) (see below), unless and until a relevant Emirate exercises the powers reserved to it by Article 7(3) to issue legislation implementing international agreements into the domestic law of the relevant Financial Free Zone, such obligations will not form part of that domestic law – in the same way as treaty obligations do not form part of the domestic law of any State unless and until implemented by the State.
However, the Court of Appeal was careful to say that, although the Riyadh Convention was not binding law in the DIFC, the DIFC Court was a UAE Court and thus could invoke the provisions of the Riyadh Convention to facilitate service where it was applicable. In such cases, whether service is validly effected as a matter of DIFC Law will turn upon the question of whether service has taken place in accordance with the rules of the Court.
Article 3(2)
As set out above, Article 3 provides that all Financial Free Zones are subject to all Federal Laws “with the exception of Federal civil and commercial laws”. On the assumption that the Riyadh Convention formed part of the UAE Federal Law, the critical question for the Court of Appeal was whether the Riyadh Convention generally, or Article 6 of the Riyadh Convention specifically, were “civil and commercial laws” and therefore excepted from the operation of Article 3(2). The Court of Appeal found as follows:
- Article 3(2) is properly construed as applying to the specific rule or obligation which it is contended should be applied within the relevant Zone, rather than as a reference to the instrument in which that rule, law or obligation is located. So the question was not whether the Riyadh Convention is a civil and commercial law, but whether the relevant provisions are (e.g. Article 6).
- The relevant provisions in the Riyadh Convention relate to service of DIFC Court documents. This is a matter of civil procedure. Pursuant to the case of IGPL v Standard Chartered Bank[13], matters of civil procedure are matters of civil and commercial law, and thus excepted from the operation of Article 3. This is further supported by the application of Article 6, which is expressly said to relate to “civil, commercial and administrative cases and cases of personal status”.
For these reasons Article 3(2) expressly excludes Article 6 of the Riyadh Convention from application within the DIFC. The Judge in Pearl Petroleum was wrong to conclude otherwise.
(2) Is the service regime in the Riyadh Convention exclusive?
While strictly unnecessary given the finding that the Riyadh Convention did not apply in the DIFC under either Article 5 or Article 3(2), the Court of Appeal also considered whether the Riyadh Convention specified an exclusive service regime. The Court of Appeal answered this in the negative, finding that:
- The Riyadh Convention does not state that Convention Service is the exclusive means by which service can be validly effected.
- Any construction of the Riyadh Convention to that effect would be antithetical to its objects and purpose.
- The proposition that service by alternative methods may only be permitted after service under the Riyadh Convention had been attempted but failed therefore falls away.
(3) Can the DIFC Court in any event dispense with service so that the Riyadh Convention is not engaged?
The Riyadh Convention also did not prevent the DIFC Court from dispensing with service. Article 6 applies to documents which are “required to be served or notified”. Determining which documents fall within that category is a matter for the Court in which the proceedings are being conducted. If that Court concludes, in accordance with its own rules, that a document is not required to be served, Article 6 has no application.
Take-away points
To recap, the key points from the Judgment are as follows:
- Article 5 of Federal Law No. 8 of 2004 does not provide that international agreements to which the UAE is party apply automatically within the DIFC. Subject to Article 3(2), unless and until a relevant Emirate expressly implements the international agreement into the domestic law of the relevant Financial Free Zone, such obligations will not form part of that domestic law. The Riyadh Convention is not therefore part of DIFC Law.
- In any event, the Riyadh Convention does not provide an exclusive service regime.
- The DIFC Court can, in an appropriate case, order alternative service or dispense with service in respect of a receiving party domiciled in a Convention State.
- That said, where a receiving party is domiciled in a Convention State, the Riyadh Convention should be considered a ‘tool in the arsenal’ – it can still be used to effect valid service, provided the DIFC Court Rules are satisfied.
Conclusion
The Court of Appeal’s decision will be welcomed by DIFC Court practitioners and users. It provides welcome clarity to an issue that has dogged practitioners since Pearl Petroleum, and confirms flexibility regarding service-out of DIFC Court documents on parties resident in Convention states. No longer are parties bound to attempt Convention Service, and blocked when Convention Service fails. This reaffirms the DIFC Court’s status as a regional dispute resolution hub that is pro-arbitration and committed to enforcement. Further, and perhaps most importantly, the decision has answered the fundamental question of when and how international agreements to which the UAE is a party become part of DIFC law. This will no doubt be relied on in many cases to come.
For further information or advice regarding the Court of Appeal decision, or service and enforcement more generally, please contact the highly experienced team at Gibson Dunn.
____________________
[1] The 1983 Riyadh Arab Agreement for Judicial Cooperation (the “Riyadh Convention”). The Riyadh Convention has state signatories from across the Arab world (including the UAE, Jordan, Bahrain, Tunisia, Egypt, Algeria, Djibouti, Saudi Arabia, Sudan, Syria, Somalia, Iraq, Oman, Palestine, Qatar, Kuwait, Lebanon, Libya, Morocco, Mauritania and Yemen).
[2] Pearl Petroleum Company Limited & Others v The Kurdistan Regional Government of Iraq [2017] DIFC ARB 003 (“Pearl Petroleum”).
[3] A translation of Article 6 of the Riyadh Convention provides (with alternative wording in square brackets): “Legal and non- legal [Judicial and non-judicial] documents and papers relating [pertaining] to civil, commercial and administrative cases and cases of personal status required to be served or notified to [which are to be published or which are to be transmitted to] persons residing in one of the contracting states shall be sent [dispatched] directly by the authority or the competent legal office [from the judicial body or officer concerned] to the court which the person who is required to be served or notified resides in its jurisdiction area [to the court of the district in which the person to be notified resides].”
[4] Article 5 provides: “The Financial Free Zones shall not do anything which may lead to contravention of any international agreements to which the state is or shall be a party”.
[5] That is to say, apply without express implementation by Dubai or DIFC Law, or the agreement of the parties.
[6] Law No. 10 of 2004. Article 30 provides: “Governing Law (1) In exercising its power and functions, the DIFC Court shall apply: (a) the Judicial Authority Law; (b) DIFC Law or any legislation made under it; (c) the Rules of Court; or (d) such law as is agreed by the parties. (2) The DIFC Court may, in determining a matter or proceeding, consider decisions made in other jurisdictions for the purpose of making its decision”.
[7] Article 42(1) provides: “For the avoidance of doubt, where the UAE has entered into an applicable treaty for the mutual enforcement of judgments, orders or awards the DIFC Court shall comply with the terms of such treaty”.
[8] Article 24(2) provides: “Where the UAE has entered into an applicable treaty for the mutual enforcement of judgments, orders or awards, the Court of First Instance shall comply with the terms of such treaty”. In his additional reasons for granting permission to appeal, Justice Al Sawalehi found that, Article 24(2) was an express exception to the general rule that UAE treaties do not apply directly within the DIFC. The need for this express exception carried with it a negative implication – i.e. that UAE treaties do not have direct effect within the DIFC absent DIFC legislation enacting the treaty as law. This was consistent with the relationship between UAE treaties and the rest of the UAE. This does not mean that DIFC Courts cannot comply with UAE treaties which have not been expressly incorporated into DIFC Law; it simply means that the effectiveness of proceedings will not come down to compliance or non-compliance with them. This is similar to the approach of the English Courts with respect to UK treaties.
[9] The Court also briefly discussed other issues that had been raised by the Parties, including: (1) whether the DIFC Court was precluded from applying Federal Laws generally, absent agreement of the Parties and (2) whether the New York Convention overrode any inconsistent provisions of the Riyadh Convention. Ultimately the Court found it was unnecessary to decide these issues given its primary finding that the Riyadh Convention was not a part of DIFC law.
[10] Article 2 provides: “A Financial Free zone shall be established by a Federal Decree. It shall have a body corporate and shall be represented by the President of its Board. It and no one else shall be responsible for the obligations arising out of the conduct of its activities. The Cabinet will describe its area and location”.
[11] The DIFC Courts are a separate (in effect, subsidiary) corporate body established under the Dubai Law No. 9 of 2004, which was made pursuant to the legislative powers specifically reserved to the Emirate of Dubai by Article 7(3) of Federal Law No. 8 of 2004.
[12] Article 7(3) provides: “Subject to the provisions of Article 3, the concerned Emirate may, within the limits of the goals of establishing the Financial Free Zone, issue legislation necessary for the conduct of its activities”.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work, or the following authors in the firm’s Dubai office:
Graham Lovett (+971 (0) 4 318 4620, glovett@gibsondunn.com)
Michael Stewart (+971 (0) 4 318 4638, mjstewart@gibsondunn.com)
Sophia Cafoor-Camps (+971 (0) 4 318 4629, scafoor-camps@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’s Equal Pay for Equal Work Act (EPEW), as well as the accompanying Rules and guidance, took effect on January 1, 2021. Prior to the new year, however, the Rocky Mountain Association of Recruiters (RMAR) sued the Colorado Department of Labor and Employment (CDLE) in the U.S. District Court for the District of Colorado, challenging the constitutionality of the law’s compensation and promotion posting requirements. On May 27, 2021, after previously ordering supplemental briefs on the posting requirements’ burdens on interstate commerce, Judge William J. Martinez denied the RMAR’s request for a preliminary injunction to suspend enforcement of the posting provisions at issue.
Colorado’s Equal Pay for Equal Work Act Posting Requirements
With a stated goal of aiding in achieving pay equity in Colorado, the EPEW has an expansive reach, covering all public and private employers that employ at least one person in Colorado. The law includes extensive compensation and promotion posting requirements, which employers—particularly multi-jurisdictional employers—have struggled with implementing. In fact, the posting provisions have proved so burdensome in practice that some employers have elected to wholly remove some employment opportunities from Colorado rather than navigate compliance difficulties. See https://www.9news.com/article/news/investigations/job-posting-labor-laws/73-7f2ac237-06fe-4353-8318-00a4b52d80bc.
Under the EPEW’s compensation posting requirements, employers are required to “disclose in each posting for each job the hourly or salary compensation, or a range of the hourly or salary compensation, and a general description of all of the benefits and other compensation to be offered to the hired applicant.” C.R.S. § 8-5-201(2) (2021). In addition to postings for jobs in Colorado, the requirement also reaches postings for all remote positions that could be performed in Colorado. 7 CCR 1103-13 (4.3)(B).
Additionally, the EPEW requires employers to “make reasonable efforts to announce, post, or otherwise make known all opportunities for promotion to all current employees on the same calendar day and prior to making a promotion decision.” C.R.S. § 8-5-201(1) (2021). Under the Rules, a “promotional opportunity” is broadly defined as “when an employer has or anticipates a vacancy in an existing or new position that could be considered a promotion for one or more employee(s) in terms of compensation, benefits, status, duties, or access to further advancement.” 7 CCR 1103-13 (4.2.1). Postings are required even if no one in Colorado is qualified for the promotional opportunities. The promotion requirement applies widely and only allows for a few narrow exceptions, such as when employees are unaware they will be separated from their employers.
Background on Rocky Mountain Association of Recruiters v. Moss
In its initial complaint, the RMAR argued that: (1) the EPEW’s posting requirements constitute unlawfully “compelled speech” in violation of the First Amendment; and (2) the requirements violate the Dormant Commerce Clause due to their excessive burden on interstate commerce and their conflict with other states’ statutory schemes. The RMAR requested from the court a declaration that the posting requirements are unconstitutional, as well as a permanent injunction barring the CDLE’s enforcement of the posting provisions. Additionally, the RMAR filed a motion for a preliminary injunction on December 31, 2020, which would prevent the posting provisions’ enforcement until a decision on their legality is reached.
On April 21, 2021, Judge William J. Martinez held a hearing on the RMAR’s motion for preliminary injunction. The court ordered supplemental briefings from the CDLE and RMAR on the burdens that the EPEW posting requirements place on interstate commerce—hinting that the court was potentially amenable to the RMAR’s Dormant Commerce Clause argument. The supplemental briefs were filed on May 6, 2021, and response briefs were filed on May 17, 2021.
For the RMAR’s supplemental brief, the court directed it to identify the two most burdensome aspects of both the compensation and promotion posting requirements. For the compensation posting requirements, the RMAR identified as most burdensome: (1) the requirement to post compensation for remote jobs or other jobs that “could” be performed in Colorado; and (2) the forced disclosure of confidential information and trade secrets. For the most burdensome aspects of the promotion posting requirements, the RMAR identified: (1) the requirement to notify Colorado employees of “promotional opportunities” anywhere in the world and to pause any hiring or promotions until such notice is provided; and (2) the lack of exceptions for trade secret disclosures, confidential searches, and corporate mergers and reorganizations. In its response brief, the CDLE argued that the RMAR’s identified burdens were “simply operational or logistical burdens” on individual firms, which do not rise to cognizable burdens on interstate commerce under the Dormant Commerce Clause.
From the CDLE, the court requested a supplemental brief on why the operational compliance costs incurred by employers do not matter to Dormant Commerce Clause analysis. In its brief, the CDLE argued that the RMAR failed to show that interstate commerce would be unduly burdened, as individual companies’ increased operational or compliance costs do not equate to a harm to the national market. It also argued that, because the EPEW’s effects are felt primarily in Colorado (or equally inside and outside of Colorado), precedent dictates that the court should not engage in Dormant Commerce Clause balancing analysis at all. Finally, the CDLE contended that, even if the court proceeds with a balancing test, the RMAR’s allegations are too broad and general to use as evidence in such a test. In response, the RMAR reiterated that the posting requirements burden interstate commerce by interfering with “a fundamental part of the process of talent acquisition and mobility nationwide (and worldwide)” and that the burdens on its members are representative of the burdens on interstate commerce.
Injunction Holding & Key Takeaways
On Thursday, May 27, 2021, Judge William J. Martinez denied the RMAR’s motion for preliminary injunction, finding that the RMAR failed to demonstrate a substantial likelihood of success on the merits of its Dormant Commerce Clause or First Amendment claims. Notably, the court categorized the RMAR’s request as a disfavored preliminary injunction and applied a heightened standard, with the RMAR bearing a heavier burden to show likelihood of success on the merits of its claims.
For the RMAR’s Dormant Commerce Clause claim, the court found that the RMAR “failed to put forward the necessary evidence regarding the relative magnitude of the local benefits, as compared to the burdens on interstate commerce.” That is, given the record’s lack of specific evidence regarding the EPEW’s harm to interstate commerce, the court could not effectively engage in the necessary balancing test. As such, the RMAR failed to establish a substantial likelihood of success on its Dormant Commerce Clause claim.
For the RMAR’s First Amendment claim, the court found that the EPEW bears a reasonable relationship to a substantial government interest and that, at this stage, the RMAR failed to show that the posting provisions created an undue burden on employers. Specifically, the court noted that, based on testimony and common sense, the posting requirements rationally related to the law’s goal of reducing the wage pay gap. Further, the court found that the requirements do not drown out employers’ individual messages in job postings, because they can be satisfied “in short statements and by disclosing promotion opportunities available to some employees to current Colorado employees.” The court was similarly unpersuaded by the RMAR’s argument that the provisions chill commercial speech, because “employers are still able to recruit candidates with compensation rates for positions of the employers’ choosing.” Thus, the RMAR failed to show a substantial likelihood of success on its First Amendment claim.
It is worth noting that the RMAR’s Dormant Commerce Clause claim failed due to the record’s lack of evidence at this initial, pre-discovery stage of litigation. This leaves the door open for the record to be developed adequately, as the suit proceeds, with the types of specific evidence the court identified as necessary for determining whether the Dormant Commerce Clause claim has merit. (The court seemed less receptive to the First Amendment claim, as its Order tended to focus on the substantive flaws of the RMAR’s arguments.) Thus, while the court denied the RMAR’s motion for preliminary injunction, the RMAR could still ultimately succeed in the suit and, if so, potentially obtain a permanent injunction that would prevent enforcement of the EPEW’s posting provisions. It will be important for employers to continue to comply with the EPEW’s posting requirements in the meantime.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment practice group, or the following authors:
Jessica Brown – Denver (+1 303-298-5944, jbrown@gibsondunn.com)
Marie Zoglo – Denver (+1 303-298-5735, mzoglo@gibsondunn.com)
Labor and Employment Group:
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Co-Chair, Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)
Rachel S. Brass – San Francisco (+1 415-393-8293, rbrass@gibsondunn.com)
Jessica Brown – Denver (+1 303-298-5944, jbrown@gibsondunn.com)
Catherine A. Conway – Los Angeles (+1 213-229-7822, cconway@gibsondunn.com)
Jesse A. Cripps – Los Angeles (+1 213-229-7792, jcripps@gibsondunn.com)
Theane Evangelis – Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com)
Gabrielle Levin – New York (+1 212-351-3901, glevin@gibsondunn.com)
Michele L. Maryott – Orange County (+1 949-451-3945, mmaryott@gibsondunn.com)
Karl G. Nelson – Dallas (+1 214-698-3203, knelson@gibsondunn.com)
Molly T. Senger – Washington, D.C. (+1 202-955-8571, msenger@gibsondunn.com)
Greta B. Williams – Washington, D.C. (+1 202-887-3745, gbwilliams@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.
Background
On May 28, 2021, the Administration released its fiscal year (FY) 2022 Budget, outlining a plan for $6 trillion of federal spending and $4.1 trillion in revenue for FY 2022 alone. Each year, the White House publishes the President’s Budget request for the upcoming fiscal year, which begins on October 1st. The President’s Budget lays out the Administration’s proposals for discretionary spending, revenue and borrowing and typically marks the opening of a dialog with Congress that culminates in appropriations bills and, on a parallel path, tax expenditure and revenue-raising legislation.
Detailed descriptions of the Administration’s legislative tax proposals have historically been provided in a “Greenbook” that includes revenue estimates generated by economists in Treasury’s Office of Tax Policy.[1] With the December 2017 enactment of sweeping changes to the federal tax law in legislation commonly known as the “Tax Cuts and Jobs Act” (the “TCJA”),[2] the prior administration did not publish a separate document laying out new tax legislative proposals. Thus, for the first time since the Obama Administration’s FY 2017 Budget (released in February 2016), the President’s FY 2022 Budget includes a Greenbook with detailed proposals for changes to the federal tax law, including provisions that would modify, expand or add to existing tax expenditures and revenue-raising measures.
Although the Greenbook is only the opening chapter in the FY 2022 budget and appropriations process, the current unified Democratic control of both the White House and of Congress, albeit each House of Congress by small margins, suggests that at least some of its proposals have a significant, although by no means certain, likelihood of moving forward as part of the Appropriations process or in separate pieces of legislation like an infrastructure bill. Most notably, the narrow Democratic majority in the House and the potential use of “reconciliation” procedures in an evenly divided Senate allow Democratic Senators, if they all agree, to pass legislation in Congress without help from Senate Republicans. The prospect of Democrats enacting legislation into law without Republican buy-in provides a new dynamic this year and makes this the most anticipated set of administration legislative tax proposals in recent memory.
The following summaries focus on tax expenditure and revenue-raising proposals in the Greenbook that affect business taxpayers and their owners, as follows:
Part I: Increased Rates for Corporations and Individuals
Part II: Elimination of Certain Significant Benefits
Part III: Sea Changes for International Tax
Part IV: Changes to Prioritize Clean Energy
Part V: Improve Compliance and Tax Administration
PART I: INCREASED RATES FOR CORPORATIONS AND INDIVIDUALS
Corporate Income Tax Rate Raised to 28%
The Greenbook proposes to increase the federal income tax rate on C corporations from 21 percent to 28 percent, effective for taxable years beginning after the end of 2021 (with a phase-in rule for taxpayers that have a non-calendar taxable year).
Recent comments by President Biden caused many to expect a proposed increase to 25 percent, rather than 28 percent, and it remains possible that the Administration will end up agreeing to a smaller corporate rate increase. An increased corporate income tax rate may incentivize corporations to accelerate income into the 2021 calendar year and to defer deductions until a later calendar year. This proposal may also encourage the use of passthrough entities (although taxpayers must also take into account the proposed increase in individual rates). Moreover, the proposed increase would push the corporate rate well above the 23.51 percent average rate for trading partners in the Organisation for Economic Co-Operation and Development (the “OECD”), raising again the long-standing tension between avoiding a “race to the bottom” on rates and strengthening the global tax competitiveness of U.S.-based companies.
It is noteworthy that in proposing an increase in the corporate rate, the Greenbook makes no reference to repealing or modifying the deduction for qualifying business income of certain passthrough entities (e.g., partnerships and S corporations) under Internal Revenue Code (the “Code”) section 199A. That provision was included in the TCJA late in the legislative drafting process in order to create parity between corporations and business operated in passthrough form, such as partnerships, S corporations, and sole proprietorships. Setting the corporate rate at 28 percent (along with the proposed elimination of lower rates on qualified dividends above stated thresholds) may tend to shift the incentive in the opposite direction, although Code section 199A is scheduled to expire in 2025.
Corporate taxpayers with GAAP-based financial statements will have to consider the impact of any rate increase on the values of their deferred tax assets and liabilities.
New 15 Percent Minimum Tax on Book Earnings of Large Corporations
The Greenbook proposes a 15 percent minimum tax on worldwide pre-tax book income for corporations whose book income exceeds $2 billion annually.
This proposal, taken together with the proposal for disallowing interest deductions, would further integrate income tax treatment with financial statement accounting treatment. Historically, these treatments have operated independently, but began to be integrated for limited purposes with the enactment of Code section 451(b) in 2017. The link to financial statement treatment is one of two proposals in the Greenbook (along with the proposed SHIELD provision discussed below) that would significantly expand reliance on third-party accounting standards to determine federal tax liability, a notable shift from the long-standing assumption, recognized by the Supreme Court in Thor Power Tool Co. v. United States, that there are “differing objectives of tax and financial accounting” and the risks and challenges associated with conforming them. It would also re-introduce the complexity of parallel sets of tax rules that Congress sought to eliminate when it repealed the corporate alternative minimum tax as part of the TCJA.
The proposal would be effective for taxable years beginning after December 31, 2021.
Top Marginal Tax Rate for Individuals Raised to 39.6%
Under current law, the top marginal income tax rate for individuals is 37 percent (before accounting for the additional 3.8 percent tax rate on net investment income), but would revert to 39.6 percent (again, before accounting for the additional 3.8 percent tax rate on net investment income) for taxable years beginning on and after January 1, 2026. In 2021, the top marginal rate applies to taxable income that exceeds $628,300 (for married couples filing jointly) or $523,600 (for single filers).
The Greenbook proposes that, beginning in 2022, the new 39.6 percent (before accounting for the additional 3.8 percent tax rate on net investment income) top marginal income tax rate would apply to taxable income that exceeds $509,300 (for married couples filing jointly) or $452,700 (for single filers); the thresholds would be adjusted for inflation in taxable years after 2022. The proposed increase in individual tax rates was not accompanied by a repeal of the limitation on deductibility of state and local taxes.
Tax Certain Capital Gains at Ordinary Income Rates for High Earners
Currently, individual taxpayers are taxed at preferential rates on their long-term capital gains and qualified dividends as compared to ordinary income—the current highest rate for long-term capital gains and qualified dividends is 20 percent (23.8 percent, including the net investment income tax, if applicable).
The Greenbook proposes to tax individuals’ long-term capital gains and qualified dividends at ordinary income tax rates to the extent that the individual’s adjusted gross income exceeds $1 million ($500,000 for married filing separately), indexed for inflation after 2022. For example, an individual with $200,000 of long-term capital gains and $900,000 of wages would have $100,000 of long-term capital gains taxed at ordinary income rates (the $100,000 excess over $1 million).
Other than a brief period of time after passage of the Tax Reform Act of 1986, capital gains have received preferential federal income tax treatment since the 1920s. The Greenbook proposal will add to the long-standing debate on the merits of this preference and undoubtedly cause taxpayers to consider ways in which they can defer or avoid recognition events.The proposal would also remove a historic tax incentive to hold capital assets for one year, possibly resulting in earlier and more common dispositions of assets held for 10 or 11 months.
The proposal would be effective for gain recognized after the date of the announcement (understood to be April 28, 2021, the date when President Biden announced the proposal as part of the American Families Plan). As with other aspects of the Greenbook proposals, the effective date could change during the Budget reconciliation process.
“Deemed” or “Forced” Realization – New Realization Events for Gifts, at Death and for Certain Partnerships and Trusts
Under general tax principles, taxpayers take into account increases and decreases in the value of their assets only at the time of a realization event, such as a sale. Currently, gifts and transfers upon death are not treated as taxable events. This is the case on transfers on death, even though the heir generally takes a “stepped up” fair market value basis in the decedent’s assets upon death, with no income tax due at that time.
Under the Greenbook proposal, donors and decedents would recognize capital gain upon a transfer to a donee or heir, as applicable, based on the asset’s fair market value at the time of transfer. A decedent would be permitted to use capital losses and carry-forwards to offset such capital gains.
The proposal would require the recognition of unrealized appreciation by partnerships, trusts, and other non-corporate entities that are the owners of the property if that property has not been subject to a recognition event in the prior 90 years. Because the look-back period begins January 1, 1940, this aspect of the proposal would not become operational until December 31, 2030. The operational aspects of this proposal – such as which property would be taxed, who would bear the incidence of tax, and the extent of adjustment to basis – are not addressed by the Greenbook.
The proposal also would treat otherwise tax-deferred contributions to, or distributions from, partnerships, trusts, and other non-corporate entities as taxable events. The description of this aspect of the proposal in the Greenbook is startling in its breadth. That is, if taken literally the proposal would upend the bedrock principles in partnership taxation that contributions to and distributions by partnerships generally are tax free. Presumably, the proposal was intended to address indirect donative transfers, and it is hoped that clarification will be forthcoming in short order.
Exclusions would apply to assets transferred to U.S. spouses and charities. Additionally, there would be a $1 million per-person exclusion (generally $2 million per married couple) that would be indexed for inflation. Payment of tax would be deferred in the case of certain family-owned and -operated businesses (which are not defined but would presumably be modeled on the payment extension provisions for estate taxes in Code section 6166) until the interest in the business is sold or the business ceases to be family-owned and -operated. Additionally, the proposal would allow a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death (excluding certain liquid assets and transfers of businesses for which the deferral election is made). This proposal has the potential to create substantial liquidity issues for closely held businesses. As proposed, no change would be made to the exclusion of certain capital gains under Code section 1202.
The proposal generally would be effective beginning January 1, 2022.
Eliminate Gap in Medicare Taxes for High Earners
The current 3.8 percent “net investment income tax” generally applies to passive income and gains recognized by high-income individuals, including trade or business income earned by taxpayers who do not materially participate in the business. The separate 3.8 percent “SECA” tax currently applies to self-employment earnings of high-income taxpayers—both taxes are intended to fund Medicare and are often colloquially referred to as “Medicare” taxes.
Neither form of Medicare tax currently applies to limited partners (many taxpayers believe that certain members of limited liability companies classified as partnerships for federal income tax purposes are “limited partners” for this purpose) and S corporation shareholders (who are subject to Medicare tax solely on “reasonable compensation” paid in an employee capacity) who are treated as materially participating in a trade or business. The Biden Administration likens this gap to a loophole because certain high-income taxpayers’ distributive share of business income may escape Medicare taxation.
The Greenbook proposal would subject all trade or business income of high-income taxpayers (earned income exceeding $400,000) to the 3.8 percent Medicare tax (either through the net investment income tax or the SECA tax) and would apply to taxable years beginning on or after January 1, 2022. The Greenbook bases this change on fair and efficient tax administration. “Different treatment [for owners of different types of passthrough entities] is unfair, inefficient, distorts choice of organizational form, and provides tax planning opportunities for business owners, particularly those with high income, to avoid paying tax.” Notwithstanding that explanation, the proposal goes to some lengths to ensure that it does not impact taxpayers with less than $400,000 in earned income, although it is noteworthy that the proposal is explicit in saying that this threshold would not be indexed for inflation. It is also noteworthy that the exclusion for these lower income taxpayers is linked to earned income rather than “taxable income (from all sources),” which is used elsewhere in the Greenbook as the trigger for proposed denial of capital gain treatment for carried interest.
PART II: ELIMINATION OF CERTAIN SIGNIFICANT BENEFITS
Tax Carried Interests as Ordinary Income
The Greenbook, following in the footsteps of many previously proposed bills, proposes to tax a partner’s share of profits from, and gain from the disposition of, an “investment services partnership interest” as ordinary income, regardless of the character of the income at the partnership level.
Under current law, partnerships are generally able to issue a partnership interest to a service provider who then holds the interest as a capital asset, with the character of the partner’s share of profits from the partnership being determined by reference to the character of the profits in the hands of the partnership. Thus, if the partnership recognizes capital gain, the service provider’s share of such income would generally likewise be capital gain. These equity grants may take the form of a “profits interest,” which is referred to as a “carried interest” in the private equity context, an “incentive allocation” in the hedge fund context, or a “promote” in the real estate context. The TCJA limited the ability to recognize long-term capital gain with respect to these profits interests by enacting Code section 1061, which generally treats gain recognized with respect to certain partnership interests held for less than three years as short-term capital gain.
The Greenbook proposal would eliminate this benefit, but only for partners whose taxable income (from all sources) exceeds $400,000. Partners whose taxable income does not exceed $400,000 would continue to be subject to Code section 1061, which generally treats gain recognized with respect to certain partnership interests or partnership assets held for less than three years as short-term . The “cliff” effect of this proposal would add considerable complexity to the tax law, requiring a parallel set of rules that may apply differently to different members of the same partnership.
The proposal would apply to profits interests held by persons who provide services to a partnership that is an “investment partnership.” A partnership would be an investment partnership if (i) substantially all of its assets are investment-type assets and (ii) more than half of the partnership’s contributed capital is from partners whose partnership interest is an investment (i.e., partners in whose hands the partnership interest is not held in connection with a trade or business). The proposal would not apply to a partnership interest attributable to any capital contributed by the service provider. The proposal includes certain anti-abuse rules intended to prevent the avoidance of the recharacterization rule through the use of compensatory arrangements other than partnership interests.
It appears that the most significant differences between the proposal in the Greenbook and existing law under Code section 1061 would be (i) unlimited time duration (Code section 1061 applies only to recharacterize long-term capital gain recognized with respect to an asset held for three years or less), (ii) treatment of the recharacterized amount as ordinary income rather than short-term capital gain (there is no rate differential, but there could be sourcing and other differences), and (iii) subjecting the income to SECA.
Given that final Treasury regulations under Code section 1061 were released only this year, the proposal to repeal and replace Code section 1061 in certain cases is somewhat surprising, although similar proposals have recently been introduced in Congress. If enacted, this proposal could meaningfully impact the taxation of individuals in the private equity, hedge fund, and real estate industries, and other service providers receiving a profits interest as a form of compensation. It should be noted that if the proposal ending the preferential treatment of long-term capital gain is also enacted, this carried interest proposal would materially affect only profits interests holders with taxable income below $1 million (the threshold in the long-term capital gain proposal).
The provision would be effective for taxable years beginning after December 31, 2021.
Make Permanent Excess Business Loss Limitation of Noncorporate Taxpayers
The TCJA requires that “excess business losses” be carried forward as net operating losses rather than deducted currently. Very generally, an excess business loss is the amount of losses from a business that exceeds the sum of the gains from business activities and a stated threshold ($524,000 for married couples filing jointly and $262,000 for other taxpayers).
Under current law, the excess business loss provision expires in 2027; the Greenbook would make the provision permanent.
Severely Limit Deferral of Gain from Like-Kind Exchanges
Code section 1031 currently provides for non-recognition of gain on exchanges of real property for other like-kind real property (like-kind exchanges). The Greenbook proposes to limit the applicability of Code section 1031 to exchanges that defer gain of less than $500,000 (or $1 million in the case of married individuals filing a joint return) in a taxable year. The proposal does not index the exclusion amounts to inflation, although it does apply those amounts on an annual basis.
This proposal represents a significant change for the real estate, oil and gas, and mineral industries, which together engage in billions of dollars of like-kind exchanges per year. In particular, the proposal could significantly impact the business of REITs, which must distribute at least 90 percent of their taxable income per year and often use Code section 1031 to reduce the amount of income subject to this distribution requirement in order to keep additional cash on hand to complete other real estate purchases. Further, oil and gas “acreage swaps” and mineral interest exchanges could be severely limited. If enacted, the $500,000 / $1 million exclusion included in the proposal could create an incentive to divide property and make partial, tax-deferred dispositions. It could also create an incentive for taxpayers to use tenant-in-common or other pooled structures, like tax partnerships, to facilitate transactions without triggering taxation.
The proposal would be effective for exchanges completed in taxable years beginning after December 31, 2021.
PART III: SEA CHANGES FOR INTERNATIONAL TAX
The TCJA introduced sweeping reform on international tax matters with the goal of incentivizing multinational companies to remain in the United States. Along these lines, not only did the TCJA lower the U.S. corporate income tax rate and provide a 100 percent dividends-received deduction for certain offshore dividends, but it also introduced new obstacles and penalties to discourage so-called inversions and established the global intangible low-tax income (GILTI) and base erosion anti-avoidance regimes to generally provide a minimum level of tax on certain foreign earnings.
The Greenbook, as described in further detail below, proposes to—again—usher in comprehensive changes and unscramble some of the TCJA complexity. Interestingly, several of these proposals are reminiscent of similar proposals made by the OECD. In fact, the Greenbook mentions the OECD four times (compared to zero mentions in the JCT’s Blue Book for the TCJA), suggesting a willingness to find common ground with the OECD on some principles of international taxation.
The proposed changes to the international tax regime come less than four years after passage of the TCJA and inject a new level of uncertainty and instability into U.S.-based companies’ decisions around the global deployment of capital. Moreover, the IRS is just now beginning to audit many of the returns filed for the 2018 tax year, the first year in which TCJA was in full effect. Beyond the front-end planning challenges for taxpayers, enactment of the Greenbook proposals will raise significant administrability issues for the IRS as it works with taxpayers to sort through several interlocking but materially different regimes for taxing cross-border activities.
Revised Global Minimum Tax Regime
The Greenbook proposal would increase the effective tax rate of U.S. multinational companies by overhauling the GILTI regime. Specifically, the so-called “QBAI” (or qualified business asset income) exemption would be eliminated, with the result that a U.S. shareholder’s entire net tested income would be subject to tax (i.e., net tested income would no longer be offset by a deemed 10 percent return on certain depreciable tangible property).
The elimination of the QBAI exemption would remove the last fig leaf of the quasi-territorial tax system that was announced with much fanfare in 2017. If enacted, the United States will stake new ground in the international tax arena by requiring U.S. shareholders to pay tax on all earnings in foreign companies, as compared to most countries that tax analogous shareholders only on certain foreign earnings (e.g., corporate earnings from low-tax countries or passive income). Moreover, since all foreign earnings would now be taxed, the Code section 245A dividend-received exemption would become increasingly irrelevant, since the earnings underlying the dividends would generally have been taxed under subpart F or GILTI at the time the foreign corporation earned the income.
It is also worth noting that QBAI is generally tangible property eligible for depreciation, such as buildings or machinery, but QBAI does not include assets that are not depreciable (such as land) nor intangible assets. As a result, the elimination of QBAI may disproportionately affect companies with more tangible assets, rather than companies whose value is primarily intangible assets (like intellectual property). In addition, the cost-benefit analysis of a potential Code section 338(g) election, which regularly arises in cross-border acquisitions, will change given that the step-up in asset basis will no longer produce a tax benefit in the form of QBAI to reduce future GILTI inclusions, though Code section 338(g) elections still have other benefits.
The proposal would also effectively increase the GILTI rate by reducing the Code section 250 deduction from 50 percent to 25 percent. Under current law, U.S. shareholders are entitled to a 50 percent deduction against a 21 percent tax rate, resulting in an effective 10.5 percent GILTI rate. The Greenbook proposal, however, would reduce the deduction to 25 percent. Taken together with the proposed corporate rate increase to 28 percent, this change would result in an effective GILTI rate of 21 percent. Interestingly, the Greenbook’s proposal does not do away with the Code section 250 deduction. Rather, it achieves the 21 percent rate by changing the percentage of the deduction. This approach suggests a willingness to use the relative percentage deduction as a way to reach a compromise on the overall package.
Consistent with the general increase in corporate tax rates, this change to the effective GILTI rate may encourage taxpayers to accelerate gain recognition transactions and/or defer deductions.
In addition, the Greenbook proposes that U.S. shareholders of a controlled foreign corporation (“CFC”) calculate their global minimum tax on a country-by-country basis. In other words, a U.S. shareholder’s global minimum tax inclusion, and tax on such inclusion, would be determined separately for each country in which it or its CFCs operate, rather than permitting taxes paid to higher-taxed jurisdictions to reduce the residual U.S. tax paid on income earned in lower-taxed foreign jurisdictions. This proposed change results in a separate foreign tax credit limitation for each country.
The Greenbook does not suggest any changes to the 80 percent limitation that currently applies to GILTI foreign tax credits. If the 80 percent limitation still exists, GILTI will be exempt from further U.S. tax only if it is subject to foreign taxation at a rate of at least 26.25 percent, since 20 percent (or 5.25) of the foreign tax credit is disallowed under current law.
Finally, this proposal would also repeal the high tax exemption to subpart F income and repeal the cross-reference to that provision in the global minimum tax rules in Code section 951A. This proposal would end the controversy over the Treasury Regulations that provided a high tax exemption for GILTI.
In a proposal that is remarkable for its potential deference to the OECD, these general rules would be adjusted for foreign-parented multinational groups (consistent with the OECD/G20 Inclusive Framework on BEPS project’s Pillar Two proposal (the “Pillar Two”)).
These rules would be effective for taxable years beginning after December 31, 2021.
Expanded Application of Anti-Inversion Rules
To backstop the changes to the global minimum tax regime and prevent U.S. companies from moving offshore to avoid the global minimum tax, the Greenbook proposes a dramatic expansion of the anti-inversion regime under Code section 7874. Code section 7874 currently applies to the acquisition of a U.S. corporation by a foreign corporation if, after the transaction, the former shareholders of the U.S. corporation own more than 80 percent, by vote or value, of the foreign corporation and certain other conditions are satisfied. In this case, Code section 7874 applies to treat the foreign acquiring corporation as a domestic corporation for U.S. federal income tax purposes, assuming certain other conditions are satisfied. If the portion of the foreign corporation held by former shareholders of the U.S. corporation (the so-called ownership fraction) is between 60 and 80 percent, current law subjects the foreign corporation to the possibility of increased taxation, but does not treat it as a domestic taxpayer.
The Greenbook proposal would replace the current 80-percent threshold with a 50-percent threshold and would eliminate the current 60-percent test entirely. In addition, the proposal would expand the universe of acquisitions treated as inversions (regardless of ownership fraction) to include acquisitions where (1) immediately prior to the acquisition, the fair market value of the domestic entity is greater than the fair market value of the foreign acquiring corporation, (2) after the acquisition, the expanded affiliated group is primarily managed and controlled in the United States, and (3) the expanded affiliated group does not conduct substantial business activities in the country in which the foreign acquiring corporation is created or organized. The proposal would also broaden Code section 7874 in several important ways, by including certain asset acquisitions and stock distributions, picking up U.S. businesses operated by foreign partnerships, and by considering the spinoff of a foreign subsidiary the equivalent of an inversion under certain circumstances.
Code section 7874 is already exceedingly complex and broad in many respects and is thus a frequent trap for the unwary. These proposals, if enacted, will require careful scrutiny by taxpayers and practitioners to avoid dangerous foot faults. Introduction of the management and control and substantial business activities tests, in particular, would add a new level of subjectivity and uncertainty to the threshold question of whether the rules apply.
These rules would be effective for transactions that are completed after the date of enactment of such rules. The lack of an exception for transactions for which there is a binding contract as of the effective date could chill market activity even before passage.
Repeal of Deduction for Foreign-Derived Intangible Income
The Greenbook proposes the repeal of the deduction currently available to domestic corporations with respect to 37.5 percent of any foreign-derived intangible income for taxable years beginning after December 31, 2021. This proposal was expected, and is framed by the Greenbook as the elimination of an inefficient subsidy to multinational corporations. Additionally, many commentators viewed the existing provision as violating World Trade Organization principles. The increased tax revenue that is estimated to come from repeal would be “used to encourage R&D” (presumably in the United States), although no details are provided on how the $123 billion would be deployed.
Replace BEAT with Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD) Rule
The Greenbook would replace the “base erosion and anti-abuse tax” (“BEAT”) in Code section 59A with a new rule—the Stopping Harmful Inversions and Ending Low-Tax Developments (“SHIELD”) rule—disallowing deductions by domestic corporations with respect to members in their financial reporting group whose income is subject to (or deemed to be subject to) an effective tax rate that is below either the rate agreed to under OECD Pillar Two or the U.S. global minimum tax rate of 21 percent. Disallowance may be complete or partial, depending on whether the payment is made directly to such low-taxed entities.
The rule would apply to financial reporting groups with greater than $500 million in global annual revenues, although the proposal permits the Treasury Department to exempt from SHIELD (i) certain financial reporting groups, if they meet a minimum effective level of tax (on a jurisdiction-by-jurisdiction basis) and (ii) payments to investment funds, pension funds, international organizations, or non-profit entities. It is unclear whether the exemption would extend to investors that rely on the Code section 892 exemption. As discussed above in connection with the proposed minimum tax on book earnings, the link to financial statement reporting would mark another notable shift to reliance on third-party standards for determining U.S. income tax liability.
This proposal could adversely impact entities that have already “inverted,” or foreign-parented entities with domestic subsidiaries (and which conduct significant business in the United States). Foreign-parented entities that have substantial offshore intellectual property held in lower-tax jurisdictions may be particularly affected by this proposal.
The rule would be effective for taxable years beginning after December 31, 2022.
Limit Foreign Tax Credits from Sales of Hybrid Entities
The Greenbook would require that, for purposes of applying the foreign tax credit rules, the source and character of items of certain hybrid entities resulting from either a disposition of an interest in such a hybrid entity or a change in the U.S. tax classification of such entity that is not recognized for foreign tax purposes be determined as if the recognition event were a sale or exchange of stock.
The rule would be effective for transactions occurring after the date of enactment.
Restrict Interest Deductions for Disproportionate Borrowing in the United States
This proposal potentially disallows deductions for interest paid by an entity that is a member of a multinational group that prepares consolidated financial statements. Such an entity’s interest deductions would be disallowed to the extent they exceed an amount determined by reference to the entity’s proportionate share (based on its proportion of group earnings) of the group’s net interest expense as reported on the group’s consolidated financial statement.
Alternatively, if an entity subject to the proposal fails to substantiate its proportionate share of the group’s net interest expense for financial reporting purposes, or an entity so elects, the entity’s interest deduction would be limited to the entity’s interest income plus ten percent of the entity’s adjusted taxable income (as defined under Code section 163(j)).
The proposal would not apply to financial services entities. The proposal also would not apply to groups that would otherwise report less than $5 million of net interest expense, in the aggregate, on one or more U.S. income tax returns for a taxable year.
The proposal would be effective for taxable years beginning after December 31, 2021.
Tax Incentive for Onshoring Jobs
This proposal would create a new general business credit equal to 10 percent of certain expenses paid or incurred in connection with moving a trade or business located outside the United States to the United States to the extent the action results in an increase in U.S. jobs.
The proposal would also reduce tax benefits associated with U.S. companies moving jobs outside of the United States by disallowing deductions for certain expenses paid or incurred in connection with offshoring a U.S. trade or business to the extent the action results in a loss of U.S. jobs.
The proposal would be effective for expenses paid or incurred after the date of enactment.
Expand Taxation of Foreign Fossil Fuel Income
Under current law, certain non-U.S. oil-and-gas-related income effectively is taxed at a lower rate than similar oil-and-gas-related income from activities within the United States. For example, “foreign oil and gas extraction income” is excluded from a controlled foreign corporation’s “gross tested income” and may be repatriated tax free. In addition, taxpayers may claim a credit against U.S. income tax liability for certain levies paid to non-U.S. governments.
The Greenbook proposes scaling back the beneficial tax treatment afforded to non-U.S. oil-and-gas-related income. Specifically, the proposal would require foreign oil-and-gas-extraction income to be included in a CFC’s gross tested income for purposes of GILTI and would limit the situations in which taxpayers can claim a credit for levies paid to non-U.S. governments.
The proposal would be effective for taxable years beginning after December 31, 2021.
PART IV: CHANGES TO PRIORITIZE CLEAN ENERGY
Extension of Tax Credits for Wind, Solar and Other Renewable Generation Facilities
The production tax credit (“PTC”) and investment tax credit (“ITC”) are long-standing renewable energy incentives. The PTC is a production-based incentive, available as power produced from qualifying renewable resources (e.g., wind, solar) is sold to unrelated parties. The ITC is a cost-based incentive, determined as a percentage of eligible basis, that arises when a qualifying renewable energy facility is placed in service. The credits have historically been subject to a complicated patchwork of rules for different resources (e.g., when construction of a facility needs to begin, when the facility must be placed in service, etc.), the qualification rules have changed frequently and often unpredictably, and the credits have been non-refundable. Taken together, these features have presented challenges in the development and financing of renewable energy projects.
The Greenbook proposes a long-term extension of the rules, with the full PTC and ITC both being available for facilities whose construction begins after December 31, 2021 and before January 1, 2027, followed by a predictable, stepped phase-down period. Moreover, unlike the current PTC and ITC, taxpayers would have the option to elect a cash payment in lieu of the tax credits (the so-called “direct pay” option).
If enacted, these proposals would bring greater predictability to project developers and, through the direct pay option, make it meaningfully easier for taxpayers lacking sufficient tax “appetite” to efficiently participate in renewables transactions, spurring additional investment in renewable energy generation facilities. While not described in detail, this “direct pay” option would appear to effectively make the credits refundable, meaning that funding is available irrespective of whether the taxpayer has positive income tax liability. Although this could reduce the incentive to use partnership structures to utilize the credits, it would also add a new level of complexity to their administration and raise concerns from the IRS about the potential for abuse.
The proposal would be effective for taxable years beginning after December 31, 2021.
Expansion of Tax Credits to Stand-Alone Energy Storage and Energy Transmission Assets
Historically, energy storage assets (such as battery storage projects) have been eligible for the ITC only when paired with certain renewable energy resources, and the ITC has been unavailable with respect to energy transmission property. The Greenbook proposes to make certain stand-alone energy storage assets and energy transmission infrastructure assets eligible for the ITC. Moreover, as with the generation facility credit, taxpayers would be eligible to elect a cash payment in lieu of tax credits.
We expect that these proposals to increase the scope of ITC-eligible assets will provide strong incentives for investment in infrastructure designed to make the nation’s electric grid more reliable and resilient.
The proposal would be effective for taxable years beginning after December 31, 2021.
New Tax Credits for Qualifying Advanced Energy Manufacturing
Existing law authorizes a tax credit for the establishment of certain clean energy manufacturing facilities (e.g., facility to manufacture wind or solar equipment), but the amount of the credit is subject to a relatively low cap, which makes the incentive unavailable to certain otherwise-qualifying credit applicants. The Greenbook would expand the availability of the credit to include various new manufacturing facilities (including those focused on energy storage equipment, electric grid modernization equipment, energy conservation technology, and carbon oxide sequestration equipment) and significantly expand the cap, with a material portion of the credit being specifically allocable to projects in coal communities. Again, taxpayers would be eligible to elect a cash payment in lieu of tax credits. Taken together, the proposal intends to spur the production of domestic manufacturing of clean energy property.
The proposal would be effective for taxable years beginning after December 31, 2021.
Eliminate Fossil Fuel Tax Preferences
Current law provides a number of tax incentives meant to encourage oil and gas production. These incentives were targeted for repeal under the Obama Administration’s Greenbook in each year beginning with the 2011 fiscal year. The Biden Administration’s fiscal year 2022 Greenbook picks up where the Obama Administration left off, proposing to repeal a nearly identical set of fossil fuel-related tax incentives. Specifically, the Greenbook proposes repealing: (1) the enhanced oil recovery credit for eligible costs attributable to a qualified enhanced oil recovery project; (2) the credit for oil and gas produced from marginal wells; (3) the expensing of intangible drilling costs; (4) the deduction for costs paid or incurred for any tertiary injectant used as part of a tertiary recovery method; (5) the exception to passive loss limitations provided to working interests in oil and natural gas properties; (6) the use of percentage depletion with respect to oil and gas wells; (7) two-year amortization of independent producers’ geological and geophysical expenditures, instead allowing amortization over the seven-year period used by integrated oil and gas producers; (8) expensing of exploration and development costs; (9) percentage depletion for hard mineral fossil fuels; (10) capital gains treatment for royalties; (11) the exemption from the corporate income tax for publicly traded partnerships with qualifying income and gains from activities relating to fossil fuels; (12) the Oil Spill Liability Trust Fund excise tax exemption for crude oil derived from bitumen and kerogen-rich rock; and (13) accelerated amortization for air pollution control facilities.
If enacted, the repeal of these incentives would make the production of oil and gas costlier by increasing producers’ effective tax rate. That said, some of these incentives, like the intangible drilling cost deduction, predate the Internal Revenue Code itself and have survived numerous political cycles. Efforts to repeal a nearly identical set of incentives proved difficult for the Obama Administration, even where the revenue generated from repeal was projected to be higher during the Obama Administration.
The proposal generally would be effective for taxable years beginning after December 31, 2021, although the repeal of item 11 above (exception for certain publicly traded partnerships) will only become effective for taxable years beginning after December 31, 2026.
Expand and Enhance the Carbon Oxide Sequestration Credit
Current law provides a tax credit for the capture and sequestration of certain types of carbon oxide captured with carbon-capture equipment placed in service at certain qualifying facilities, with the amount of the credit dependent on when and how the carbon oxide is sequestered.
The Greenbook proposes increasing the value of the sequestration credit by (i) $35 dollars per metric ton for carbon oxide that is more difficult to capture, such as carbon oxide from cement production, steelmaking, or hydrogen production, and (ii) $70 per metric ton for direct air carbon capture projects. Further, the “begin construction” date for qualifying facilities eligible for the credit would be extended five years to January 1, 2031. As is the case for the Greenbook’s other clean energy proposals, taxpayers could elect to receive a direct cash payment in lieu of the credits. The enhanced credits, together with the begin construction date extension and the direct pay option, should spur investment in carbon capture facilities and technologies.
The proposal would be effective for taxable years beginning after December 31, 2021.
Other Clean Energy Proposals
- Establish Tax Credits for Heavy- and Medium-Duty Zero Emissions Vehicles
- Provide Tax Incentives for Sustainable Aviation Fuel
- Provide a Production Tax Credit for Low-Carbon Hydrogen
- Extend and Enhance Energy Efficiency and Electrification Incentives
- Provide Disaster Mitigation Tax Credit
- Extend and Enhance the Electric Vehicle Charging Station Credit
- Reinstate Superfund Excise Taxes and Modify Oil Spill Liability Trust Fund Financing
PART V: IMPROVE COMPLIANCE AND TAX ADMINISTRATION
The Administration has been vocal in recent months in calling for an increase in IRS funding to reverse more than a decade of declining budgets and staff attrition, and to address information technology infrastructure challenges, all of which have driven historically low audit rates. On April 9, 2021, the Office of Management and Budget released an outline of the President’s request for fiscal year 2022 discretionary spending that would provide the IRS with $13.2 billion in funding for next year alone, a $1.2 billion or 10.4 percent increase over enacted IRS funding for 2021.[3] This increase would be used in part to improve taxpayer service but a major focus of the increased funding would be on increasing taxpayer compliance with existing law, reducing the “gap” between what is paid over to Treasury in taxes each year and what is actually owed. The most recent official estimates, covering the 2011 – 2013 tax years, are that this “tax gap” is roughly $441 billion annually (reduced by existing enforcement efforts to roughly $ $281 billion), although IRS Commissioner Charles Rettig recently suggested that a more accurate number may be closer to $1 trillion.
While there are some estimates that the IRS can collect $4 in additional tax for every $1 in increased IRS funding, those estimates cover a broad range of enforcement activity and are likely skewed toward low-cost/high-return functions like automated matching of information returns, rather than audits of complex tax returns. And, in the context of those more complex returns, there is considerably more uncertainty around what tax is actually owed, given ambiguities in the underlying law. Moreover, according to the IRS’s own estimates, over time the voluntary compliance rate has remained remarkably constant at just under 85 percent, even during periods of significantly declining budgets and enforcement activity, raising the question as to whether a material increase in IRS funding will translate into the expected increase in compliance.
Introduce Comprehensive Financial Account Reporting to Improve Tax Compliance
Recognizing that increased funding for the IRS alone will not be sufficient to make the necessary dent in the tax gap, the Greenbook includes several proposals that would equip the IRS with better information to address noncompliance with existing tax laws. The premise for these proposals is that third-party reporting can increase voluntary compliance rates from below 50 percent to as high as 95 percent. From that premise, the Administration proposes to create a “comprehensive financial account reporting regime,” that would require financial institutions to report gross transfers into and out of accounts, including accounts owned by the same taxpayer. This proposal is estimated to raise $8.3 billion in FY 2022 alone and, once fully implemented, to raise over $462 billion over the next 10 years. While increased information reporting will undoubtedly improve voluntary compliance, by how much is an open question. The proposed reporting regime falls several steps short of the Form W-2 reporting that ties directly into taxable income and also falls short of most existing Form 1099 reporting, which ties directly into gross income. Rather, like merchant card reporting under Code section 6050W, the comprehensive reporting regime would provide the IRS with information about fund flows that could lead to uncovering unreported taxable income (or encourage taxpayers to more accurately report taxable income to begin with) but will not do so directly. Whether this helps move compliance from under 50 percent to closer to 95 percent will depend on a number of variables, including the extent to which and how quickly financial institutions can implement a new reporting requirement and whether the IRS has the resources in place to effectively utilize the new information through deployment of artificial intelligence and comprehensive audit follow up. Successful implementation of the program will present additional challenges to the extent that, as proposed, it covers crypto assets, where a longer period of time for implementation could be needed, and unique substantive issues around transfers of “property,” as the IRS has characterized cryptocurrency, are likely to be raised. Even with established financial institutions that have deep experience with reporting information to the IRS, implementation of prior information reporting regimes including broker accounts and FATCA have proven far more complicated and burdensome than first expected.
Oversight of Paid Tax Return Preparers
The Greenbook proposes to provide the Secretary with explicit authority to regulate paid tax return preparers. This proposal has been included in several pieces of introduced legislation and was proposed in a number of prior-year Budget requests. In the past it was met with resistance from some in the tax professional community as well as members of Congress who oppose imposing new regulatory requirements on small businesses.
The proposal would be effective for taxable years beginning after December 31, 2021.
Modifications to Partnership Audit Rules
Under the BBA Centralized Partnership Audit Regime signed into law in 2015 and generally effective for tax years beginning in 2018, partners in the “adjustment” year of a partnership’s return are responsible for any tax payment obligation arising from adjustments going back to the “reporting year” return at issue. The BBA generally permits partnerships undergoing audit for certain tax years to make a “push out” election whereby the reporting year partners, and not the adjustment year partnership, become responsible for payments arising from an audit adjustment. If an adjustment reduces, instead of increases, a partner’s tax liability, the partner can use the decrease to offset its tax liability in the current year, but not below zero, with any reduction in excess of its tax liability in the current year being lost. The proposed change would treat the excess as a tax overpayment, potentially allowing a refund. This proposal reflects the Administration’s priority on increased enforcement for flow-through entities.
The proposal would be effective upon enactment.
_________________________
[1] The term “Bluebook” has also been used in prior administrations. Greenbook and Bluebook legislative proposals dating back to 1990 are available on the Treasury Department’s website, https://home.treasury.gov/policy-issues/tax-policy/revenue-proposals. The Joint Committee on Taxation (“JCT”) periodically publishes a general explanation of recently enacted tax legislation in a publication that is also known as a “Blue Book.” In December 2018, JCT released a Blue Book that explains the TCJA, which can be found at https://www.jct.gov/publications/2019/jcs-2-19/.
[2] TCJA is formally titled “An act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” Pub. L. No. 115-97, 131 Stat. 2045.
[3] https://www.whitehouse.gov/wp-content/uploads/2021/04/FY2022-Discretionary-Request.pdf.
This alert was prepared by Jennifer Sabin, John-Paul Vojtisek, Dora Arash, Michael D. Bopp, James Chenoweth, Michael J. Desmond, Pamela Lawrence Endreny, Roscoe Jones, Jr., Kathryn Kelly, Brian W. Kniesly, David Sinak, Eric Sloan, Jeffrey M. Trinklein, Edward Wei, Lorna Wilson, Daniel A. Zygielbaum, Michael Cannon, Jennifer Fitzgerald, Evan M. Gusler, Brian Hamano, James Jennings, James Manzione and Collin Metcalf.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Tax or Public Policy practice groups, or the following authors:
Jennifer Sabin – New York (+1 212-351-5208, jsabin@gibsondunn.com)
John-Paul Vojtisek – New York (+1 212-351-2320, jvojtisek@gibsondunn.com)
Dora Arash – Los Angeles (+1 213-229-7134, darash@gibsondunn.com)
James Chenoweth – Houston (+1 346-718-6718, jchenoweth@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)
Kathryn A. Kelly – New York (+1 212-351-3876, kkelly@gibsondunn.com)
Brian W. Kniesly – New York (+1 212-351-2379, bkniesly@gibsondunn.com)
David Sinak – Dallas (+1 214-698-3107, dsinak@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)
Edward S. Wei – New York (+1 212-351-3925, ewei@gibsondunn.com)
Lorna Wilson – Los Angeles (+1 213-229-7547, lwilson@gibsondunn.com)
Daniel A. Zygielbaum – Washington, D.C. (+1 202-887-3768, dzygielbaum@gibsondunn.com)
Public Policy Group:
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)
Roscoe Jones, Jr. – Washington, D.C. (+1 202-887-3530, rjones@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.
Gibson Dunn strongly condemns acts of violence, hatred and bigotry of any kind. In recent weeks, we have seen a disturbing rise of anti-Jewish hate erupt in communities around the world. These attacks rooted in anti-Semitism have no place in society, and we denounce anti-Semitism in any form, and in any context.
It has been a difficult year for many, and we know that many of our colleagues, friends and family members have been impacted by the recent attacks on the Jewish community and are struggling on a very personal level with these heinous acts of bigotry and prejudice. These horrific acts of physical violence in our communities and explicit anti-Semitic messages are deeply disturbing.
If we have learned anything from this past year, it is that we must not be afraid to condemn acts of hatred and violence wherever, and whenever, we see them in our communities. As Elie Wiesel said, “I swore never to be silent whenever human beings endure suffering and humiliation.” Silence is complicity and Gibson Dunn has never been silent. At Gibson Dunn, we have always and will always defend the rule of law, civil liberties, and equal justice for all. Our lawyers have been encouraged to take up that mantle, through pro bono efforts, charitable giving, or otherwise. The firm is proud of our longstanding partnerships with organizations committed to fighting anti-Semitism, including the Anti-Defamation League and the American Jewish Committee, which recently issued a groundbreaking survey on anti-Semitism in America. We are proud of the pro bono work that we have done in collaboration with organizations like Bet Tzedek and so many others, and we commit ourselves to further engaging in these important efforts.
Indeed, we have always prided ourselves on being on the frontlines of all major social justice and human rights issues of the day. Whether fighting for marriage equality; protecting those impacted most directly by the Travel Ban; fighting to reunite families separated at the southern border; standing up for the Dreamers and ultimately saving the DACA program; tackling police reform and criminal justice reform; defending the rights of peaceful protestors demanding racial justice in the wake of the murder of George Floyd; or advocating for victims of anti-Asian hate, we have actively taken a leadership role in righting such inequities. And this has never been more true than over the past year – Gibson Dunn has repeatedly reaffirmed our commitment to fighting hatred, injustice and inequity in our communities – particularly when these acts of hatred are rooted in discrimination against race, religion, color, sexual orientation, or national origin. We continue to stand with our colleagues and will fight prejudice and bigotry as we continue to advocate for tolerance, inclusion and understanding.
Gibson Dunn is committed to doing our part to combat anti-Semitism and hate in all of its forms. We encourage you to read this OpEd published in The American Lawyer from law firm leaders that we are proud to co-sign.
Mass arbitration is a recent phenomenon in which thousands of plaintiffs—often consumers, employees, or independent contractors—bring arbitration demands against a company at the same time. Many mass arbitrations are the product of sophisticated advertising campaigns in which a plaintiffs’ firm uses social media to generate a list of thousands of individual “clients.” Other mass arbitrations arise after a court has enforced a class-action waiver in an arbitration agreement—instead of filing a single arbitration on behalf of the named plaintiff only, the plaintiffs’ firm tries to replicate the failed class action by bringing thousands of arbitrations on behalf of would-be class members.
Mass arbitrations can impose significant, even crippling, costs on companies, particularly in light of the hefty filing fees that many arbitration providers charge. For example, if a company’s filing-fee obligation is $2,000 per arbitration, a mass arbitration of 5,000 individuals could result in the arbitration provider invoicing the company for $10 million in nonrefundable filing fees. Equally large invoices—for case management fees and arbitrators’ fees—can quickly follow.
Because mass-arbitration plaintiffs are often recruited on social media, with little-to-no vetting, a mass arbitration might include hundreds of plaintiffs who never had any relationship or dealings with the company. Nonetheless, it is often difficult to identify and eliminate those frivolous claims before the arbitrations commence, and many arbitration providers insist on the company paying nonrefundable filing fees regardless of whether the claims have merits. A recent California law (SB 707) raises the stakes even further by requiring companies to pay arbitration fees within 30 days, and failure to do so can lead to default judgments and liability for the plaintiffs’ attorneys’ fees.
Many companies, however, have deployed successful strategies for deterring and defending against mass arbitrations, primarily through the careful drafting of their arbitration agreements. Below, we identify a few of the strategies that have been deployed. This list is not exhaustive, not all strategies are right for each company, and mass arbitration tactics are evolving and changing rapidly.
- Informal dispute resolution clauses. Companies can often reduce mass-arbitration costs by requiring the parties to engage in a mediation or informal dispute resolution conference before either side serves an arbitration demand. Those conferences can often result in the settlement or dismissal of many claims, and also deter the filing of frivolous claims, saving the company costly arbitration filing fees.
- Require individualized arbitration demands. Plaintiffs’ firms often try to initiate mass arbitrations by sending the company a single arbitration demand and appending a list of their purported clients. This tactic often fails to give companies sufficient information about the claimants bringing the arbitration demands, and also increases companies’ nonrefundable filing fees. To deter this tactic, some companies have required claimants to serve individualized arbitration demands, each of which must clearly identify the claimant, their legal claims, the requested relief, and an express authorization by the claimant to bring the arbitration demand.
- Cost-splitting provisions. Courts generally permit companies to require consumers, employees or independent contractors to bear some of the costs of arbitration, including the amount it would cost a claimant to file a lawsuit in a local court. Requiring claimants to pay for some arbitration fees can reduce the cost of a mass arbitration and deter the filing of frivolous claims.
- Fee-shifting for frivolous claims. Companies may also consider inserting clauses in their arbitration agreements that allow the arbitrator to award fees and costs to the prevailing party if the arbitrator finds that the losing party filed a frivolous claim. This can be another useful tool for deterring frivolous mass arbitrations and, at a minimum, it incentivizes plaintiffs’ counsel to vet claimants before bringing claims on their behalf.
- Offers of judgment. In many jurisdictions, an offer of judgment shifts costs to the plaintiff if they recover less money at trial than the settlement offer. A company may be able to reduce its costs and exposure by making offers of judgment at the outset of a mass arbitration. While most jurisdictions automatically enforce offers of judgment in arbitration, companies may consider including provisions in their arbitration agreements that expressly permit offers of judgment, with cost-shifting.
- Selecting the arbitration provider. Arbitration providers charge filing fees and other fees that vary widely. Some arbitration providers have dedicated fee schedules and other protocols for mass arbitrations. Companies should research and compare providers’ fee schedules and mass-arbitration protocols before selecting a provider for their arbitration agreement. It is also advisable to include a provision in the arbitration agreement that allows either side to negotiate lower fees with the provider—without such a provision, the provider may be unwilling to enter into such negotiations.
- Reserve the right to settle claims on a class-wide basis. A company facing a mass arbitration may wish to obtain global peace by entering into a class settlement that extinguishes all claims. No clause in an arbitration agreement should be necessary to allow a company to settle a class action. Indeed, for years, companies have settled class actions despite having arbitration agreements with class-action waivers. However, some plaintiffs’ lawyers have argued that class-action waivers preclude companies from settling a class action. Therefore, in an abundance of caution, companies might consider adding a clause to their arbitration agreements that allows any party to settle claims on a class-wide basis.
- Establish a protocol for adjudicating a mass arbitration. Some companies have inserted specific protocols in their arbitration agreements to help reduce the cost of a potential mass arbitration. For example, some arbitration agreements state that, in the event more than 100 similar arbitrations are filed at the same time, they will be “batched” into groups of 100, with each batch assigned to a single arbitrator and triggering a single filing fee. In this particular example, the batching protocol could potentially cut the company’s arbitration costs by up to 99%. However, having arbitrators assigned to multiple arbitrations could create additional risk for the company. In addition to batching, there are other mass-arbitration protocols that offer different risk/cost profiles.
Conclusion
Mass arbitrations can create significant cost and risk for a company. Being proactive and drafting an arbitration agreement with an eye toward mass arbitration can help reduce that cost and risk.
We will continue to monitor closely and develop new strategies and approaches to mass arbitration. If you have any questions or would like additional information about these or other developments, please reach out to any of your contacts at Gibson Dunn, any member of the firm’s Class Actions practice group, or the author of this alert:
Michael Holecek – Los Angeles (+1 213-220-6285, mholecek@gibsondunn.com)
The following Gibson Dunn attorneys also are available to assist in addressing any questions you may have regarding this alert:
Christopher Chorba – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com)
Theane Evangelis – Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com)
Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com)
Dhananjay S. Manthripragada – Los Angeles (+1 213-229-7366, dmanthripragada@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 May 2021, Gibson Dunn attorneys won a landmark case before the General Court of the European Union (case T-561/18, ITD and Danske Fragtmænd v European Commission).
Gibson Dunn represented ITD (a Danish trade association of international companies operating parcel and logistics services) and Danske Fragtmænd (a company operating in this sector in Denmark) in a case concerning state subsidies in the Danish post and courier market. The EU General Court partially annulled a European Commission decision of 28 May 2018 authorising certain aid measures granted by the Danish and Swedish States to Post Danmark, the Danish postal incumbent and former monopolist owned by PostNord AB, a holding company in turn owned by the Danish and Swedish States. In its decision the Commission had rejected claims that a capital injection from Post Danmark’s parent company and a tax exemption in favour of Post Danmark involved unlawful State aid, but the General Court overturned this decision.
With the rapid decline in letter volumes across the EU, ex monopolists in the postal sector have been struggling to remain viable and have become more actively engaged in the booming parcel freight transport market based on e-commerce transactions. The problem is that ex monopolists still receive funding from their owners, i.e., the State, and while that funding may lawfully be granted for providing a universal letter service in remote areas, it is not justified to use it to gain a competitive advantage in markets such as parcel transport. The EU courts have therefore intensified its scrutiny of Member States which transfer funding to their State owned ex monopolists in various sectors, including in the postal sector. While Member States are allowed to invest in their own companies, capital contributions to loss making entities with no prospect of a reasonable return constitute prohibited State aid. Similarly tax exemptions granted selectively to State owned companies are illegal.
Post Danmark, the ex monopolist for letter services in Denmark, has experienced a 80% decline in letter volumes and has been unable to generate a profit even in the parcel transport market. The company has been incurring catastrophic losses for a decade (or more).
On 5 May 2021, the General Court of the European Union annulled the Commission’s finding that a capital injection to Post Danmark of EUR 135 million in 2017 did not involve State aid as well as a finding that a VAT exemption (with an annual value of approx. EUR 37 million) benefitting Post Danmark for at least 10 years did not constitute State aid. The Danish State and PostNord AB (the Danish-Swedish owned parent company of Post Danmark) intervened in the case to support the European Commission while two freight transport companies, Jørgen Jensen Distribution and Dansk Distribution, intervened in support of ITD and Danske Fragtmænd.
This judgment is the latest in a series by EU Courts setting out requirements regarding Member States’ capital injections in loss making State owned companies in the EU. Specifically, the General Court makes clear that State aid granted in the form of capital injections must be capable of producing a reasonable rate of return in order to avoid being classified as prohibited State aid.
Indeed, while the European Commission had concluded that the capital injection of EUR 135 million granted to loss making Post Danmark would make it possible to restore Post Danmark’s viability, the General Court found that the Commission had no basis for coming to this conclusion. There was no evidence that the company could be brought back to profitability nor that it would have prospects of generating a reasonable return. In the same vein, while the Commission had accepted their arguments that Denmark and Sweden were not involved in the capital injection (as it had been contributed by the parent company to Post Danmark) and were merely ‘passive spectators’ to this payment, the General Court held that the Commission cannot just rely on States’ own arguments whilst ignoring conflicting information submitted by the complainants. Instead the Commission must diligently investigate the matter especially in view of the Commission’s obligation to conduct an impartial examination of the complaint.
The judgment also finds that the VAT exemption (with an annual value of approx. EUR 37 million) benefiting Post Danmark, which allowed e-commerce companies not to charge their customers VAT if they used Post Danmark as their freight company, also benefits Post Danmark and thus involves illegal State aid. The General Court specifically pointed out that this VAT exemption is not covered by the existing permissible VAT exemption covering the provision of Universal Service Obligations based on the VAT Directive 2006/112/EC of 28 November 2006.
As a result of the judgment, the Commission must now reopen the case and will probably be forced to consider that the capital injection of EUR 135 million and the VAT exemption involve incompatible, and therefore unlawful, State aid that must be recovered from Post Danmark. In view of its catastrophic financial situation, this may mean that Post Danmark will unable to survive, at least in its current form.
The following Gibson Dunn lawyers assisted in preparing this client update: Lena Sandberg, Yannis Ioannidis and Pilar Pérez-D’Ocon.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the firm’s Antitrust and Competition practice group:
Antitrust and Competition Group:
Brussels
Attila Borsos (+32 2 554 72 11, aborsos@gibsondunn.com)
Christian Riis-Madsen (+32 2 554 72 05, criis@gibsondunn.com)
Lena Sandberg (+32 2 554 72 60, lsandberg@gibsondunn.com)
David Wood (+32 2 554 7210, dwood@gibsondunn.com)
Alejandro Guerrero (+32 2 554 7218, aguerrero@gibsondunn.com)
London
Ali Nikpay (+44 20 7071 4273, anikpay@gibsondunn.com)
Deirdre Taylor (+44 20 7071 4274, dtaylor2@gibsondunn.com)
Philip Rocher (+44 20 7071 4202, procher@gibsondunn.com)
Patrick Doris (+44 20 7071 4276, pdoris@gibsondunn.com)
Charles Falconer (+44 20 7071 4270, cfalconer@gibsondunn.com)
Frankfurt
Georg Weidenbach (+49 69 247 411 550, gweidenbach@gibsondunn.com)
Munich
Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com)
Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com)
Hong Kong
Kelly Austin (+852 2214 3788, kaustin@gibsondunn.com)
Sébastien Evrard (+852 2214 3798, sevrard@gibsondunn.com)
Washington, D.C.
Adam Di Vincenzo (+1 202-887-3704, adivincenzo@gibsondunn.com)
Scott D. Hammond (+1 202-887-3684, shammond@gibsondunn.com)
Joseph Kattan (+1 202-955-8239, jkattan@gibsondunn.com)
Kristen C. Limarzi (+1 202-887-3518, klimarzi@gibsondunn.com)
Joshua Lipton (+1 202-955-8226, jlipton@gibsondunn.com)
Richard G. Parker (+1 202-955-8503, rparker@gibsondunn.com)
Michael J. Perry (+1 202-887-3558, mjperry@gibsondunn.com)
Cynthia Richman (+1 202-955-8234, crichman@gibsondunn.com)
Jeremy Robison (+1 202-955-8518, wrobison@gibsondunn.com)
Stephen Weissman (+1 202-955-8678, sweissman@gibsondunn.com)
Andrew Cline (+1 202-887-3698, acline@gibsondunn.com)
Chris Wilson (+1 202-955-8520, cwilson@gibsondunn.com)
New York
Eric J. Stock (+1 212-351-2301, estock@gibsondunn.com)
Lawrence J. Zweifach (+1 212-351-2625, lzweifach@gibsondunn.com)
Los Angeles
Daniel G. Swanson (+1 213-229-7430, dswanson@gibsondunn.com)
Christopher D. Dusseault (+1 213-229-7855, cdusseault@gibsondunn.com)
Samuel G. Liversidge (+1 213-229-7420, sliversidge@gibsondunn.com)
Jay P. Srinivasan (+1 213-229-7296, jsrinivasan@gibsondunn.com)
Rod J. Stone (+1 213-229-7256, rstone@gibsondunn.com)
San Francisco
Rachel S. Brass (+1 415-393-8293, rbrass@gibsondunn.com)
Caeli A. Higney (+1 415-393-8248, chigney@gibsondunn.com)
Dallas
Veronica S. Lewis (+1 214-698-3320, vlewis@gibsondunn.com)
Mike Raiff (+1 214-698-3350, mraiff@gibsondunn.com)
Brian Robison (+1 214-698-3370, brobison@gibsondunn.com)
Robert C. Walters (+1 214-698-3114, rwalters@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 May 18, 2021, the New York Privacy Act (“NYPA”) passed out of the New York Senate Consumer Protection Committee.[1] Senator Kevin Thomas previously introduced a version of this bill in the 2019-2020 legislative session, but this is the first time that the bill—or any comprehensive privacy bill in New York—has made it out of committee. In addition to needing the approval of the majority of the full senate, the bill must progress in the New York Assembly before it is enacted. If the NYPA is enacted, it would be the third comprehensive state privacy law in the United States following the California Consumer Privacy Act (as amended by the California Privacy Rights Act) (“CCPA”) and the Virginia Consumer Data Protection Act (“VCDPA”), the latter of which was signed into law earlier this year and goes into effect in January 2023. While the New York Privacy Act shares similarities with its counterparts in California and Virginia, such as prohibiting discrimination against consumers that exercise their rights under the laws, the NYPA is substantially broader.[2] If the NYPA is signed into law, many companies doing business in New York will need to assess their compliance and may need to modify their compliance efforts and collection and use of consumer personal information.
The NYPA’s broad jurisdictional mandate applies to any entity that “conduct[s] business in New York or produce[s] products or services that are targeted to residents of New York,” and that (1) has annual gross revenue of $25 million or more, (2) controls or processes the personal data of at least 100,000 New York consumers, (3) controls or processes the personal data of at least 500,000 individuals nationwide and 10,000 New York consumers, or (4) derives over 50% of gross revenue from the sale of personal data and controls or processes the personal data of at least 25,000 New York consumers.[3] Just like the CCPA and VCDPA do not define “doing” or “conduct[ing]” business in California or Virginia, the NYPA does not define “conduct[ing] business in New York.” It seems likely that the NYPA will apply to for-profit and business-to-business companies that interact with New York residents, or process personal data of New York residents on a relatively large scale. Like the CCPA, the NYPA would exempt a list of enumerated data types, including data already subject to certain laws and regulations, like the Gramm-Leach-Bliley Act (“GLBA”).[4]
The cornerstone of the NYPA is the creation of an expansive consumer “bill of rights,” which contains similar rights as enacted in California and Virginia, but also goes further to give unprecedented rights to consumers. Similar to the California and Virginia laws, consumer rights under the NYPA include the right to know the categories of personal data collected, and purposes of such categories; the right to access, correct, and delete their personal information; the right to data portability; and anti-discrimination rights.[5] Unlike the California and Virginia laws, which provide consumers with the right to opt out of certain data selling, sharing, and/or processing, under the NYPA data controllers must obtain opt-in consent before processing personal data or “mak[ing] any changes in the processing or processing purpose,” such as using “less protective” methods of collection.[6]
The NYPA would also go further in codifying the concept of a “data fiduciary.” This concept would prevent controllers from using consumers’ personal information in a way that would harm them—that is, in a manner against a consumer’s physical, financial, psychological, or reputational interests. As a data fiduciary, a controller would be required pursuant the NYPA’s duty of loyalty to notify consumers about data processing foreseeably adverse to their interests and prohibit controllers from engaging in “unfair, deceptive, or abusive…practices with respect to obtaining consumer consent.”[7] Complying with the NYPA’s duty of care would require implementing certain practices, such as annual risk assessments and reasonable safeguards to protect personal data.[8] The bill’s consumer focus also extends to authorizing a broad private right of action for violations of any of these consumer rights—unlike the California laws, which provide for a narrow private right of action, and the Virginia law, which provides for no private right of action at all.[9] The Attorney General also has authority to enforce the law. Finally, the Virginia and California laws provide the opportunity to cure violations before enforcement, which is not explicitly provided for in the NYPA.[10]
The NYPA would create an even broader comprehensive privacy regime than its counterparts in Virginia and California. If the NYPA is enacted, it would mandate yet another privacy regime in the United States and pose additional challenges as businesses attempt to navigate this already complex environment. Gibson Dunn is tracking this bill through the end of the legislative session, and will continue to monitor developments in New York and nationwide.
______________________
[2] Compare id. § 1103(1)(C) with Cal. Civ. Code § 1798.125 (as amended by California Consumer Privacy Rights and Enforcement Act on November 3, 2020) and Virginia Consumer Data Protection Act, S.B. 1392 § 59.1-574(A)(4).
[3] Senate Bill No. 6701 § 1101.
[9] Compare id. § 1106 with Cal. Civ. Code § 1798.150 and S.B. 1392 § 59.1-579(C).
[10] See, e.g., Cal. Civ. Code § 1798.199.45; S.B. 1392 § 59.1-579(B).
This alert was prepared by Alexander H. Southwell, Mylan L. Denerstein, Amanda M. Aycock, Jennifer Katz and Lisa V. Zivkovic.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Privacy, Cybersecurity and Data Innovation practice group, or the following authors:
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, asouthwell@gibsondunn.com)
Mylan L. Denerstein – Co-Chair, Public Policy Practice (+1 212-351-3850, denerstein@gibsondunn.com)
Privacy, Cybersecurity and Data Innovation Group:
United States
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, asouthwell@gibsondunn.com)
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, aberinger@gibsondunn.com)
Debra Wong Yang – Los Angeles (+1 213-229-7472, dwongyang@gibsondunn.com)
Matthew Benjamin – New York (+1 212-351-4079, mbenjamin@gibsondunn.com)
Ryan T. Bergsieker – Denver (+1 303-298-5774, rbergsieker@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Robert K. Hur – Washington, D.C. (+1 202-887-3674, rhur@gibsondunn.com)
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, jjessen@gibsondunn.com)
Kristin A. Linsley – San Francisco (+1 415-393-8395, klinsley@gibsondunn.com)
H. Mark Lyon – Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com)
Karl G. Nelson – Dallas (+1 214-698-3203, knelson@gibsondunn.com)
Ashley Rogers – Dallas (+1 214-698-3316, arogers@gibsondunn.com)
Deborah L. Stein – Los Angeles (+1 213-229-7164, dstein@gibsondunn.com)
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com)
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com)
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, mwong@gibsondunn.com)
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, cgaedt-sheckter@gibsondunn.com)
Europe
Ahmed Baladi – Co-Chair, PCDI Practice, Paris (+33 (0)1 56 43 13 00, abaladi@gibsondunn.com)
James A. Cox – London (+44 (0) 20 7071 4250, jacox@gibsondunn.com)
Patrick Doris – London (+44 (0) 20 7071 4276, pdoris@gibsondunn.com)
Kai Gesing – Munich (+49 89 189 33-180, kgesing@gibsondunn.com)
Bernard Grinspan – Paris (+33 (0)1 56 43 13 00, bgrinspan@gibsondunn.com)
Penny Madden – London (+44 (0) 20 7071 4226, pmadden@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com)
Alejandro Guerrero – Brussels (+32 2 554 7218, aguerrero@gibsondunn.com)
Vera Lukic – Paris (+33 (0)1 56 43 13 00, vlukic@gibsondunn.com)
Sarah Wazen – London (+44 (0) 20 7071 4203, swazen@gibsondunn.com)
Asia
Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com)
Connell O’Neill – Hong Kong (+852 2214 3812, coneill@gibsondunn.com)
Jai S. Pathak – Singapore (+65 6507 3683, jpathak@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.
I. Introduction
Following two major cybersecurity events, President Biden issued a sweeping Executive Order on May 12, 2021,[1] reinforcing his commitment that fighting cyberattacks is “a top priority and essential to national and economic security.” The executive action is the latest of the Administration’s efforts on “prevention, detection, assessment, and remediation of cyber incidents,” coming on the heels of the Colonial Pipeline ransomware attack, and just a few months after the SolarWinds breach.
In brief, reports in December 2020 revealed that hackers accessed the systems of SolarWinds, an IT management software company, and implemented malicious code that enabled the hackers to install malware that was used to spy on SolarWinds and its customers, including several U.S. government agencies and many Fortune 500 companies. And in early May 2021, Colonial Pipeline, an oil pipeline system, was targeted by a criminal cybergroup encrypting its system and demanding a ransom. Although aimed at business technology, the attack caused Colonial Pipeline to shut down operations on a major pipeline serving the Northeast, leading to gas shortages and panic buying.
These two high-profile incidents illustrate the reality that cyberattacks are a growing threat facing both the public and private sectors. The scope and incidence of these attacks has grown steadily year over year, with experts from Cybersecurity Ventures estimating that cybercrime will cost $6 trillion globally in 2021 and continue to grow by 15% annually over the next five years.[2] Cyberattacks can have wide-ranging implications, including theft of sensitive personal data, breach of state and trade secrets, and network and power disruptions, so investment in cybersecurity infrastructure is critical.
In light of these threats, the Order is the latest step in the Biden Administration’s commitment to “disrupt and deter our adversaries from undertaking significant cyberattacks.” President Biden’s appointments have signaled his seriousness in this regard — he has appointed a number of experienced cybersecurity professionals to significant roles, including for the newly-created role of National Cyber Director and a Deputy National Security Advisor for Cyber and Emerging Technology (a role that elevated the subject within the Administration). While the Administration has indicated intentions to push for more comprehensive cybersecurity legislation, in the interim, the Order will have a significant impact on the way that federal government agencies and government contractors approach cybersecurity. The Administration intends the Order to also “encourage private sector companies to follow the Federal Government’s lead,” a strategy that had prior success with the widespread adoption of the National Institute of Standards and Technology’s 2014 voluntary cybersecurity framework.
II. Key Provisions of the Executive Order
The Order aims to improve the nation’s cybersecurity and protect federal government networks against sophisticated, malicious cyber activity from both nation-state actors and cyber criminals. As many high-profile cyber incidents have shared risk factors and other commonalities, such as similar cybersecurity vulnerabilities and a lack of robust defenses, the Order focuses on measures likely to have an immediate and wide-ranging impact on critical infrastructure systems, such as strengthening federal network protections, promoting information-sharing between the U.S. government and private sector, and enhancing the ability to respond to incidents. While many federal agencies and contractors already maintain and abide by existing agency-specific cybersecurity measures, the Order establishes additional mechanisms and standards to ensure that all information systems used or operated by federal agencies or contractors “meet or exceed” the cybersecurity standards and requirements set forth in the Order.
The Order aims to spur substantial participation and investment from a diverse array of relevant stakeholders in both the public and private sectors. Although the Order’s requirements apply only to federal agencies and contractors, the Order acknowledges the private sector’s integral role in providing and maintaining domestic critical infrastructure. To this end, the Order expressly encourages the private sector — including entities that are not government contractors — to adopt comparable and ambitious measures to minimize future cyber incidents.
The Order contains eight key components and provisions for modernizing the federal government’s defenses and responses to cyberattacks, which are summarized below.
Sec. 2. Removing Barriers to Sharing Threat Information.
The Order calls for the review and update of Federal Acquisition Regulation (“FAR”) and Defense Federal Acquisition Regulation Supplement (“DFARS”) requirements to ensure that federal contractors collect, preserve, and share information related to cyber threats and incidents. The anticipated revisions to the FAR and DFARS provisions would also require service providers to collaborate with federal agencies in investigating and responding to incidents or potential incidents. The Order establishes a federal government policy that information and communications technology service providers must promptly report the discovery of cyber incidents to the appropriate federal agencies, and contemplates revisions to the FAR identifying the types of cyber incidents that will trigger such reporting, the types of information to be reported, the time periods within which to report cyber incidents based on a graduated scale of severity, and the types of contractors and service providers to be covered by the proposed language. The Order also contemplates the standardization of agency-specific cybersecurity requirements through the anticipated FAR updates. Furthermore, the Biden Administration has conveyed its expectation that these revised contract terms will spur adoption of the practices by the private sector more broadly.
Sec. 3. Modernizing Federal Government Cybersecurity.
Recognizing that the cyber threat environment is “dynamic and increasingly sophisticated,” the Order identifies necessary steps for modernizing its approach to cybersecurity and ensuring effective defenses, including: (1) adopting security best practices; (2) advancing toward Zero Trust Architecture; (3) accelerating movement to secure cloud services, including Software as a Service (“SaaS”), Infrastructure as a Service (“IaaS”), and Platform as a Service (“PaaS”); (4) centralizing and streamlining access to cybersecurity data to drive analytics for identifying and managing cybersecurity risks; and (5) investing in both technology and personnel to match these modernization goals.
Tools such as multi-factor authentication and encryption for data at rest and in transit, as well as endpoint detection response, logging, and operating in a zero-trust environment, will be rolled out across federal government networks on a tight timeline. The Order also requires the development of cloud-security technical reference architecture documentation that illustrates recommended approaches to cloud migration and data protection, as well as the development and issuance of a cloud-service governance framework. Notably, the Order also requires modernization of the existing FedRAMP program, a government-wide program that delivers a standard approach to the security assessment, authorization, and continuous monitoring of cloud products and services.
Sec. 4. Enhancing Software Supply Chain Security.
The Order also seeks to improve the security of commercial software used by the federal government in three ways. First, the Order calls for the creation of baseline guidelines and standards for the security of software used by the federal government based on industry best practices established by the National Institute of Standards and Technology (“NIST”) with input from “the Federal Government, private sector, academia, and other appropriate actors.” Second, the Order seeks to jumpstart the market for secure software by leveraging federal buying power. The Order requires the FAR Council to consider recommendations for contract language requiring software suppliers to comply with, and attest to complying with, the new software standards. Agencies will then be directed to remove and remediate software products that do not meet the amended FAR requirements. Third, the Order directs NIST to develop a cybersecurity “pilot program” labeling initiative to give consumers visibility into the security of the software.
Sec. 5. Establishing a Cyber Safety Review Board.
The Order establishes a Cyber Safety Review Board composed of both federal officials and representatives from private-sector entities to review and assess threat activity, vulnerabilities, mitigation activities, and agency responses related to “significant” cyber incidents. The Board, which is modeled after the National Transportation Safety Board’s investigations of civil transportation incidents, would convene following significant cyber incidents and provide recommendations for improving cybersecurity and incident response practices.
Sec. 6. Standardizing the Federal Government’s Playbook for Responding to Cybersecurity Vulnerabilities and Incidents.
As current cybersecurity vulnerability and incident response procedures vary across agencies, the Order calls for standardized response processes to “ensure a more coordinated and centralized cataloging of incidents and tracking of agencies’ progress toward successful responses.” The Order mandates that federal agencies work together in the development of a “standard set of operational procedures (playbook)” that incorporates NIST standards, as well as articulates all phases of an incident response while also building in flexibility. The Administration intends for this playbook to “also provide the private sector with a template for its response efforts.”
Sec. 7. Improving Detection of Cybersecurity Vulnerabilities and Incidents on Federal Government Networks.
Endpoint detection and response is an emerging technology intended to address the need for continuous monitoring and response to advanced threats. The Order calls for an Endpoint Detection and Response (EDR) initiative to “support proactive detection of cybersecurity incidents within Federal Government infrastructure, active cyber hunting, containment and remediation, and incident response.” Federal adoption of EDR has lagged behind the private sector, which has already begun incorporating it as central component of cybersecurity programs within industry.
Sec. 8. Improving the Federal Government’s Investigative and Remediation Capabilities.
The Order requires “agencies to establish requirements for logging, log retention, and log management, which shall ensure centralized access and visibility for the highest level security operations center of each agency,” and requires that the FAR Council consider the recommendations for these policies in promulgating the revisions to the FAR described in Section 2 of the Order. Therefore, companies should anticipate changes to contractual requirements to establish logging policies.
Sec. 9. National Security Systems.
The Order calls for “National Security Systems requirements that are equivalent to or exceed the cybersecurity requirements set forth in this order that are otherwise not applicable to National Security Systems,” which will be reflected in a National Security Memorandum (“NSM”). Generally speaking, a “national security system” is an information system used or operated by an agency or contractor that involves intelligence activities, cryptologic activities, command and control of military forces, equipment integral to a weapon or weapons system, or that is critical to the fulfilment of military or intelligence missions.
III. Analysis and Takeaways
Among the many takeaways from the Order, the most noteworthy is the expected and intended impact beyond federal agencies and contractors, given the express goal of influencing the broader private sector’s cybersecurity best practices. The Order’s ultimate impact will largely be shaped by the regulations issued in the coming months to comply with these new requirements.
- The Order contemplates an aggressive timeline for these reforms, with deadlines ranging between 45 and 120 days for agencies to begin implementing many of the Order’s key requirements.
- Many of these requirements have already been established as common or best practices in the private sector, but widespread adoption by federal agencies may encourage additional private sector businesses to conform to these standards.
- With the forthcoming guidelines, private companies — regardless of whether they intend to pursue federal contracts — may see a new “best practice” to which its own standards will be compared and evaluated. As a result, the requirements promulgated in response to the Order could impact what amounts to “reasonableness” and the duty of care for civil liability.
- The Order’s recognition of the need for collaboration and cooperation between the federal government and the private sector creates an opportunity for input from private sector stakeholders. Industry should monitor forthcoming rulemakings to implement the Order and consider opportunities to comment.
The legal issues and obligations related to Executive Order 14028, entitled “Improving the Nation’s Cybersecurity,” are likely to shift as federal agencies implement its provisions. We will continue to monitor and advise on developments to stay on the forefront of this rapidly-changing area. We are available to guide companies through these and related issues. Please do not hesitate to contact us with any questions.
____________________
[1] See Exec. Order No. 14,028, 86 Fed. Reg. 26,633 (May 12, 2021).
[2] Steve Morgan, Cybercrime To Cost The World $10.5 Trillion Annually By 2025, Cybercrime Magazine (Nov. 13, 2020), https://cybersecurityventures.com/cybercrime-damage-costs-10-trillion-by-2025/.
This alert was prepared by Alexander H. Southwell, Eric D. Vandevelde, Ryan T. Bergsieker, Lindsay M. Paulin, Jennifer Katz and Terry Y. Wong.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Privacy, Cybersecurity and Data Innovation or Government Contracts practice groups, or the following authors:
Alexander H. Southwell – New York (+1 212-351-3981, asouthwell@gibsondunn.com)
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com)
Ryan T. Bergsieker – Denver (+1 303-298-5774, rbergsieker@gibsondunn.com)
Lindsay M. Paulin – Washington, D.C. (+1 202-887-3701, lpaulin@gibsondunn.com)
Jennifer Katz – New York (+1 212-351-4066, jkatz@gibsondunn.com)
Privacy, Cybersecurity and Data Innovation Group:
United States
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, asouthwell@gibsondunn.com)
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, aberinger@gibsondunn.com)
Debra Wong Yang – Los Angeles (+1 213-229-7472, dwongyang@gibsondunn.com)
Matthew Benjamin – New York (+1 212-351-4079, mbenjamin@gibsondunn.com)
Ryan T. Bergsieker – Denver (+1 303-298-5774, rbergsieker@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Robert K. Hur – Washington, D.C. (+1 202-887-3674, rhur@gibsondunn.com)
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, jjessen@gibsondunn.com)
Kristin A. Linsley – San Francisco (+1 415-393-8395, klinsley@gibsondunn.com)
H. Mark Lyon – Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com)
Karl G. Nelson – Dallas (+1 214-698-3203, knelson@gibsondunn.com)
Ashley Rogers – Dallas (+1 214-698-3316, arogers@gibsondunn.com)
Deborah L. Stein – Los Angeles (+1 213-229-7164, dstein@gibsondunn.com)
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com)
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com)
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, mwong@gibsondunn.com)
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, cgaedt-sheckter@gibsondunn.com)
Europe
Ahmed Baladi – Co-Chair, PCDI Practice, Paris (+33 (0)1 56 43 13 00, abaladi@gibsondunn.com)
James A. Cox – London (+44 (0) 20 7071 4250, jacox@gibsondunn.com)
Patrick Doris – London (+44 (0) 20 7071 4276, pdoris@gibsondunn.com)
Kai Gesing – Munich (+49 89 189 33-180, kgesing@gibsondunn.com)
Bernard Grinspan – Paris (+33 (0)1 56 43 13 00, bgrinspan@gibsondunn.com)
Penny Madden – London (+44 (0) 20 7071 4226, pmadden@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com)
Alejandro Guerrero – Brussels (+32 2 554 7218, aguerrero@gibsondunn.com)
Vera Lukic – Paris (+33 (0)1 56 43 13 00, vlukic@gibsondunn.com)
Sarah Wazen – London (+44 (0) 20 7071 4203, swazen@gibsondunn.com)
Asia
Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com)
Connell O’Neill – Hong Kong (+852 2214 3812, coneill@gibsondunn.com)
Jai S. Pathak – Singapore (+65 6507 3683, jpathak@gibsondunn.com)
Government Contracts Group:
Dhananjay S. Manthripragada – Los Angeles (+1 213-229-7366, dmanthripragada@gibsondunn.com)
John W.F. Chesley – Washington, D.C. (+1 202-887-3788, jchesley@gibsondunn.com)
Joseph D. West – Washington, D.C. (+1 202-955-8658, jwest@gibsondunn.com)
Lindsay M. Paulin – Washington, D.C. (+1 202-887-3701, lpaulin@gibsondunn.com)
Justin Paul Accomando – Washington, D.C. (+1 202-887-3796, jaccomando@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 April 28, 2021, the U.S. Senate approved a resolution to repeal EPA’s 2020 policy amendments to regulations of upstream and midstream oil and gas operations. Under the 2020 policy amendments, the Trump Administration had declined to regulate oil and gas transmission and storage operations or set methane emission limits under Section 111 of the Clean Air Act’s (“CAA”) New Source Performance Standards (“NSPS”). If the U.S. House of Representatives approves the resolution and it is signed by the President, then the 2020 policy amendments would no longer be in effect, thus restoring key aspects of an earlier rule from the Obama Administration regulating methane from production and processing facilities at upstream oil and gas facilities as well as transmission and storage operations.
Key Takeaways:
- The recent Senate resolution targets the last Administration’s rulemaking declining to regulate methane emissions from production and processing operations at oil and gas facilities. The soon-to-be repealed rule also declined to regulate associated transmission and storage operations.
- Once the House of Representatives passes the same resolution and it is signed into law by President Biden, EPA will be able to quickly commence regulation of methane emissions for this sector as well as volatile organic compounds (“VOC”) and methane emissions for transmission and storage operations.
- Impacted sources in the sector should begin evaluating compliance with the 2016 Obama Administration rules governing methane from production and processing operations as well as transmission and storage operations.
- For production and processing operations, compliance with methane requirements should complement existing VOC compliance programs under NSPS Subpart OOOOa, although additional requirements could attach for operations in areas of ozone nonattainment.
- The 2020 technical amendments to the NSPS Subpart OOOOa program governing production and processing operations remain unaffected.
Detailed Analysis: Beginning in 2012 and again in 2016, the Obama administration promulgated new regulations of the oil and gas industry under the CAA’s NSPS (“2016 NSPS”). Pursuant to the 2016 NSPS, the transmission and storage segment of the oil and gas industry was included in the NSPS regulated source category.[1] This applied the NSPS standards to storage tanks, compressors, equipment leaks, and pneumatic controllers, among other sources in the transmission and storage segment.[2] The 2016 NSPS also added methane emission limits for the same segment.[3]
In 2020, EPA repealed these changes, issuing final policy amendments that removed the transmission and storage segment sources from the NSPS source category.[4] Further, EPA rescinded the separate methane emission limits for the production and processing segments of the source category while retaining limits for VOCs, and EPA also interpreted the CAA to require a “significant contribution finding” for any particular air pollutant before setting performance standards for that pollutant unless EPA addressed the pollutant when first listing or regulating the source category.[5] This latter requirement was significant, among other reasons, because the EPA did not consider methane emissions at the time it initially listed the oil and gas source category in 1979, and would thus require “significant contribution finding” for methane.[6]
In a separate rulemaking also finalized in 2020, EPA made a number of separate technical amendments to the 2016 NSPS.[7] This final rule was not cited in the resolution that passed the Senate.
This week, Congress began the process of reversing course. The Senate passed a resolution, S.J. RES. 14,[8] which disapproved of the EPA’s 2020 policy amendments. The Senate voted by a 52-42 margin, with three Republicans voting in the majority, to repeal the 2020 policy amendments pursuant to its authority under the Congressional Review Act (“CRA”). Pursuant to the CRA, certain agency rules must be reported to Congress and the Government Accountability Office.[9] After receiving the report, Congress is authorized to disapprove of the promulgated rule within 60 session days.[10] Significantly, when certain criteria are met, a joint resolution of disapproval cannot be filibustered in the Senate.[11] Moreover, disapproval carries with it longer term effects: the CRA prohibits a rule in “substantially the same form” as the disapproved rule from being subsequently promulgated (unless so authorized by a subsequent law).
Although the Senate resolution is a significant step towards repeal of the 2020 policy amendments, the 2016 NSPS are not yet back in effect. In order to repeal the 2020 rule and reinstate the 2016 NSPS (subject to the technical changes finalized in 2020 that are unaffected by the CRA resolution), the House of Representatives will also need to pass the same resolution, which it is expected to vote on in the coming weeks.[12] Disapproval renders the 2020 rule “as though such rule had never taken effect.”[13] Questions remain as to whether this repeal will reignite past litigation challenging the 2012 and 2016 NSPS rulemakings.
Affected facilities in the transmission and storage segments of the source category that will soon be subject to the NSPS should prepare for compliance. Furthermore, all facilities in the source category subject to NSPS, including in the production and processing segments, should ensure that they have adequate controls to meet the 2016 NSPS requirements for methane emissions. The practical impact of this reversion is uncertain, particularly given EPA’s findings in 2020 that separate methane limitations for these segments of the industry are redundant because controls used to reduce VOC emissions also reduce methane. Moreover, given the uncertainty created by the CRA’s language that a disapproved rule is rendered not only ineffective moving forward but also “as though such rule had never taken effect,” EPA likely will need to issue guidance to regulated entities in order to explain its expectations for compliance and the timing thereof. EPA likely also will need to promulgate a ministerial rule restoring the applicable regulatory text from the 2016 NSPS in the Code of Federal Regulations.
Litigation over the 2012 and 2016 rulemakings, currently held in abeyance, likely will resume in the wake of this resolution. In addition, EPA will once again be responsible for issuing an existing source rule for this source category. Because EPA rescinded methane limits for the source category, EPA was no longer required to issue emission guidelines to address existing sources. This will change after the CRA resolution is approved.
_____________________
[1] EPA Issues Final Policy Amendments to the 2012 and 2016 New Source Performance Standards for the Oil and Natural Gas Industry: Fact Sheet, epa.gov (Aug. 13, 2020), https://www.epa.gov/sites/production/files/2020-08/documents/og_policy_amendments.fact_sheet._final_8.13.2020_.pdf.
[2] EPA’s Policy Amendments to the New Source Performance Standards for the Oil and Gas Industry, epa.gov (Aug. 2020), here.
[3] Supra note 1. For additional analysis of the previous standard, see S. Fletcher and D. Schnitzer, “Inside EPA’s Plan for Reducing Methane Emissions,” Law360 (Aug. 20, 2015), available at https://www.gibsondunn.com/wp-content/uploads/documents/publications/Fletcher-Schnitzer-Inside-EPAs-Plan-For-Reducing-Methane-Emissions-Law360-08-20-2015.pdf; “Client Alert: EPA Announces Program Addressing Methane Emissions from Oil and Gas Production,” (Jan. 15, 2015), available at https://www.gibsondunn.com/epa-announces-program-addressing-methane-emissions-from-oil-and-gas-production/
[8] A joint resolution providing for congressional disapproval under chapter 8 of title 5, United States Code, of the rule submitted by the Environmental Protection Agency relating to “Oil and Natural Gas Sector: Emission Standards for New, Reconstructed, and Modified Sources Review”, S.J.Res.14, 117th Cong. (2021).
[12] Jeff Brady, Senate Votes To Restore Regulations On Climate-Warming Methane Emissions, NPR (Apr. 28, 2021), https://www.npr.org/2021/04/28/991635101/senate-votes-to-restore-regulations-on-climate-warming-methane-emissions.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Environmental Litigation and Mass Tort practice group, or the following authors:
Stacie B. Fletcher – Washington, D.C. (+1 202-887-3627, sfletcher@gibsondunn.com)
David Fotouhi – Washington, D.C. (+1 202-955-8502, dfotouhi@gibsondunn.com)
Mark Tomaier – Orange County, CA (+1 949-451-4034, mtomaier@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.
Join Gibson Dunn panelists Michelle Kirschner and Matthew Nunan for a discussion of:
- Recent FCA criminal prosecutions;
- Lessons for board governance from the Aviva plc Final Notice;
- Update on the Investment Firms Prudential Regime (IFPR) and remuneration;
- Crystal ball gazing
View Slides (PDF)
Michelle M Kirschner: A partner in the London office. She advises a broad range of financial institutions, including investment managers, integrated investment banks, corporate finance boutiques, private fund managers and private wealth managers at the most senior level.
Matthew Nunan: A partner in the London office. He specializes in financial services regulation and enforcement, investigations and white collar defense.
Martin Coombes: An associate in the London office and a member of the Financial Institutions group. He specialises in advising on UK and EU financial services regulation. This includes a wide range of financial services and compliance issues including advice on UK and EU regulatory developments, the regulatory aspects of corporate transactions and the on-going compliance obligations of financial services firms.
Chris Hickey: An associate in the London office and a member of the firm’s Financial Institutions group. He advises on a range of UK and EU financial services regulatory matters. This includes the regulatory elements of corporate transactions, regulatory change management and ongoing compliance requirements to which firms are subject.
CPD TRAINING/MCLE CREDIT INFORMATION:
Gibson, Dunn & Crutcher LLP is authorized by the Solicitors Regulation Authority to provide in-house CPD training. This program is approved for CPD credit in the amount of 1.0 hour. Regulated by the Solicitors Regulation Authority (Number 324652).
This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the areas of professional practice requirement.
This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact 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 hour.
California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.
On his first day in office, President Biden signed an Executive Order that directed his administration to focus on addressing climate change, and issued a mandate that certain agencies immediately review a number of agency actions from the previous administration regarding greenhouse gas (GHG) emissions.[1] In keeping with that directive, the National Highway Traffic Safety Administration (NHTSA) and the U.S. Environmental Protection Agency (EPA) have formally announced their intent to reconsider the 2019 Safer Affordable Fuel-Efficient Vehicles Rule Part One: One National Program (SAFE 1),[2] which curtailed California’s ability to establish and enforce more stringent GHG emission standards and a Zero Emission Vehicle (ZEV) sales mandate.[3] These steps are consistent with the Biden administration’s efforts to move swiftly to reexamine—and possibly to revoke—environmental regulations promulgated under the Trump administration, and could serve as a prime example of the shifting regulatory landscape for industries subject to GHG regulations.
Through SAFE 1, EPA withdrew the portions of California’s waiver under Section 209(b)(1) of the Clean Air Act (CAA) that allowed California to establish its own GHG emission standards and establish a mandate for the sale of ZEVs.[4] EPA went on to interpret the CAA as preventing other states from adopting California’s GHG standards, as well.[5] In the same action, NHTSA similarly cut back on California’s independent regulatory powers by concluding that NHTSA’s authority to regulate fuel economy under the Energy Policy and Conservation Act (EPCA) preempted all state and local regulations “related to” fuel economy.[6]
On April 22 and April 23, 2021, respectively, NHTSA and EPA formally announced that they are reconsidering this action, and will be soliciting public comment on the agencies’ separate proposed paths forward.
NHTSA
On April 22, 2021, NHTSA issued a notice of proposed rulemaking that would repeal those portions of SAFE 1 (including the regulatory text and interpretive statements in the preamble) that found California’s GHG and ZEV mandates preempted by EPCA.[7] In particular, NHTSA proposes to conclude that it lacks legislative rulemaking authority to issue a preemption regulation. The notice does not take a position on the substance of EPCA preemption. Rather, NHTSA says merely that it seeks to restore a “clean slate”—i.e., to take no formal agency position on express preemption by EPCA.[8]
The notice goes on to state, however, that even if NHTSA had legislative rulemaking authority, it would nonetheless repeal SAFE 1 because “NHTSA now has significant doubts about the validity of its preemption analysis as applied to the specific state programs discussed in SAFE 1,”[9] including federalism concerns and concerns with the “categorical” manner of the analysis taken in SAFE 1.[10]
NHTSA’s notice of proposed rulemaking includes a comment period of 30 days after publication in the Federal Register, which is expected in the coming days.
EPA
One day after NHTSA issued its notice, EPA announced its parallel action on SAFE 1. In its notice, EPA takes no new positions on the Agency’s authority to withdraw a previously granted waiver or the statutory interpretation of CAA Section 209.[11] Rather, EPA’s notice merely summarizes its past positions and tees up these issues, along with issues raised in administrative petitions, for public comment as part of a reconsideration. The notice states that the Agency now believes that there are “significant issues” with the positions taken in SAFE 1 and that “there is merit in reviewing issues that petitioners have raised” in the reconsideration petitions submitted to EPA.[12] However, the notice does not propose to take any specific alternative interpretation.
Notably, EPA has not initiated a rulemaking proceeding, but rather describes this as an informal adjudication.[13] The Agency also states that for waiver decisions, “EPA traditionally publishes a notice of opportunity for public hearing and comment and then, after the comment period has closed, publishes a notice of its decision in the Federal Register. EPA believes it is appropriate to use the same procedures for reconsidering SAFE 1.”[14]
A virtual public hearing will take place on June 2, 2021, and EPA will accept comments until July 6, 2021.[15]
Conclusion
In announcing the reconsideration of SAFE 1, EPA Administrator Michael Regan stated, “Today, we are delivering on President Biden’s clear direction to tackle the climate crisis by taking a major step forward to restore state leadership and advance EPA’s greenhouse gas pollution reduction goals.”[16] Final agency actions resulting from these reconsiderations are still months away, but EPA’s and NHTSA’s announcements signal the agencies’ continuing focus on GHG emissions and revisiting regulations issued by the previous administration. As executive branch agencies continue to carry out the directives in President Biden’s Executive Orders related to climate change, the landscape for regulated industries will remain in flux.
___________________________
[1] Exec. Order No. 13990, 86 Fed. Reg. 7037, 7041 (Jan. 25, 2021) (issued Jan. 20, 2021).
[2] 84 Fed. Reg. 51310 (Sept. 27, 2019). The SAFE 1 Rule was challenged in a series of consolidated cases before the U.S. Court of Appeals for the D.C. Circuit, where Gibson Dunn represented a coalition of automotive industry members as Intervenors in support of the rule. See Union of Concerned Scientists v. NHTSA, No. 19-1230 (D.C. Cir.). That matter has been held in abeyance at the request of the United States pending further review of the SAFE 1 rulemaking by EPA and NHTSA.
[3] Press Release, U.S. Dep’t of Transp., NHTSA, NHTSA Advances Biden-Harris Administration’s Climate & Jobs Goals (Apr. 22, 2021), here; U.S. EPA, Notice of Reconsideration of a Previous Withdrawal of a Waiver for California’s Advanced Clean Car Program (Light-Duty Vehicle Greenhouse Gas Emission Standards and Zero Emission Vehicle Requirements), here.
[4] 84 Fed. Reg. at 51328.
[5] Id. at 51350.
[6] Id. at 51313.
[7] U.S. Dep’t of Transp., NHTSA, Notice of Proposed Rulemaking (prepublication version), Corporate Average Fuel Economy (CAFE) Preemption (Apr. 22, 2021), here.
[8] Id. at 12.
[9] Id. at 13.
[10] Id. at 37.
[11] U.S. EPA, Notice of Reconsideration (prepublication version), California State Motor Vehicle Pollution Control Standards; Advanced Clean Car Program; Reconsideration of a Previous Withdrawal of a Waiver of Preemption; Opportunity for Public Hearing and Public Comment (Apr. 23, 2021), here.
[12] Id. at 7.
[13] Id. at 27.
[14] Id.
[15] Id. at 2.
[16] Press Release, U.S. EPA, EPA Reconsiders Previous Administration’s Withdrawal of California’s Waiver to Enforce Greenhouse Gas Standards for Cars and Light Trucks (Apr. 26, 2021), here.
The following Gibson Dunn lawyers assisted in preparing this client update: Ray Ludwiszewski, Stacie Fletcher, David Fotouhi, Rachel Corley, and Veronica Till Goodson.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Environmental Litigation and Mass Tort practice group, or the following practice leaders and authors in Washington, D.C.:
Stacie B. Fletcher – Co-Chair (+1 202-887-3627, sfletcher@gibsondunn.com)
David Fotouhi (+1 202-955-8502, dfotouhi@gibsondunn.com)
Raymond B. Ludwiszewski (+1 202-955-8665, rludwiszewski@gibsondunn.com)
Daniel W. Nelson – Co-Chair (+1 202-887-3687, dnelson@gibsondunn.com)
Rachel Levick Corley (+1 202-887-3574, rcorley@gibsondunn.com)
Veronica Till Goodson (+1 202-887-3719, vtillgoodson@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 April 2021 edition of Gibson Dunn’s Aerospace and Related Technologies Update discusses newsworthy developments, trends, and key decisions from 2020 and early 2021 that are of interest to companies in the aerospace, space, defense, satellite, and drone sectors as well as the financial, technological, and other institutions that support them.
This update addresses the following subjects: (1) commercial unmanned aircraft systems, or drones; (2) recent government contracts decisions involving companies in the aerospace and defense industry; and (3) the commercial space sector.
___________________
TABLE OF CONTENTS
A. New Rules Remote ID
B. Flight Over People, Over Vehicles, or at Night
C. Continued Lack of Clarity on Airspace
D. Newsworthy FAA Approvals
E. COVID-19 and Use of Drones
A. First Private Human Space Launch
B. Noteworthy Space Achievements in Countries Other than the United States
C. Other Noteworthy Space Developments
D. NASA’s Perseverance Rover, Past Updates, and Future Plans
E. Record-Setting Private investment
F. Satellite Internet Constellations
G. Expected Impact of Biden Administration
___________________
I. Unmanned Aircraft Systems
A. New Rules Remote ID
On December 28, 2020, the FAA released final rules regarding the Remote Identification of Unmanned Aircraft (“Remote ID”) and operations at night.[1] These rules, published in the Federal Register on January 15, 2021,[2] require that certain unmanned aircraft (“drones”) broadcast their identification and location during operation. The final rules reflect the FAA’s attempt to balance the competing interests in the federal airspace between commercial operators, hobbyists, law enforcement, and the general public.
The FAA received significant feedback on the Remote ID rules following its initial December 31, 2019 Notice of Proposed Rulemaking (“NPRM”), accumulating over 53,000 comments from manufacturers, organizations, state and local governments, and a significant number of individual recreational pilots.[3] In a departure from the original proposal, under the final rule, drones must broadcast the required Remote ID information “using radio frequency spectrum compatible with personal wireless devices” rather than over the internet to a third-party service provider.[4] The FAA received substantial feedback criticizing the original proposal as expensive and requiring additional hardware and a data plan from a wireless carrier, depending on internet connectivity.[5] But with drones now required to broadcast Remote ID information over ranges that can be received by cell phones, members of law enforcement and the general public will be able to receive the broadcasts and determine flight information about drones flying in their vicinity without special receiving technology.[6]
Compliance with Remote ID Rules
The rules create three ways in which operators and manufacturers can comply with the Remote ID rules: (1) a drone containing “Standard Remote ID,” (2) a drone retrofitted with a “broadcast module,” and (3) a drone without Remote ID operating recreationally in specified areas.[7] The rules include an exception for drones weighing less than 0.55 pounds (250 grams), which are not subject to the Remote ID rules if flown recreationally.[8]
Standard Remote ID
The primary form of compliance is “Standard Remote ID.”[9] Standard Remote ID is built into a drone at the time of manufacturing and tested for compliance via FAA-approved methods. It requires the most robust broadcast, including the location of both the drone and its operator, along with certain flight parameters, a unique ID assigned to the drone and registered by the operator, and an emergency status indication. Additionally, Standard Remote ID drones must be configured to prevent takeoff if the Remote ID equipment is not functional.
Remote ID Broadcast Module
The second form of compliance involves the installation on a drone of a Remote ID “broadcast module.”[10] This allows drones not manufactured with Standard Remote ID, including those currently in use, to comply with the Remote ID rules. The broadcast module’s transmission is similar to Standard Remote ID, except that it broadcasts the takeoff location rather than the location of the operator. Furthermore, drones outfitted with a broadcast module are not required to send an emergency status indication, and need not prevent the drone from taking off if the module is not functional. Unlike Standard Remote ID drones, those fitted with a Remote ID broadcast module are expressly limited to operation within visual line of sight.
Manufacturers should not rely on the Remote ID broadcast module moving forward. Starting eighteen months after the final rule becomes effective, manufacturers must meet the Remote ID standard in their production of drones. Restrictions on operation of noncompliant drones will take effect thirty months after the final rule becomes effective. As of now, the FAA has delayed implementation of the rule until April 21, 2021 as part of the Biden administration’s regulatory freeze.[11]
FAA-Recognized Identification Areas
Lastly, the new rules create FAA-Recognized Identification Areas (“FRIAs”) in which drones can be operated recreationally without complying with the Remote ID rules.[12] FRIAs are fixed locations where drones can be flown safely, thus preserving minimally regulated operations at hobbyist airfields, such as those maintained by the Academy of Model Aeronautics. In a departure from the proposed rules in the NPRM, which limited applicants to community-based organizations, the new rules expanded the list of potential FRIA applicants to include educational institutions.
Addressing Concerns Regarding Improper Use
The commercial drone industry has faced questions and concerns that drones will be operated in an unprofessional manner or used by malicious individuals to obtain data for nefarious purposes.[13] Law enforcement and government agencies have also shared concerns related to illegal operations, such as interference with manned aircraft.[14] The Remote ID rules will help address those concerns by allowing these organizations to identify the drone owner or determine if the drone is not equipped with Remote ID and not legally operating. Addressing these concerns will minimize some of the resistance the industry has faced. Further, Remote ID helps lay a foundation for an ecosystem in which tens of thousands of drones operate autonomously beyond visual line of sight on a daily basis. Although the current rules may be modified and more technology-developed, transmitting basic identification and location information will be a pillar of future large-scale autonomous operations. These rules are an important early step on the path to an integrated regime for regulating a rapidly growing body of unmanned aeronautical operations.
B. Flight Over People, Over Vehicles, or at Night
On December 28, 2020, the FAA released final rules impacting drone operations over people, over moving vehicles, or at night.[15] Prior to the new rules, Part 107 of the FAA regulations required commercial drone operators to receive a waiver in order to fly over people, over moving vehicles, or at night. In early 2019, the FAA and the Department of Transportation shared an NPRM, proposing alterations to Part 107 to make the operation of small unmanned aircraft over people or at night legal, under certain circumstances, without a waiver. On January 15, 2021, the final rule was published in the Federal Register.[16] The rule is scheduled to take effect on April 21, 2021.[17]
Drone Operations Over People
The new law permits commercial drone operations over people under certain conditions based on four categories of drones operating under Part 107. Category One, Two, and Four drones must be compliant with Remote ID rules discussed above to have sustained flight over open-air assemblies, but Category Three drones may never operate over open-air assemblies.
Category One is the most lenient category, consisting of drones that are both under 0.55 pounds (250 grams) and lack any exposed rotating parts that would cause lacerations.[18] Due to the weight restrictions, the drones in this Category will most likely initially be limited to photography and videography drones, but these restrictions may result in innovation of new lightweight sensors for expanded operations within Category One.
Categories Two and Three cover drones greater than 0.55 pounds and less than 55 pounds.[19] These categories allow drones to be flown over people only if the manufacturer has proven that a resulting injury to a person would be under a specified severity threshold. Category Two aircraft will need to demonstrate a certain injury threshold, and Category Three aircraft will have a higher injury threshold with additional operating limitations. Category Three drones can only operate over people (1) in a restricted access site in which all individuals on the ground have notice, or (2) without maintaining any sustained flight over people unless they are participating in the operations or protected by a structure.[20]
The new rules also created a fourth category that was not included under the proposed rules, but clarifies that specific drones for which the FAA has issued an airworthiness certificate under Part 21 can conduct operations over people unless prohibited under its operating limitations.[21]
Drone Operations Over Moving Vehicles
Although the proposed rule did not allow operations over moving vehicles, the final rule does allow such operations under two circumstances: (1) if in a restricted access site and the people in the vehicle are on notice, or (2) when the drone does not maintain sustained flight over moving vehicles.[22] This addition is a welcome change for all drone operators who no longer have to cancel, delay, or change an operation due to an unexpected vehicle or nearby traffic.
Drone Operations at Night
The rule also allows operations at night under two conditions: (1) the remote pilot in command must complete an updated initial knowledge test or online recurrent training, and (2) the drone must have proper anti-collision lighting that is visible for at least three statute miles.[23] Operators will be pleased with this change because it removes the need for nighttime waivers and delays associated with obtaining such waivers.
Looking Ahead
The Part 107 changes are steps in the right direction for increased commercial use of drones. Operating over people, moving vehicles, and at night expands the applications and timing of operations available to commercial operators. The additions to the proposed rules, such as permitting operations over moving vehicles, are an indication that the FAA is listening to the drone community and working to advance this industry.
C. Continued Lack of Clarity on Airspace
While new rules for Remote ID and operations over people, over moving vehicles, and at night are helpful to move the industry forward, they do not address the most challenging legal issue that remains for the commercial drone industry: control of low-altitude airspace. It remains unclear as to how much, if any, airspace is owned by private landowners and whether states and municipalities have any jurisdiction over low-altitude airspace. Furthermore, a legislative solution on this issue is increasingly improbable, and it will instead likely be decided by the courts years in the future.
In a nutshell, the confusion regarding low-altitude operations stems from the FAA’s claim that it controls the airspace “from the ground up” and that the claim that it does not control all the airspace below 400 feet is a “myth.”[24] However, many local governments and property owners do not agree with the FAA’s interpretation. While the FAA has jurisdiction over “navigable airspace,” many assert that the boundary of where that airspace ends and begins is far from clear.[25]
To date, this boundary has not been directly addressed by a court in the context of drones. The closest that federal courts have come to addressing this issue was in July 2016 when U.S. District Judge Jeffrey Meyer, of the District of Connecticut, questioned the FAA’s position: “[T]he FAA believes it has regulatory sovereignty over every cubic inch of outdoor air in the United States . . . . [T]hat ambition may be difficult to reconcile with the terms of the FAA’s statute that refer to ‘navigable airspace.’”[26] The dicta raised the question of where the FAA’s authority begins, but noted that the “case does not yet require an answer to that question.”[27] In time a case will require such an answer.
The legal uncertainty surrounding low-altitude operations remains one of the most significant barriers to large-scale commercial operations, and it is likely to be one of the most important issues for the industry for years to come.
D. Newsworthy FAA Approvals
This past year saw several groundbreaking approvals of new uses for unmanned aircraft systems, specifically in operations beyond the visual line of sight and in the agricultural context. The industry also saw progress in setting airworthiness standards.
Beyond the Visual Line-of-Sight Approvals
Perhaps the most well-known approval occurred in August 2020, when, according to public filings, the FAA approved Amazon’s use of a fleet of Prime Air delivery drones, allowing the company to expand its unmanned package delivery operations.[28] The FAA issued this authorization under Part 135 of its Unmanned Aircraft Systems regulations, which govern the use of drones beyond the visual line of sight (“BVLOS”) of the operator.[29] Although the Prime Air fleet is not yet fully scaled, this authorization enables the company to soon be able to deliver packages weighing five pounds or less in areas with relatively low population density.[30]
Further expanding the boundaries of BVLOS drone use, the FAA gave its first-ever approval of a company’s use of automated drones without a human operator on site earlier this year.[31] In January 2021, the FAA authorized American Robotics, a Boston-based drone systems developer that specializes in operating in rugged environments, to begin such automated operations.[32] Obtaining this approval required a four-year testing program in which the company ran up to ten automated drone flights per day.[33] While only beginning to be fully understood, the automated use of drones without the need for on-site human personnel could have enormous ramifications for the agricultural, energy, and infrastructure industries.[34]
Agricultural Use Approvals
The agricultural industry may experience additional aerospace innovation after the FAA approved the Iowa-based startup Rantizo’s use of drone swarms to spray crops.[35] The company received approval in July 2020 to operate three-drone swarms, which move in concert with one another with the help of one drone operator and one visual observer.[36] The approval will allow the company to cover between 40 and 60 acres of farmland per hour.[37]
Rantizo was not the only company to receive approval to operate drone swarms. In October 2020, the company DroneSeed obtained FAA approval to use five-drone swarms of heavy-lift drones beyond the visual line of sight for reforestation efforts in Arizona, California, Colorado, Montana, New Mexico, and Nevada.[38] Each of the company’s drones can carry up to a 57-pound payload, and reports suggest that the company may focus its reforestation efforts on areas ravaged by wildfires.[39]
Creation of Airworthiness Standards
Lastly, in September 2020, the FAA opened for public comment its first-ever set of type-certification airworthiness standards relating to drones, with the goal of streamlining the certification of certain classes of drones.[40] Whereas the FAA has airworthiness standards in place for most types of manned aircraft, allowing companies seeking approval of such vehicles to avoid a cumbersome, case-by-case process, no such process previously existed for drones. The creation of a standard airworthiness certificate for drones as a class of aircraft could significantly shorten the drone approval process, potentially accelerating innovation in the aerospace industry.
E. COVID-19 and Use of Drones
As discussed in last year’s update, many expected the global COVID-19 pandemic to usher in a new era of drone applications. In the early months of the pandemic, governments began using drones in novel ways: spraying disinfectant across large areas, developing disease detection mechanisms, and even enforcing social distancing requirements. Though these initial reports of drone usage in the age of COVID-19 dealt mostly with disease control efforts, corporations soon shifted their focus to the socially distant environment, turning to drones to facilitate deliveries to consumers and medical providers alike and provide services in a safer way.
Consumer Deliveries
For years, corporations have been hoping to facilitate deliveries via drone, and the pandemic amplified consumer interest. With more and more people looking to avoid crowds and stay at home, demand for drone delivery of consumer goods increased, and many companies deployed their technology to facilitate deliveries via drone.
Wing (Alphabet’s drone delivery company) launched a pilot program in October 2019, partnering with several local retailers to deliver certain products to people in Christiansburg, Virginia.[41] Since the pandemic, it has expanded its program by adding new products and new retailers, and deliveries have more than doubled.[42]
In North Dakota, Flytrex, an airborne delivery service company, launched a program allowing customers to order from a selection of 200 Walmart items.[43] The two companies recently introduced a partnership in North Dakota for grocery deliveries.[44] The company also delivers snacks to golfers at King’s Walk course in North Dakota.[45]
In addition to consumer goods, food delivery via drone has also increased since the pandemic. In fact, Flytrex has begun testing drone delivery of food and drink items in North Carolina.[46] And in Alabama, the company Deuce Drone has partnered with some restaurants for drone doorstep delivery.[47]
As discussed above, in August 2020, Amazon received FAA approval under Part 135 of FAA regulations to “safely and efficiently deliver packages to customers.”[48] This allows Amazon to transport property on small drones “beyond the visual line of sight.”[49] Amazon, which began testing drones in 2013, is continuing to test the technology and has not yet deployed drones at scale.[50]
Medical Supplies Deliveries
Drones also delivered medical supplies in 2020. In May, Zipline, a company that has been using drones to deliver blood in Rwanda since 2016, began delivering medical supplies and personal protective equipment via drones to a medical center in North Carolina.[51]
In November 2020, Wal-Mart received approval to deliver COVID-19 test kits to El Paso, Texas residents.[52] A few months later, Nevada-based Flirtey announced: “that it has successfully conducted multiple deliveries of at-home COVID-19 test kits in Northern Nevada during the initial phase of its test program.”[53] Drone delivery of COVID-19 test kits is more efficient and more convenient, and it reduces exposure risks.[54]
Remote Service Providers
Beyond deliveries, the pandemic also drove up demand for remote services as companies adapted to social distancing guidelines that made providing in-person services more difficult. Since the pandemic started, flights by construction-related companies are up 70%.[55] DroneDeploy, a startup that “has a program that analyzes drone footage of farmers’ fields and helps make recommendations about when to apply pesticides” has reported that these agriculture flights have tripled during the first several months of the pandemic.[56] The company also reported significant increases in flights using its energy app, which helps solar panel installers calculate where best to place the panels.[57]
Lasting Impact?
Though there has certainly been an expansion of drone services in the U.S., this expansion is not widespread. Many of the examples discussed above are limited to small geographic areas and it is still unclear when mass adoption will occur. While the pandemic appears to have pushed forward the adoption of drone delivery and service programs, it is unclear if that mentality will change after societies are no longer quarantined at home. Will there be as much of a demand for drone deliveries and services once there is no longer a pandemic-driven crisis?
Despite these uncertainties, many are optimistic about the future of drone deliveries. Technologies are improving, and most of the elements needed for the widespread adoption of drones are already available in the market.[58]
II. Government Contracts
In this update, we summarize select recent government contracts decisions that involve companies in the aerospace and defense industry, as well as decisions that may be of interest to them, from the tribunals that hear government contracts disputes. These cases address a wide range of issues with which government contractors in the aerospace and defense industry should be familiar.
DFARS 252.227-7103(f) Does Not Prohibit Markings On Noncommercial Technical Data That Restrict Third-Party Rights
In The Boeing Co. v. Sec’y of the Air Force, 983 F.3d 1321 (Fed. Cir. 2020), the Federal Circuit considered whether Defense Federal Acquisition Regulation Supplement 252.227-7103(f) (“DFARS 252.227-7103(f)”) applies to legends that restrict only the rights of third parties but do not restrict the rights of the Government. Boeing applied a legend to its technical data that stated, “NON-U.S. GOVERNMENT ENTITIES MAY USE AND DISCLOSE ONLY AS PERMITTED IN WRITING BY BOEING OR THE U.S. GOVERNMENT.” The Government rejected Boeing’s data deliverables because the legend allegedly did not conform to DFARS 252.227‑7103(f), which stated that the contractor could “only assert restrictions on the Government’s rights,” and specified the legends authorized under the contract. The Armed Services Board of Contract Appeals’ (“ASBCA”) decisions below found in favor of the Government. On appeal, Boeing argued that its legend conformed to the requirements of DFARS 252.227-7103(f) because the clause is applicable only to legends that assert restrictions on the Government’s rights, and is silent on legends that assert restrictions on the rights of third parties. The Federal Circuit agreed with Boeing that DFARS 252.227-7103(f) applies only to legends that assert restrictions to the Government’s rights in the data, and is silent on legends that restrict the rights of third parties. The Federal Circuit remanded the decision to the ASBCA to decide whether, as a matter of fact, Boeing’s legend asserted rights that restricted the Government’s rights in the data on which the legend was included.
ASBCA Declines To Decide Whether Fly America Act Applies To Indirect Costs
In Lockheed Martin Corp., ASBCA No. 62377 (Jan. 7, 2021), the ASBCA did not reach the question of whether the Fly America Act, 49 U.S.C.A. § 40118, as implemented by Federal Acquisition Regulation 52.247-63, Preference for U.S.-Flag Air Carriers, applies to a contractor’s indirect costs because there was no “live dispute” between the parties. FAR 52.247-63, “requires that all . . .Government contractors and subcontractors use U.S.-flag air carriers for U.S. Government-financed international air transportation of personnel (and their personal effects) or property, to the extent that service by those carriers is available.” It further requires that “[i]f available, the Contractor, in performing work under this contract, shall use U.S.-flag carriers for international air transportation of personnel (and their personal effects) or property.”
In 1997, Lockheed Martin Corporation and the Government entered into a memorandum of understanding (“MOU”) that the Fly America Act applied only to direct costs. However, in 2019, the corporate administrative contracting officer (“CACO”) withdrew the MOU on the purported basis that the MOU had misinterpreted FAR 52.247-63, and issued a final decision asserting the interpretation that FAR 52.247-63 applies to indirect costs. The ASBCA did not address the merits of the issue, finding that because Lockheed had not changed its practices as a result of the Government’s withdrawal of the MOU or the CACO’s final decision, there was no evidence that there was a live dispute to decide.
ASBCA Clarifies Types Of Activities That Are Not Unallowable Costs Under The FAR
In Raytheon Co. & Raytheon Missile Sys., ASBCA Nos. 59435 et al., (Feb. 1, 2021), the ASBCA issued a lengthy decision on the allowability of various types of costs incurred by Raytheon Company and its business segment Raytheon Missile Systems (“Raytheon”). The ASBCA sustained all but $18,109 of Raytheon’s appeals of the Government’s $11.8 million claims. The types of costs addressed in the decision include costs for Raytheon’s Government relations group, costs for Raytheon’s corporate development group, and airfare costs.
Government Relations Costs. In 2007 and 2008, Raytheon included Government relations group costs as indirect costs in its incurred cost submissions, but withdrew a portion of those costs as unallowable lobbying costs in accordance with FAR 31.205-22, Lobbying and political activity costs, which requires that contractors “maintain adequate records to demonstrate that the certification of costs as being allowable or unallowable…pursuant to this subsection complies with the requirements of this subsection.” The Government disagreed with Raytheon’s practice and disallowed 100 percent of the costs incurred by Raytheon’s Government relations group as expressly unallowable costs.
The ASBCA held that the Government had the burden to prove that the costs were expressly unallowable and that there was no basis to shift the burden to the contractor. The ASBCA further held that the Government did not meet its burden of proving that any of the Government relations costs included in Raytheon’s incurred costs submissions were unallowable, and that Raytheon’s method of removing unallowable lobbying costs was proper based on its disclosed accounting practice.
Corporate Development Costs. Raytheon included a portion of corporate development group costs as indirect costs in its incurred cost submission in 2007 and 2008, but withdrew a portion of the costs as unallowable organizational costs under FAR 32.205-27, Organization Costs. Raytheon implemented a “bright line” rule for its employees to determine the difference between costs for allowable activities under FAR 31.205-12, Economic Planning Costs, and FAR 31.205-38, Selling costs, and costs for unallowable activities under FAR 31.205-27. The Board found Raytheon’s corporate development employees kept track of their time in accordance with the bright line rule, that the allowable costs for the corporate development group were supported by documentation and credible witness testimony, and that the Defense Contract Management Agency (“DCMA”) did not meet its burden of proving that the corporate development costs were unallowable organization costs under FAR 31.205-27.
Airfare Costs. With respect to airfare costs, the ASBCA addressed two distinct issues: (1) whether the pre-Jan. 11, 2010 version of FAR 31.205-46(b) required Raytheon to take into account its corporate discounts in determining its allowable airfare; and (2) whether Raytheon’s policy of allowing business class travel for trans-oceanic flights in excess of 10 hours was reasonable and consistent with FAR 31.205-46(b). Prior to Jan. 11, 2010, FAR 31.205-46(b) stated:
Airfare costs in excess of the lowest customary standard, coach, or equivalent airfare offered during normal business hours are unallowable except when such accommodations require circuitous routing, require travel during unreasonable hours, excessively prolong travel, result in increased cost that would offset transportation savings, are not reasonably adequate for the physical or medical needs of the traveler, or are not reasonably available to meet mission requirements. However, in order for airfare costs in excess of the above standard airfare to be allowable, the applicable condition(s) set forth in this paragraph must be documented and justified.
(Emphasis added.) Effective Jan. 11, 2010, FAR 31.205-46(b) was amended to read: “Airfare costs in excess of the lowest priced airfare available to the contractor during normal business hours are unallowable except …” (emphasis added).
The ASBCA concluded that prior to Jan. 11, 2010, contractors were not required to factor in any negotiated corporate discounts when determining the allowable amounts of airfare costs. The ASBCA also held that Raytheon’s travel policy “documented and justified premium airfare,” as required by FAR 31.205-46(b), and that there is no requirement that premium airfare be “documented and justified” on an individual, flight-by-flight basis. Moreover, the ASBCA held that the CO acted within the scope of his authority when he determined that Raytheon’s travel policy complied with FAR 31.205-46(b), and that his determination was binding on DCMA.
ASBCA Rules That Government Shares Liability for Contractor’s Underfunded Pension Plan
In Appeal of Northrop Grumman Corp., ASBCA No. 61775 (Oct. 7, 2020), the ASBCA found that Northrop Grumman (“NG”)’s valuation of a nonqualified defined benefits pension plan adopted in 2003 and frozen in 2014 was compliant with the Cost Accounting Standards despite the Government’s objections to the company’s valuation methodology. During the plan’s existence, NG allocated its costs to numerous government contracts, all of which included FAR 52.215-15, Pension Adjustments and Asset Reversions; FAR 52.230-2, Cost Accounting Standards; and FAR 52.233-1, Disputes.
When the plan was frozen, NG calculated that the plan’s liabilities exceeded its market value and requested that the Government pay its pro rata share to NG to “true-up” the plan under CAS 413. The Government argued, inter alia, that NG’s reduction to its calculation of investment income to account for taxes on such income was non-compliant with CAS 412. Although the Board disagreed with NG’s approach of reducing its investment rate of return by the marginal tax rate, the Board found that roughly the same outcome would have been achieved had NG accounted for taxes as an administrative expense. Because FAR 30.602(c)(1) provides that the Government should make no adjustment to the contract when there is no material cost difference due to the alleged CAS violation, the Board sustained NG’s appeal and remanded to the parties to calculate the amount due and owing from the Government to NG.
Contractor’s REAs Were Not Contract Disputes Act (“CDA”) Claims Subject to the CDA Statute of Limitations
In Appeal of BAE Sys. Ordnance Sys., Inc., ASBCA No. 62416 (Feb. 10, 2021), the Board considered whether BAE’s requests for equitable adjustment (“REAs”) constituted claims in light of the Federal Circuit’s recent decision in Hejran Hejrat Co. Ltd v. United States Army Corps of Engineers, 930 F.3d 1354 (Fed. Cir. 2019). In Hejran Hejrat, the Federal Circuit ruled that, under certain circumstances, an REA can actually constitute an implicit request for a final decision.
BAE submitted three REAs seeking reimbursement for state-issued fines it received as a result of environmental conditions at the plant. The contracting officer (“CO”) replied that he would “entertain reimbursement” of a portion of the state fines, but later issued a “final determination” rejecting the REAs entirely. Subsequently, BAE submitted a CDA claim to which the Government failed to respond. BAE appealed the deemed denial of its claim to the Board. The Army then moved to dismiss the appeal asserting that BAE’s challenge to the CO’s decision was untimely because the REAs were, in fact, CDA claims, and the CO’s final determination upon them was thus a CO’s Final Decision. In denying the government’s motion to dismiss the appeal for lack of jurisdiction as outside of the CDA’s statute of limitations, the Board found that “BAE did all that it could to keep its REAs from falling within the realm of being also considered CDA claims by carefully avoiding making a request — explicit or implicit — for a [contracting officer]’s final decision.” Therefore, the Board found that BAE’s claims were timely filed and denied the government’s motion to dismiss.
III. Space
A. First Private Human Space Launch
On November 15, 2020, the launch of SpaceX’s Resilience marked the first “NASA-certified commercial human spacecraft system.”[59] The mission is the first of six crewed missions NASA and SpaceX plan to fly as part of the Commercial Crew Program, a program designed to provide “safe, reliable, and cost-effective transportation to and from the International Space System from the United States.”[60] The crew is comprised of four members, including three NASA astronauts and one member of the Japan Aerospace Exploration Agency.[61]
Resilience autonomously docked at the International Space Station on November 16, 2020 for a sixth-month stay, making it the longest space mission launched from the United States. During the mission, the crew is conducting various science and research investigations, including a “study using chips with tissue that mimics the structure and function of human organs to understand the role of microgravity on human health and diseases.”[62] The crew will also conduct various space walks, encounter several uncrewed spacecraft, and welcome crews from the Russian Soyuz vehicle and the next SpaceX Crew Dragon.[63] At the end of the mission, Resilience will autonomously undock and return to Earth.
B. Noteworthy Space Achievements in Countries Other than the United States
Countries and private companies are racing to the Moon, Mars, and even asteroids. This space race involves countries that are both newcomers to space and those that seek a return to the unknown.
China
Chang’e-5’s Lunar Exploration Mission
Following the Chang’e-4’s successful lunar exploration mission in 2019,[64] China reached the Moon again in 2020. On November 23, 2020, Chang’e-5 lifted off from Wenchang Space Launch Center on Hainan Island, China and went into the Moon’s orbit on November 28, 2020.[65] The descender craft separated from the orbiter on November 29, 2020 and landed on the Mons Rümker region of Oceanus Procellarum on December 1, 2020.[66] Once on the Moon’s surface, the lander system used a scoop and drill to dig up lunar samples.[67] After collection and storage, Chang’e-5 made its return to Earth on December 16, 2020, landing in the Siziwang Banner grassland of the autonomous region of Inner Mongolia in northern China.[68] The successful mission retrieved about 1,731 g (61.1 oz.) of lunar samples.[69] Chang’e-5 was China’s first successful lunar sample return mission,[70] and the first in the world in over four decades since the Soviet Union’s Luna-24 in 1976.[71]
The Chang’e-5 venture demonstrates China’s increasing capability in space, and is part of a broader effort under the Chinese National Space Administration Chang’e Lunar Exploration Program.[72] The Chang’e-6, expected to launch in 2023, will be China’s next lunar sample-return mission.[73]
Tianwen-1 Reaches Mars’s Orbit
China’s first independent interplanetary mission is well underway with the launch of the Tianwen-1 spacecraft on July 23, 2020.[74] After a 202-day, 295-million-mile journey through space, it arrived in orbit around Mars on February 10, 2021.[75] The first phase of Tianwen-1’s mission is to circle Mars’s orbit and map the planet’s morphology and geology, while allowing the orbiter to find a secure landing zone.[76]
About three months after arrival into orbit, in May 2021, the craft’s lander is expected to detach from its orbiter and descend onto Mars’s surface in a region known as Utopia Planitia.[77] Once on the surface, the lander will unveil a rover carrying a panoramic camera.[78] The solar-powered rover will also investigate surface soil characteristics for potential water-ice distribution with a ground-penetrating radar.[79] Tianwen-1 comes on the heels of several successful lunar missions for China’s space program.[80]
China’s Ambitious Plans for a Space Station
China has ambitious plans for a new space station.[81] Tianhe, the station’s core module, is expected to launch sometime in 2021.[82] The module is 59 feet (18 meters) long, weighs about 24 tons (22 metric tons), and will provide living space and life support for astronauts and house the outpost’s power and propulsion elements.[83] Tianhe’s launch will be one of eleven total liftoffs that will be required to build the space station, which China wants to finish by the end of 2022.[84]
China’s iSpace Fails to Reach Orbit During Second Attempt
China’s iSpace, also known as Beijing Interstellar Glory Space Technology Ltd. (a different company than the Japanese lunar startup ispace) was the first Chinese private company to reach orbit when it successfully launched its Hyperbola-1 rocket on July 25, 2019.[85] On February 1, 2021, iSpace’s four-stage Hyperbola-1 rocket failed to reach orbit during its second attempt to go to space.[86]
Despite its failed launch, iSpace is a prominent name in the Chinese private space industry, having raised $173 million in Series B funding for the Hyperbola rocket line. The company has indicated plans for a potential IPO and is in the midst of creating its Hyberbola-2 rocket.[87] Other private Chinese companies, including Galactic Energy, One Space, and Deep Blue Aerospace, are planning launches later this year.[88]
Japan
Hayabusa2’s Samples From Asteroid Ryugu
After spending over a year collecting and storing samples on a near-Earth asteroid named Ryugu,[89] Japan’s Hayabusa2 spacecraft started its journey back towards Earth in November 2019.[90] It completed its yearlong journey to return the asteroid samples back to Earth on December 5, 2020.[91] The return capsule landed in South Australia, carrying with it samples from the asteroid’s surface and interior.[92] From the samples, scientists hope to learn more about the composition of Ryugu’s minerals, as well as the origin and evolution of the solar system.[93]
Hayabusa2 was originally launched in 2014,[94] and its mission is far from over.[95] The Hayabusa2’s main craft separated from the return capsule just two days before the delivery of Ryugu’s samples was complete and retreated back to work on an extended mission.[96] Hayabusa2’s extended mission will feature visits to two more asteroids, one in 2026 and another in 2031.[97]
Japanese Startup Is Targeting the Moon in 2021
A Japanese startup, ispace (a different company than China’s iSpace), is targeting the Moon.[98] On August 22, 2020, company representatives stated ispace intends to go to the lunar surface on a stationary lander in 2021.[99] The company is also planning a second mission in 2023, in which it will deploy a rover for surface exploration.[100] These two missions will ride as secondary payloads on SpaceX Falcon 9 rockets, and together make up ispace’s Hakuto-Reboot program.[101]
United Arab Emirates
Hope Arrives on Mars
On February 9, 2021, the UAE’s Hope orbiter entered into Mars’s orbit,[102] making the UAE the fifth country to visit the Red Planet (China became the sixth the next day with its Tianwen-1 mission),[103] and the first Arab nation in history to do so.[104] Hope will take up a near-equatorial orbit as it observes the planet’s atmosphere, weather, and climate systems.[105] Hope also aims to study the leakage of hydrogen and oxygen into space, which scientists suspect is a contributing factor to Mars missing the once-abundant water that previously occupied its surface.[106]
Russia
Expected Launch of Luna-25 in October 2021
After a nearly half-century hiatus for its space program,[107] Russia is gearing up for a launch to the Moon.[108] Russia’s Luna-25 spacecraft will be the first Russian or Soviet Moon mission since 1976,[109] and will mark the reactivation of Russia’s Moon exploration program.[110] The Luna-25 lander will include scientific instruments to research the composition and structure around the Moon’s south pole.[111] Luna-25 is expected to launch in October 2021.[112]
Looking Ahead
As more countries join the space race, the global community benefits from all of research, technology, and discoveries resulting from outer space exploration. With upcoming missions to the Moon, Mars, and the development of a space station, the upcoming year is sure to result in tremendous advancement in our understanding of space.
C. Other Noteworthy Space Developments
The last year featured a number of developments in space technology, including from SpaceX, which became the first private company to launch astronauts to space, made progress on its Starship design, and launched a public beta program of its Starlink satellite internet service.
Crewed Flights
On May 30, 2020, SpaceX became the first private company to launch astronauts into orbit.[113] The mission marked the first launch of NASA astronauts from the U.S. since the space shuttles were retired in 2011.[114] The Falcon 9 Rocket carried a Crew Dragon capsule, an upgraded version of SpaceX’s Dragon capsule, which has been used to carry cargo to the space station.[115] While on board, the astronauts, tested all of the systems and verified that they performed as designed.[116] The astronauts arrived at the International Space Station on May 31, 2020,[117] and returned safely to Earth on August 2, 2020.[118]
Just five and a half months later, SpaceX sent astronauts to space again. As discussed above, on November 15, 2020, NASA’s SpaceX Crew-1 mission lifted off—the first of six crewed missions NASA and SpaceX plan to fly as part of the Commercial Crew Program, a program designed to provide safe, reliable, and cost-effective transportation between the ISS and the U.S.[119] The mission marked many firsts, including “the first flight of the NASA-certified commercial system designed for crew transportation.”[120] In contrast to the May launch, the Crew-1 mission transported four astronauts (three NASA astronauts and one from the Japan Aerospace Exploration Agency) to the International Space Station for a six-month science mission.[121] The crew arrived safely on November 16, and will eventually reboard Crew Dragon for transport back to Earth.[122]
Starship SN Flights
Following the successful launch of its first astronaut mission in May, SpaceX shifted gears to focus on the Starship, the rocket designed to launch cargo and up to 100 passengers at a time on missions to the Moon and Mars.[123] CEO Elon Musk acknowledged that the rocket has many milestones to reach before people can fly in it.[124]
After multiple launches of several starship prototypes failed, on August 4, 2020, SpaceX flew the Starship SN5 test vehicle for the first time ever.[125] Though the SN5 was only in the air for about 40 seconds, the short hop allowed SpaceX to gather valuable data necessary to analyze and smooth out the launch process.[126]
Just several weeks later, SpaceX launched SN6, which rose to nearly 500 feet above the ground before touching down near the launchpad.[127] Similar to the SN5 launch, the launch of the SN6 prototype was used to help SpaceX understand the technologies needed for a fully reusable launch system for deep space missions.[128]
On December 9, 2020, SpaceX launched Starship SN8 to 40,000 feet above its facility in Boca Chica, Texas.[129] After completing several objectives, including testing its aerodynamics and flipping to prepare for landing, the rocket exploded on impact as it attempted to land.[130] SpaceX declared the launch a success; despite the fiery landing, the nearly seven-minute flight provided helpful information to improve the probability of success in the future.[131]
Other Updates
SpaceX launched many satellites into orbit in 2020. Throughout the year, SpaceX launched satellites for the U.S. Space Force[132] and foreign militaries.[133] SpaceX also began to launch satellites for its Starlink mega-constellation, an infrastructure project designed to provide global broadband coverage to people in rural and remote areas.[134] As of January 29, 2021, SpaceX had deployed 1,023 satellites over the course of 18 launches.[135] In October, SpaceX began a public beta program of the Starlink satellite internet service in the northern U.S., Canada, and the U.K.[136] By February 2021, the Starlink satellite internet service had over 10,000 users.[137]
SpaceX had a monumental fundraising year. In May, SpaceX raised more than $346 million.[138] In August, the company reported its largest single fundraising round to date: $1.9 billion in new funding.[139] SpaceX also sold an additional $165 million in common stock.[140] In December, SpaceX began discussing another funding round with investors. This round will likely value the company at a minimum of $60 billion and possibly as high as $92 billion.[141]
D. NASA’s Perseverance Rover, Past Updates, and Future Plans
Two of NASA’s biggest accomplishments this year were the successful landing of the Perseverance Rover on Mars and the publication of the Artemis Plan, a document that outlines NASA’s intention to return a human to the Moon.
Perseverance Rover
On February 18, 2021, NASA’s Perseverance Rover landed safely in an area known as Jezero Crater on Mars.[142] Perseverance’s mission is to search for signs of ancient life and collect samples of rock and regolith for a return to Earth.[143] The Perseverance Rover will examine Martian dirt and rock with a variety of sophisticated scientific gear, including an instrument called SuperCam, which will zap rocks with a laser and gauge the composition of the resulting vapor.[144] The Rover will also utilize its drill and long robotic arm to collect samples and seal them into special tubes, and these samples will be brought back to Earth, perhaps as early as 2031.[145] Once returned, these samples will be analyzed and studied by scientists for decades to come.[146]
Artemis Plan
The United States is pushing forward on its plans to return to the Moon, with NASA publishing its comprehensive Artemis Plan in September 2020.[147] Under the Artemis Plan, the United States plans to send the next man and first woman to the Moon by 2024, and establish a sustained human presence on the Moon by 2028.[148] However, Congress is only providing $850 million for work on the Human Landing System to support NASA’s Artemis mission, well short of the requested $3.37 billion on the project.[149] This shortfall is the biggest risk to the ambitious goals and timing of the Artemis Plan.[150]
The Artemis I Mission
Artemis I is set to be the first mission under the Artemis Plan, and it is currently scheduled for launch on November 2021.[151] It will be an uncrewed mission from NASA’s Kennedy Space Station in Florida.[152] This mission will allow NASA to test its powerful new Space Launch System and Orion spacecraft.[153]
Commercial Lunar Payload Services
Under the Artemis Plan, NASA established the Commercial Lunar Payload Services initiative (“CLPS”) to partner with the U.S. commercial space industry to introduce new lander technologies and deliver payloads to the surface of the Moon.[154] As of February 2021, NASA had 14 companies on contract through CLPS to bid on delivery science experiments and technology demonstrations to the lunar surface.[155] Most recently, NASA awarded Firefly Aerospace of Cedar, Texas approximately $93.3 million to deliver a suite of ten science investigations and technology demonstrations to the Moon in 2023.[156]
Lunar Orbital Platform Gateway
The Lunar Orbital Platform Gateway is instrumental to NASA’s goal of sustaining a human presence on the Moon.[157] The Gateway will be a station orbiting the Moon that will serve as a holding area for astronaut expeditions and science investigations, as well as a port for deep space transportations.[158] NASA has selected SpaceX to provide launch services for the first two Gateway modules, the Power and Propulsion Element (“PPE”) and Habitation and Logistics Outpost (“HALO”), which are targeted to launch together no earlier than May 2024.[159]
Human Landing System
NASA’s Human Landing System Program (“HLS”) is tasked with developing a lander that will haul two astronauts to the Moon in 2024, and then safely return them to lunar orbit before their trip back to Earth.[160] Three companies have been selected to begin development work for the HLS: Blue Origin (of Kent, Washington), Dynetics, a Leidos company (of Huntsville, Alabama), and SpaceX (of Hawthorne, CA).[161] HLS is also charged with developing a sustainable, long-term presence on and around the Moon.[162]
E. Record-Setting Private investment
Over the past several years, there has been increased interest in investing in pure aerospace companies, and more recently, space and space-satellite-based companies have become the focus of special-purpose acquisition companies (“SPACs”).[163] Numerous milestones are driving the rise of space stocks traded on exchanges. For example, companies such as Virgin Galactic have been developing, and are on the cusp of starting, a commercial space tourism service; AstraSpace is entering the public market through a blank-check merger with Holicity; and Momentus is going public via Stable Road Capital, among others.[164] In addition to the above, exchange traded funds (“ETF”) have been rising in popularity as well.
To further illustrate the above, one only has to look to ETFs such as Procure Space ETF, a space-related fund launched in 2019, which has holdings in various space stocks.[165] In January, Cathie Wood’s Ark Investment Management announced in a filing that it was looking to start the ARK Space Exploration ETF.[166] This ETF would focus on exposure to “companies involved in space-related businesses like reusable rockets, satellites, drones, and other orbital and sub-orbital aircrafts.”[167]
In terms of SPACs, the aerospace industry has shown a significant amount of growth. SPACs are among the trendiest, high-growth investment opportunities in the finance world at the moment.[168]A SPAC raises money through an IPO to acquire an existing operating company. In the past, we have seen successful SPACs such as when Virgin Galactic merged with Social Capital Hedosophia, or when Momentus Space merged with Stable Road Acquisition Corp.[169] Another company considering a merger with a SPAC is Kraus Hamdani Aerospace, whose aircraft can “safely carry satellite payloads within the stratosphere, providing a lower cost alternative to satellites with zero carbon footprint[.]”[170] It appears that SPACs can provide a beneficial pathway for aerospace companies to obtain important access to capital.
There are other companies to watch for as well in the near term. Firefly Aerospace is a “small launch vehicle developer” that is increasingly nearing its first orbital launch attempt, and it is looking to raise $350 million to “scale up production and work on a new, larger vehicle.”[171] This is after Relativity Space, a similar launch vehicle developer, raised $500 million in November of 2020.[172]
In viewing the industry, it seems clear that the rise in space and space-related development is leading to more and more opportunities for small to large companies to expand into the public markets in order to raise the capital necessary to further expand these companies’ operations. Moreover, with the similar rise in ETFs and SPACs, access to equity in space companies, which may have been limited to a select few in years prior, is now more available to the general public than ever before. As such, the space industry market should be one to follow and watch for in the coming years.
F. Satellite Internet Constellations
The space industry, which includes the consumer broadband sector, saw record private investment in 2020.[173] One area of investment was in the continued development of satellite constellations that provide internet access across the globe. These new technologies offer great business potential and provide internet access to underserved remote populations. In fact, federal agencies are encouraging more private investment in the space economy, including internet satellite constellations.[174]
In December 2020, the FCC awarded $9.2 billion in funding to bidders as part of the Phase I Auction from its Rural Digital Opportunity Fund (“Fund”). The Fund, established in 2019 with $20 billion in funding, is to be used for providing internet access to the millions of Americans without internet access, particularly in rural and remote areas.[175] The funding is estimated to provide high-speed broadband internet service to 5.22 million users[176]— Former FCC Chairman Ajit Pai described it as the “single largest step ever taken to bridge the digital divide.”[177] According to Pai, the awards would bring “welcome news to millions of unconnected rural Americans who for too long have been on the wrong side of the digital divide. They now stand to gain access to high-speed, high-quality broadband service.”[178]
On January 19, 2021, over 150 members of Congress wrote a letter urging the FCC “to thoroughly vet the winning bidders to ensure that they are capable” and to “consider opportunities for public input on the applications.”[179] Among other requirements, winning bidders must deliver financial statements, coverage maps, and certify to the FCC that their network is able to deliver “to at least 95% of the required number of locations in each relevant state.”[180]
Multiple companies developing satellite constellations that provide internet access from low earth orbit are creating many opportunities, but these projects have also led to some concern. The U.S. National Oceanic and Atmospheric Administration projected that the number of active satellites in orbit could increase by 50% or more in 2021.[181] The injection of more satellites into low earth orbit increases the risk of collisions between man-made objects, which could create orbital debris that itself might collide with other space objects, thus resulting in greater accumulations of “space junk.”[182] According to Morgan Stanley, some government agencies now struggle to track this orbital debris, creating potential demand for private companies to track and maintain this potentially catastrophic threat.[183]
The rapidly developing breakthroughs in satellite broadband internet access will bridge the gap in the digital divide, and be the driving force in a projected trillion-dollar industry. Morgan Stanley projects that the global space economy could generate more than $1 trillion in revenue by 2040, with satellite broadband accounting for 50-70% of the projected growth.[184]
G. Expected Impact of Biden Administration
The inauguration of President Biden on January 20, 2020 signaled the beginning of significant changes to policies of the Trump administration in many key areas, but thus far President Trump’s space-related policies have generally proven a uniquely bipartisan area of continuity during this latest transition of power.
Having inherited a global pandemic, among other issues, President Biden’s first priorities have primarily been more terrestrial in focus, and insight into future policy decisions generally have to be gleaned from statements made on the campaign trail. However, the administration’s early remarks regarding Trump-era ventures like the Space Force and NASA’s Project Artemis have given those with their eyes turned skyward reasons for optimism, which has only been bolstered by President Biden’s symbolic decoration of the Oval Office with a moon rock collected during the Apollo 17 mission of 1972.[185]
Space Force
On December 20, 2019, President Trump signed the National Defense Authorization Act for Fiscal Year 2020 (“NDAA”) establishing the United States Space Force as the sixth branch of the United States military, and the first new military service in more than 70 years.[186] Its duties are to “(1) protect the interests of the United States in space; (2) deter aggression in, from, and to space; and (3) conduct space operations.”[187] Since its establishment, about 2,400 service members have officially transferred into the Space Force service, with plans to grow to 6,400 active-duty troops and add a reserve component in 2021.[188]
Despite earlier speculation to the contrary, White House spokeswoman Jen Psaki recently affirmed that the Space Force “absolutely has full support of the Biden administration.”[189] In response, the Chief of Space Operations Gen. John Raymond emphasized that the White House’s unambiguous statement of support for the Space Force makes it “really clear that this is not a political issue, it’s an issue of national security.”[190] That same sentiment is also reflected in Congress among bipartisan lawmakers who view the new branch as integral to ensuring the military puts enough focus on space to counter China and Russia.[191] Although President Biden has not yet publicly detailed his plans for the future of the Space Force, it does appear to be here to stay.
Space Exploration
In early February 2021, the White House also announced support for Project Artemis, NASA’s effort to return astronauts to the lunar surface. President Biden’s endorsement of the Artemis program means it will become the first major deep space human exploration effort with funding to survive a change in presidents since Apollo, after several fitful efforts to send astronauts back to the moon and beyond ultimately went nowhere.[192]
The Trump administration embraced exploration and directed NASA to speed up its moon campaign, directing it to land another man, and the first woman, on the lunar surface by 2024, but the time frame of this goal appears to be stifled by budgetary constraints, safety concerns, and other matters of national priority like COVID-19 relief.[193] For example, NASA requested a total of $25.2 billion for FY2021, a 12 percent increase over FY2020, in order to pay for Artemis. Although Congress had been steadily adding money to NASA’s budget for several prior years, in this case it provided less, $23.3 billion, suggesting there are limits to what it will allocate.[194]
Additionally, speculation remains that the Biden administration may instead prioritize NASA missions focused on increasing earth-observation capabilities, rather than space exploration. Lori Garver, the NASA deputy administrator during the Obama administration, was a key speaker at the SpaceVision 2020 convention on November 7 and 8, 2020. She noted, “[m]anaging the Earth’s ability to sustain human life and biodiversity will likely, in my view, dominate a civil space agenda for a Biden-Harris administration.”[195] However, eleven Democratic senators have already sent a letter to President Biden urging greater funding for Project Artemis, stressing that other NASA programs should not be cannibalized to pay for it.[196] As such, the first explicit insight into President Biden’s support for human spaceflight, and the timeline at which it can proceed, will likely be the FY2022 budget request that the President will send to Congress in the coming months.
Nevertheless, space exploration remains an overwhelmingly popular and bipartisan goal among Americans. Polls taken last year showed, for example, that 80% of Americans believed space travel supports scientific discovery; 78% had a favorable impression of NASA; 73% said NASA contributes to pride and patriotism; and 71% said NASA is not just a desirable agency, but a necessary one.[197] Such uniquely bipartisan support in this area cannot go unnoticed by the administration. Indeed, it appears that even if delayed for now, the question of landing another man or woman on the moon—or beyond—is a matter of when, not if, for the Biden Administration.
________________________
[1] Press Release – U.S. Department of Transportation Issues Two Much-Anticipated Drone Rules to Advance Safety and Innovation in the United States, Fed. Aviation Admin. (Dec. 28, 2020), available at https://www.faa.gov/news/press_releases/news_story.cfm?newsId=25541.
[2] Fed. Aviation Admin., Final Rule on Remote Identification of Unmanned Aircraft (Jan. 15, 2021), available at https://www.federalregister.gov/documents/2021/01/15/2020-28948/remote-identification-of-unmanned-aircraft.
[11] Fed. Aviation Admin., Operation of Small Unmanned Aircraft Systems Over People; Delay; Withdrawal; Correction (Mar. 10, 2021), available at https://public-inspection.federalregister.gov/2021-04881.pdf.
[12] Fed. Aviation Admin., supra note 2 at 4511–12.
[13] See James Roger, The dark side of our drone future, The Bulletin (Oct. 4, 2019), available at https://thebulletin.org/2019/10/the-dark-side-of-our-drone-future/.
[14] See Office of the Attorney General, Guidance Regarding Department Activities to Protect Certain Facilities or Assets from Unmanned Aircraft and Unmanned Aircraft Systems (Apr. 13, 2020), available at https://www.justice.gov/archives/ag/page/file/1268401/download.
[15] Fed. Aviation Admin., Operations Over People General Overview (Jan. 4, 2021), available at https://www.faa.gov/uas/commercial_operators/operations_over_people/.
[16] Operation of Small Unmanned Aircraft Systems Over People, 86 Fed. Reg. 4,314 – 4,387 (14 CFR 11, 21, 43, 107) (Jan. 15, 2021), available at https://www.federalregister.gov/documents/2021/01/15/2020-28947/operation-of-small-unmanned-aircraft-systems-over-people.
[17] Fed. Aviation Admin., Operation of Small Unmanned Aircraft Systems Over People; Delay; Withdrawal; Correction (Mar. 10, 2021), available at https://public-inspection.federalregister.gov/2021-04881.pdf.
[22] Fed. Aviation Admin., Executive Summary Final Rule on Operation of Small Unmanned Aircraft Systems Over People (Dec. 28, 2020), available at https://www.faa.gov/news/media/attachments/OOP_Executive_Summary.pdf.
[24] Fed. Aviation Admin., Busting Myths about the FAA and Unmanned Aircraft (Mar. 7, 2014), available at https://www.faa.gov/news/updates/?newsId=76240.
[25] 49 U.S.C. § 40103(b)(1); 49 U.S.C. § 40102(32); 14 C.F.R. § 91.119(b)(c).
[26] Huerta v. Haughwout, No. 3:16-cv-358, Dkt. No. 30 (D. Conn. July 18, 2016).
[28] Annie Palmer, Amazon wins FAA approval for Prime Air drone delivery fleet, CNBC (Aug. 31, 2020), available at https://www.cnbc.com/2020/08/31/amazon-prime-now-drone-delivery-fleet-gets-faa-approval.html.
[31] Flying robots get FAA approval in first for drone sector, ZDNet (Jan. 20, 2021), available at https://www.zdnet.com/article/flying-robots-get-faa-approval-in-first-for-drone-sector/.
[35] Rantizo receives FAA approval to operate drone swarms, Clay and Milk (July 7, 2020), available at https://clayandmilk.com/2020/07/07/rantizo-receives-faa-approval-to-operate-drone-swarms/.
[38] DroneSeed is first in U.S. to receive approval from FAA for post-wildfire reforestation in California and five other states, PR Newswire (Oct. 6, 2020), available at https://www.prnewswire.com/news-releases/droneseed-is-first-in-us-to-receive-approval-from-faa-for-post-wildfire-reforestation-in-california-and-five-other-states-301146779.html.
[40] Fed. Aviation Admin., Notice of Proposed Rulemaking on Type Certification of Certain Unmanned Aircraft Systems (Sept. 18, 2020), available at https://www.federalregister.gov/documents/2020/09/18/2020-17882/type-certification-of-certain-unmanned-aircraft-systems.
[41] Alan Levin, Alphabet’s Drone Delivery Service in Virginia Sees Surge During Pandemic, Transport Topics (Apr. 8, 2020), available at https://www.ttnews.com/articles/alphabets-drone-delivery-service-virginia-sees-surge-during-pandemic.
[43] Aaron Pressman, Drone industry flies higher as COVID-19 fuels demand for remote services, Fortune (July 13, 2020), available at https://fortune.com/2020/07/13/coronavirus-drones-dji-wing-flytrex-covid-19-pandemic/.
[45] Ryan Duffy, A Q&A with Flytrex CEO and Cofounder Yariv Bash, Emerging Tech Brew (Feb. 22, 2021), available at https://www.morningbrew.com/emerging-tech/stories/2021/02/22/qa-flytrex-ceo-cofounder-yariv-bash.
[46] Brian Straight, If drones can deliver Starbucks, what’s taking so long for packages?, Modern Shipper (Feb. 15, 2021), available at https://www.freightwaves.com/news/if-drones-can-deliver-starbucks-whats-taking-so-long-for-packages.
[47] Tyler Fingert, The future of doorstep delivery being tested in Mobile; Drones could soon deliver orders in minutes, Fox 10 News (Aug. 5, 2020), available at https://www.fox10tv.com/news/mobile_county/the-future-of-doorstep-delivery-being-tested-in-mobile-drones-could-soon-deliver-orders-in/article_93138836-d786-11ea-872e-536e9c4176b9.html.
[51] John Porter, Zipline’s drones are delivering medical supplies and PPE in North Carolina, The Verge (May 27, 2020), available at https://www.theverge.com/2020/5/27/21270351/zipline-drones-novant-health-medical-center-hospital-supplies-ppe.
[52] Walmart using drones to deliver Covid-19 test kits to El Paso homes, ABC-7 KVIA (Nov. 16, 2020), available at https://kvia.com/news/business-technology/2020/11/16/walmart-to-start-using-drones-to-delivery-covid-19-test-kits-to-homes-in-el-paso/.
[53] Kaleb Roedel, Flirtey successfully conducts drone deliveries of COVID test kits, Nevada Appeal (Feb. 19, 2021), available at https://www.nevadaappeal.com/news/2021/feb/22/flirtey-successfully-conducts-drone-deliveries-cov/.
[55] Aaron Pressman, Drone industry flies higher as COVID-19 fuels demand for remote services, Fortune (July 13, 2020), available at https://fortune.com/2020/07/13/coronavirus-drones-dji-wing-flytrex-covid-19-pandemic/.
[58] Bijan Khosravi, How The Global Pandemic Became An Inflection Point for Drones, Forbes (Dec. 6, 2020), available at https://www.forbes.com/sites/bijankhosravi/2020/12/06/how-the-global-pandemic-became-an-inflection-point-for-drones/?sh=1fa1ddb01870.
[59] NASA’s SpaceX Crew-1 Astronauts Headed to International Space Station, NASA (Nov. 15, 2020), available at https://www.nasa.gov/press-release/nasa-s-spacex-crew-1-astronauts-headed-to-international-space-station.
[64] See Adam Mann, China’s Chang’e Program: Missions to the Moon, Space.com (Feb. 1, 2019), available at https://www.space.com/43199-chang-e-program.html.
[65] NASA Space Science Data Coordinated Archive, Chang’e 5, NASA, available at https://nssdc.gsfc.nasa.gov/nmc/spacecraft/display.action?id=2020-087A.
[67] Jonathan Amos, China’s Chang’e-5 mission returns Moon samples, BBC (Dec. 16, 2020), available at https://www.bbc.com/news/science-environment-55323176.
[70] Adam Mann, China’s Chang’e 5 mission: Sampling the lunar surface, Space.com (Dec. 10, 2020), available at https://www.space.com/change-5-mission.html.
[73] Dr. David R. Williams, Future Chinese Lunar Missions, NASA (Dec. 21, 2020), available at https://nssdc.gsfc.nasa.gov/planetary/lunar/cnsa_moon_future.html.
[74] Andrew Jones, China’s Tianwen-1Mars probe captures epic video of Red Planet during orbital arrival, Space.com (Feb. 12, 2021), available at https://www.space.com/tianwen-1.html.
[76] Vicky Stein, Tianwen-1: China’s first Mars mission, Space.com (Feb. 8, 2021), available at https://www.space.com/tianwen-1.html.
[81] See Mike Wall, China plans to launch core module of space station this year, Space.com (Jan. 7, 2021), available at https://www.space.com/china-space-station-core-module-launch-spring-2021.
[85] Elizabeth Howell, China’s ispace fails to reach orbit in 2nd launch attempt, Space.com (Feb. 4, 2021), available at https://www.space.com/chinese-startup-ispace-rocket-launch-failure.
[89] Smriti Mallapaty, Asteroid dust recovered from Japan’s daring Hayabusa2 mission, Nature.com (Dec. 15, 2020), available at https://www.nature.com/articles/d41586-020-03451-6.
[90] Meghan Bartels, Samples of asteroid Ryugu arrive in Japan after successful Hayabusa2 capsule landing, Space.com (Dec. 8, 2020), available at https://www.space.com/hayabusa2-asteroid-ryugu-samples-arrive-in-japan.
[93] Mallapaty, supra note 89.
[95] See Doris E. Urrutia, Japan’s asteroid sample-return spacecraft Hayabusa2 gets extended mission, Space.com (Sept. 30, 2020), available at https://www.space.com/japan-asteroid-mission-hayabusa2-extended.
[98] Mike Wall, Japanese Company ispace Now Targeting 2021 Moon Landing for 1st Mission, Space.com (Aug. 23, 2019), available at https://www.space.com/japan-ispace-first-moon-mission-2021.html.
[102] Jonathan Amos, UAE Hope mission returns first image of Mars, BBC (Feb. 14, 2021), available at https://www.bbc.com/news/science-environment-56060890.
[103] Meghan Bartels, Behold! See the 1st Mars closeup from UAE’s Hope orbiter (photo), Space.com (Feb. 16, 2021), available at https://www.space.com/uae-hope-mars-spacecraft-first-close-photo.
[104] Natasha Turak and Dan Murphy, United Arab Emirates becomes first Arab country to reach Mars, CNBC (Feb. 10, 2021), available at https://www.cnbc.com/2021/02/09/mars-probe-uae-attempts-to-become-first-arab-country-to-reach-mars-with-hope-probe.html.
[105] Jonathan Amos, Hope probe: UAE launches historic first mission to Mars, BBC (July 19, 2020), available at https://www.bbc.com/news/science-environment-53394737.
[107] Leonard David, Luna-25 Lander Renew Russian Moon Rush, Scientific American (Aug. 27, 2020), available at https://www.scientificamerican.com/article/luna-25-lander-renews-russian-moon-rush/.
[109] Leonard David, Russia gearing up to launch moon mission in 2021, Space.com (Aug. 7, 2020), available at https://www.space.com/russia-moon-mission-luna-25.html.
[113] Kenneth Chang et al., SpaceX Launch: Highlights from NASA Astronauts’ Trip to Orbit, The New York Times (May 30, 2020), available at https://www.nytimes.com/2020/05/30/science/spacex-launch-nasa.html.
[117] Meghan Bartels, Space X’s 1st Crew Dragon with astronauts docks at space station in historic rendezvous, Space.com (May 31, 2020), available at https://www.space.com/spacex-crew-dragon-demo-2-docking-success.html.
[118] Mike Wall, SpaceX Crew Dragon makes historic 1st splashdown to return NASA astronauts home, Space.com (Aug. 2, 2020), available at https://www.space.com/spacex-crew-dragon-demo-2-splashdown.html.
[119] NASA’s SpaceX Crew-1 Astronauts Headed to International Space Station, NASA (Nov. 15, 2020), available at https://www.nasa.gov/press-release/nasa-s-spacex-crew-1-astronauts-headed-to-international-space-station.
[123] Michael Sheetz, SpaceX launches and lands another Starship prototype, the second flight test in under a month, CNBC (Sep. 3, 2020), available at https://www.cnbc.com/2020/09/03/spacex-launches-and-lands-starship-sn6-prototype-in-flight-test.html.
[125] Mike Wall, SpaceX’s Starship SN5 prototype soars on 1st test flight! ‘Mars is looking real,’ Elon Musk says, Space.com (Aug. 5, 2020), available at https://www.space.com/spacex-starship-sn5-prototype-1st-test-flight.html.
[128] Tariq Malik, SpaceX launches Starship SN6 prototype test flight on heels of Starlink mission, Space.com (Sep. 3, 2020), available at https://www.space.com/spacex-starship-sn6-first-test-flight.html.
[129] Michael Sheetz, SpaceX’s prototype Starship rocket reaches highest altitude yet but lands explosively on return attempt, CNBC (Dec. 9, 2020), available at https://www.cnbc.com/2020/12/09/spacex-starship-rocket-sn8-explodes-after-high-altitude-test-flight-.html.
[132] Amy Thompson, SpaceX launches advanced GPS satellite for US Space Force, sticks rocket landing, Space.com (June 30, 2020), available at https://www.space.com/spacex-space-force-gps-3-sv03-launch-success.html.
[133] Amy Thompson, SpaceX launches South Korea’s 1st military satellite, nails rocket landing at sea, Space.com (July 20, 2020), available at https://www.space.com/spacex-launches-south-korean-military-satellite-anasis-2-lands-rocket.html.
[134] Amy Thompson, SpaceX launches 60 Starlink internet satellites, sticks rocket landing, Space.com (Sep. 3, 2020), available at https://www.space.com/spacex-starlink-11-satellites-launch-september-2020.html.
[135] Michael Sheetz, SpaceX looks to build next-generation Starlink internet satellites after launching 1,000 so far, CNBC (Jan. 29, 2021), available at https://www.cnbc.com/2021/01/28/spacex-plans-next-generation-starlink-satellites-with-1000-launched.html.
[137] Michael Sheetz, SpaceX says its Starlink satellite internet service now has over 10,000 users, CNBC (Feb. 4, 2021), available at https://www.cnbc.com/2021/02/04/spacex-starlink-satellite-internet-service-has-over-10000-users.html?recirc=taboolainternal.
[138] Samantha Mathewson, SpaceX raises $1.9 billion in latest funding round: report, Space.com (Aug. 21, 2020), available at https://www.space.com/spacex-raises-1.9-billion-funding-round.html.
[141] Reuters, Wire Service Content, SpaceX Valuation to Hit at Least $60 Billion in New Funding Round – Business Insider, U.S. News (Jan. 28, 2021), available at https://www.usnews.com/news/technology/articles/2021-01-28/spacex-finalizing-new-funding-round-at-minimum-valuation-of-60-bln-business-insider.
[142] Mike Wall, Touchdown! NASA’s Perseverance rover lands on Mars to begin hunt for signs of ancient life, Space.com (Feb. 18, 2021), available at https://www.space.com/perseverance-mars-rover-landing-success.
[147] See NASA, The Artemis Plan (2020), available at https://www.nasa.gov/sites/default/files/atoms/files/artemis_plan-20200921.pdf.
[148] Thalia Patrinos, Artemis Moon Program Advances – The Story So Far, NASA (Oct. 7, 2019), available at https://www.nasa.gov/artemis-moon-program-advances.
[150] See Elizabeth Howell, NASA receives $23.3 billion for 2021 fiscal year in Congress’ omnibus spending bill: report, Space.com (Dec. 22, 2020), available at https://www.space.com/nasa-2021-budget-congress-omnibus-spending-bill.
[151] Lia Rovira and Deborah Byrd, NASA’s moon program – Artemis – boosted at White House press briefing, EarthSky (Feb. 6, 2021), available at https://earthsky.org/space/what-is-nasas-artemis-program-moon.
[154] Commercial Lunar Payload Services, NASA (Feb. 9, 2021), available at https://www.nasa.gov/content/commercial-lunar-payload-services-overview.
[156] Sean Potter, NASA Selects Firefly Aerospace for Artemis Commercial Moon Delivery in 2023, NASA (Feb. 4, 2021), available at https://www.nasa.gov/press-release/nasa-selects-firefly-aerospace-for-artemis-commercial-moon-delivery-in-2023.
[157] See Adam Mann, NASA’s Artemis Program, NASA (July 3, 2019), available at https://www.space.com/artemis-program.html.
[158] Kelli Mars, Gateway, NASA (Feb. 11, 2021), available at https://www.nasa.gov/gateway.
[159] Sean Potter, NASA Awards Contract to Launch Initial Elements for Lunar Outpost, NASA (Feb. 10, 2021), available at https://www.nasa.gov/press-release/nasa-awards-contract-to-launch-initial-elements-for-lunar-outpost.
[160] Leonard David, NASA’s 2024 Moon Goal: Q&A with Human Landing System Chief Lisa Watson-Morgan, NASA (Oct. 7, 2019), available at https://www.space.com/nasa-2024-moon-human-landing-system-chief-interview.html.
[161] Sean Potter, NASA Names Companies to Develop Human Landers for Artemis Moon Mission, NASA (Jan. 4, 2021), available at https://www.nasa.gov/press-release/nasa-names-companies-to-develop-human-landers-for-artemis-moon-missions.
[162] See Mike Wall, NASA picks SpaceX, Dynetics and Blue Origin-led team to develop Artemis moon landers, Space.com (Apr. 30, 2020), available at https://www.space.com/nasa-artemis-moon-landers-spacex-blue-origin-dynetics-selection.html.
[163] Gillian Rich, First Space Stock of its Kind Faces SpaceX Threat, Crowded Field, Investors.com (Feb. 2, 2021), available at https://www.investors.com/news/space-stocks-astra-space-to-go-public-but-faces-spacex-threat-crowded-field/.
[164] Gillian Rich, You Can’t Buy SpaceX Yet But These Space Stocks Are Up For Grabs, Investors.com (Mar. 25, 2021), available at https://www.investors.com/news/space-stocks-upstart-space-companies-moon-mars/.
[166] ARK ETF Trust, Registration Statement Under The Securities Act of 1933 Amendment No. 31, Securities and Exchange Commission (Jan. 13, 2021), available at https://www.sec.gov/Archives/edgar/data/0001579982/000110465921003837/tm212832d1_485apos.htm.
[167] Ark Invest, Space Exploration, Ark-Invest.com (2021), available at https://ark-invest.com/strategy/space-exploration/.
[168] Mike Bellin, Alan Jones, and Eric Watson, How special purpose acquisition companies (SPACs) work, PWC (accessed Apr. 2, 2021), available at https://www.pwc.com/us/en/services/audit-assurance/accounting-advisory/spac-merger.html.
[170] Melissa Rowley, How SPACs Are Changing The Investment Landscape For Space Exploration And Beyond, Forbes (Feb. 9, 2021), available at https://www.forbes.com/sites/melissarowley/2021/02/09/how-spacs-are-changing-the-investment-landscape-for-space-exploration-and-beyond/?sh=5a2ba29435c4.
[173] 5 Key Themes in the New Space Economy, Morgan Stanley (Feb. 4, 2021), available at https://www.morganstanley.com/ideas/space-economy-themes-2021.
[175] Michael Sheetz and Magdalena Petrova, Why in the Next Decade Companies Will Launch Thousands More Satellites Than in all of History, CNBC (Dec. 15, 2019), available at https://www.cnbc.com/2019/12/14/spacex-oneweb-and-amazon-to-launch-thousands-more-satellites-in-2020s.html; Federal Communications Commission, 2020 BROADBAND DEPLOYMENT, 5 FCC Rcd 8986 (11) (Apr. 20, 2020), available at https://docs.fcc.gov/public/attachments/FCC-20-50A1.pdf.
[176] David Shepardson, FCC Awards $9.2 Billion to Deploy Broadband to 5.2 Million U.S. Homes, Businesses U.S. (2020), available at https://www.reuters.com/article/us-usa-internet-fcc/fcc-awards-9-2-billion-to-deploy-broadband-to-5-2-million-u-s-homes-businesses-idUSKBN28H2V1.
[177] Christopher Davenport, FCC Announces Billions of Dollars in Awards to Provide Rural Areas with Broadband Access, Washington Post (Dec. 7, 2020), available at https://www.washingtonpost.com/technology/2020/12/07/fcc-digital-divide-spacex-broadband/.
[179] Ryan Tracy, Elon Musk’s SpaceX Riles Its Rivals for Broadband Subsidies, The Wall Street Journal (Jan. 31 2021), available at www.wsj.com/articles/elon-musks-spacex-riles-its-rivals-for-broadband-subsidies-11612108801.
[180] Public Notice: Rural Digital Opportunity Fund Phase I Auction (Auction 904) Closes; Winning Bidders Announced; FCC Form 683 Due January 29, 2021, Federal Communications Commission (Dec. 7, 2020), available at https://docs.fcc.gov/public/attachments/DA-20-1422A1.pdf.
[181] Morgan Stanley, supra note 173.
[182] The Economist, It’s time to tidy up space, The Economist (Jan. 16, 2021), available at https://www.economist.com/leaders/2021/01/14/its-time-to-tidy-up-space.
[183] Morgan Stanley, supra note 173.
[184] Space: Investing in the Final Frontier | Morgan Stanley, Morgan Stanley (July 24, 2020), available at https://www.morganstanley.com/ideas/investing-in-space.
[185] Jeffrey Kluger, The Biden Presidency Could Fundamentally Change the U.S. Space Program, Time (Jan. 29, 2021), available at https://time.com/5933447/biden-space-nasa/.
[186] Sec’y of the Air Force Public Affairs, With the Stroke of a Pen, U.S. Space Force Becomes a Reality (Dec. 20, 2019), available at https://www.spaceforce.mil/News/Article/2046055/with-the-stroke-of-a-pen-us-space-force-becomes-a-reality.
[187] National Defense Authorization Act for Fiscal Year 2020, S. 1790, 116th Cong. § 952 b(4) (as passed by Senate, June 27, 2019), available at https://www.congress.gov/116/bills/s1790/BILLS-116s1790enr.pdf.
[188] Rebecca Kheel, Space Force Expected To Live On Past Trump Era, The Hill (Dec. 19, 2021), available at https://thehill.com/policy/technology/530936-space-force-expected-to-live-on-past-trump-era.
[189] Reuters, Biden Decides to Stick with Space Force as Branch of U.S. Military, Reuters (Feb. 3, 2021), available at https://www.reuters.com/article/us-usa-biden-spaceforce/biden-decides-to-stick-with-space-force-as-branch-of-u-s-military-idUSKBN2A32Z6.
[190] Sandra Erwin, Raymond: Space Force ‘Not a Political Issue’, Space News (Mar. 3, 2021), available at https://spacenews.com/raymond-space-force-not-a-political-issue/.
[192] Christian Davenport, The Biden Administration Has Set Out To Dismantle Trump’s Legacy, Except In One Area: Space, The Washington Post (Mar. 2, 2021), available at https://www.washingtonpost.com/technology/2021/03/02/biden-space-artemis-moon-trump/.
[193] Marcia Smith, Biden Administration “Certainly” Supports Artemis Program, Space Policy Online (Feb. 4, 2021), available at https://spacepolicyonline.com/news/biden-administration-certainly-supports-artemis-program/.
[195] Lia Rovira, How Will the U.S. Space Program Fare Under Joe Biden?, EarthSky, (Jan. 10, 2021), available at https://earthsky.org/human-world/how-will-the-u-s-space-program-fare-under-joe-biden.
The following Gibson Dunn lawyers assisted in preparing this client update: Dhananjay Manthripragda, Jared Greenberg, Lindsay Paulin, Sarah Ediger, Macey Olave, Andrew Blythe, Jacob Rierson, Sarah Scharf, Casper Yen, Alayna Monroe, Zak Baron, and Christopher Wang.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding the issues discussed above. Please contact the Gibson Dunn lawyer with whom you usually work, any of the following in the Aerospace and Related Technologies practice group:
Los Angeles
William J. Peters (+1 213-229-7515, wpeters@gibsondunn.com)
David A. Battaglia (+1 213-229-7380, dbattaglia@gibsondunn.com)
Perlette M. Jura (+1 213-229-7121, pjura@gibsondunn.com)
Dhananjay S. Manthripragada (+1 213-229-7366, dmanthripragada@gibsondunn.com)
Denver
Jared Greenberg (+1 303-298-5707, jgreenberg@gibsondunn.com)
Washington, D.C.
Lindsay M. Paulin (+1 202-887-3701, lpaulin@gibsondunn.com)
Christopher T. Timura (+1 202-887-3690, ctimura@gibsondunn.com)
New York
David M. Wilf – Chair (+1 212-351-4027, dwilf@gibsondunn.com)
London
Mitri J. Najjar (+44 (0)20 7071 4262, mnajjar@gibsondunn.com)
Paris
Ahmed Baladi (+33 (0)1 56 43 13 00, abaladi@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.
Each month, Gibson Dunn’s Media, Entertainment and Technology Practice Group highlights notable developments and rulings that may impact future litigation in this area. This month we focus on the increasingly popular digital asset known as non-fungible tokens or “NFTs” and related issues in the entertainment space and beyond.
Issue: Non-Fungible Tokens (NFTs)
Summary: NFTs have gone mainstream in what some have called a new “gold rush.” An NFT sold for almost $70 million at a Christie’s auction last month, NFTs of basketball video highlights have generated hundreds of millions of dollars in sales on the NBA Top Shot platform, and NFTs even were the subject of a skit on a recent episode of Saturday Night Live. Some consider them a fad or a bubble, citing the almost $600,000 sale of an image of an animated flying cat with a pop-tart body that anyone can download from the internet for free. But in one form or another, NFTs are here to stay. Even if the market matures and interest wanes in some unconventional pieces of digital art, NFTs will continue to offer a significant potential revenue stream for artists and entities in the film and television, music, and online gaming industries, among many others. We highlight below some of the emerging legal and policy issues related to NFTs, which include intellectual property law, profit participation issues, securities law, and even climate change.
What do the music group Megadeth, former University of Iowa basketball player Luka Garza, and New York City track and field center The Armory have in common? In the span of 24 hours earlier this month, each of them entered the rapidly expanding NFT market. They joined a number of artists and entertainers who have led the charge in selling NFTs. As film studios and other entities with large content libraries consider following suit, they will need to consider a number of deeply rooted legal issues against a relatively new technological backdrop.
I. Background
There are widely varied understandings of NFTs and related issues concerning tokens and blockchain technology. While many of our readers are familiar with these terms, a brief introduction is helpful to frame the issues that follow.
A. What are NFTs and What is the Blockchain?
An NFT, or “non-fungible token,” is a unique unit of data stored on a public ledger of transactions called a blockchain. The unique data could represent an image, an electronic deed to a piece of property, or a digital ticket for a particular seat at a sporting event. In contrast to these “non-fungible” tokens, cryptocurrencies such as Bitcoin and Ether—just like U.S. dollars, British pounds and other “fiat” government-issued currencies—are fungible; one penny in your pocket has the same intrinsic value as the penny under your couch cushion.
Today, NFTs generally reside on the Ethereum blockchain, which also supports, among other things, the cryptocurrency Ether—the second largest cryptocurrency in terms of market capitalization and volume after Bitcoin. While other blockchains can have their own versions of NFTs, right now Ethereum is the most widely used (though NBA Top Shot uses the Flow blockchain).
But what is a blockchain? As noted above, it is an electronic database or ledger showing a history of transactions. Each transaction is represented by an entry into the electronic ledger and multiple ledger entries are ordered in data batches known as “blocks” to await verification on the network. New blocks are added after the current block reaches its data limit. The blocks are connected using cryptography: each block contains a “hash” (a sort of coded electronic signature linking it to the previous block), which is how the blockchain gets its name.
A key feature of the Ethereum blockchain that distinguishes it from a database one might have at a business or law firm is that the blockchain is decentralized across a community of servers. Data is not stored in any one location or managed by any particular body. Rather, it exists on multiple computers simultaneously, with network participants holding identical copies of the ledger reflecting the encrypted transactions.
That is why blockchains are touted as both verifiable and secure. It is similar to the tracking details showing each step in a package’s journey from the shipper to its final delivery destination. Unlike the tracking details provided by a shipping company, however, on the blockchain no one person can alter that record to change the encrypted data without the network’s users noticing and rejecting the fraudulent version. And if any one computer system fails, there are duplicate images of the tracking details on the blockchain ledger available on other computers around the world.
B. What Do You Get When You Buy An NFT?
While an NFT is unique, it is important to keep in mind what that unique digital item actually is. In most cases the NFT is a digital identifier recording ownership, not—to borrow an example from the above—the actual image of the pop-tart cat. What amounts to your “receipt” is reflected in the blockchain, but the image file itself resides elsewhere.
This has to do with blockchain storage limitations and costs. The digital image itself theoretically can be stored in metadata on the blockchain, but in the vast majority of cases it is hosted on a regular website or the decentralized InterPlanetary File System (IPFS). The identifier is logged on the blockchain, but if the image is taken down from its non-blockchain location—say, because it violates someone’s copyright—the NFT could end up being a unique digital path to a closed door (even if there may be seemingly identical “copies” of the digital asset elsewhere). The immutable purchase record would remain on the blockchain, but the original image might not be viewable.
Almost uniformly, the NFT transfer conveys an interest in a licensed copy while copyright ownership of the underlying image or song is not transferred. The NFT may be in a limited edition and it may have some additional perceived value because it is officially authorized by the copyright holder or originated from the address of the copyright holder. But while the underlying copyright can be transferred when the NFT is sold or licensed, typically it isn’t. The terms and conditions of an NFT platform may reveal the limits of what actually is being transferred and how it might be used.
Under NBA Top Shot’s terms, for example, the purchaser who obtains a license to a “Moment” cannot use it for a commercial purpose, modify it, or use the image alongside anything the NBA considers offensive or hateful. An NFT platform that controls the image file is able to remove that file from its platform.
* * *
Monetization strategies for NFTs are constantly evolving, so one cannot generalize and say that all NFTs fall in one legal bucket or another. An NFT can be fair use of a copyright or it can violate it. An NFT likewise could be a simple collectible or it may be offered in such a way to convert it into a security subject to myriad regulations and disclosure requirements. It depends on the NFT. But as the market evolves, complicated questions will need to be answered by NFT creators, platforms, and, potentially, courts.
II. Intellectual Property
Any NFT platform must be particularly focused on the intellectual property rights underlying the NFTs stored, sold, or licensed on the platform. A single NFT may include various copyrightable elements, including a video clip and any accompanying music. Whereas the platform may be able to invoke a statutory liability protection with respect to some potential claims—like defamation—certain intellectual property claims are not precluded.
Specifically, Section 230 of the Communications Decency Act of 1996 shields certain online service providers from liability for hosting content that someone else created. In particular, Section 230(c)(1) states that “No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.”
To the extent Section 230 applies to a particular NFT platform, the law’s broad protection still has carve-outs. Among other things, it does not apply to “any law pertaining to intellectual property.” Courts have different interpretations of the scope of Section 230’s reference to “intellectual property.” In Perfect 10 v. CCBill, 488 F.3d 1102 (9th Cir. 2007), the Ninth Circuit ruled that Section 230 permitted claims under federal intellectual property laws but preempted state intellectual property claims alleging a violation of the plaintiff’s right of publicity. In Atlantic Recording Corp. v. Project Playlist, Inc., 603 F. Supp. 2d 690 (S.D.N.Y. 2009), a Southern District of New York court reached the opposite conclusion, holding that the “intellectual property” carve-out extended beyond intellectual property claims under federal law to include state-law claims.
Whether or not an NFT platform would be subject to potential liability for violating someone’s state-law right in her or his name and likeness, federal intellectual property law still would apply. And offering an NFT that potentially infringes a copyright could result in liability for the platform if, for example, it does not take the necessary steps under the Digital Millennium Copyright Act. That risk is heightened for some platforms given how easy it is to tokenize someone else’s work. Speculators can turn any digital image into an NFT that they can then try to sell, even if the original creator does not agree to that use or even know about it.
Studios and other intellectual property rights holders will need to be especially vigilant in protecting their intellectual property—and NFT platforms likewise will need to promptly remove content if a copyright owner notifies it of an infringement—as the market for small pieces of content expands.
III. Profit Participations
Especially in the current NFT environment, it is not difficult to imagine the potential value of tokenized iconic moments from movies and television. Of course, there would be a number of contractual issues for a rightsholder to navigate, which would vary from deal to deal. Valuable clips might come from movies dating back long before the advent of NFTs, the internet, or even computers. The relevant agreements certainly would not address NFTs, but even analogous provisions might be difficult to identify. Agreements may refer to “clips,” for example, but typically a clip is used to promote the full program or film rather than to be monetized on its own.
Depending on what it depicts, an NFT might not be a “clip” at all. Again using NBA Top Shot as an example, a “Moment” is not just a short video excerpt showing a pass or dunk; it is a package of on-court video, still photographs, digital artwork, and game information. Contracts would need to be analyzed to determine if the NFT should be categorized as a clip, a derivative production, merchandising, promotional material, or something else, with potential consequences on the calculation of gross receipts and any corresponding rights to profit participations or Guild royalties.
Exclusivity provisions in film or television licenses to third parties might bar or limit a studio from “minting” an NFT from a work in its library. Other considerations might also limit a rightsholder’s willingness to enter the NFT space. With vast libraries of well-known and high‑quality content, however, studios are better positioned than most to take advantage of the increased interest and marketability of discrete portions of a film or program.
IV. Securities Law
Particularly in light of the SEC’s increased focus on cryptocurrencies, including its recent lawsuit accusing Ripple Labs Inc. and two of its executives of engaging in an unregistered “digital asset securities offering,” anyone involved in marketing an NFT should give careful consideration to whether the NFT is a security under U.S. law.
This should be of particular concern to the celebrities marketing their own NFTs. Several years ago, in response to celebrity endorsements for cryptocurrency Initial Coin Offerings (ICOs), the SEC warned that “[a]ny celebrity or other individual who promotes a virtual token or coin that is a security must disclose the nature, scope, and amount of compensation received in exchange for the promotion.”[1] A failure to do so would be “a violation of the anti-touting provisions of the federal securities laws.”[2] The same principle would apply to NFTs, with the key question being whether an NFT is a security. This issue has significant bearing on the NFT platform as well. If an NFT is a security, the offeror must follow securities law disclosure requirements and restrictions on who may invest.
The term “security” in U.S. securities laws includes an “investment contract” as well as other instruments like stocks and bonds. Both the SEC and federal courts often use the “investment contract” analysis to determine whether unique instruments, such as digital assets, are securities subject to federal securities laws.
To determine whether a digital asset has the characteristics of an investment contract, courts apply a test derived from the U.S. Supreme Court’s decision in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Under that Howey test, federal securities laws apply where
- there is an investment of money or some other consideration,
- in a common enterprise,
- with a reasonable expectation of profits,
- to be derived from the efforts of others.
Again, it would depend on the NFT, but transactions that resemble a fan buying a collectible likely would not be securities under this test. The notion that an NFT is non-fungible also makes it less likely to be a security.
Nevertheless, the NFT market is a creative one. Many NFTs, for example, are configured through the “smart contracts”—which are essentially computer programs—to automatically pay out royalties to the digital artwork’s original creator with every future sale of the NFT on that platform; the artist could package those royalty rights for sale to potential investors.
NFT issuers also can sell fractional interests in NFTs or groups of NFTs. As prices for some NFTs climb into the stratosphere, this approach becomes more appealing to potential buyers who want a piece of the NFT but are unwilling or unable to pay for the whole thing. According to recent statements by SEC Commissioner Hester Peirce, however, doing so increases the likelihood that the NFT would be deemed a security under the Howey test.[3] That likelihood grows where the NFT issuer or a third party claim to be able to help increase the NFT’s value.
V. Climate Change
A major issue that has arisen related to NFTs— and cryptocurrency generally—is their believed effect on the environment. Articles abound comparing the energy consumption of the Ethereum blockchain to entire countries. An analysis by Cambridge University asserts that what it calls the “Bitcoin network” uses more energy than Argentina.[4] NFTs thus have proven somewhat controversial, with one online marketplace for digital artists dropping its plans to launch an NFT platform after backlash that included an artist labeling NFTs an “ecological nightmare pyramid scheme.”[5]
Some contend that these ecological concerns are exaggerated and misleading, noting that NFTs themselves do not cause carbon emissions. As one platform wrote in a recent blog post, “Ethereum has a fixed energy consumption at a given point of time.”[6] The carbon footprint of the Ethereum blockchain would be the same if people minted more NFTs or stopped minting them altogether. But even the post acknowledges that “[i]t is true that Ethereum is energy intensive.”[7]
The crypto energy consumption issue relates to how blockchain technology currently operates. To validate a transaction—and engender trust in a system that is not backed by any central bank or other government authority—the blockchain network relies on a method called “Proof of Work.” The hashing function described above that allows the blocks to be chained together requires complex mathematical equations that only powerful computers can solve. “Miners” must solve these equations to add a new block to the chain. As incentive to solve the mathematical puzzles, the miner receives a reward of new tokens or transaction fees.
The energy costs to complete the hash functions under the Proof of Work model can be high, with miners using entire data centers to compete to solve the puzzles first and garner the reward. To mitigate any environmental effects, mining sites may increasingly rely on renewable energy and “stranded” energy, which is surplus energy created, for example, by excess power that some hyrdroelectric dams around the world generate during rainy seasons.
Another option, at least for the Ethereum blockchain, is moving to a “Proof of Stake” model. Rather than relying on miners using significant amounts of electricity in a race to solve an equation the fastest, the Proof of Stake model involves validators of transactions who are assigned randomly via an algorithm. These validators also have to commit some of their own cryptocurrency, giving them a “stake” in keeping the blockchain accurate.
Reports indicate that Ethereum may move to the Proof of Stake model as soon as this year.[8] Doing so would decrease energy consumption associated with NFTs, allow more transactions per second than in the Proof of Work model, and seemingly remove (or at least mitigate) an apparent drag on the willingness of some to embrace NFTs.
At the same time, one recent article noted what a crypto-mining finance company executive called the “‘inherent security issue of using the native tokens of a blockchain to decide the future of those tokens or the blockchain.’”[9] If the value of the tokens fall, the value of a validator’s stake falls along with it. The validator then has less to lose if they decide to propose an incorrect transaction or otherwise misbehave.
VI. Conclusion
NFTs present significant opportunities for content creators and owners, but they also present novel legal and policy issues across a wide range of areas as the technology continues to evolve. Beyond those listed here, areas of potential concern include Commodities/Derivatives, Tax, Data Privacy, and Cross-Border Transactions. Understanding the potential complications of moving into the NFT space is a necessity in anticipation of the regulatory scrutiny and litigation that often follow similar explosions of interest and investment.
_______________________
[1] https://www.sec.gov/news/public-statement/statement-potentially-unlawful-promotion-icos (Nov. 1, 2017).
[2] Id.
[3] https://cointelegraph.com/news/sec-s-crypto-mom-warns-selling-fractionalized-nfts-could-break-the-law (Mar. 26, 2021).
[4] https://www.bbc.com/news/technology-56012952 (Feb. 10, 2021).
[5] https://www.theverge.com/2021/3/15/22328203/nft-cryptoart-ethereum-blockchain-climate-change (Mar. 15, 2021).
[6] https://medium.com/superrare/no-cryptoartists-arent-harming-the-planet-43182f72fc61 (Mar. 2, 2021).
[7] Id.
[8] https://www.coindesk.com/ethereum-proof-of-stake-sooner-than-you-think (Mar. 17, 2021).
[9] https://cryptonews.com/exclusives/proof-of-disagreement-bitcoin-s-work-vs-ethereum-s-planned-s-9788.htm (Apr. 3, 2021).
The following Gibson Dunn lawyers assisted in the preparation of this client update: Michael Dore and Jeffrey Steiner.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or the following leaders and members of the firm’s Media, Entertainment & Technology Practice Group:
Scott A. Edelman – Co-Chair, Media, Entertainment & Technology Practice, Los Angeles (+1 310-557-8061, sedelman@gibsondunn.com)
Kevin Masuda – Co-Chair, Media, Entertainment & Technology Practice, Los Angeles (+1 213-229-7872, kmasuda@gibsondunn.com)
Orin Snyder – Co-Chair, Media, Entertainment & Technology Practice, New York (+1 212-351-2400, osnyder@gibsondunn.com)
Brian C. Ascher – New York (+1 212-351-3989, bascher@gibsondunn.com)
Michael H. Dore – Los Angeles (+1 213-229-7652, mdore@gibsondunn.com)
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Ilissa Samplin – Los Angeles (+1 213-229-7354, isamplin@gibsondunn.com)
Nathaniel L. Bach – Los Angeles (+1 213-229-7241,nbach@gibsondunn.com)
Please also feel free to contact the following members of the firm’s Digital Currencies and Blockchain Technology team:
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Judith Alison Lee – Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Alexander H. Southwell – New York (+1 212-351-3981, asouthwell@gibsondunn.com)
S. Ashlie Beringer – Palo Alto (+1 650-849-5327, aberinger@gibsondunn.com)
Michael H. Dore – Los Angeles (+1 213-229-7652, mdore@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 April 15, 2021, the United States announced a significant expansion of sanctions on Russia, including new restrictions on the ability of U.S. financial institutions to deal in Russian sovereign debt and the designation of more than 40 individuals and entities for supporting the Kremlin’s malign activities abroad. As part of a sprawling package of measures, the Biden administration imposed sectoral sanctions on some of Russia’s most economically consequential institutions—including the country’s central bank, finance ministry, and sovereign wealth fund. The administration also blacklisted an array of individuals and entities implicated in Russia’s annexation of Crimea, foreign election interference, and the SolarWinds cyberattack. Most of the sanctions authorities included in newly issued Executive Order (“E.O.”) 14024 were already in force across a range of earlier Executive Orders and actions promulgated to respond to Russia’s initial incursion into Crimea in 2014, Moscow’s malicious cyber activities, election interference, chemical weapons attacks, and human rights abuses. This new initiative, however, suggests that the Biden administration is prepared to move aggressively to deter Moscow from further engaging in destabilizing activities. Moreover, we assess that this new initiative by the Biden administration is designed, at least in part, to elicit multilateral support, principally from the United Kingdom and the European Union. Whether Washington’s transatlantic allies take up the call (London is apparently poised to follow soon) and whether these measures ultimately change Russia’s behavior remains to be seen. In the meantime, the already frosty relationship between the West and Moscow appears likely to further deteriorate, which could have significant repercussions for multinational companies active in both jurisdictions.
Executive Order 14024
E.O. 14024 authorizes blocking sanctions against, among others, (1) persons determined to operate in certain sectors of the Russian economy; (2) those determined to be responsible for or complicit in certain activities on behalf of the Russian Government such as malicious cyber activities, foreign election interference, and transnational corruption; (3) Russian Government officials; and (4) Russian Government political subdivisions, agencies, and instrumentalities. As noted above, many of these bases for designation already exist under earlier Executive Orders. The duplication of these authorities suggests that the Biden administration may be looking both to put its own stamp on U.S. sanctions policy and to have a single, consolidated sanctions tool that it can use to target the full range of Russian malign behavior. E.O. 14024 also expands upon some of those earlier authorities, for example, by authorizing the imposition of sanctions against the spouse and adult children of individuals sanctioned pursuant to the new E.O. This is a somewhat uncommon provision apparently designed to prevent sanctions evasion by those who may seek to shift assets to close relatives—a strategy that the United States has seen in its implementation and enforcement of Russian sanctions, especially with respect to oligarchs.
Restrictions on Russian Sovereign Debt
While the 46 individual and entity designations (discussed more fully below) are potentially impactful on the specific parties targeted, the most systemically important component of E.O. 14024 comes in the form of a new Directive issued by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”). Such directives have in the past only been issued in the context of sectoral sanctions imposed against Russia. This latest Directive prohibits U.S. financial institutions, as of June 14, 2021, from either (1) participating in the primary market for “new” ruble and non-ruble denominated bonds issued by the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation (Russia’s principal sovereign wealth fund), or the Ministry of Finance of the Russian Federation, or (2) lending ruble or non-ruble denominated funds to those three entities. Modeled on earlier sectoral sanctions targeting major actors in Russia’s financial services, energy, defense, and oil sectors, the new Directive prohibits U.S. financial institutions from engaging only in certain narrow categories of transactions involving the targeted entities. Absent some other prohibition, U.S. banks may continue engaging in all other lawful dealings with the named entities. This reflects the delicate balance that President Biden and earlier administrations have attempted to strike by imposing meaningful consequences on large, globally significant actors without at the same time roiling global markets or imposing unpalatable collateral consequences on U.S. allies. Notably, the Biden administration stopped far short of more draconian measures such as blacklisting Russia’s sovereign wealth fund, or the Russian Government itself (as the Trump administration did in Venezuela).
The sectoral sanctions on Russia’s central bank, sovereign wealth fund, and finance ministry are further circumscribed in several key respects. First, they do not become effective until 60 days after the issuance of the Directive. Second, they are one of the rare instances in which OFAC’s Fifty Percent Rule does not apply, meaning that the Directive’s restrictions extend only to bonds issued by, and loans made to, the three named Russian Government entities and not to any other entities in which they may own a direct or indirect majority interest. Third, the Directive also does not prohibit U.S. financial institutions from participating in the secondary market for Russian sovereign bonds—a potentially wide loophole under which U.S. banks may continue to purchase such debt, just not directly from the three targeted entities. This is a loophole that could be significantly closed if the United Kingdom and European Union adopted similar measures—further supporting our assessment that the administration designed these restrictions in part to be imposed alongside similar restrictions promulgated by London and Brussels.
Particularly in light of existing restrictions on U.S. banks’ ability to participate in the primary market for non-ruble denominated Russian sovereign bonds, and from lending non-ruble denominated funds to the Russian sovereign, the Directive’s main significance is that it will make it more difficult for the Russian Government, starting on June 14, 2021, to borrow new funds in local currency. From a policy perspective, the Directive therefore appears calculated to further restrict potential sources of financing for the Russian state—in effect, penalizing the Kremlin by driving up its borrowing costs. Such a seemingly narrow expansion of restricted activities also leaves room to further strengthen measures if the Kremlin’s malign activities continue.
Sanctions Targeting Russia’s Other Troubling Activities
In addition to imposing restrictions on Russian sovereign debt, the Biden administration also designated dozens of individuals and entities to OFAC’s Specially Designated Nationals and Blocked Persons (“SDN”) List for their involvement in Russia’s destabilizing operations abroad. As a result of these designations, U.S. persons are generally prohibited from engaging in transactions involving the targeted individuals and entities and any property and interests in property of the targeted persons that come within U.S. jurisdiction are frozen. Underscoring the scope of the Biden administration’s concerns, these sanctions designations target an accumulation of Russian activities during the preceding months, including efforts to cement Russian control of the Crimea region of Ukraine, foreign election interference, and the SolarWinds cyberattack.
Among those targeted were eight individuals and entities involved in Russia’s annexation of Crimea. In particular, OFAC designated various persons involved in constructing the Kerch Strait Bridge, which connects the Crimean peninsula by rail to the Russian mainland. These designations also targeted Russian and local government officials for attempting to exercise control over Crimea, as well as a detention facility in the Crimean city of Simferopol that has been implicated in human rights abuses. Through these actions—which come amid reports of Russian troops massing on the eastern Ukrainian border—the United States appears to be signaling its continuing commitment to the territorial integrity of Ukraine.
In a second batch of designations, OFAC added a further 32 individuals and entities to the SDN List for attempting to influence democratic elections in the United States and Africa at the behest of the Russian state. Notably, these designations include a network of Russian intelligence-linked websites that allegedly engaged in a campaign of disinformation and election interference. OFAC also targeted associates and enablers of Yevgeniy Prigozhin, the principal financial backer of the Russia-based Internet Research Agency, as well as the Russian political consultant Konstantin Kilimnik. This set of sanctions targets not only Russian actors engaged in disinformation on behalf of the Russian government, but also those that facilitate this harmful behavior—adding a new layer of accountability to the extensive disinformation-related sanctions put in place over the last five years.
Finally, the Biden administration announced a long-awaited group of designations targeting six companies in the Russian technology sector in response to last year’s high-profile SolarWinds cyberattack on government and private networks—which the United States for the first time definitively attributed to Russia’s intelligence services. These technology companies, which were the first to be designated pursuant to E.O. 14024, were targeted because they are funded and operated by the Russian Ministry of Defense and allegedly helped research and develop malicious cyber operations for Russia’s three main intelligence agencies.
Taken together, these actions targeting a broad spectrum of disruptive activities beyond Russia’s borders mark a significant escalation of U.S. pressure on Moscow. U.S. Secretary of the Treasury Janet Yellen in a statement described the measures as “the start of a new U.S. campaign against Russian malign behavior,” implying that additional designations may be on the horizon. For example, a fresh round of sanctions could soon be announced if further harm were to come to the jailed Russian dissident Alexey Navalny.
Next Steps Between Washington and Moscow
This week’s wide-ranging sanctions on Moscow suggest that President Biden is likely to continue using sanctions and other instruments of economic coercion to deter and impose costs on the Kremlin. As for what this latest development means for foreign investors and multinational companies, the answer depends in part on how Russia ultimately responds. By reportedly holding out the possibility of a U.S.-Russia summit in a recent call with Russia’s President Vladimir Putin, as well as refraining from imposing more biting sanctions, President Biden appears to have left open the possibility of limited retaliation by Russia and an eventual de-escalation of tensions between Washington and Moscow. The Kremlin’s public response so far has been muted, including the expulsion of a handful of U.S. diplomats and the imposition of sanctions against eight senior U.S. officials. However, if Russia were to respond more forcefully—such as by launching an incursion further into Ukraine or through renewed cyberattacks against the United States and allied nations—the imposition of more severe sanctions barring U.S. persons from participating in the secondary market for Russian bonds or the designation of a major enterprise in the country’s energy sector could occur. At a minimum, the sanctions announced this past week are likely to further increase the risks, and the yield, associated with new issuance of Russian sovereign debt—marking the beginning of a new chapter in U.S. Government efforts to change the Russian Government’s behavior, or at least impose significant costs if the Kremlin refuses to alter course.
The following Gibson Dunn lawyers assisted in preparing this client update: Scott Toussaint, Judith Alison Lee, Adam Smith, Stephanie Connor, Christopher Timura and Laura Cole.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s International Trade practice group:
United States:
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Jose W. Fernandez – New York (+1 212-351-2376, jfernandez@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, sconnor@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Laura R. Cole – Washington, D.C. (+1 202-887-3787, lcole@gibsondunn.com)
R.L. Pratt – Washington, D.C. (+1 202-887-3785, rpratt@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)
Asia:
Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com)
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Beijing – (+86 10 6502 8534, qyue@gibsondunn.com)
Europe:
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Nicolas Autet – Paris (+33 1 56 43 13 00, nautet@gibsondunn.com)
Susy Bullock – London (+44 (0)20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris – London (+44 (0)207 071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly – London (+44 20 7071 4205, sharber-kelly@gibsondunn.com)
Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com)
Steve Melrose – London (+44 (0)20 7071 4219, smelrose@gibsondunn.com)
Matt Aleksic – London (+44 (0)20 7071 4042, maleksic@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com)
Richard W. Roeder – Munich (+49 89 189 33-160, rroeder@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.
Protecting First Amendment rights has long been a hallmark of Gibson Dunn’s practice. In particular, we have vigilantly defended freedom of the press and its indispensable role in a healthy democracy. On this episode of the podcast, Ted Boutrous and Ted Olson discuss some of the most important and interesting First Amendment cases they’ve worked on.
Previous Episode | Next Episode
All episodes of The Two Teds are available on GibsonDunn.com and wherever you listen to podcasts. You can also subscribe to be notified of new episodes via e-mail.
HOSTS:
Ted Boutrous – Theodore J. Boutrous, Jr., a partner in the Los Angeles office of Gibson, Dunn & Crutcher LLP, is global Co-Chair of the firm’s Litigation Group and previously led the firm’s Appellate, Crisis Management, Transnational Litigation and Media groups. He also is a member of the firm’s Executive and Management Committees. Recognized for a decade of excellence in the legal profession, the Daily Journal in 2021 named Mr. Boutrous as a Top Lawyer of the Decade for his victories. As a tireless advocate and leader for high-stakes and high-profile cases, Mr. Boutrous was also named the 2019 “Litigator of the Year, Grand Prize Winner” by The American Lawyer.
Ted Olson – Theodore B. Olson is a Partner in Gibson, Dunn & Crutcher’s Washington, D.C. office; a founder of the Firm’s Crisis Management, Sports Law, and Appellate and Constitutional Law Practice Groups. Mr. Olson was Solicitor General of the United States during the period 2001-2004. From 1981-1984, he was Assistant Attorney General in charge of the Office of Legal Counsel in the U.S. Department of Justice. Except for those two intervals, he has been a lawyer with Gibson, Dunn & Crutcher in Los Angeles and Washington, D.C. since 1965.
On April 6, 2021, New York Governor Andrew Cuomo signed into law Senate Bill 297B/Assembly Bill 164B (the “New York LIBOR Legislation”), the long anticipated New York State legislation addressing the cessation of U.S. Dollar (“USD”) LIBOR.[1] The New York LIBOR Legislation generally tracks the legislation proposed by the Alternative Reference Rates Committee (“ARRC”).[2] It provides a statutory remedy for so-called “tough legacy contracts,” i.e., contracts that reference USD LIBOR as a benchmark interest rate but do not include effective fallback provisions in the event USD LIBOR is no longer published or is no longer representative, and that will remain in existence beyond June 30, 2023 in the case of the overnight, 1 month, 3 month, 6 month and 12 month tenors, or beyond December 31, 2021 in the case of the 1 week and 2 month tenors.[3]
Under the new law, if a contract governed by New York law (1) references USD LIBOR as a benchmark interest rate and (2) does not contain benchmark fallback provisions, or contains benchmark fallback provisions that would cause the benchmark rate to fall back to a rate that would continue to be based on USD LIBOR, then on the date USD LIBOR permanently ceases to be published, or is announced to no longer be representative, USD LIBOR will be deemed by operation of law to be replaced by the “recommended benchmark replacement.” The New York LIBOR Legislation provides that the “recommended benchmark replacement” shall be based on the Secured Overnight Financing Rate (“SOFR”) and shall have been selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or the ARRC for the applicable type of contract, security or instrument. The recommended benchmark replacement will include any applicable spread adjustment[4] and any conforming changes selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or the ARRC.
The New York LIBOR Legislation also establishes a safe harbor from liability for the selection and use of a recommended benchmark replacement and further provides that a party to a contract shall be prohibited from declaring a breach or refusing to perform as a result of another party’s selection or use of a recommended benchmark replacement.
It should be noted that the New York LIBOR Legislation does not affect contracts governed by jurisdictions other than New York, and that the parties to a contract governed by New York law remain free to agree to a fallback rate that is not based on USD LIBOR or SOFR; the new law does not override a fallback to a non-USD LIBOR based rate (e.g., the Prime rate) agreed to by the parties to a contract. Although this legislation provides crucial safeguards, it should not be viewed as a substitute for amending legacy USD LIBOR contracts where possible. Rather, it should be viewed as a backstop in the event that counterparties are unwilling or unable to agree to adequate fallback language prior to the cessation date or date of non-representativeness.
The ARRC, the Federal Reserve Board and several industry associations and groups have expressed their strong support for the new law.[5]
__________________
[1] See https://www.nysenate.gov/legislation/bills/2021/S297.
[2] See https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/libor-legislation-with-technical-amendments.
[3] We note that certain contracts, such as derivatives entered into under International Swaps and Derivatives Association (ISDA) standard documentation, provide for linear interpolation of the 1 week and 2 month USD LIBOR tenors until USD LIBOR ceases to exist for all tenors on June 30, 2023. The New York LIBOR Legislation provides that if the first fallback in a contract is linear interpolation, then, for the 1 week or 2 month tenor USD LIBOR contracts, the parties to the contract would continue to use linear interpolation for the period between December 31, 2021 and June 30, 2023. See the definition of “LIBOR Discontinuance Event” and “LIBOR Replacement Date” in the New York LIBOR Legislation.
[4] Note that the ICE Benchmark Administration Limited and the UK Financial Conduct Authority formally announced LIBOR cessation and non-representative dates for USD LIBOR on March 5, 2021. These announcements fixed the spread adjustment contemplated under certain industry-standard documents. See Gibson Dunn’s Client Alert: The End Is Near: LIBOR Cessation Dates Formally Announced, available at https://www.gibsondunn.com/the-end-is-near-libor-cessation-dates-formally-announced/.
[5] See “ARRC Welcomes Passage of LIBOR Legislation by the New York State Legislature,” ARRC (March 24, 2021, available at https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/20210324-arrc-press-release-passage-of-libor-legislation; see also, Randall Quarles, Keynote Address at the “The SOFR Symposium: The Final Year,” an event hosted by the Alternative Reference Rates Committee, New York, New York (March 22, 2021), available at https://www.federalreserve.gov/newsevents/speech/quarles20210322a.htm.
Gibson Dunn’s lawyers are available to answer questions about the LIBOR transition in general and these developments in particular. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Capital Markets, Derivatives, Financial Institutions, Global Finance or Tax practice groups, or the following authors of this client alert:
Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com)
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)
John J. McDonnell – New York (+1 212-351-4004, jmcdonnell@gibsondunn.com)
Please also feel free to contact the following practice leaders and members:
Capital Markets Group:
Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com)
Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com)
Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com)
Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com)
Derivatives Group:
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)
Darius Mehraban – New York (+1 212-351-2428, dmehraban@gibsondunn.com)
Erica N. Cushing – Denver (+1 303-298-5711, ecushing@gibsondunn.com)
Financial Institutions Group:
Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, mkirschner@gibsondunn.com)
Global Finance Group:
Aaron F. Adams – New York (+1 212 351 2494, afadams@gibsondunn.com)
Linda L. Curtis – Los Angeles (+1 213 229 7582, lcurtis@gibsondunn.com)
Ben Myers – London (+44 (0) 20 7071 4277, bmyers@gibsondunn.com)
Michael Nicklin – Hong Kong (+852 2214 3809, mnicklin@gibsondunn.com)
Jamie Thomas – Singapore (+65 6507 3609, jthomas@gibsondunn.com)
Tax Group:
Sandy Bhogal – London (+44 (0) 20 7071 4266, sbhogal@gibsondunn.com)
Benjamin Fryer – London (+44 (0) 20 7071 4232, bfryer@gibsondunn.com)
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224/+1 212-351-2344), jtrinklein@gibsondunn.com)
Bridget English – London (+44 (0) 20 7071 4228, benglish@gibsondunn.com)
Alex Marcellesi – New York (+1 212-351-6222, amarcellesi@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 summarizes key petitions for certiorari in cases originating in the Federal Circuit, addresses the Federal Circuit’s announcement that Judge Wallach will be taking senior status and the court’s updated Rules of Practice, and discusses recent Federal Circuit decisions concerning issue preclusion, Section 101, appellate procedure for PTAB appeals, and the latest mandamus petitions on motions to transfer from the Western District of Texas.
Federal Circuit News
Supreme Court:
Today, the Court decided Google LLC v. Oracle America, Inc. (U.S. No. 18-956). In a 6-2 decision, the Court held that because Google “reimplemented” a user interface, “taking only what was needed to allow users to put their accrued talents to work in a new and transformative program,” Google’s copying of the Java API was a fair use of that material as a matter of law. The Court did not decide the question whether the Copyright Act protects software interfaces. “Given the rapidly changing technological, economic, and business-related circumstances,” the Court explained, “[the Court] should not answer more than is necessary to resolve the parties’ dispute.” The Court therefore assumed, “purely for argument’s sake,” that the Java interface is protected by copyright.
This month, the Supreme Court did not add any new cases originating at the Federal Circuit. As we summarized in our January and February updates, the Court has two such cases pending: United States v. Arthrex, Inc. (U.S. Nos. 19-1434, 19-1452, 19-1458); and Minerva Surgical Inc. v. Hologic Inc. (U.S. No. 20-440).
The Court will hear argument on the doctrine of assignor estoppel on Wednesday, April 21, 2021, in Minerva v. Hologic.
Noteworthy Petitions for a Writ of Certiorari:
There are three new potentially impactful certiorari petitions that are currently before the Supreme Court:
Ono Pharmaceutical v. Dana-Farber Cancer Institute (U.S. No. 20-1258): “Whether the Federal Circuit erred in adopting a bright-line rule that the novelty and non-obviousness of an invention over alleged contributions that were already in the prior art are ‘not probative’ of whether those alleged contributions were significant to conception.”
Warsaw Orthopedic v. Sasso (U.S. No. 20-1284): “Whether a federal court with exclusive jurisdiction over a claim may abstain in favor of a state court with no jurisdiction over that claim.”
Sandoz v. Immunex (U.S. No. 20-1110): “May the patent owner avoid the rule against double patenting by buying all of the substantial rights to a second, later-expiring patent for essentially the same invention, so long as the seller retains nominal ownership and a theoretical secondary right to sue for infringement?”
The petitions in American Axle & Manufacturing, Inc. v. Neapco Holdings LLC (U.S. No. 20-891) and Ariosa Diagnostics, Inc. v. Illumina, Inc. (U.S. No. 20-892) are still pending.
After requesting a response, the Court denied Argentum’s petition in Argentum Pharmaceuticals LLC v. Novartis Pharmaceuticals Corporation (U.S. No. 20-779). Gibson Dunn partners Mark Perry and Jane Love were counsel for Novartis.
Other Federal Circuit News:
Judge Wallach to Retire. On March 16, 2021, the Federal Circuit announced that Judge Evan J. Wallach will retire from active service and assume senior status, effective May 31, 2021. Judge Wallach served on the Federal Circuit for nearly 10 years and, prior to that, served on the U.S. Court of International Trade for 16 years. Judge Wallach’s full biography is available on the court’s website. On March 30, President Biden announced his intent to nominate Tiffany Cunningham for the empty seat. Ms. Cunningham has been a partner in the Patent Litigation practice of Perkins Coie LLP since 2014, and serves on the 17-member Executive Committee of the firm. She began her legal career as a law clerk to Judge Dyk.
Federal Circuit Practice Update
Updated Federal Circuit Rules. Pursuant to the court’s December 9, 2020 public notice, the court has published an updated edition of the Federal Circuit Rules. This edition incorporates the emergency amendment to Federal Circuit Rule 15(f) brought about by the court’s en banc decision in NOVA v. Secretary of Veterans Affairs (Fed. Cir. No. 20‑1321).
Upcoming Oral Argument Calendar
The list of upcoming arguments at the Federal Circuit are available on the court’s website.
Live streaming audio is available on the Federal Circuit’s new YouTube channel. Connection information is posted on the court’s website.
Case of Interest:
New Vision Gaming & Development, Inc. v. SG Gaming, Inc. (Fed. Cir. No. 20‑1399): This case concerns “[w]hether the unusual structure for instituting and funding AIA post-grant reviews violates the Due Process Clause in view of Tumey v. Ohio, 273 U.S. 510 (1927), and its progeny, which establish ‘structural bias’ as a violation of due process.” It attracted an amicus brief from US Inventor in support of appellant, which argues that the administrative patent judges’ compensation and performance rating system affects their decision making. Panel M will hear argument in New Vision Gaming on April 9, 2021, at 10:00 AM Eastern.
Key Case Summaries (March 2021)
SynQor, Inc. v. Vicor Corp. (Fed. Cir. No. 19-1704): In an inter partes reexamination (“IPR”), the Patent Trial and Appeal Board (“PTAB”) found several claims of SynQor’s patent unpatentable over the prior art. SynQor appealed, arguing that common law preclusion arising from a prior reexamination involving two related patents collaterally estopped the Board from finding a motivation to combine.
The Federal Circuit panel majority (Hughes, J., joined by Clevenger, J.) vacated and remanded, holding that common law issue preclusion can apply to IPRs. Analyzing the statutory scheme, the majority determined that Congress did not intend to prevent application of common law estoppel. Instead, the estoppel provisions of 35 U.S.C. §§ 315(c), 317(b) were more robust than common law collateral estoppel and fully consistent with allowing common law estoppel. The majority also determined that IPRs satisfied the traditional elements of issue preclusion. The majority explained that unlike an ex parte reexamination, Congress provided the third-party reexamination requestor the opportunity to fully participate in inter partes proceedings. The majority also determined that inter partes reexaminations contained sufficient procedural elements necessary to invoke issue preclusion. In an IPR, a party has the opportunity to respond to the other party’s evidence, challenge an expert’s credibility and submit its own expert opinions. Thus, the majority found that the lack of cross-examination did not prevent common law issue preclusion from applying to IPRs.
Judge Dyk dissented, arguing that common law issue preclusion should not apply to inter partes reexaminations because of the lack of compulsory process and cross-examination.
In Re: Board of Trustees of the Leland Stanford Junior University (Fed. Cir. No. 20-1012): The PTAB affirmed the examiner’s final rejection of Stanford’s claims directed to determining haplotype phase, on the basis that the claims were ineligible. The process of haplotype phasing involves determining from which parent an allele was inherited. The PTAB held that the claims were directed to “receiving and analyzing information,” which are “mental processes within the abstract idea category,” and that the claims lacked an inventive concept.
The Federal Circuit (Reyna, J., joined by Prost, C.J. and Lourie, J.) affirmed. At step one, the court held that the claims were directed to the abstract idea of “mathematically calculating alleles’ haplotype phase.” At step two, it held that the claims lacked an inventive concept, noting that the claims recited no steps that “practically apply the claimed mathematical algorithm.” The court held that, instead, the claims merely stored the haplotype phase information, which could not transform the abstract idea into patent-eligible subject matter. It further held that the dependent claims recited limitations amounting to no more than an instruction to apply that abstract idea.
Mylan Laboratories v. Janssen Pharmaceutica (Fed. Cir. No. 20-1071): Mylan petitioned for IPR of Janssen’s patent. Janssen opposed institution on the grounds that instituting the IPR would be an inefficient use of the PTAB’s resources because of two co-pending district court actions: one against Mylan and a second against Teva Pharmaceuticals that was set to go to trial soon after the institution decision. The Board applied its six-factor standard articulated in Fintiv and denied institution. Mylan appealed and requested mandamus relief; arguing that denying IPR based on litigation with a third party undermined Mylan’s constitutional and other due process rights, and that application of the six-factor standard violated congressional intent.
The Federal Circuit (Moore, J., joined by Newman, J. and Stoll, J.) granted Janssen’s motion to dismiss the appeal and denied Mylan’s petition for a writ of mandamus. The court dismissed Mylan’s direct appeal and reiterated that the court lacks jurisdiction over appeals from decisions denying institution because Section 314(d) specifically makes institution decisions “nonappealable.” The court noted that “judicial review [of institution decisions] is available in extraordinary circumstances by petition for mandamus,” even though “the mandamus standard will be especially difficult to satisfy” when challenging a decision denying institution of an IPR. Indeed, the court noted that “it is difficult to imagine a mandamus petition that challenges a denial of institution and identifies a clear and indisputable right to relief.” Considering the merits of Mylan’s petition, the court explained that “there is no reviewability of the Director’s exercise of his discretion to deny institution except for colorable constitutional claims,” which Mylan had failed to present.
Uniloc 2017 v. Facebook (Fed. Cir. No. 19-1688): Uniloc appealed from a PTAB ruling that the petitioners were not estopped from challenging the claims and that the patents at issue were invalid as obvious. Facebook filed two IPR petitions and then joined an IPR petition that had been previously filed by Apple, which challenged only a subset of the claims in the Facebook petitions. LG then joined Facebook’s two petitions, but not Apple’s. After instituting trial on Facebook’s two IPR petitions, the PTAB issued it final written decision in the Apple IPR, upholding the validity of Apple’s claims. The PTAB determined that, as of the final written decision on the Apple IPR, Facebook was estopped from challenging the overlapping claims in its own IPR petitions under § 315 (e)(1). LG, however, was not estopped from challenging the overlapping claims.
The Federal Circuit (Chen, J., joined by Lourie, J. and Wallach, J.) affirmed. The panel first determined that it had jurisdiction to review the challenge because the final written decision in the Apple IPR did not issue until after the institution of trial on the Facebook petitions. Next, the panel held that LG was not a real-party-at-interest or privy of Facebook because there was no evidence of any sort of preexisting, established relationship that indicates coordination related to the Apple IPR. According to the panel, moreover, Facebook was not estopped from addressing the non-overlapping claims (even the claim that depended from an overlapping claim) because § 315 (e)(1) specifically applies to claims in a patent. The panel then addressed the PTAB’s obviousness determination regarding the challenged claims and affirmed the Board’s obviousness findings as supported by substantial evidence.
In Re TracFone Wireless (Fed. Cir. No. 21-118): Precis Group sued TracFone in the Western District of Texas, alleging that venue was proper because TracFone has a store in San Antonio. TracFone moved to transfer on the grounds that venue was inconvenient, as well as improper because it no longer has a branded store in the district. For several months, the district court (Judge Albright) did not decide the motion, and instead kept the case moving towards trial. After eight months, TracFone petitioned the Federal Circuit for a writ of mandamus.
In its decision granting mandamus, the Federal Circuit (Reyna, J., joined by Chen, J. and Hughes, J.) ordered Judge Albright to “issue its ruling on the motion to transfer within 30 days from the issuance of this order, and to provide a reasoned basis for its ruling that is capable of meaningful appellate review.” It also ordered that all proceedings in the case be stayed until further notice. Notably, the court explained “that any familiarity that [the district court] has gained with the underlying litigation due to the progress of the case since the filing of the complaint is irrelevant when considering the transfer motion and should not color its decision.” Judge Albright denied the motion to transfer the day after the mandamus decision issued.
The Federal Circuit has recently denied two other petitions for mandamus involving cases before Judge Albright. In In re Adtran, Inc. (Fed. Cir. No. 21-115), the court denied a petition for mandamus directing Judge Albright to stay all deadlines unrelated to venue pending a decision on transfer. In In re True Chemical Solutions (Fed. Cir. No. 21-131), the court denied a petition for mandamus reversing Judge Albright’s grant of a motion for intra-division transfer. Notably, Judge Albright now oversees 20% of new US patent cases (link).
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Federal Circuit. Please contact the Gibson Dunn lawyer with whom you usually work or the authors of this alert:
Blaine H. Evanson – Orange County (+1 949-451-3805, 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:
Wayne Barsky – Los Angeles (+1 310-552-8500, wbarsky@gibsondunn.com)
Josh Krevitt – New York (+1 212-351-4000, jkrevitt@gibsondunn.com)
Mark Reiter – Dallas (+1 214-698-3100, mreiter@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 26 March 2021, the European Commission (the “Commission”) published guidance on the circumstances under which it is likely to accept requests from national competition authorities within the EU to investigate mergers that do not meet the EU or even national jurisdictional tests (the “Guidance”).[1] The Guidance concerns the application of the referral mechanism under Article 22 of the EU Merger Regulation, a hitherto relatively little-used provision.[2] The Guidance firmly cements the Commission’s change in policy towards deals in the pharma and digital sectors, in particular with respect to so-called “killer acquisitions”, designed to address an apparent enforcement gap in these sectors.[3] The effect of the Guidance is likely to increase significantly the jurisdictional reach of the Commission, and may go so far as to lead to a de facto notification process in the absence of sufficient turnover to meet mandatory filing requirements.
1. A radical shift in the Commission’s approach
In a speech to the IBA in September 2020,[4] Commissioner Vestager (in charge of EU competition law enforcement) looked back on 30 years of EU merger control, including whether it is still right that the EU turnover-based thresholds for filings are the appropriate way to identify “mergers that matter for competition”. She noted that “these days, a company’s turnover doesn’t always reflect its importance in the market. In some industries, like the digital and pharmaceutical industries, competition in the future can strongly depend on new products or services that don’t yet have much in the way of sales”. In that speech, Vestager ruled out lowering the EUMR thresholds to capture such deals (as this would disproportionately capture a lot of irrelevant deals) and signalled that a change in approach to the Article 22 referral process “could be an excellent way to see the mergers that matter at a European scale”.
The Article 22 referral mechanism allows one or more Member States to ask the Commission to review a concentration that does not meet the EU thresholds but that (a) affects trade between Member States and (b) threatens to significantly affect competition within the territory of the Member State or States making the request. Until now, the Commission’s practice has been to discourage Article 22 referrals from Member States that did not have the power to review a deal under their own national merger control rules. This meant that deals that did not trigger national merger control in at least one Member State were not, in practice, referred for Commission review.
Vestager therefore stated that the Commission planned to “start accepting referrals from national competition authorities of mergers that are worth reviewing at the EU level – whether or not those authorities had the power to review the case themselves”.
The Guidance published on 26 March gives effect to this plan and sets out how the Commission foresees this new jurisdictional approach working.
2. What deals are likely to be caught by this new approach
The Commission can accept referrals with respect to any deal, regardless of whether national filings might be required or not, provided that it meets the two formal conditions noted above. The Guidance makes is clear that these are low thresholds:
- An effect on trade between Member States requires no more than “some discernible influence on the pattern of trade between Member States”, whether direct or indirect, actual or potential. The Guidance highlights that customers located in different Member States, cross-border sales/availability, collection of data across borders or the commercialisation of R&D efforts in more than on Member State would all meet this requirement.
- Threatening to significantly affect competition within the territory of the Member State requires no more than a demonstration that “based on a preliminary analysis, there is a real risk” of such an effect. Here, the Guidance notes that this could include circumstances such as the “ elimination of a recent or future entrant, making entry/expansion more difficult, or the ability and incentive to leverage a strong market position from one market to another.
Further, given the Commission’s approach to date with respect to Article 22 referrals, in practice, we would not expect the Commission to take a restrictive approach to whether these conditions are met, particularly in cases where the Commission invites a national competition authority to make a referral request.
It is clear that the Commission’s focus is not on all deals involving new entrants, but primarily on the pharma and digital sectors where “services regularly launch with the aim of building up a significant user base and/or commercially valuable data inventories, before seeking to monetise the business” and where “there have been transactions involving innovative companies conducting research & development projects and with strong competitive potential, even if these companies have not yet finalised, let alone exploited commercially, the results of their innovation activities”.[5]
The Guidance also specifies that the Commission is most likely to exercise its discretion to investigate where the deal that has been referred to it is one in which the “turnover of at least one of the undertakings concerned does not reflect its actual or future competitive potential”. This may occur where the value of the consideration received by the seller is particularly high compared to the current turnover of the target. It may also occur where one party:
- is a start-up or recent entrant with significant competitive potential that has yet to develop or implement a business model generating significant revenues (or is still in the initial phase of implementing such business model);
- is an important innovator or is conducting potentially important research;
- is an actual or potential important competitive force;
- has access to competitively significant assets (such as for instance raw materials, infrastructure, data or intellectual property rights); and/or
- provides products or services that are key inputs/components for other industries.
As the above, non-exhaustive list, shows, this new approach has the potential to catch almost any deal involving a new pharma or digital start-up, innovative company or company exploring new market areas. It would also clearly catch so-called “killer acquisitions” of small companies with high potential future value.
3. How will the process work?
The Article 22 mechanism requires a Member State that wishes to make a referral to send a reasoned request to the Commission within 15 working days from when the concentration is made known to it.[6] The Commission then informs the other Member States and they have a further 15 working days to join the request if they so wish. After the expiry of this period, the Commission must decide within 10 working days if it accepts the referral request. Upon receipt of a referral request from a Member State, the Commission must inform the parties of the request. Once the parties are informed of this, the suspension obligation under the EU Merger Regulation applies and the transaction cannot be closed unless it has already been implemented.
Importantly, whilst the European merger control system is a pre-closing suspensory one and companies are used to assessing the need to factor in a Commission investigation prior to completion, the Guidance specifies that referrals can be made post-completion provided they are within a suitably short period. In this respect, the Guidance states that a period of six months is likely to be an appropriate period, although this may be longer if the deal is not made public on completion or if there is a sufficiently large potential for competition concerns or detrimental effect on consumers.
4. What does this mean for deals?
The new approach has the potential to significantly reduce legal certainty for companies engaged in M&A activity in these sectors and to increase the procedural burdens on parties.
By moving the possibility of an EU-level review away from turnover-based thresholds, towards a more qualitative assessment of potential effects, and allowing for investigations to be opened post-completion, the Commission’s change in approach means that the EU system now mirrors that of the UK (with its broad “share of supply” test and post-completion review process) for deals that do not meet the EU merger review thresholds. The level of uncertainty that the UK’s system has meant for deals in these sectors in light of recent CMA decisions (see client alert on Roche/Spark) will now be felt at wider, EU-level.
Additionally, there is little likelihood that the Commission would refrain from using its new approach to referrals extensively. The Guidance states that the Commission will engage actively with Member States to “identify concentrations that may constitute potential candidates for a referral” and encourages third-parties to contact either the Commission or the Member States to inform them of potential referral cases. Additionally, the Commission has, at the same time as it issued the Guidance, consulted on changes to the “simplified procedure” process to allow for easy/fast review of cases that do not raise competition concerns. The implication is that the Commission is “clearing the decks” to allow it to focus on these more interesting digital and pharma deals. We can therefore expect the Commission to actively seek out deals that might warrant an EU-level review and to secure their referral by one or more Member States.
For companies active in the pharma and digital sectors, their M&A planning will need to include not just an assessment of the relevant thresholds and filing requirements across EU Member States, but a more general assessment of the potential for an EU referral.
With the possibility that a Commission investigation could be initiated months after completion, with the attendant substantive risks, companies may find that it is advisable (at least in some circumstances) to proactively engage with the Commission to provide the information necessary to determine whether a deal is a good candidate for referral. Indeed, this type of de facto voluntary notification is expressly provided for in the Guidance.[7]
Companies’ M&A planning process will also need to factor in the potential impact on deal timing of this new approach. As section 3 above shows, the time period involved before the parties will even know if a deal is being investigated, not to mention the time involved for the actual Commission investigation, is significant.
___________________
[1] Commission Guidance on the application of the referral mechanism set out in Article 22 of the Merger Regulation to certain categories of cases, C(2021) 1959 final, available at: https://ec.europa.eu/competition/consultations/2021_merger_control/guidance_article_22_referrals.pdf.
[2] In the last 30 years, Article 22 referral requests by Member States have been made only 41 times: See https://ec.europa.eu/competition/mergers/statistics.pdf (statistics to end February 2021).
[3] In announcing the Guidance, together with the results of the Commission’s evaluation of the procedural and jurisdictional aspects of EU merger control, Executive Vice-President Margrethe Vestager, in charge of competition policy, said: “A number of transactions involving companies with low turnover, but high competitive potential in the internal market are not reviewed by either the Commission or the Member States. A more frequent use of the existing tool of referrals under Article 22 of the Merger Regulation can help us capture concentrations which may have a significant impact on competition in the internal market”.
[4] Available at: https://ec.europa.eu/commission/commissioners/2019-2024/vestager/announcements/future-eu-merger-control_en.
[5] See Guidance, paragraph 9.
[6] This means being in receipt of sufficient information to make a preliminary assessment as to the existence of the criteria relevant for the assessment of the referral. It is unlikely that a newspaper article or press release would qualify as providing sufficient information for the national competition authorities to make an assessment. In practice, national competition authorities can be expected to request information from the parties about deals that have attracted their (or the Commission’s) attention and the 15-day period will start running upon receipt of the parties response to their information request.
[7] Guidance, paragraph 24.
The following Gibson Dunn lawyers prepared this client alert: Deirdre Taylor, Attila Borsos, Christian Riis-Madsen, and Ali Nikpay.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the firm’s Antitrust and Competition practice group:
Antitrust and Competition Group:
Brussels
Attila Borsos (+32 2 554 72 11, aborsos@gibsondunn.com)
Christian Riis-Madsen (+32 2 554 72 05, criis@gibsondunn.com)
Lena Sandberg (+32 2 554 72 60, lsandberg@gibsondunn.com)
David Wood (+32 2 554 7210, dwood@gibsondunn.com)
Alejandro Guerrero (+32 2 554 7218, aguerrero@gibsondunn.com)
London
Ali Nikpay (+44 20 7071 4273, anikpay@gibsondunn.com)
Deirdre Taylor (+44 20 7071 4274, dtaylor2@gibsondunn.com)
Philip Rocher (+44 20 7071 4202, procher@gibsondunn.com)
Patrick Doris (+44 20 7071 4276, pdoris@gibsondunn.com)
Charles Falconer (+44 20 7071 4270, cfalconer@gibsondunn.com)
Frankfurt
Georg Weidenbach (+49 69 247 411 550, gweidenbach@gibsondunn.com)
Munich
Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com)
Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com)
Hong Kong
Kelly Austin (+852 2214 3788, kaustin@gibsondunn.com)
Sébastien Evrard (+852 2214 3798, sevrard@gibsondunn.com)
Washington, D.C.
Adam Di Vincenzo (+1 202-887-3704, adivincenzo@gibsondunn.com)
Scott D. Hammond (+1 202-887-3684, shammond@gibsondunn.com)
Joseph Kattan (+1 202-955-8239, jkattan@gibsondunn.com)
Kristen C. Limarzi (+1 202-887-3518, klimarzi@gibsondunn.com)
Joshua Lipton (+1 202-955-8226, jlipton@gibsondunn.com)
Richard G. Parker (+1 202-955-8503, rparker@gibsondunn.com)
Michael J. Perry (+1 202-887-3558, mjperry@gibsondunn.com)
Cynthia Richman (+1 202-955-8234, crichman@gibsondunn.com)
Jeremy Robison (+1 202-955-8518, wrobison@gibsondunn.com)
Stephen Weissman (+1 202-955-8678, sweissman@gibsondunn.com)
Andrew Cline (+1 202-887-3698, acline@gibsondunn.com)
Chris Wilson (+1 202-955-8520, cwilson@gibsondunn.com)
New York
Eric J. Stock (+1 212-351-2301, estock@gibsondunn.com)
Lawrence J. Zweifach (+1 212-351-2625, lzweifach@gibsondunn.com)
Los Angeles
Daniel G. Swanson (+1 213-229-7430, dswanson@gibsondunn.com)
Christopher D. Dusseault (+1 213-229-7855, cdusseault@gibsondunn.com)
Samuel G. Liversidge (+1 213-229-7420, sliversidge@gibsondunn.com)
Jay P. Srinivasan (+1 213-229-7296, jsrinivasan@gibsondunn.com)
Rod J. Stone (+1 213-229-7256, rstone@gibsondunn.com)
San Francisco
Rachel S. Brass (+1 415-393-8293, rbrass@gibsondunn.com)
Caeli A. Higney (+1 415-393-8248, chigney@gibsondunn.com)
Dallas
Veronica S. Lewis (+1 214-698-3320, vlewis@gibsondunn.com)
Mike Raiff (+1 214-698-3350, mraiff@gibsondunn.com)
Brian Robison (+1 214-698-3370, brobison@gibsondunn.com)
Robert C. Walters (+1 214-698-3114, rwalters@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.