On April 9, 2020, the New York Empire State Development Corporation (“ESD”) further updated its guidance for determining whether businesses are “essential” and therefore exempt from the in-person workforce restrictions established in Governor Cuomo’s March 20, 2020 “New York State on PAUSE” Executive Order (EO 202.8). That March 20 order required all non-essential businesses keep 100 percent of their workforce at home. These updates, which we review in this alert, demonstrate that ESD is continuing to evolve the breadth and depth of its guidance on what constitutes an essential business. It is therefore critical that businesses continue to stay apprised of the latest developments.
The ESD’s April 9 version of the guidance contains four primary updates to its previous guidance, which was last updated on April 8.[1]
- First, the new guidance adds two new essential business categories—“Recreation” and “Professional services with extensive restrictions”—which together set forth social distancing and workplace restrictions regarding parks and open public spaces, legal and real estate services, and houses of worship.
- Second, the updated guidance provides further detail on what constitutes essential construction in the context of affordable housing and the energy industry, and clarifies that essential construction also includes construction necessary to protect the health and safety of occupants of a structure as well as construction for existing projects of an essential business.
- Third, the updated guidance incorporates new examples of essential businesses in the preexisting healthcare, manufacturing, retail, and essential services industry categories.
- Fourth, the updated guidance broadens the list of businesses deemed non-essential and therefore prohibited from requesting a designation as an essential business under the guidance.
These four primary updates to the guidance are reviewed below in further detail.
I. The Updated Guidance Incorporates Two New Essential Business Categories
The updated guidance now includes two additional essential business categories: “Recreation” and “Professional services with extensive restrictions.” According to the guidance, recreation includes parks and other open public spaces—except for golf courses, the use of boat launches and marinas for recreational vessels, and “playgrounds and other areas of congregation where social distancing cannot be abided.”
The new professional services category is largely directed to legal and real estate services, as well as houses of worship. With respect to legal services, the guidance clarifies that lawyers may provide in-person services, but only in support of essential businesses. Even so, the guidance recommends that such work be conducted “as remotely as possible,” while mandating that the remainder of all legal work shall be performed remotely. With respect to real estate services, the guidance permits services necessary to complete a transfer of real property to occur in person “only to the extent legally necessary and in accordance with appropriate social distancing and cleaning/disinfecting protocols.” Otherwise, all real estate transactions should be conducted remotely. Finally, with respect to houses of worship, the revised guidance allows individuals to enter them only where six feet of distance can be maintained between persons. That permission notwithstanding, the guidance cautions that individuals should not be gathering in houses of worship until the end of the COVID-19 public health emergency, and encourages religious leaders to hold virtual religious services.
II. The Updated Guidance Provides Further Detail Concerning What Constitutes Essential Construction
The ESD’s prior guidance on construction, which Gibson Dunn reviewed in a prior alert, provided that all non-essential construction must cease, except for emergency construction such as projects “necessary to protect health and safety of the occupants” or projects for which it would be unsafe to allow them to remain incomplete. The prior guidance also noted that essential construction included that of roads, bridges, transit facilities, utilities, hospitals or health care facilities, affordable housing, and homeless shelters. And it provided that essential and non-essential emergency construction must adhere to social distancing and safety best practices, to be enforced by state and local authorities, with up to $10,000 fines for a violation. All that remains in effect in the updated guidance.
The updated guidance, however, affords new detail on what constitutes “essential” construction with respect to affordable housing and the energy industry. Construction of affordable housing is now defined as construction work where: “either (i) a minimum 20% of the residential units are or will be deemed affordable and are or will be subject to a regulatory agreement and/or a declaration from a local, state, or federal government agency or (ii) where the project is being undertaken by, or on behalf of, a public housing authority.” And certain construction in the energy industry is now expressly included as “essential” construction which may continue, as set forth in greater detail in the response to Question 14 of the ESD’s FAQs.[2] The updated guidance also categorizes as essential construction that which is “necessary to protect the health and safety of occupants of a structure” and construction for “existing (i.e. currently underway) projects of an essential business.”
III. The Updated Guidance Incorporates New Examples into Several Other Essential Business Categories
The revised guidance sets forth additional examples of essential businesses among several of the original 12 categories of businesses provided in the prior guidance and narrows the scope of one example in the financial institutions category. These essential business categories and their new examples are set forth below.
- Essential Health Care Operations: Emergency chiropractic services; physical therapy, prescribed by a medical professional; occupational therapy, prescribed by a medical professional.
- Essential Manufacturing: Any parts or components necessary for essential products that are referenced within the guidance, such as sanitary and personal care products regulated by the Food and Drug Administration.
- Essential Retail: Telecommunications to service existing customers and accounts; and delivery for orders placed remotely via phone or online at non-essential retail establishments—provided that only one employee is physically present at the business location to fulfill orders.
- Essential Services: Marine vessel repair and marinas, but only to support government or essential commercial operations, and not for recreational purposes; landscaping, but only for maintenance or pest control and not cosmetic purposes; designing, printing, publishing and signage companies to the extent that they support essential businesses or services; remote instruction or streaming of classes from public or private schools or health/fitness centers—provided that no in-person congregate classes are permitted.
- Financial Institutions: The prior example of “services related to financial markets” has been narrowed to exclude debt collection services.
IV. The Updated Guidance Provides Further Examples of Businesses Deemed Non-Essential
The ESD’s updated guidance broadens the types of businesses deemed non-essential and therefore ineligible to request a designation as an essential business. The prior guidance provided that non-essential businesses included those that were previously ordered to close due to prior restrictions on gatherings with 50 or more participants, such as bars, restaurants, gyms, movie theatres, casinos, auditoriums, concerts, conferences, worship services, sporting events, and any physical fitness centers.[3]
The revised guidance now also specifically enumerates certain additional businesses as “non-essential.” These include “[a]ny indoor common portions of retail shopping malls with 100,000 or more square feet of retail space available for lease,”; “[a]ll places of public amusement, whether indoors or outdoors,” such as amusement rides, aquariums, bowling alleys, and children’s play centers, among others; and barbershops, hair salons, tattoo or piercing parlors, and related personal care services like nail technicians, and laser hair removal services. The new restrictions further note that restaurant take-out or delivery for off-premise consumption do not fall within the scope of restaurants deemed non-essential, which are now more clearly specified as those offering dine-in restaurant or bar services.
* * *
In sum, as ESD continues to help businesses navigate the effects of Governor Cuomo’s “New York State on PAUSE” Executive Order, its guidance on what constitutes essential businesses continues evolving as to the breadth and depth of the types of business and activities covered. Gibson Dunn will continue to track these updates and will report on important developments.
Prior client alerts providing an overview of the Governor Cuomo’s “New York State on PAUSE” executive order’s in-person workforce restrictions and ESD’s guidance on essential businesses exempt from the order may be accessed here, here, and here. As noted in Gibson Dunn’s March 24, 2020 alert, New York Attorney General Letitia James has urged employees who believe their employers to be acting in violation of Governor Cuomo’s executive order to file a complaint with the New York State Office of the Attorney General’s Labor Bureau.
[1] The April 8 guidance removed the following sentence that was present in earlier versions: “Houses of worship are not ordered closed however it is strongly recommended not to hold congregate services. If held, social distance must be maintained and compliance with DOH guidance, which can be found at https://coronavirus.health.ny.gov/ information-providers.”
[2] The answer to Question 14 in the ESD’s FAQs explains (among other things) that utility operations and maintenance for existing power generation, fuel supply, and “[t]ransmission and distribution infrastructure,” are examples of essential construction “necessary to respond to the COVID-19 state emergency or to provide basic human services” like food, shelter, and safety.
[3] See Governor Andrew M. Cuomo, E.O. 202.3 (March 16, 2020).
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 outbreak. For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team.
Mylan Denerstein – New York (+1 212.351.3850, mdenerstein@gibsondunn.com)
Lauren Elliot – New York (+1 212.351.3848, lelliot@gibsondunn.com)
Stella Cernak – New York (+1 212.351.3898, scernak@gibsondunn.com)
Lee Crain – New York (+1 212.351.2454, lcrain@gibsondunn.com)
Doran Satanove – New York (+1 212.351.4098, dsatanove@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Many companies have retooled (or are considering retooling) their businesses to meet the rising demand for personal protective equipment (“PPE”), ventilators, and other products or services to address the COVID-19 pandemic. Moreover, on April 2, 2020, the President ordered the Department of Health and Human Services to use its authority under the Defense Production Act (“DPA”) of 1950, as amended, 50 U.S.C. §§ 4501 et seq., to facilitate the supply of materials for the production of ventilators by several companies operating in the United States.[1] This alert reviews the limited protection against potential patent infringement lawsuits and damages that the law provides for infringement that occurs during the production, use, or sale of products or services in response to these emergency declarations.
Under the Patent Act, “whoever without authority makes, uses, offers to sell, or sells any patented invention, within the United States or imports into the United States any patented invention during the term of the patent therefor, infringes the patent.” 35 U.S.C. § 271(a). The Act further provides for an award of damages “adequate to compensate for the infringement,” which may be trebled in certain instances, 35 U.S.C. § 284; injunctive relief is also available. 35 U.S.C. § 283.
The Patent Act creates no exceptions for patent infringement damages during public health crises or pandemics such as COVID-19, but several other statutes and doctrines may provide some protections for businesses responding to urgent demands for products or services. As discussed below, some protections may be available for manufacturers and providers of emergency equipment under a Declaration pursuant to the Public Readiness and Emergency Preparedness Act (“PREP Act”), 42 U.S.C. § 247d-6d; the DPA; and a statute relating to government use of patents, 28 U.S.C. § 1498(a). This alert also considers arguments that might be advanced to minimize damages for the infringement of patent claims that might cover certain emergency equipment. Although the principles discussed here are relevant to many emergency activities taken during the COVID-19 pandemic, the development and marketing of new pharmaceutical treatments for COVID-19 raises additional patent issues that this alert does not address.
I. Potential Protection from Patent Infringement Liability
A. The PREP Act and PREP Declaration
As described in a previous client alert, on March 17, 2020, Alex Azar, Secretary of the Department of Health and Human Services (HHS), issued a Declaration activating the PREP Act, 42 U.S.C. § 247d-6d. The Declaration extends immunity “from suit and liability under federal and state law with respect to all claims for loss caused by, arising out of, relating to, or resulting from” administration or use of qualifying products used to combat or reduce the spread of COVID-19 (the “PREP Declaration”).[2] Along with other recent FDA guidance relaxing regulatory oversight for certain COVID-19-fighting products, the PREP Declaration protects manufacturers, suppliers, distributors, and others helping to mitigate supply shortages during the current crisis.
There are several pertinent limitations on the applicability of the PREP Declaration to the circumstances described here. First, no court has yet determined that immunity under the PREP Act extends to immunity from liability for patent infringement. Although the PREP Act confers “immun[ity] from suit and liability under Federal and State law,” nothing in the Act or legislative history shows specific consideration of intellectual property laws. There is also no express exclusion of patent suits, however, and potential defendants would be expected to argue that in view of the broad language of the statute, combined with courts’ frequent treatment of patent law as a species of statutory tort law, PREP Act immunity from suit “under Federal . . . law” includes claims of patent infringement.[3]
Second, even if the PREP Act applies to patent infringement, not every product used in response to COVID-19 is a qualified product under the PREP Declaration. For example, a qualified product must be FDA approved, licensed for use under the Public Health Service Act, or cleared for use under a FDA emergency use authorization (EUA).[4]
Thus, activities directed towards masks and ventilators that are not approved by FDA or NIOSH (or otherwise authorized by FDA based on compliance with foreign agency standards), and that are not created pursuant to a federal contract or governmental response, are not likely to be afforded PREP Act immunity. In short, protections under the PREP Act are limited, and businesses should consider these limitations when evaluating whether the PREP Declaration protects their activities.[5]
B. The Defense Production Act and 28 U.S.C. § 1498(a)
Individuals or businesses that facilitate the production of COVID-19 response products through contracts with the federal government, including those arising from the President’s recent invocation of the DPA, are granted certain protections from patent infringement liability under 28 U.S.C. § 1498(a).
1. The DPA
The DPA authorizes the President to require businesses to prioritize any of their government contracts deemed “necessary or appropriate to promote the national defense” “over performance under any other contract,” and “to require” private businesses to “accept[] and perform[]” such government contracts where the President finds those businesses capable of performance. 50 U.S.C. § 4511(a)(1). The DPA also confers on the President the authority “to allocate materials, services, and facilities, to such extent as he shall deem necessary or appropriate.” 50 U.S.C. § 4511(a)(2). These powers can be used to control the distribution of materials in the United States market, but only where the President first finds that those materials are “a scarce and critical material essential to the national defense,” and that “the requirements of the national defense for such material cannot otherwise be met without creating a significant dislocation of the normal distribution of such material . . . .” 50 U.S.C. § 4511(b).
This is the case with personal protective equipment and ventilators used to combat the COVID-19 virus: the President’s March 18, 2020 Executive Order specifically found that “personal protective equipment and ventilators” met “the criteria specified in [§ 4511(b)],” and further delegated the Secretary of Health and Human Services to “identify additional specific health and medical resources” that met § 4511(b)’s criteria. The President then invoked the DPA on March 27, 2020, ordering “General Motors Company to accept, perform and prioritize contracts or orders for the number of ventilators that the Secretary determines to be appropriate.” And on April 2, 2020, as previously noted, the President again invoked the DPA, ordering the Secretary of Health and Human Services to use its DPA authority to facilitate the supply of materials for the production of ventilators by a handful of companies in addition to General Motors.
2. Section 28 U.S.C. 1498(a) Protects Certain Federal Contractors from Liability
Although the DPA does not itself create immunity from claims of patent infringement against those ordered to perform contracts under the DPA,[6] another federal statute effectively supplies an affirmative defense for federal government contractors who face patent infringement claims. That protection, codified at 28 U.S.C. § 1498(a), limits a patent owner’s remedy for infringement of inventions “used or manufactured by or for the United States”—i.e., inventions used or manufactured “with the authorization and consent of the Government”—to an “action against the United States in the United States Court of Federal Claims for the recovery of . . . reasonable and entire compensation for such use and manufacture.” 28 U.S.C. § 1498(a).[7] That section requires the United States government to defend such actions, waiving its sovereign immunity in the process. The U.S. government’s “consent and authorization” for a contractor to use and manufacture a patented invention can be expressly made in the applicable contract, pursuant to Federal Acquisition Regulation (“FAR”) 52.227-1.[8] Accordingly, federal contractors cannot be held directly liable for patent infringement claims arising from conduct undertaken for the benefit of the federal government, with that government’s authorization and consent.[9]
But the protections of § 1498(a) only go so far. A federal contractor nevertheless may be required to indemnify the government for any damages assessed in a suit that proceeds by virtue of § 1498(a). Indeed, FAR 27.201-1(d) authorizes the Government to require certain contractors to reimburse it for patent infringement “liability” and “costs” incurred in performing the contract by inserting an indemnity clause into the contract.[10] It would thus behoove federal contractors to try to exclude that clause from government contracts—if possible. Moreover, parties to federal contracts arising from the DPA might argue that such an indemnity clause is unenforceable under FAR-52.227-3(b)(1), which provides that the indemnity clause does not apply to infringement claims where, among other things, the infringement results from “the Contracting Officer . . . directing a manner of performance of the contract not normally used by the Contractor.” Although the scope of that exception does not appear to have been tested in the context of the DPA, it is expected that contractors ordered to facilitate the manufacture of products they do not normally produce would argue for its application in these circumstances.
In short, a federal contract for the manufacture, supply, and distribution of PPE and ventilators may help insulate manufacturers and others from direct claims of patent infringement for certain activities, but that protection may be of limited value if they are thereafter required to indemnify the government against such claims.
II. Businesses Meeting the Urgent Needs of the COVID-19 Pandemic May Be Expected to Argue That Any Patent Damages for Their Activities Should Be Minimal
The expected arguments for minimizing patent damages and other remedies for the production, sale, or use of infringing PPE and ventilators during the pandemic—even in the absence of a federal contract—find some support in existing Federal Circuit case law.
A. Injunctive Relief Would Be Unlikely
As an initial matter, it is unlikely that patent owners could obtain injunctive relief against infringers of patents on PPE and ventilators in the context of the COVID-19 crisis. To obtain a permanent injunction against an infringer, a patentee must satisfy the well-established four-factor test, by showing that: “(1) it has suffered an irreparable injury; (2) remedies available at law are inadequate to compensate for that injury; (3) considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted; and (4) the public interest would not be “disserved” by a permanent injunction.”[11] Patentees would have tremendous difficulty meeting their burden for the seemingly obvious reason that enjoining the production of supplies that prevent the spread of COVID-19 and treat infected individuals would disserve the public interest. Indeed, the Federal Circuit has held that the public interest would be disserved by a reduction in availability of cancer and hepatitis test kits, and pacemakers—at times where no comparable global health pandemics were declared.[12] A patentee’s expected failure to meet the public interest prong would almost certainly be fatal to any claim for injunctive relief.[13]
B. Defendants’ Arguments for Reduced Damages Might Find Purchase with a Court
A patent owner who prevails in patent litigation is entitled to “damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer,” 35 U.S.C. § 284. Moreover, “the court may increase the damages up to three times the amount found or assessed,” an enhancement that typically involves a finding of willful infringement. Id. The circumstances of the COVID-19 pandemic would render unlikely any award of lost profits damages or enhanced damages for willful infringement. Lost profits damages require the patentee to show (among other things) that it had the manufacturing and marketing capability to meet public demand for the product.[14] The extraordinary present need for PPE and ventilators, as two examples, would militate against such a showing.
An award of enhanced damages for willful infringement rests within the district court’s discretion for “egregious cases of misconduct beyond typical infringement.”[15] Even during a pandemic, the question of whether infringement directed toward preventing the spread of COVID-19 meets the “egregious” standard may depend on a variety of factors, among them whether the government directed production of the product or service—in which case a court may very well find the infringing conduct does not constitute the “malicious, bad-faith” conduct the egregious standard is intended to capture.[16] Likewise, the Patent Act provides that the “court in exceptional cases may award reasonable attorney fees to the prevailing party.” 35 U.S.C. § 285. We do not expect courts to find that cases arising out of the COVID-19 pandemic are “exceptional” such that prevailing plaintiffs are entitled to fees—but in circumstances where defendants prevail, courts might use a finding that the case was “exceptional” to deter meritless suits against companies attempting to address the COVID-19 pandemic.
The minimum damages to which prevailing patent-holders are entitled are a “reasonable royalty.” Manufacturers, distributors, and users of COVID-19 response products who are found liable for patent infringement would be expected to argue that any such reasonable royalty would be minimal under the circumstances.[17]
C. Commentators Have Suggested Other Ways to Permit Businesses to Respond to the Current Emergency Without the Risk of Infringement Suits and Liability
The urgency of the COVID-19 crisis has given rise to other suggestions for ways to permit businesses to provide urgently-needed supplies without the risk of defending against expensive patent infringement litigation and being assessed damages. One suggestion calls for the donation of intellectual property rights to the fight against COVID-19. For example, on March 31, 2020, a group of prominent scientists, lawyers, and entrepreneurs introduced the “Open COVID Pledge,” in an effort to promote the removal of obstacles involving intellectual property in the fight against COVID-19. The pledge, available on the group’s website, is intended for signature by “patent, copyright and other intellectual and industrial property rights (other than trademarks and trade secrets)” and would grant a non-exclusive, royalty-free, worldwide license to such intellectual property “for the sole purpose of ending” the COVID-19 pandemic. The license would be limited in time to the period of December 1, 2019 until one year after the World Health Organization declares the pandemic to have ended.
Companies such as Intel and Mozilla have reportedly joined the Open COVID-19 pledge. While it remains to be seen how many patent holders ultimately do so, the pledge itself reflects a sentiment that companies contribute to the fight against the pandemic by forgoing the enforcement of their intellectual property rights—in essence, by donating them. But that sentiment—which may dissuade intellectual property owners from bringing suit now—may ultimately be significantly less valuable than an enforceable pledge or right. Because even if a non-binding spirit of public contribution (and public pressure) prevents patent owners from asserting infringement claims during the current climate, businesses should bear in mind that the current emergency will (hopefully) abate, and that patent-holders may typically seek damages for six years of pre-suit damages—meaning that activities now may not be the subject of suits until 2026, when the climate may be different.
In sum, businesses or individuals facilitating the manufacture, supply, distribution, and use of COVID-19 response products should be mindful that many of these products are subject to patents. While the PREP Act and PREP Declaration may afford immunity from patent infringement claims in limited instances, and while federal contractors may rely on 28 U.S.C. § 1498 as an affirmative defense to such claims, other persons and entities that infringe patent claims on PPE and ventilator components could conceivably face reasonable royalty damages. Those considering aiding in the production or distribution of PPE and ventilators should consider doing so through federal government contracts, and by negotiating license agreements with patent holders upfront. Likewise, legislative and regulatory solutions (such as, for example, clear tax benefits for the donation of intellectual property for use by businesses trying to meet emergency needs), and business philanthropy, may help address the emergency, and businesses are advised to monitor any such developments. We will report on any advances of note. Government actions impacting intellectual property rights owners may also raise constitutional issues concerning property rights more broadly, as addressed in a prior client alert available here.
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[1] These companies include General Electric Company; Hill-Rom Holdings, Inc.; Medtronic Public Limited Company; ResMed Inc.; Royal Philips N.V.; and Vyaire Medical, Inc. The President previously invoked his powers under the DPA, on March 27, 2020, by requiring that General Motors Company “accept, perform and prioritize contracts or orders for the number of ventilators that the Secretary [of Health and Human Services] determines to be appropriate.”
[2] 85 Fed. Reg. 15198 (March 17, 2020).
[3] See Carbice Corp. of Am. v. Am. Patents Dev. Corp., 283 U.S. 27, 33 (1931); Akamai v. Limelight Networks Inc., 786 F.3d 899, 905 (Fed. Cir. 2015), rev’d on other grounds, 797 F.3d 1020 (Fed. Cir. 2015) (en banc) (per curiam); Mars, Inc. v. Coin Acceptors, Inc., 527 F.3d 1359, 1365 (Fed. Cir. 2008); Orthokinetics Inc. v. Safety Travel Chairs Inc., 806 F.2d 1565, 1579 (Fed. Cir. 1986).
[4] 85 Fed. Reg. 15198 § VI (“Covered Countermeasures”) (“To be a Covered Countermeasure, qualified pandemic or epidemic products or security countermeasures also must be approved or cleared under the FD&C Act; licensed under the PHS Act, or authorized for emergency use under Sections 564, 564A, or 564B of the FD&C Act.”)
[5] 85 Fed. Reg. 15198 (March 17, 2020).
[6] The DPA states that “[n]o person shall be held liable for damages or penalties for any act or failure to act resulting directly or indirectly from compliance with a rule, regulation, or order issued pursuant to this chapter[.]” 50 U.S.C. § 4557. But that provision has been interpreted to apply only to third-party breach of contract claims against parties whose performances of their contracts were frustrated under a DPA order. See Hercules, Inc. v. United States, 24 F.3d 188, 203-04 (Fed. Cir. 1994), aff’d, 516 U.S. 417 (1996).
[7] The full text of 28 U.S.C. § 1498(a) provides: “Whenever an invention described in and covered by a patent of the United States is used or manufactured by or for the United States without license of the owner thereof or lawful right to use or manufacture the same, the owner’s remedy shall be by action against the United States in the United States Court of Federal Claims for the recovery of his reasonable and entire compensation for such use and manufacture . . . For the purposes of this section, the use or manufacture of an invention described in and covered by a patent of the United States by a contractor, a subcontractor, or any person, firm, or corporation for the Government and with the authorization or consent of the Government, shall be construed as use or manufacture for the United States.”; see also Liberty Ammunition, Inc. v. United States, 835 F.3d 1388, 1394 n.3 (Fed. Cir. 2016) (noting that § 1498 effects a waiver of the government’s sovereign immunity).
[8] FAR 52.227-1 more specifically sets forth an express grant of “authorization and consent” for contractors and subcontractors for the use and manufacture of any patented invention (1) embodied in the structure or composition of any article delivered to and accepted by the government related to a government contract; or (2) used in machinery, tools, or methods necessary for a contractor to comply with the specifications of a contract, or if such use is directed by a contracting officer’s specific written instructions.
[9] IRIS Corp. v. Japan Airlines Corp., 769 F.3d 1359 (Fed. Cir. 2014); Zoltek Corp. v. United States, 672 F.3d 1309, 1322-23 (Fed. Cir. 2012) (en banc); Advanced Software Design Corp. v. Federal Reserve Bank of St. Louis, 583 F.3d 1371, 1376-77 (Fed. Cir. 2009).
[10] The indemnity clause is set forth in FAR 52.227-3 (titled “Patent Indemnity”) and provides that “[t]he contractor shall indemnify the Government and its officers, agents, and employees against liability, including costs, for any infringement of any United States patent . . . arising out of the manufacture or delivery of supplies, the performance of services, or the construction, alteration, modification, or repair of real property . . . or out of the use or disposal by or for the account of the Government of such supplies or construction work.”
[11] i4i Ltd. Ptrp. v. Microsoft Corp., 598 F.3d 831, 861 (Fed. Cir. 2010) (citing eBay v. MercExchange L.L.C, 547 U.S. 388, 391 (2006)).
[12] Hybritech Inc. v. Abbott Laboratories, 849 F.2d 1446, 1458 (Fed. Cir. 1988); Cordis Corp. v. Medtronic, Inc., 835 F.2d 859, 864 (Fed. Cir. 1986).
[13] See Amgen Inc. v. Sanofi, 872 F.3d 1367, 1381 (Fed. Cir. 2017) (finding district court erred in granting permanent injunction where it found that the public interest would be disserved by one). The same is true with respect to obtaining preliminary injunctive relief, which similarly requires that the patentee establish that the balance of equities weighs in its favor, that the injunction serves the public interest, that it is likely to succeed on the merits, and that it will suffer irreparable harm in the absence of an injunction. Trebro Mfg., Inc. v. Firefly Equipment, LLC, 748 F.3d 1159, 1165 (Fed. Cir. 2014).
[14] Mentor Graphics Corp. v. EVE-USA, Inc., 851 F.3d 1275, 1285 (Fed. Cir. 2017) (citing Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152 (6th Cir. 1978)). The patentee must also show demand for the patented product, an absence of acceptable non-infringing alternatives, and the amount of profit it would have made. See id.
[15] Halo Elecs., Inc. v. Pulse Elecs., Inc., 136 S. Ct. 1923, 1929 (2016).
[16] Id. at 1932.
[17] See 35 U.S.C. § 284 (providing that a court “shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer”). The reasonable royalty is commonly calculated by attempting “to ascertain the royalty upon which the parties would have agreed had they successfully negotiated an agreement just before infringement began.” Lucent Technologies, Inc. v. Gateway, Inc., 580 F.3d 1301, 1324 (Fed. Cir. 2009). In cases where only components of a product infringe a patent, the patentee must “apportion or separate the damages” between the patented and unpatented parts of the multicomponent product. Exmark Mfg. Co. v. Briggs & Stratton Power Prods. Grp., 879 F.3d 1332, 1349 (Fed. Cir. 2018).
Gibson Dunn lawyers regularly counsel clients on the issues raised by this pandemic, and we are working with many of our clients on their response to COVID-19. For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team. Please also feel free to contact the Gibson Dunn lawyer with whom you usually work, or the authors:
Authors: Joe Evall (jevall@gibsondunn.com), Richard Mark (rmark@gibsondunn.com), and Doran Satanove (dsatanove@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
The COVID-19 pandemic is already reshaping federal and state regulatory enforcement actions in the United States and around the world. Although it is too early to know the path or impact of future enforcement, experience gleaned from previous post-disaster enforcement activity and an analysis of enforcement activity to date brings into focus a few areas likely to prominently figure in regulator’s activity. These changes will not be consistent. As in the past, the political environment, enforcement resources, and ways in which fraud emerges from the crisis will differ across domestic and international borders.
With this in mind, in this alert, the beginning of a series of on-going Gibson Dunn alerts, we provide an overview of early enforcement actions in the United States, the United Kingdom, the European Union, and Asia, as well as specific areas in which increased enforcement activity is likely in the future: namely, insider trading, state-level consumer protection, and False Claims Act enforcement.
Gibson Dunn will continue to monitor enforcement actions and trends in the United States and abroad and provide updated analysis to assist our clients as they navigate the changing tides.
COVID-19 Enforcement in the United States
On March 20, 2020, the U.S. Department of Justice issued a press release announcing that Attorney General William Barr “directed all U.S. attorneys to prioritize the investigation and prosecution of Coronavirus-related fraud schemes.”[1] According to the press release, Deputy Attorney General Jeffrey Rosen “further directed each U.S. Attorney to appoint a Coronavirus Fraud Coordinator to serve as the legal counsel for the federal judicial district on matters relating to the Coronavirus, direct the prosecution of Coronavirus-related crimes, and to conduct outreach and awareness.”[2] Attorney General Barr also “urg[ed] the public to report suspected fraud schemes related to COVID-19.”[3]
On March 22, 2020, the DOJ announced its first action in federal court to combat fraud related to COVID-19. The DOJ sought, and received, a temporary restraining order in the United States District Court for the Western District of Texas against a website offering access to a (non-existent) Coronavirus vaccine kit from the World Trade Organization.[4]
On March 24, 2020, the Department of Justice established the COVID-19 Hoarding and Price Gouging Task Force “to address COVID-19-related market manipulation, hoarding, and price gouging.”[5] On April 2, 2020, the Department of Justice, in partnership with the Department of Health and Human Services, announced “the distribution of hoarded personal protective equipment (PPE), including approximately 192,000 N95 respirator masks,” discovered by the Federal Bureau of Investigations during an enforcement operation.[6]
Similarly, the United States Securities and Exchange Commission (“SEC”) has announced that, in response to the Coronavirus pandemic, it remains focused on “continuity of Commission operations,” “monitoring market functions and system risks,” “providing prompt, targeted regulatory relief and guidance,” and “maintaining [its] enforcement and investor protection efforts.”[7] Recently, the SEC announced trading suspensions in connection with false COVID-19 information, including the suspension of trading for a company that made statements “about having, and being able to obtain, large quantities of N95 masks,”[8] the suspension of trading for a company with “purported international marketing rights to an approved coronavirus treatment,”[9] the suspension of trading for a company in which third-party promoters disseminated information about “the viability of the company’s product to treat the coronavirus,”[10] and the suspension of trading of an OTC company amidst “concerns about investors confusing this issuer with a similarly-named NASDAQ-listed issuer . . . which has seen a rise in share price during the on-going COVID-19 pandemic.”[11]
Further, the SEC’s Office of the Chief Accountant has identified areas of particular focus with respect to ensuring high-quality financial information reporting, including the importance of well-reasoned accounting judgment and estimates (such as, fair value and impairment considerations, revenue recognition, and going concern), audit issues (in particular auditor independence issues in partnership with the Public Company Accounting Oversight Board), the impact of international accounting and audit-related standards, and continued investor outreach.[12] Notably, in the post-2008 financial crisis period, the SEC brought enforcement actions in connection with, among other things, concealed risks, misleading disclosures, false statements with respect to a company’s financial position, and the failure by auditors to appropriately scrutinize management estimates.[13] For more information on potential SEC enforcement, please refer to Gibson Dunn’s recent alert “SEC Enforcement Focus on Fallout from COVID-19: Insights for Public Companies and Investment Advisers During a Crisis.”[14]
Past may be prologue in connection with post-crisis federal enforcement—particularly with respect to oversight of emergency government stimulus funds. On March 27, 2020, the President signed into law the Coronavirus Aid Relief and Economic Security Act (the “CARES Act”), a $2 trillion emergency stimulus package.[15] During the 2008 financial crisis, Congress similarly established emergency government stimulus programs, including the Troubled Asset Relief Program (“TARP”) “to implement programs to stabilize the financial system.”[16] Regulatory oversight was included in the legislation establishing TARP, specifically, the Office of the Special Investigator General for the Troubled Asset Relief Program (“SIGTARP”). SIGTARP, which remains active today, “is a federal law enforcement agency and an independent audit watchdog that targets financial institution crime and other fraud, waste, and abuse related to TARP.”[17] Notably, the CARES Act also establishes a Special Inspector General for Pandemic Recovery (“SIGPR”) to “conduct, supervise, and coordinate audits and investigations of the making, purchase, management, and sale of loans, loan guarantees, and other investments” made by the Department of Treasury pursuant to the CARES Act.[18] On April 4, 2020, the President nominated Brian D. Miller as the Special Inspector General.[19] Mr. Miller is currently a special assistant to the President and senior associate counsel in the Office of White House Counsel.[20] In addition to SIGPR, the CARES Act established a Pandemic Response Accountability Committee and a Congressional Oversight Commission.[21]
SIGTARP’s continued enforcement function over a decade after its enactment predicts that the even larger, suddenly-organized distribution of government funds through the CARES Act, and other legislative efforts that may follow it, will dominate much of the enforcement agenda for the next decade. That so much of it involves funds loaned through federally-insured banks will provide the government with the benefit of a ten-year statute of limitations to proceed.[22] For instance, we should expect that law enforcement will look to loan or other government funding applications as a regular component of financial fraud investigations involving domestic targets or subjects, scouring them for alleged misstatements.
COVID-19 Enforcement in The United Kingdom
In the UK, the Coronavirus Act 2020[23] and the Health Protection (Coronavirus) Regulations 2020[24] have mandated amongst other things a national “lockdown,” the closure of businesses except those deemed to be essential, and restrictions on traveling to work unless necessary. The Coronavirus Act contains various offences for those that flout the rules, and limited related enforcement action has been taken by authorities.
A number of agencies have reported a spike in scams, including in the financial services sector, and there were reports early on that some companies were exploiting the pandemic and engaging in price gouging. Recently, a senior UK civil servant told Parliament that he expects to see organized crime targeting the Government’s multibillion-pound employee furlough scheme.
The Crown Prosecution Service issued guidance to police forces and prosecutors directing them that “all COVID-19 related cases” must be fed into the criminal justice system “Immediately” (above “High Priority”), including, for example, assaults on emergency workers.[25]
Competition and Consumer Law: The Competition and Markets Authority (“CMA”) has established a COVID-19 Taskforce[26] and in March issued Guidance indicating that competitor coordination will be permitted (and no enforcement action will be taken) if it is undertaken solely to address market needs arising from the pandemic and lasts no longer than necessary,[27] and an open letter to drug makers and food and drink companies warning against capitalizing on COVID-19 by charging unjustifiably high prices for essential goods or by making misleading claims about their efficacy.[28] The CMA publicly stated that it “will not tolerate unscrupulous businesses exploiting the crisis as a ‘cover’ for non-essential collusion.”[29] This includes “exchanging [] information on future pricing or business strategies, where this is not necessary to meet the needs of the current situation.”[30]
Financial Services Sector: The Financial Conduct Authority, the UK’s financial services regulator and enforcement agency, has stated that during the COVID-19 pandemic, it is focusing its efforts on ensuring that consumers remain protected and that markets continue to function well. The FCA made several announcements in response to COVID-19, including alerting consumers to pension scams.[31] The FCA indicated that it will not change its enforcement policy and will continue to investigate and bring enforcement action. It has warned publicly that it will not “tolerate conduct that seeks to exploit the situation and harms consumers.”[32]
Firms must continue to monitor their compliance systems and adapt to new risks. The FCA has recognized that increased numbers of people working from home will pose unique challenges and called on firms to continue to monitor their systems and controls, for example in relation to the recording of sales and other calls. Anti-money laundering requirements (such as customer identification checks) must still be followed, although the FCA recognizes that firms may have to adapt their approach. The FCA is likely to give firms some latitude, but firms must continue to monitor risks and look at alternative options if routine compliance controls cannot operate.
Finally, the FCA wrote to companies during March imposing a two week moratorium to delay publication of preliminary results and thereby prevent investors relying on outdated market information. In the same statement announcing the moratorium, the FCA reminded companies that the Market Abuse Regulation, the EU-wide law dealing with market abuse, market manipulation, and insider dealing, remains in force.[33]
Criminal Enforcement Agencies: The National Crime Agency and National Economic Crime Center have published several announcements, including a warning of organized crime groups exploiting the COVID-19 pandemic by using coronavirus-themed malicious apps, websites, and email phishing attacks in order to obtain personal and financial information;[34] and alerting the public to fraud and online scams including where individuals intend to purchase medical supplies online, such as face masks and COVID-19 testing kits, which never arrive or are fake. We expect to see a spike in prosecutions of those who are engaged in COVID-19-related fraud and other scams.[35] The NCA has not published any guidance regarding implications of the pandemic for the filing of Suspicious Activity Reports.
The UK Serious Fraud Office has yet to make any announcements in response to COVID-19, but is continuing its investigative efforts where possible. The lockdown measures will undoubtedly result in delays in SFO investigations (for example the agency may not be able to conduct interviews), but the extent of those delays will depend on the length of the lock down. To date, at least one SFO trial has been adjourned and remains on hold until further notice, and there are likely to be significant delays to others as the Lord Chief Justice has ordered a halt to all new jury trials.
Information Commissioner’s Office: The ICO has issued guidance stating that it would not penalize companies that the ICO “know[s] need to prioritise other areas or adapt their usual approach during this extraordinary period.”[36] For further details, please refer to the Gibson Dunn alert “Privacy and Cybersecurity Issues Related to COVID-19.”[37]
International Trade: The UK has prohibited the parallel export of certain critical medicines currently being tested for efficacy in treating COVID-19. On March 20, 2020, over 80 additional medicines used to treat patients in intensive care units were banned from parallel export from the UK in order to seek to ensure uninterrupted supply to NHS hospitals treating coronavirus patients. For further details, please refer to the Gibson Dunn alert “COVID-19 & International Trade – Nation-State Responses to a Global Pandemic.”[38]
COVID-19 Enforcement in The European Union
In the European Union, the primary authority to fight COVID-19 and its detrimental effects on health and security lies with each of the Member States. As such, the rules and the measures adopted by Member States differ in detail among the Member States (and, for example in Federations like Germany, among different regions within a Member State).
Most of the Member States have imposed severe measures, including travel restrictions, limitations to public life, and lockdowns as a response to the pandemic. Most notably, some Member States have imposed curfews on their citizens to varying degrees of severity. Failure to follow such measures—e.g. opening retail stores in spite of a prohibition or ignoring a curfew—may, depending on the Member State, constitute a regulatory or even a criminal offense.[39] The longer these restrictions remain, the more likely it becomes that enforcement actions will play a bigger role in the near future.
European security standards already are shifting focus as criminals try to benefit from the current state of affairs. Following the COVID-19 outbreak, EU law enforcement agencies, such as Europol, have observed a rise in crime in the following areas:[40] Cybercrime, Fraud, Counterfeit and Substandard Goods, and Organized Property Crimes.
Cybercrime: Cybercrime appears to be on the rise because criminals are using the COVID-19 crisis to carry out social engineering attacks themed around the pandemic to distribute various malware packages. As a greater number of employers institute work from home policies and allow external connections to their organizations’ systems, cybercriminals are expected to increase attacks on networks. Most critically, there are signals that cybercriminals have already attacked critical infrastructure such as hospitals (which is believed to have already occurred in the Czech Republic). Prior to the pandemic, in an effort to prepare for major cross-border cyberattacks, a EU Law Enforcement Emergency Response Protocol (“EU LE ERP”) was adopted in December 2018. The EU LE ERP supports EU law enforcement authorities in providing immediate response to major cross-border cyber-attacks through rapid assessment, the secure and timely sharing of critical information, and effective coordination of the international aspects of their investigations.[41]
Fraud: Fraud linked to the current pandemic often preys on the fear of EU citizens. In one recent case, for example, the transfer of €6.6 million by one company to another company in Singapore in order to purchase alcohol gels and FFP3/2 masks is under investigation because the goods were never received by the buyer. Similarly, criminals are also reported to have adapted investment scams to solicit speculative investments in stocks related to COVID-19 with promises of substantial profits.
As in the United States, we expect European investigations of fraud and subsidy fraud offenses will play a bigger role as the wave of applications to get access to state aid is now under way. Various governments are keen on making support funds[42] for businesses available—“quickly and without red tape,” as governments like to emphasize—and the age-old dynamic of fraud following urgency is equally predictable in Europe. As far as European funds are affected by such fraudulent acts (see, e.g., the new EU program for temporary Support to mitigate Unemployment Risks in an Emergency, also known as SURE[43]), EU agencies such as Europol and OLAF, the European Anti-Fraud Office, likely will get involved.
Counterfeit and Substandard Goods: The sale of counterfeit health care, sanitary/pharmaceutical products and personal healthcare equipment has become one of the main areas of criminal activity in the EU. These schemes often leverage people’s fear of infection. For example, the reported distribution of fake coronavirus home testing kits are particularly worrying from a public health perspective, because apart from being ineffective these kits may inflict bodily harm upon their users.
Organized Property Crime: Organized Property Crimes include the ‘nephew’ or ‘grandchild’ trick and the impersonation of representatives of public authorities. Criminals have adapted their modi operandi to the current situation. The number of attempts involving these types of thefts and scams is likely to increase across the EU. Multiple Member States have reported to Europol a similar modus operandi for theft. The perpetrators gain access to private homes by impersonating medical staff providing information material or hygiene products or conducting a “corona test.” The EU tries to handle the situation by working closely with all the Member States enforcement authorities on a 24/7 basis and informs the public about these scams regularly.[44]
That these forms of illicit activity occur now is no surprise. But the way European regulators redeploy resources will orient the direction companies and other market actors staff and pursue compliance initiatives and should be carefully followed.
COVID-19 Enforcement in Asia
Regulators in Asian countries, which have been combating COVID-19 since January, have ramped up enforcement efforts against market misconduct such as price gouging of medical supplies and false advertising.
In China, the State Administration for Market Regulation and its local branches have launched a series of enforcement actions targeting sales of substandard face masks and price gouging of face masks as well as raw materials that are essential for producing medical supplies. Regulators around the country have initiated approximately 14,800 investigations relating to pricing violations, half of which involved face masks.[45] As some cities in China are resuming normal business activities, local regulators are adopting a more comprehensive approach in combating market misconduct. The Shanghai Municipal Administration for Market Regulation, a key regulator for multinational companies that have operations in Shanghai, has announced an anti-unfair competition campaign that will last until the end of July of this year.[46] The campaign focuses on, among other things, false advertising and commercial bribery in medical device procurement, medical services, and education services. Notably, the Shanghai Municipal Administration for Market Regulation has called out potentially anti-competitive practices such as donating medical devices in exchange for the purchase of consumables.[47]
Regulators in Korea, including the Korean National Police Agency, the National Tax Services, the Ministry of Food and Drug Safety, and the Fair Trade Commission, have formed a joint task force to crack down on unfair market practices such as price gouging.[48] For example, the Korean National Tax Services has reportedly cracked down on 222 retailers and 41 mask manufacturers for hoarding and price gouging behavior.[49]
To contain the spread of COVID-19, government agencies and private enterprises in China are collecting personal data for contact tracing. Regulators have stepped up the protection of the personal information collected. In February 2019, the Cyberspace Administration of China (“CAC”) issued a circular regarding the collection and use of personal information in connection with COVID-19.[50] The CAC stressed in the circular that companies are only allowed to collect personal information from their employees as required by government entities for the purpose of containing COVID-19 or for purposes directly related to the performance of employment contracts, and should not use the personal information that they collected for any other purposes.[51] In particular, companies and government agencies are prohibited from disclosing names and family addresses of COVID-19 patients unless consent is given.[52] The Chinese government has already prosecuted several cases involving unauthorized disclosure of personal information of COVID-19 patients.[53] For instance, a local branch of the Commission for Discipline Inspection of the Communist Party of China is investigating a deputy at Hunan Yiyang County Health Bureau for disseminating a case study involving a COVID-19 patient that contains protected personal information of the patient and the patient’s eleven relatives.[54]
Enforcement Trends to Watch: Insider Trading
There has been widespread coverage—and condemnation—of potential insider trading by at least four senators in the early weeks of the Coronavirus pandemic. These senators allegedly received confidential briefings on how badly the U.S. economy might be hit by the pandemic, and thereafter sold substantial stock holdings before the recent Coronavirus-induced market drops, thus avoiding millions of dollars in losses.[55] The U.S. Department of Justice is now investigating,[56] the U.S. Securities and Exchange Commission issued a blanket warning against trading on material non-public information related to the coronavirus,[57] and private lawsuits are beginning to be filed.[58]
The last time allegations of pervasive congressional insider trading received this much attention, the federal government responded by passing the Stop Trading on Congressional Knowledge Act (the “STOCK Act”) in 2012. Designed to prevent members of Congress and other government employees from using nonpublic information derived from their official positions for personal benefit or other purposes, the STOCK Act prohibits members and employees of Congress and others from using “nonpublic information derived from such person’s position . . . or gained from the performance of such person’s official responsibilities as a means for making a private profit.”[59] However, certain portions of the STOCK Act that mandated greater transparency, reporting, and applicability were quietly rolled back in 2013.[60] Recent events have highlighted that potential insider trading by government officials continues to be a problem, and the public is again lamenting the country’s apparent inability to effect meaningful reform—both in Washington, D.C., and with respect to insider trading generally.[61] Indeed, some have suggested that it may be difficult to prosecute these senators for their alleged Coronavirus-related trading, given the many challenges built into our current insider trading jurisprudence.[62]
This renewed focus on insider trading arising from information asymmetries in COVID-19 related fact patterns may provide the public pressure necessary to enact real change in our country’s current insider trading laws. There are no laws specifically addressing insider trading in the U.S. Rather, insider trading law arises from a series of increasingly complex federal court decisions interpreting the anti-fraud provisions of the Securities Exchange Act of 1934. Over the years, there have been various initiatives to replace our current regime with explicit insider trading legislation—as other countries have done[63]—but they have all failed to gain traction to date.[64]
It is unclear whether the current public outcry hardens into the motivation necessary to systematically and comprehensively address this issue once and for all. When the dust of the current public health crisis settles, this may emerge as a top legislative issue—similar to the enactment of the Foreign Corrupt Practices Act (“FCPA”) in 1977 following concerns about widespread bribery of foreign officials by U.S. companies.[65]
Enforcement Trends to Watch: Enhanced State-Level Consumer Protection
State Attorneys General have announced their intentions to focus on fraud in connection with the pandemic—specifically identifying consumer protection and price gouging as areas already requiring enforcement.[66] To date, state Attorneys General have, among other things, sought temporary restraining orders and permanent injunctions to stop the sale of alleged COVID-19 treatments,[67] issued subpoenas against third-party sellers concerning allegations of price gouging,[68] and sent cease and desist letters to individuals and entities marketing products as COVID-19 treatments.[69] Numerous state Attorneys General have partnered with federal authorities to identify and prosecute COVID-19-related fraud.[70]
In addition to new federal regulatory enforcement initiatives, we can expect that preexisting anti-fraud initiatives may swiftly ripen into expanded investigative authority. The aforementioned progression of the FCPA in the aftermath of Watergate presages how enforcement initiatives facing uncertain enactment suddenly gather steam to implementation. Two state initiatives—in New York and California—may soon prove this point.[71] In response to perceived lax enforcement over the financial services industry at the federal level by the Consumer Financial Protection Bureau (“CFPB”), both New York and California have been pursuing significant expansions of the regulatory powers of state agencies.
In New York, Governor Andrew Cuomo’s January 2020 proposed budget sought to expand the enforcement authority of the New York State Department of Financial Services (“DFS”), the state’s banking and insurance regulator.[72] The proposed budget expanded the definition of “financial product or service” to include “the sale or provision to a consumer or small business of any security, investment advice, or money management device,” which could have turned the DFS into another state securities regulator (in addition to the New York State Attorney General)—with implications far beyond simply banks and insurance companies operating in New York.[73] The pre-pandemic proposed budget further expanded the power of DFS to levy (increased) civil penalties by removing requirements to prove intentionality and by including oversight of unfair, deceptive, or abusive acts or practices.[74] If passed, the DFS’ authority could have mirrored the authority of the state Attorney General under the Martin Act—the New York State law aggressively utilized by the state Attorney General to conduct investigations and bring civil and criminal actions for securities fraud.[75] The enacted budget, signed by Governor Cuomo on April 3, 2020, however, removed the proposal from the final budget.[76] New York’s effort to enhance its state financial services regulator have fallen to the wayside in response to the expected COVID-19 budget crunch.[77]
In California, Governor Gavin Newsom’s proposed 2020-2021 budget, which must be voted on by June 15, 2020, expands and restructures the California Department of Business Oversight (“DBO”). At present, the DBO oversees the operations of state-licensed financial institutions, such as banks, and licenses and regulates a variety of financial businesses, such as securities brokers and dealers.[78]
The proposed budget includes the California Consumer Financial Protection Law which “seeks to cement California’s consumer protection leadership amidst a retreat on that front by federal agencies.”[79] Under this proposal, the DBO would be rebranded as the Department of Financial Protection and Innovation. Its budget would increase by $19.3 million over the course of 2-3 years, and its staffing would increase by 90 positions over the same period.[80]
Explaining that “[t]he federal government’s rollback of the CFPB leaves Californians vulnerable to predatory businesses,” the California Consumer Financial Protection Law will expand the DBO’s authority to oversee and regulate unlicensed financial services providers not currently subject to regulatory oversight, including debt collectors, credit reporting agencies, and financial technology companies.[81]
Initially, funding is proposed to be covered by available settlement proceeds, with future costs covered by fees generated from newly covered industries and increased fees on existing licenses.[82] However, this proposal was issued prior to the Coronavirus pandemic, and the impact of the Coronavirus on the proposed budget, similar to New York’s recent experience, is unknown.
But when the greatest urgency from the COVID-19 pandemic passes, either or both of these bold initiatives, or some variants of them, may find ready support in New York and California. This is particularly so if they are viewed as holding promise not only to enhance enforcement, but to generate revenue derived from enforcement fines and penalties.
Enforcement Trends to Watch: False Claims Act
In a March 31, 2020 alert, Gibson Dunn detailed measures that companies can take now to decrease the risk that DOJ and/or qui tam whistleblowers will, down the line, successfully second-guess companies’ responses to the COVID-19 pandemic (through False Claims Act suits).
Public crises prompt government spending (for example, the CARES Act), and such spending inevitably leads to post-crisis DOJ and/or whistleblower suits targeting corporations that directly received or indirectly benefited from public funds. Given this historical precedent, turning square corners with the government, documenting communications with (and decisions by) government contractors, and responding thoroughly to internal whistleblower reports can meaningfully decrease False Claims Act exposure in the wake of the COVID-19 crisis.
For more detailed information, please refer to the Gibson Dunn alert, “Implications of COVID-19 Crisis for False Claims Act Compliance.”[83]
_________________________
[1] Press Release, U.S. Dep’t of Justice, Attorney General William P. Barr Urges American Public to Report COVID-19 Fraud (Mar. 20, 2020), available at www.justice.gov/opa/pr/attorney-general-william-p-barr-urges-american-public-report-covid-19-fraud.
[3] Id. Attorney General Barr urged the public to report suspected fraud to the National Center for Disaster Fraud (“NCDF”). The NCDF was established in 2005, in the wake of Hurricane Katrina, and is the national coordinating agency for man-made and natural disasters. In the wake of Hurricane Katrina, federal prosecutors charged over 1,300 disaster fraud cases. See National Center for Disaster Fraud, U.S. Dep’t of Justice, www.justice.gov/disaster-fraud (last visited Apr. 8, 2020). It can be expected that federal prosecutors will be similarly aggressive in addressing Coronavirus-related fraud reported to the NCDF.
[4] Press Release, U.S. Dep’t of Justice, Justice Department Files its First Enforcement Action Against COVID-19 Fraud (Mar. 22, 2020), available at www.justice.gov/opa/pr/justice-department-files-its-first-enforcement-action-against-covid-19-fraud.
[5] Memorandum from the Attorney General, U.S. Dep’t of Justice, Department of Justice COVID-19 Hoarding and Price Gouging Task Force (Mar. 24, 2020), available at www.justice.gov/file/1262776/download.
[6] Press Release, U.S. Dep’t of Justice, Department of Justice and Department of Health and Human Services Partner to Distribute More Than Half a Million Medical Supplies Confiscated from Price Gougers (Apr. 2, 2020), available at www.justice.gov/opa/pr/department-justice-and-department-health-and-human-services-partner-distribute-more-half.
[7] SEC Coronavirus (COVID-19) Response, U.S. Secs. & Exch. Comm’n, www.sec.gov/sec-coronavirus-covid-19-response (last visited Apr. 8, 2020).
[8] In the Matter of Praxsyn Corp., 2020 WL 1611114 (Mar. 25, 2020), available at www.sec.gov/litigation/suspensions/2020/34-88479-o.pdf.
[9] Exchange Act Release No. 88265, 2020 WL 916766 (Feb. 24, 2020), available at www.sec.gov/litigation/suspensions/2020/34-88265.pdf.
[10] Exchange Act Release No. 88142, 2020 WL 870115 (Feb. 7, 2020), available at www.sec.gov/litigation/suspensions/2020/34-88142.pdf.
[11] Exchange Act Release No. 88477, 2020 WL 1610845 (Mar. 25, 2020), available at www.sec.gov/litigation/suspensions/2020/34-88477.pdf.
[12] Public Statement, Sagar Teotia, Chief Accountant, Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19 (Apr. 3, 2020), available at www.sec.gov/news/public-statement/statement-teotia-financial-reporting-covid-19-2020-04-03.
[13] SEC Enforcement Actions Addressing Misconduct that Led to or Arose from the Financial Crisis, U.S. Secs. & Exch. Comm’n (last modified July 15, 2019), www.sec.gov/spotlight/enf-actions-fc.shtml.
[14] See SEC Enforcement Focus on Fallout from COVID-19: Insights for Public Companies and Investment Advisers During a Crisis, Gibson Dunn & Crutcher LLP (Mar. 26, 2020), available at www.gibsondunn.com/sec-enforcement-focus-on-fallout-from-covid-19-insights-for-public-companies-and-investment-advisers-during-a-crisis/#_edn1.
[15] See Erica Werner et al., Trump signs $2 trillion coronavirus bill into law as companies and households brace for more economic pain, Wash. Post (Mar. 27, 2020), available at www.washingtonpost.com/us-policy/2020/03/27/congress-coronavirus-house-vote/.
[16] About TARP, U.S. Dep’t of Treasury (last modified Nov. 20, 2019), www.treasury.gov/initiatives/financial-stability/about-tarp/Pages/default.aspx.
[17] Office of the Special Inspector Gen. for the Trouble Asset Relief Program, www.sigtarp.gov (last visited Apr. 8, 2020).
[18] CARES Act, H.R. 748 § 4018(c)(1) (2020).
[19] Alex Leary, Trump Nominates White House Layer to Oversee Coronavirus Business Loans, Wall St. J. (Apr. 4, 2020), available at www.wsj.com/articles/trump-nominates-white-house-lawyer-to-oversee-coronavirus-business-loans-11585965870?ns=prod/accounts-wsj.
[21] CARES Act, H.R. 748 §§ 4020, 15010 (2020). CARES Act §§ 4020, 15010. It is of note that, in a signing statement, the President took issue with aspects of both the Pandemic Response Accountability Committee and SIGPR. As to the Pandemic Response Accountability Committee, the President announced his intention to treat as hortatory, not mandatory, the requirement that the Chairperson of the Council of the Inspectors General on Integrity and Efficiency consult with members of Congress regarding the selection of the Executive Director and Deputy Executive Director of the Committee. As to the SIGPR, the President took issue with the requirement that SIGPR report to Congress “without delay” any unreasonable refusal by a government agency to produce information requested by SIGPR. The President stated that the administration would not treat this provision as permitting SIGPR to issue reports to Congress without presidential supervision. See Statement by the President, The White House (Mar. 27, 2020), available at www.whitehouse.gov/briefings-statements/statement-by-the-president-38/.
[22] See 18 U.S.C. § 3293 (2020) (“No person shall be prosecuted, tried, or punished for a violation of, or a conspiracy to violate . . . (2) section 1341 or 1343, if the offense affects a financial institution . . . unless the indictment is returned or the information is filed within 10 years after the commission of the offense.”).
[23] Coronavirus Act 2020, c. 7 (Eng.), available at www.legislation.gov.uk/ukpga/2020/7/contents/enacted.
[24] The Health Protection (Coronavirus) Regulations 2020, SI 2020/129, (Eng.), available at www.legislation.gov.uk/uksi/2020/129/contents/made.
[25] Interim CPS Charging Protocol – Covid-19 crisis response, CPS (Apr. 1, 2020), available at www.cps.gov.uk/sites/default/files/documents/legal_guidance/Interim-CPS-Charging-Protocol-Covid-19-crisis-response.pdf.
[26] CMA COVID-19 taskforce, U.K. Ministry of Justice (Mar. 20, 2020), www.gov.uk/government/publications/covid-19-cma-taskforce/cma-covid-19-taskforce.
[27] CMA approach to business cooperation in response to COVID-19, Competition and Mkts. Auth. 7 (Mar. 25, 2020), available at assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/875468/COVID-19_guidance_-.pdf.
[28] An Open Letter to the Pharmaceutical and Food and Drink Industries, Competition and Mkts. Auth. (Mar. 20, 2020), available at assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/874240/COVID_19_Open_letter_to_pharmaceutical_and_food_and_drink_industries2.pdf.
[29] CMA approach to business cooperation in response to COVID-19, Competition and Mkts. Auth. 6 (Mar. 25, 2020), available at assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/875468/COVID-19_guidance_-.pdf.
[31] Covid-19: savers stay calm and don’t rush financial decisions, Fin. Conduct Auth. (last modified Apr. 3, 2020), www.fca.org.uk/news/press-releases/covid-19-savers-stay-calm-dont-rush-financial-decisions.
[32] FCA and PSR respond to the CMA’s guidance on business cooperation under competition law, Fin. Conduct Auth. (last modified Mar. 27, 2020), www.fca.org.uk/news/statements/fca-and-psr-respond-cmas-guidance-business-cooperation-under-competition-law.
[33] FCA requests a delay to the forthcoming announcement of preliminary financial accounts, Fin. Conduct Auth. (last modified Mar. 22, 2020), www.fca.org.uk/news/statements/fca-requests-delay-forthcoming-announcement-preliminary-financial-accounts.
[34] National Crime Agency warn that organised crime groups may try to exploit the coronavirus outbreak to target the UK, Nat’l Crime Agency (Mar. 22, 2020), www.nationalcrimeagency.gov.uk/news/national-crime-agency-warn-that-organised-crime-groups-may-try-to-exploit-the-coronavirus-outbreak-to-target-the-uk.
[35] Beware fraud and scams during Covid-19 pandemic fraud, Nat’l Crime Agency (Mar. 26, 2020), www.nationalcrimeagency.gov.uk/news/fraud-scams-covid19.
[36] Data protection and coronavirus: what you need to know, Info. Comm’rs Office, ico.org.uk/for-organisations/data-protection-and-coronavirus/ (last visited Apr. 8, 2020).
[37] Privacy and Cybersecurity Issues Related to COVID-19, Gibson Dunn & Crutcher LLP (Mar. 20, 2020), available at www.gibsondunn.com/privacy-and-cybersecurity-issues-related-to-covid-19/.
[38] COVID-19 & International Trade – Nation-State Responses to a Global Pandemic, Gibson Dunn & Crutcher LLP (Apr. 1, 2020), available at www.gibsondunn.com/covid-19-international-trade-nation-state-responses-to-a-global-pandemic/.
[39] For further details on the German Infectious Diseases Protection Act, see COVID-19: The German Infectious Diseases Protection Act – What Makes You Stay At Home, Gibson Dunn & Crutcher LLP (Mar. 20, 2020), available at www.gibsondunn.com/covid-19-german-infectious-diseases-protection-act-what-makes-you-stay-at-home/.
[40] Press Release, Europol, How Criminals Profit from the Covid-19 Pandemic (Mar. 27, 2020), available at www.europol.europa.eu/newsroom/news/how-criminals-profit-covid-19-pandemic.
[41] Pandemic Profiteering: How Criminals Exploit the Covid-19 Crisis, Europol (Mar. 27, 2020), available at www.europol.europa.eu/publications-documents/pandemic-profiteering-how-criminals-exploit-covid-19-crisis.
[42] For more details see European and German Programs Counteracting Liquidity Shortfalls and Relaxations in German Insolvency Law, Gibson Dunn & Crutcher LLP (Mar. 25, 2020), available at www.gibsondunn.com/european-and-german-programs-counteracting-liquidity-shortfalls-and-relaxations-in-german-insolvency-law/.
[43] Questions and Answers: Commission Proposes SURE, A New Temporary Instrument Worth up to €100 Billion to Help Protect Jobs and People in Work, European Comm’n (Apr. 2, 2020), available at ec.europa.eu/commission/presscorner/detail/en/qanda_20_572.
[44] For updates see Staying Safe During Covid-19: What You Need to Know, Europol (last modified Apr. 1, 2020), www.europol.europa.eu/staying-safe-during-covid-19-what-you-need-to-know.
[45] Li Ang, “Zero Tolerance” Towards Illegal Acts During COVID-19, Sina Finance (Mar. 26, 2020), available at finance.sina.com.cn/chanjing/cyxw/2020-03-26/doc-iimxyqwa3197497.shtml.
[46] Notice by the Shanghai Municipal Administration for Market Regulation Regarding Further Enhancing Anti-Competition Enforcement Work (Feb. 25, 2020), available at scjgj.sh.gov.cn/shaic/html/govpub/2020-03-03-0000009a202002200011.html.
[48] Han-na Park, Seoul Gets Tough on Profiteering on Masks, Sanitizers, The Korea Herald (Feb. 6, 2020), available at www.koreaherald.com/view.php?ud=20200206000709.
[49] Yeon-joo Kim et al., S. Korea tightens mask exports to relieve local shortage, Pulse (Feb. 26, 2020), available at pulsenews.co.kr/view.php?year=2020&no=198103.
[50] Notice Regarding Protecting Personal Information and Utilizing Big Data to Support the Combat Against COVID-19, Cyberspace Admin. of China (Feb. 9, 2020), www.cac.gov.cn/2020-02/09/c_1582791585580220.htm.
[53] Xue Li, Dozens Prosecuted for Disclosing Private Information Regarding COVID-19 Patients, Tencent News (Feb. 24, 2020), available at xw.qq.com/cmsid/20200224A0Q39T00.
[54] Mengyao Wang, A Health Bureau Deputy Being Investigated for Disclosing Personal Information of a COVID-19 Patient, Caixin (Jan. 30, 2020), available at china.caixin.com/2020-01-30/101509610.html.
[55] See, e.g., Robert Faturechi and Derek Willis, Senator Dumped Up to $1.7 Million of Stock After Reassuring Public About Coronavirus Preparedness, ProPublica (Mar. 19, 2020), available at www.propublica.org/article/senator-dumped-up-to-1-7-million-of-stock-after-reassuring-public-about-coronavirus-preparedness; Richard Cowan et al., U.S. senators defend selling shares before coronavirus crash, Reuters (Mar. 20, 2020), available at www.reuters.com/article/us-health-coronavirus-usa-congress/reports-that-republican-u-s-senators-dumped-stock-before-coronavirus-market-crash-spark-calls-to-resign-idUSKBN2171AL.
[56] See David Shortell et al., Exclusive: Justice Department reviews stock trades by lawmakers after coronavirus briefings, CNN (Mar. 30, 2020), available at www.cnn.com/2020/03/29/politics/justice-stock-trades-lawmakers-coronavirus/index.html.
[57] Statement from Stephanie Avakian and Steven Peikin, Co-Directors of the SEC’s Division of Enforcement, Regarding Market Integrity U.S. Secs. & Exch. Comm’n (Mar. 23, 2020), available at www.sec.gov/news/public-statement/statement-enforcement-co-directors-market-integrity.
[58] See, e.g., Complaint, Jacobson v. Burr, 1:20-cv-00799 (D.D.C. Mar. 23, 2020).
[59] Stop Trading on Congressional Knowledge Act of 2012 § 3, 5 U.S.C. app. 1010 note prec. (2012).
[60] See Tamara Keith, How Congress Quietly Overhauled Its Insider-Trading Law, NPR (Apr. 16, 2013), available at www.npr.org/sections/itsallpolitics/2013/04/16/177496734/how-congress-quietly-overhauled-its-insider-trading-law.
[61] E.g., Matt Taibbi, After Richard Burr’s Coronavirus Scandal, Will the Government Finally Crack Down on Congressional Insider Trading?, Rolling Stone (Mar. 24, 2020), available at www.rollingstone.com/politics/politics-features/richard-burr-coronavirus-insider-trading-972101/ (“Members of congress trading against a pandemic is as low as it gets. On the long and winding history of elected officials eluding rules against political profiteering.”); John Crudele, Insider trading is business as usual for our politicians, N.Y. Post (Mar. 23, 2020), available at nypost.com/2020/03/23/insider-trading-is-business-as-usual-for-our-politicians/.
[62] See, e.g., Eric M. Creizman, COVID-19 and Congressional Trading on Nonpublic Information, N.Y. Law J. (Mar. 26, 2020), available at www.law.com/newyorklawjournal/2020/03/26/covid-19-and-congressional-trading-on-nonpublic-information/; Al Barbarino, Probes Of Senators’ Trading May Reach Uncharted Waters, Law360 (Mar. 25, 2020), available at www.law360.com/whitecollar/articles/1257242/probes-of-senators-trading-may-reach-uncharted-waters.
[63] See, e.g., Parliament and Council Regulation 596/2014 of April 14, 2014, On Market Abuse (Market Abuse Regulation) and Repealing Directive 2003/6/EC of the European Parliament and of the Council and Commission Directives 2003/124/EC and 2004/72/EC, 2014 O.J. (L 173) (EU); Act No. 108/2007 on Securities Transactions (Ice.).
[64] For example, several bills were introduced in Congress in the wake of the Second Circuit’s decision in United States v. Newman, 773 F. 3d 438 (2d. Cir. 2014), but they ultimately went nowhere. And more recently, the House passed the Insider Trading Prohibition Act in December 2019, but to date, this bill has not advanced in the Senate. The Bharara Task Force on Insider Trading likewise issued a report in January 2020 calling on Congress to pass clear and concise insider trading legislation (providing a model statute that could form the basis for a new law with clear parameters), and other legal scholars and jurists have also advocated for change and put forth proposals that, to date, have failed to take hold. See, e.g., Kenneth R. Davis, Insider Trading Flaw: Toward a Fraud-on-the-Market Theory and Beyond, 66 Am. U. L. Rev. 51 (2017); Carmen Germaine, Rakoff Urges Securities Bar to Write Insider Trading Law, Law360 (Mar. 1, 2017), available at www.law360.com/articles/897188/rakoff-urges-securities-bar-to-write-insider-trading-law.
[65] See, e.g., A Resource Guide to the U.S. Foreign Corrupt Practices Act, U.S. Dep’t of Justice & U.S. Secs. & Exch. Comm’n (2012), available at www.sec.gov/spotlight/fcpa/fcpa-resource-guide.pdf; Joe Palazzolo, From Watergate to Today, How FCPA Became So Feared, Wall St. J. (Oct. 2, 2012), available at www.wsj.com/articles/SB10000872396390444752504578024791676151154?ns=prod/accounts-wsj.
[66] Attorney Generals Are Taking Action to Protect Consumers During Coronavirus Pandemic, Nat’l Attorneys Gen. Training and Research Inst., www.consumerresources.org/covid-19-consumer-updates (last visited Apr. 8, 2020).
[67] Press Release, Eric Schmitt, Missouri Attorney General, AG Schmitt Files Suit Against Jim Bakker for Selling Fake “Coronavirus Cure” (Mar. 10. 2020), available at ago.mo.gov/home/news/2020/03/10/ag-schmitt-files-suit-against-jim-bakker-for-selling-fake-coronavirus-cure.
[68] Press Release, Florida Office of the Attorney General, Attorney General Moody Issues More Than 40 Subpoenas Over Allegations of Price Gouging by Third-Party Sellers on Amazon (Mar. 24 2020), available at www.myfloridalegal.com/newsrel.nsf/newsreleases/9D854B0F3345DC9085258535006C3BEC?Open&.
[69] Press Release, New York Attorney General, Attorney General James Order Alex Jones to Stop Selling Fake Coronavirus Treatments (Mar. 12, 2020), available at ag.ny.gov/press-release/2020/attorney-general-james-orders-alex-jones-stop-selling-fake-coronavirus-treatments.
[70] See, e.g., Press Release, Oklahoma Attorney General, Attorney General Hunter, U.S. Attorney Downing Coordinate Efforts to Combat Coronavirus Fraud (Mar. 27, 2020), available at www.oag.ok.gov/attorney-general-hunter-us-attorney-downing-coordinate-efforts-to-combat-coronavirus-fraud; Press Release, United States Attorney for the District of Columbia Timothy J. Shea Announces Launch of Metropolitan Area COVID-19 Anti-Fraud Task Force, U.S. Attorney Carpenito, AG Grewal, Acting Comptroller Walsh, Announce Federal-State COVID-19 Fraud Task Force (Mar. 30, 2020), available at www.justice.gov/usao-nj/pr/us-attorney-carpenito-ag-grewal-acting-comptroller-walsh-announce-federal-state-covid-19; Press Release, U.S. Dep’t of Justice, United States Attorney for the District of Columbia Timothy J. Shea Announces Launch of Metropolitan Area COVID-19 Anti-Fraud Task Force (Apr. 2, 2020), available at www.justice.gov/usao-dc/pr/united-states-attorney-district-columbia-timothy-j-shea-announces-launch-metropolitan.
[71] Corinne Ramey, New York, California Want More Power Over the Financial Sector, Wall St. J. (Mar. 16, 2020), available at www.wsj.com/articles/new-york-california-want-more-power-over-the-financial-sector-11584351002.
[72] See FY 2021 New York State Executive Budget, Transportation, Economic Development and Environmental Conservation, Article VII Legislation, Part NN (Jan. 21, 2020), available at www.budget.ny.gov/pubs/archive/fy21/exec/artvii/ted-bill.pdf.
[75] See 2019 Year-End Securities Litigation Update, Gibson Dunn & Crutcher LLP (Feb. 18, 2020), available at www.gibsondunn.com/2019-year-end-securities-litigation-update (discussing the Martin Act).
[76] See S. B. S7508-B, 2019-2020 Leg. Sess., Part NN (N.Y. 2020); see also A.B. 9508-B, 2019-2020 Leg. Sess., Part NN (N.Y. 2020).
[77] See Evan Weinberger, N.Y. Plan to Beef Up Financial Regulator Abandoned in Budget, Bloomberg Law (Apr. 2, 2020), available at news.bloomberglaw.com/banking-law/n-y-plan-to-beef-up-financial-regulator-abandoned-in-budget.
[78] About, Cal. Dep’t of Bus. Oversight, dbo.ca.gov/about (last visited Apr. 8, 2020).
[79] California Consumer Financial Protection Law, Cal. Dep’t of Bus. Oversight, dbo.ca.gov/California-consumer-financial-protection-law (last visited Apr. 8, 2020).
[80] Governor’s Budget Summary 2020-21, 174 (Jan. 10, 2020), available at www.ebudget.ca.gov/2020-21/pdf/BudgetSummary/FullBudgetSummary.pdf.
[83] Implications of COVID-19 Crisis for False Claims Act Compliance, Gibson, Dunn & Crutcher LLP (Mar. 31, 2020), available at www.gibsondunn.com/implications-of-covid-19-crisis-for-false-claims-act-compliance.
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The following Gibson Dunn lawyers assisted in preparing this client alert: Joel M. Cohen, F. Joseph Warin, Charles J. Stevens, Debra Wong Yang, Mylan Denerstein, Kelly Austin, Zainab Ahmad, Stephanie Brooker, John Partridge, Benno Schwarz, Patrick Doris, Darcy Harris, Amanda Aycock, David Crowley-Buck, Steve Melrose, Ning Ning, Carla Baum, and Andreas Dürr.
Gibson Dunn lawyers regularly counsel clients on the issues raised by this pandemic, and we are working with many of our clients on their response to COVID-19. Please feel free to contact the Gibson Dunn lawyer with whom you work, any member of the firm’s White Collar Defense and Investigations Group (F. Joseph Warin, Charles J. Stevens, and Joel M. Cohen, Co-Chairs), or any of the authors:
New York
Zainab Ahmad
Joel M. Cohen
Mylan Denerstein
Washington, D.C.
Stephanie L. Brooker
F. Joseph Warin
Los Angeles
Debra Wong Yang
San Francisco
Charles J. Stevens
Denver
John D.W. Partridge
London
Patrick Doris
Munich
Benno Schwarz
Hong Kong
Kelly Austin
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
The COVID-19 crisis is in full progress. Most companies are extremely burdened by the crisis and looking for easements. This newsletter shall give you an overview of various possibilities to reduce personnel costs in the short term under German law.
Next to a hiring freeze, which many companies have already implemented by now, using accrued overtime and vacation entitlement is the easiest and least intrusive option to respond to the situation. However, these measures do not directly reduce personnel costs.
Therefore, the following further measures should be considered:
A. Cut bonuses
Most bonus schemes have a clause, which allows the employer to reduce or entirely cut the bonus due to exceptional circumstances and/or financial distress. The COVID-19 crisis with its tremendous economic implications and government-induced shop closures[1] can be regarded as such an exceptional circumstance. Therefore, reducing or cutting bonuses should be the first measure, which can protect employer liquidity.
B. Short-time work (“Kurzarbeit“)
Another useful tool to counteract the initial drop in orders and labor surpluses is government-subsidized, short-time work, which already proved helpful during the 2008/2009 financial crisis. In a nutshell, short-time work means that the employer may reduce work time (even down to zero) and that, in the ultimate result, the state pays 60 %[2] of the net[3] income lost by the affected employees. After a limited period of short-time work (up to twelve months[4]), the original schedule is taken up again, thereby retaining a skilled workforce.
In response to the COVID-19 crisis, the German Federal government has introduced facilitated conditions with regard to short-time work with retroactive effect from March 1, 2020. For at least the rest of the year, short-time money will be granted under the following requirements:
- At least 10% of employees[5] suffer a loss of more than 10% of their remuneration due to an inevitable event (such as a state prohibition to temporarily operate one’s business) or due to economic causes (e.g., reduced demand or limited supply of goods as a result of the crisis);
- The loss of work must be of a temporary nature and inevitable. The company must adopt measures to counteract the reduction of work (e.g., assigning other remaining tasks to employees, cutting accrued overtime, using remaining vacation days for 2019 and before);
- The loss of work must be notified to the employment agency and shown in a convincing fashion (glaubhaft machen); and
- The option of short-time work must be provided for either in individual agreements with the respective employees or collective agreement (Tarifvertrag) or company agreement (Betriebsvereinbarung).
Short-time work might become the predominant tool to tackle the economic impacts of the crisis throughout Europe. The European Union has recently set up a program to support short-time working schemes across Europe. This new instrument for temporary Support to mitigate Unemployment Risks in an Emergency (“SURE”) provides financial assistance in the form of loans of up to €100 billion to EU Member States.
C. Voluntary salary reduction
In addition to the measures named above, a voluntary reduction of the salary or parts of it can be considered to protect the company’s liquidity regarding personnel costs. Absent any collective agreements to that effect, such a step generally requires the consent of each affected employee. While such consent is usually very difficult to obtain under normal circumstances, we have seen cases in which companies used crises of different natures to create a common conviction among their workforce to facilitate such intrusive measures.
D. Reducing the workforce
Some companies will also consider reducing their workforce.
As a principle, German labor law is extremely strict with regard to dismissals. There are only limited acknowledged reasons for dismissals, and the employer has the burden of proof as to their existence, if the employee challenges the dismissal, which happens quite often. In particular, a mere reference to the “corona crisis” does not justify a dismissal.
A termination for operational reasons (betriebsbedingte Kündigung) requires a permanent loss of the possibility to employ further. The burden of proof lies with the employer. As the COVID-19 crisis is—hopefully—of a temporary nature, this requirement would be hard to be upheld in court. The burden of proof with regard to the final loss of the job is even increased if the employee to be dismissed is working on a short-work scheme which is, by its nature, an instrument for covering a temporary loss of work. Thus, while an ordinary dismissal during short-time work is generally conceivable, the reasons for a termination due to operational reasons must necessarily go beyond the reasons that were originally given to justify an application for (temporary) short-time work.[6]
Yet, the strict dismissal protection provisions in general do not apply to (i) small shops with less than ten employees and (ii) to employees in their first six months of employment.
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[1] See also, https://www.gibsondunn.com/covid-19-german-infectious-diseases-protection-act-what-makes-you-stay-at-home/ (last visited April 7, 2020).
[2] Sixty-seven percent, if the employee has at least one child. According to media reports, the coalition parties forming the German Federal government are allegedly considering to increase the short-time money. While one suggestion put forward by the Social Democrats contains a general increase of the percent share to 80% and 87% respectively, the Christian Democrats are said to favor a sort of minimum amount of short-time money targeted at low-income beneficiaries. For further details, see Frankfurter Allgemeine Zeitung, dated April 4, 2020.
[3] Social security contributions are compensated by the employment agency.
[4] The Federal Ministry of Labor may, by way of regulation, extend the maximum period to 24 months.
[5] To be able to file a motion for short-time money, it is sufficient that a company retains a single employee. Thus, also small businesses may profit from a short-time work scheme.
[6] See Federal Labor Court, Judgment of February 23, 2012, 2 AZR 548/10, para. 21 = NZA 2012, 852, 854 et seq.
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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For further information, please contact the Gibson Dunn lawyer with whom you usually work, or the following authors in Germany.
Authors: Mark Zimmer and Andreas Dürr
Key Governance Action Items in Response to COVID-19
As public companies wrestle with the continuing and evolving impact of COVID-19, there are several key corporate governance matters that public companies and their boards of directors should consider in the short term.
- Ensure board continuity: Boards should consider whether to take action now to adopt emergency bylaws and/or appoint executive committees in order to ensure the continued ability of the board to operate in the months ahead.
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- Emergency Bylaws. The corporate laws of many states include provisions that apply in the event of an emergency to ensure that the board can continue to function. Some of these provisions require board action while others are self-executing. For example:
- Section 110(a) of the General Corporation Law of the State of Delaware (the “DGCL”) authorizes boards of companies incorporated in Delaware to adopt emergency bylaws that apply in the event that specific types of emergencies[1] prevent a quorum of the board or a standing committee. The emergency bylaws can provide flexibility regarding who can call board or committee meetings, permit a lower quorum and allow officers to serve as directors for certain meetings.
- In addition, other parts of DGCL Section 110 apply regardless of whether the board has acted. For example, DGCL Section 110(f) states that, unless otherwise provided in emergency bylaws, notice of any board meeting during an emergency may only be given to the directors that it is feasible to reach and by means that are feasible at the time. DGCL Section 110(g) also provides that to the extent necessary to achieve a quorum at any board meeting during an emergency, the company’s officers who are present shall (unless otherwise set forth in the emergency bylaws) be deemed directors for the meeting.
- Importantly, DGCL Section 110(d) states, “No officer, director or employee acting in accordance with any emergency bylaws shall be liable except for wilful misconduct.”
- Executive Committees. Another method to provide for board continuity is to create (or reconsider if previously created) an executive committee of the board comprised of a few members of the board with the remaining directors designated as alternates. This increases the likelihood that the executive committee will be able to continue to function even if several directors are unreachable and unable to participate. While it is important for the board in creating or reconsidering an executive committee to give the committee all of the powers and authority of the board that it is permitted to delegate, there are limits. For example, DGCL Section 141(c) places certain limits on board committees depending on the applicable DGCL provision and, in some instances, whether such rights were expressly delegated to the executive committee. Moreover, Delaware corporations should confirm whether the bylaws authorize committees to appoint alternate members, which provides added flexibility. Section 141(c) of the DGCL authorizes the board to appoint alternate committee members, but committees may appoint alternates only if expressly permitted in the bylaws.
- Practical Considerations: As an initial matter, companies should determine whether their bylaws already include emergency bylaws and authorize committees to appoint alternates as well as review the resolutions used to create any existing executive committee to determine whether alternates are designated and the extent of the committee’s authority. Boards also should consider which approach is preferable, considering (among other things) that there may be limits on the authority of an executive committee and that emergency bylaws create flexibility to adjust the quorums for the board and its committees, allow officers to fill board seats and, as discussed above, provide individuals acting pursuant to emergency bylaws greater protection from liability. While reviewing the bylaws in light of these issues, companies should also review the notice requirements for board and committee meetings and assess whether any changes are appropriate (consistent with state law) to enhance the board’s flexibility. As a matter of good corporate governance, even if a company has adopted one or both of these measures, it often will remain appropriate to invite all directors or committee members to any meetings so that directors remain informed and ready to act as needed.
- Emergency Bylaws. The corporate laws of many states include provisions that apply in the event of an emergency to ensure that the board can continue to function. Some of these provisions require board action while others are self-executing. For example:
- Reinforce emergency executive succession plan: A key duty of the board is to engage in succession planning for the CEO and management team, both for the long term and in the case of an emergency. Given COVID-19, it is important for boards to act now to review and confirm their emergency succession plan.[2] Specifically, boards should:
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- Confirm expected successors in an emergency. Discuss who should step in as CEO if needed and who is their replacement and understand, with input from the CEO, who are the replacements for each member of the executive team, preferably identifying at least two potential successors for each.
- Communicate with the emergency CEO successors. Inform the potential emergency CEO successors of their expected role in the event of the unexpected loss or incapacity of the CEO so that the relevant person can act until the board can formally appoint them as the new or interim CEO.
- Discuss the factors that would trigger implementation. Consider and discuss the various scenarios that may require implementation of the emergency succession plan (g., CEO hospitalization). Companies should review their bylaws to confirm whether they address officer succession events and impose any formalities on the process.
- Reinforce the role of the board’s independent leadership. Discuss designating the independent director in a leadership role (g., lead independent director or board chair) as point person for discussing if and when to trigger the CEO emergency succession plan in consultation with the board. Boards should also consider and document the role of the CEO and other executives in implementing emergency succession actions below the CEO level.
- Consider SEC disclosure of COVID-19 illnesses. In this context, boards may need to discuss whether and when to disclose a COVID-19-related illness of an executive officer. Although not necessarily a reportable event under Form 8-K, if an executive takes a leave of absence due to the illness, or can no longer perform his or her duties, disclosure under Item 5.02 of Form 8-K may be warranted. However, disclosure may be prudent, even without a leave of absence, if, under the circumstances, the company considers the illness of the executive to be a significant development in the company’s business requiring public disclosure. Companies should carefully review Form 8-K disclosure requirements in the event that an interim or replacement officer (even if temporary) has been appointed.[3]
- Consider if updates are needed to delegations of authority: Companies typically use delegations of authority to establish the specific authority given by the board to management in various areas, such as acquisitions, financing arrangements, variances from previously approved operating plans and budgets, and employee compensation matters. Given the evolving and often dramatic economic and business impacts related to COVID-19, companies should review these delegations of authority and consider whether the nature and scope of these delegations remain appropriate so that management has the flexibility to pivot as needed and the board can continue to play an appropriate oversight role.
- Evaluate how best to fulfill the board’s oversight role and directors’ fiduciary duties: Boards need to carefully balance performance of their oversight responsibilities with not unnecessarily burdening management teams that are already fully engaged. Boards should be shifting gears and spending more time overseeing issues and risks in response to the current situation, including emergency succession (discussed above), enhanced cybersecurity protections, liquidity concerns (g., if customers are delayed in paying bills), and staffing and the operation of workplace safety and work-from-home policies. This may mean delaying nonessential presentations, and moving from full- or multiple-day board and committee meetings to more frequent, shorter meetings. Other practices may also be useful in helping to keep the board informed in light of the rapidly occurring developments related to COVID-19, such as more frequent between-meeting communications with the board and having the board chairman check in individually with directors. The goal should be to ensure that the board is receiving regular reports on, and devoting appropriate time and attention to, the most critical challenges and risks facing the company, including those posed by COVID-19, and that the board’s efforts are appropriately documented. This will enable the board to fulfill its “Caremark” duties (so named for the seminal Caremark[4] case in which the Delaware Chancery Court articulated the oversight and monitoring responsibilities of a corporation’s boards of directors under Delaware law). A more recent application of this case—the Delaware Supreme Court’s 2019 decision in Marchand v. Barnhill[5]—underscores the importance of diligent monitoring when a company faces events or risks that are intrinsically critical to its business operations. Finally, directors should be mindful that in times of true crisis, a director’s fiduciary duties permit—and indeed, may even compel – the board to prioritize the interests of a range of stakeholders, because a company’s survival may depend on it. In this regard, Former Chief Justice of the Delaware Supreme Court Leo Strine recently wrote that during a national crisis, “the corporation’s obligations to its workers, its regular contractors, service providers, and lenders, and others with a legal and ethical claim to being paid comes above its duty to stockholders. Corporate leaders have the discretion to use their business judgment to best enable the corporation to weather this unprecedented storm, to honor its duties to those who have made the deepest commitment to the company’s success (that is, its employees), and to secure the solvency and long-term health of the business.”[6]
- Evaluate impacts on internal controls and internal audit function: Companies should consider the impacts of COVID-19 on their internal controls and internal audit function. In a recent statement, SEC Chairman Jay Clayton reminded companies that how they plan and respond to unfolding COVID-19 developments can be material to investment decisions and therefore may require disclosures about companies’ assessment of material risks related to COVID-19 and plans for addressing these risks. In light of this, Chairman Clayton “urge[d] companies to work with their audit committees and auditors to ensure that their financial reporting, auditing and review processes are as robust as practicable in light of the circumstances in meeting the applicable requirements.”[7] Changes to internal controls, and the implementation of new controls, may be warranted, and changes must be disclosed in Forms 10-Q and Form 10-K to the extent those changes have materially affected, or are reasonably likely to materially affect, the company’s internal controls. Companies also should consider the possibility that personnel or information critical to the effective operation of certain controls may be unavailable and that the development of alternative controls may be necessary. With respect to the internal audit function, companies may wish to revisit the internal audit plan and determine whether it is appropriate to shift priorities reflected in the plan and whether it is feasible to conduct planned audits without in-person access to certain locations. As companies continue to respond to COVID-19, internal audit can also play an important role in evaluating and making recommendations on issues such as emerging risks and business continuity plans.
- Consider how to proceed with the annual shareholders meeting: A significant number of companies expected to hold annual meetings of shareholders in the coming months now will hold virtual meetings in order to comply with government orders limiting the size of gatherings and to protect the health and safety of those who attend. While the SEC has provided relief for companies with respect to the proxy rules, companies also must consider the laws of the states in which they are incorporated.
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- Restrictions on Virtual Meetings. Some jurisdictions continue to prohibit or restrict the ability to hold virtual meetings, and some companies may not be in a position to rely upon emergency relief granted to facilitate virtual meetings.[8] As a result, some companies will need to choose between convening (or adjourning) in-person meetings with limited attendance in order to facilitate votes on key matters, and postponing the meeting for what could be a significant period of time due to COVID-19 and thus potentially incurring the costs of redistributing proxy materials.
- Holding Virtual Meetings. Companies that determine to hold a virtual meeting should carefully evaluate, among other things, the experience and workload of key virtual meeting providers and how to balance structuring the meeting agenda to complete the formal portion of the meeting quickly in case there are technological challenges with providing a forum for shareholders to engage with the company. Companies in this situation should address contingency plans for various scenarios, such as arranging in advance appropriate delegations or substitutions if the meeting chair or the designated proxyholders are unavailable. Finally, directors should strive to “attend” the virtual shareholder meeting to the extent feasible.
- Pivoting to Virtual Meetings. Companies that distributed proxy materials discussing the possibility of virtual meetings will need to decide whether to pivot to a virtual meeting several weeks in advance of the meeting in order to notify the virtual meeting provider, address state law notice requirements for record holders informing them of the change in location (if necessary—for example, if the website address for the meeting was not included in the initial materials) and issue a press release.[9] While not addressing or resolving state law concerns, the SEC’s recent guidance[10] for conducting annual meetings in light of COVID-19 addresses securities law issues for a company changing the meeting location from a physical location to a virtual one. The guidance provides that under the federal securities laws, a company that determines to change the date, time or location of its annual meeting after having mailed its definitive proxy materials may do so without needing to mail additional soliciting materials or amend its proxy materials if it issues a press release announcing such change, files the announcement as additional soliciting material on EDGAR, and takes all reasonable steps necessary to inform other intermediaries in the proxy process and relevant market participants of such change. With respect to companies opting to pivot to a virtual meeting, the SEC staff noted that it expects companies to timely notify shareholders and market participants of any plans to conduct a virtual meeting and to clearly disclose logistical details of the virtual meeting, including how shareholders can remotely access, participate in and vote at such meeting.
- (Re)examine incentive arrangements: Boards should bear in mind existing compensatory programs for senior management and employees and consider whether they provide the proper incentives in light of COVID-19. For example, establishing long-term goals based on total shareholder return (TSR) at a time of extreme stock price volatility may not create adequate incentives, and some executive compensation decisions may be better delayed until situations improve or at least stabilize. Moreover, companies should consider whether to disclose decisions by executive teams to reduce their compensation. Some boards have also considered whether to reduce their cash compensation to set the appropriate “tone at the top.”
[1] DGCL Section 110 states that emergency bylaws can be operative “during any emergency resulting from an attack on the United States or on a locality in which the corporation conducts its business or customarily holds meetings of its board of directors or its stockholders, or during any nuclear or atomic disaster, or during the existence of any catastrophe, or other similar emergency condition.”
[2] Under DGCL Section 110(b), either before or during an emergency, the board of directors may provide and modify lines of succession “in the event that during such emergency any or all officers or agents of the corporation shall for any reason be rendered incapable of discharging their duties.”
[3] See SEC Compliance and Disclosure Interpretation 217.02, stating, “When a principal financial officer temporarily turns his or her duties over to another person, a company must file a Form 8-K under Item 5.02(b) to report that the original principal financial officer has temporarily stepped down and under Item 5.02(c) to report that the replacement principal financial officer has been appointed. If the original principal financial officer returns to the position, then the company must file a Form 8-K under Item 5.02(b) to report the departure of the temporary principal financial officer and under Item 5.02(c) to report the ‘re-appointment’ of the original principal financial officer.” See also SEC Compliance and Disclosure Interpretation 217.04, providing that Item 5.02(b) of Form 8-K does not require a registrant to report the death of a director or listed officer.
[4] In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996).
[5] Marchand v. Barnhill, 2019 WL 2509617 (Del. June 18, 2019).
[6] Leo Strine, Remembering What Comes First is More Important Than Ever, Financial Times (Mar. 27, 2020).
[7] Available at https://www.sec.gov/news/press-release/2020-53.
[8] Although California law requires all shareholders to consent to the holding of virtual meetings, the governor issued an executive order suspending those requirements, dated March 30, 2020, available at https://www.gov.ca.gov/wp-content/uploads/2020/03/3.30.20-N-40-20.pdf. Other states that allow only hybrid meetings (physical and electronic) have acted to permit virtual-only meetings during the COVID-19 crisis. For example, several governors have issued executive orders to temporarily permit virtual-only meetings: Connecticut, dated March 21, 2020 (available at https://portal.ct.gov/-/media/Office-of-the-Governor/Executive-Orders/Lamont-Executive-Orders/Executive-Order-No-7I.pdf?la=en), Georgia, dated March 20, 2020 (available at https://gov.georgia.gov/document/2020-executive-order/03202002/download), Massachusetts, dated March 30, 2020 (available at https://www.mass.gov/doc/virtual-shareholder-meeting-order/download), New York, dated March 20, 2020 (available at https://www.governor.ny.gov/sites/governor.ny.gov/files/atoms/files/EO_202.8.pdf) and North Carolina, dated April 1, 2020 (available at https://files.nc.gov/governor/documents/files/EO125-Authorizing-Encouraging-Remote-Shareholder-Meetings.pdf). See also the legislation enacted in New Jersey (available at https://www.njleg.state.nj.us/2020/Bills/A4000/3861_I1.HTM).
[9] An emergency order signed by the Delaware governor on April 6, 2020, states that a public company can provide notice of a change from a physical to a virtual meeting by filing a notice with the SEC and issuing a press release that is posted on the company’s website provided that the change was due to the public health threat caused by COVID-19 and that the company distributed proxy materials in advance of the Order notifying shareholders of the physical meeting. See Tenth Modification of the Declaration of A State of Emergency for the State of Delaware Due to a Public Health Threat, available at https://governor.delaware.gov/health-soe/tenth-state-of-emergency/.
[10] See Staff Guidance for Conducting Annual Meetings in Light of COVID-19 Concerns, available at https://www.sec.gov/ocr/staff-guidance-conducting-annual-meetings-light-covid-19-concerns?auHash=zrsDVFen7QmUL6Xou7EIHYov4Y6IfrRTjW3KPSVukQs.
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work in the Securities Regulation and Corporate Governance practice group, or the authors:
Authors: Elizabeth Ising, Ronald O. Mueller, Lori Zyskowski, Courtney C. Haseley and Gillian McPhee.
NOTE: This Client Alert, which focuses on Delaware law, does not purport to provide an exhaustive guide to the issues directors should consider in times of financial stress.
The rapid spread of COVID-19, increasingly stringent government orders in response, and the profound effects on the global economy have raised concerns among corporate directors about how to adequately discharge their fiduciary duties.
First and foremost, directors can rest assured that the flexibility and protections afforded to them by the business judgment rule remain as vital today as they did before the COVID-19 pandemic. The COVID-19 pandemic does not alter the business judgment deference afforded to decisions made by a well-informed and non-conflicted board that acts in good faith towards what is best for the corporation and its stockholders.
However, directors do need to recognize that as a result of the COVID-19 pandemic, economic, regulatory, and public health related events are unfolding faster than ever. Directors must make decisions on tight timetables and with limited resources. This note is a tool for directors to help them identify some of the issues they should consider to ensure that their decisions are protected by the business judgment rule as they guide their companies during these challenging times.
Ensure Information and Reporting Systems Are Adequate. Directors generally must attempt to assure a reasonable information and reporting system exists as part of their oversight obligations. This is an area that had already become the focus of boards and their advisors over the last 18 months, as recent Delaware cases have criticized boards for failing to properly discharge their oversight obligations.[1]
Most companies already have in place systems for typically encountered business issues, including regularly scheduled management updates. Those systems should be adapted as needed to respond to the current pandemic and its impact on your business. At a minimum, evaluate whether your system involves:
- Regular Management Updates. To satisfy their duties, directors are expected to require management to deliver updates about the business to the board on a consistent basis—and to document those requirements where possible. Management is likely gathering information related to COVID-19 and tracking the effects of the pandemic on the organization. Directors should ensure they receive updates with the benefit of that information.
- Board Review and Adoption of Relevant Policies. Directors are often expected to play a role in reviewing policies that a company develops in response to applicable regulations and should oversee policies, among other things, relating to the regulatory response to COVID-19, when appropriate.
- Written Materials. It is not always possible to prepare written materials ahead of a board meeting; however, it is a good practice to provide written materials whenever practicable. While the addition of written materials to update the directors places an additional burden on management, should a board decision later be subjected to judicial review, courts may consider whether directors reviewed written materials in making significant corporate decisions. Note that written materials that reflect legal advice should be marked “privileged and confidential.”
Maintain Complete and Accurate Board Minutes. Contemporaneously recorded board minutes are generally entitled to a presumption that they accurately reflect the substance of the board’s discussions. Whenever practicable, clients should continue to record board minutes contemporaneously with any meeting to ensure that if needed, the board has a written record of its actions. And boards should evaluate how much detail is required under the circumstances: for example, merely referring to a discussion of COVID-19 as an “operational update” is unlikely to provide a sufficient basis to determine whether the directors adequately discharged their fiduciary duties, unless the record reflects that additional written materials were provided to directors that reflect in a more fulsome manner the relevant “operational update.”
Be Aware of Privilege Issues. Directors should be especially vigilant about protecting privilege given the range of third-party non-legal advisors that may be assisting clients in responding to the COVID-19 pandemic. While board communications with in-house and outside counsel are generally privileged, the mere presence of an attorney at a board meeting will not cloak a communication in privilege because privilege only attaches to legal advice, including requests for legal advice, and attorney-client communications. Additionally, the presence of third parties at board meetings where legal advice is being provided likely will constitute a waiver of privilege if the third parties (including observers and financial advisors) are not necessary for legal advice discussed. Therefore, directors should evaluate regularly whether third parties should be excused from any portion of a meeting. Directors should also exercise caution when forwarding or disseminating company materials to third parties, because doing so could constitute a waiver of privilege. In addition, communications among the directors that do not involve communications with lawyers are likely not privileged.
Regularly Evaluate Solvency. Businesses that were previously on strong financial ground are now facing financial challenges of a size and speed that was not contemplated prior to the COVID-19 pandemic. Businesses already facing financial stress will likely face even greater financial stress, potentially pushing them closer to insolvency at a faster rate. Directors should evaluate how often they need to receive reports on the financial condition of their business.
- Fiduciary Duties Expand to Cover Creditors. The board of directors owes fiduciary duties to the corporation. Generally, when a corporation is solvent, the beneficiaries of those fiduciary duties are the stockholders; creditors do not benefit from fiduciary duties and instead are instead afforded protection through contracts and other sources of creditor rights. But when a corporation becomes insolvent, under Delaware law, creditors become the primary beneficiaries of those fiduciary duties, and this shift will require that boards take into account the interests of creditors as well as stockholders when making strategic decisions. Even when fiduciary remedies extend to creditors, they are still be subject to the default business judgment rule if the underlying actions were taken by non-conflicted directors. Note that under Delaware law, LLC operating agreements can include broad waivers of fiduciary duties, so boards of those entities may want to confirm whether applicable waivers are in such operating agreements.
- Insolvency May Prohibit Scheduled Actions. Certain board decisions made before the COVID-19 pandemic may require re-evaluation to account for the company’s post-COVID-19 financial status. For example, the board may have approved an extraordinary capital expenditure prior before to the COVID-19 pandemic (g., opening a new factory), which it is prudent to revisit given the current climate. Or the board may have declared a dividend prior to the pandemic, but before paying a dividend, certain state statutes require that the corporation have sufficient assets such that the payment would not leave the corporation insolvent. Should the board determine the company is sufficiently stressed that it cannot issue a dividend, that may create legal peril if the dividend was previously declared. The prior declaration of a dividend may have created an irrevocable debtor-creditor relationship between the corporation and its stockholders, and the only lawful option might be to postpone the record date (if it has not yet passed) and payment date until a future date when adequate funds become lawfully available for distribution to stockholders. This is just one of the many previously approved board actions that boards may need to reassess after being fully informed about the company’s financial condition.
Check Your D&O Insurance. Evaluate whether you have sufficient coverage. Confirm whether your insurance policy has, or whether you need, Side A coverage (direct coverage for directors and officers who the company is unable or unwilling to indemnify) or Side B coverage (reimbursement to the company for indemnity payments made on behalf of directors and officers). Evaluate whether your policy has exclusions that would vitiate coverage in the event the company files for bankruptcy.
Key Employee Retention Plan. Evaluate whether steps should be taken to retain key management. Particularly in cases where the company is in distress, typical equity grants may be insufficient as a retention tool. Further, key employees may consider a future promise of retention payments to be too speculative or risky in light of the company’s financial stress. One strategy that may mitigate the risk is to make an upfront cash retention payment to key employees, with a written agreement that the employee will keep the payment if by a designated milestone the employee has not been fired for cause or did not resign without cause.
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[1] See Gibson, Dunn & Crutcher LLP, Delaware Supreme Court Revisits Oversight Liability (July 29, 2019), https://www.gibsondunn.com/delaware-supreme-court-revisits-oversight-liability/.
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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 pandemic. For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team, the Gibson Dunn lawyer with whom you usually work, or the authors:
Authors: Shireen Barday, Mary Beth Maloney, Dennis Friedman, Eduardo Gallardo, Robert Klyman, Jonathan Fortney and Patrick Hayden
The UK Government has announced a series of measures to support public services, people and businesses through this period of severe – but temporary – disruption caused by COVID-19. The Government’s measures are a mixture of tax relief, financing and support towards the cost of employees. Further clarity on the Government’s plans and practical processes for taking advantage of the support is expected to be provided as the days progress.
In this client alert we give a brief overview of the financial packages that have been made available to UK businesses. This is a very fluid situation where UK Government policy announcements are being made on an almost daily basis. The brief overview provided below presents the measures available as at 3 April 2020.
See also the Gibson Dunn Coronavirus (COVID-19) Resource Centre for more details on these UK Government schemes, including our prior client alerts on:
- The Covid Corporate Finance Facility and Coronavirus Business Interruption Loans: https://www.gibsondunn.com/covid-19-uk-financial-support-for-businesses-through-purchases-of-commercial-paper-and-lending-to-smes/
- The Coronavirus Job Retention Scheme and other UK employment related-matters: https://www.gibsondunn.com/uk-employment-law-considerations-for-companies-responding-to-covid-19-update/ ; https://www.gibsondunn.com/uk-employment-law-updated-considerations-for-companies-responding-to-covid-19/ ; https://www.gibsondunn.com/uk-employment-law-considerations-for-companies-responding-to-covid-19/
| Scheme | Details |
| Financial Support Measures | |
| 1. COVID-19 Corporate Financing Facility (CCFF) | Under the CCFF scheme, the Bank of England (BoE) will buy commercial paper from larger companies. The CCFF scheme will support companies that are fundamentally strong but which have been affected by a short-term funding squeeze. Small and medium-sized enterprises are unlikely to be able to access the CCFF scheme.
The scheme will operate for at least 12 months and will purchase sterling-denominated commercial paper, with the following characteristics:
The BoE notes that it will also consider whether the company generates significant revenues in the UK, serves a large number of customers in the UK or has a number of operating sites in the UK. The CCFF is open to firms that can demonstrate that they were in “sound financial health” prior to the impact of COVID-19. This means companies that had a short or long-term rating of investment grade, as at 1 March 2020, or equivalent. If firms have different ratings from different agencies, and one of those is below investment grade then the commercial paper will not be eligible. The CCFF is open to all firms and sectors, providing that the eligibility criteria as set out above are satisfied. If a firm does not have a credit rating it should speak to its existing lenders and if the firm was considered to be in “sound financial health” at 1 March 2020, a submission can be made to the BoE on that basis. Alternatively, the BoE notes that companies can contact one of the major credit rating agencies to seek an assessment of credit quality in a form that can be shared with the BoE and HM Treasury. More information on eligibility and application documents can be found on the Bank of England Website. |
| 2. Coronavirus Business Interruption Loan Scheme | This temporary scheme supports small and medium-sized businesses with an annual turnover of up to £45 million with access to £5 million of finance in the form of term loans, overdrafts, invoice finance and asset finance facilities for up to six years.
The Scheme has also been extended to enable banks to make loans of up to £25 million to firms with an annual turnover of between £45 million and £500 million. The scheme will be delivered through commercial lenders (including all major banks), backed by the UK Government-owned British Business Bank. As part of the scheme, the UK Government will provide lenders with a guarantee of 80% on each loan (subject to a per-lender cap on claims). The UK Government will also make a business interruption payment to cover the first 12 months of interest payments and any lender-levied fees. However, clients should note that the borrower remains 100% liable for the debt. Clients should also note that there is no obligation on a lender to offer a loan within the Scheme. If a lender can offer finance on normal commercial terms without making use of the Scheme, it will do so. Security is not required to secure lending below £250,000. For any borrowing above £250,000, it is open to lenders to ask for security including personal guarantees from directors and security over their assets in support of such guarantees, however, there is a prohibition on taking security over a director’s primary residential property. Taking into consideration the UK Government’s guarantee, any personal guarantees for borrowing in excess of £250,000 are capped at 20% of the outstanding value of the loan. To be eligible to participate in the Scheme the business must meet the following key tests:
The full rules of the Scheme (including further eligibility criteria and the application process) is available on the British Business Bank website. |
| 3. Insurance Claims for Notifiable Diseases | Most commercial insurance policies are unlikely to cover pandemics or unspecified notifiable diseases, such as COVID-19. However, those businesses which have an insurance policy that covers government ordered closure and pandemics or government ordered closure and unspecified notifiable disease should be able to make a claim (subject to the terms and conditions of their policy). Businesses are encouraged to check the terms and conditions of their specific policy and contact their providers.
Notifiable diseases are certain infectious diseases that registered medical practitioners have a statutory duty to notify the ‘proper officer’ at their local council or local health protection team about when they come across a suspected case. The Government keeps an updated list of notifiable diseases. On 5 March 2020, the government added COVID-19 to its list of notifiable diseases. Many insurers use diseases on notifiable diseases list as triggers for the activation or exclusion of insurance cover. For example, insurers’ policies that cover notifiable diseases will typically only cover a specific subset of notifiable diseases (such as Cholera or Anthrax) that the insurer will reference in the policy documentation. These policies will exclude any notifiable disease not on the insurers list, as well as future/unknown diseases (such as COVID-19). The price that the insurer charges for the policy is modelled against the risk posed by this set list of diseases. Some businesses will have purchased add-ons for their insurance that cover for ‘unspecified notifiable diseases’. These policies effectively cover any disease listed as a notifiable disease, enabling the business to claim for losses for all notifiable diseases as well as from diseases that are unknown at the point the policy is written. The effect of the Government adding COVID-19 to its list of notifiable diseases is to ensure that businesses with unspecified notifiable disease cover are able to make a claim – subject to the terms and conditions in their policy. For example, someone infected with COVID-19 may need to have been on the premises. The Government also asked a number of different businesses and venues to remain closed from 21 March 2020 onwards. Insurers have agreed that this advice is sufficient for businesses covered for COVID-19 losses to make a claim (if the only barrier to them making a claim was a lack of clarity on whether the government had ordered businesses to close). As such, intervention by the police or any other statutory body is no longer required to trigger cover in the current circumstances. However, most businesses’ commercial insurance policies (including for denial of access) are unlikely to offer cover for COVID-19. Insurance policies differ significantly, so businesses are encouraged to check the terms and conditions of their specific policy and contact their providers. |
| 4. State Aid | EU State aid rules apply in the UK during the Brexit transition period which expires on 31 December 2020. On 19 March 2020, the European Commission (Commission) adopted a Temporary Framework for State aid measures to support the economy in the current COVID-19 outbreak. Under the Temporary Framework, the Commission can authorize member states and the UK to adopt aid schemes in the form of tax advantages or direct grants, State guarantees or loans on an expedited basis (within 24-48 hours). On 25 March, the Commission approved two UK aid schemes. The guarantees scheme covers 80% of loan facilities for SMEs with a turnover of up to GBP 45 million to cover their working and investment capital needs and will be implemented through the British Business Bank. Under the direct grants scheme, SMEs are eligible for an up to GBP 734,000 support in the form of a direct grant. The schemes will be in place until 30 September 2020, and can be extended by the UK until 31 December 2020.
In addition to the Temporary Framework, which provides for the possibility of adopting aid schemes, the UK can grant State aid under the existing (non-COVID-19) State aid rules, which permit member states and the UK, under certain conditions, to: (i) provide rescue aid without first notifying the Commission; and (ii) provide State aid to make good the damage caused by natural disasters or exceptional occurrences. On 12 March, the EC declared that Covid-19 is an exceptional occurrence. Whether larger companies that cannot benefit from the COVID-19 aid schemes, both because of their size and their funding needs, can receive UK Government support will need to be assessed on a case-by-case basis. |
| Employment Support Measures | |
| 5. Coronavirus Job Retention Scheme | All UK employers with a PAYE (“pay as you earn”) scheme in operation on 28 February 2020 will be able to access support to continue paying part of their employees’ salary for those that would otherwise have been laid off during this crisis.
The scheme applies to all employees that have been asked to stop working, but who are being kept on the pay roll (described as “furloughed workers”). To claim, employees must be designated as furloughed workers and notified of this change. The UK tax authority (HMRC) will reimburse 80% of furloughed workers’ wages, up to £2,500 per month, plus the associated Employer’s National Insurance contributions and minimum automatic enrolment employer pension contributions on that wage. Employers can choose to “top up” the pay of a furloughed employee to 100% of their contractual pay, but are not obliged to under the scheme. The scheme will cover the cost of wages backdated to 1 March 2020. It is initially open for three months, but “will be extended if necessary”. HMRC expects the first grants to be paid by the end of April. In the meantime, if a business needs short term cash flow support, it may be eligible for a Coronavirus Business Interruption Loan (see below). More information here. |
| 6. Self-employment income support scheme | The UK government has outlined details of new Self-Employment Income Support Scheme. The scheme will provide a taxable grant to self-employed individuals (including members of partnerships) worth 80% of average monthly income taken over the last three tax years, capped at £2,500 per month.
The scheme is only open to anyone with trading profits less than £50,000 and to those who earn the majority of their income from self-employment. The scheme is unlikely to be up and running before the start of June 2020, so it will not help self-employed individuals with immediate cash flow issues. Unlike the Coronavirus Job Retention Scheme, an eligible self-employed person can continue to work while claiming the grant. |
| 7. Statutory Sick Pay Rebate | Small-and medium-sized enterprises (SME) and employers will be able reclaim Statutory Sick Pay (SSP) paid for sickness absence due to COVID-19. A company is considered an SME if it meets two out of three of the following criteria: (i) Turnover of less than £25 million; (ii) Fewer than 250 employees, and/or (iii) Gross assets of less than £12.5 million.
The eligibility criteria for the scheme will be as follows: (i) 2 weeks’ SSP per eligible employee who has been off work because of COVID-19; (ii) SMEs only; (iii) employers can reclaim expenditure for any employee who has claimed SSP (according to the new eligibility criteria) as a result of COVID-19; (iv) employers should maintain records of staff absences and payments of SSP, but employees will not need to provide a GP fit note. If evidence is required by an employer, those with symptoms of coronavirus can get an isolation note from NHS 111 online and those who live with someone that has symptoms can get a note from the NHS website; and (v) the eligible period for the scheme will commence the day after the regulations on the extension of SSP to those staying at home comes into force. The process for claiming a rebate has not yet been developed and further detail is expected in due course. More information here. |
| Tax Support Measures | |
| 8. Time to Pay | All businesses and self-employed people in financial distress, and with outstanding tax liabilities, may be eligible to receive support with their tax affairs through HMRC’s Time To Pay service. The service previously did not cover corporation tax, PAYE and Valued Added Tax (VAT), however, the UK Government’s measures have now extended to apply to VAT and HMRC will consider deferral of PAYE and corporation taxes on a case by case basis.
All arrangements are agreed on a case-by-case basis and are tailored to individual circumstances and liabilities. More information here. |
| 9. VAT Deferral | The UK Government has deferred Valued Added Tax (VAT) payments for three months (from 20 March 2020 until 30 June 2020).
All VAT-registered UK businesses are automatically eligible without application required. However, quarterly returns should still be filed as normal and HMRC will pay VAT refunds and reclaims as normal (providing cash flow for some businesses). The payment of VAT that has been deferred under the scheme should be paid at the end of the next tax year, in April 2021. More information here. |
| 10. Deferral of Self-Assessment payment | The Self- Assessment payment on account, that is ordinarily due to be paid to HMRC by 31 July 2020 may now be deferred until January 2021.
The deferment is automatic but optional. No penalties or interest for late payment will be charged if the July 2020 payment on account is deferred until January 2021. More information here. |
| 11. Business Rates Holiday for Retail, Hospitality and Leisure | Businesses in the retail, hospitality and leisure sectors in England[1] will not have to pay business rates (municipality taxes) for the 2020-21 tax year.
There is no action to take. Local authorities will automatically apply the business rates holiday to business rates bills for the 2020/2021 tax year. More information here. |
| 12. Cash Grant for Retail, Hospitality and Leisure | Businesses in England in the retail, hospitality or leisure sector with a rateable value between £15,001 and £51,000 will receive a cash grant of up to £25,000 per property.
There is no action to take. Local authorities will write to businesses that are eligible for this grant. More information here. |
| 13. Small Business Grant Funding | This scheme supports small businesses in England that already pay little or no business rates because of small business rate relief, rural rate relief and tapered relief. The scheme will provide a one-off grant of £10,000 to businesses with a rateable value of up to £15,000 to help meet their ongoing business costs.
Local Authorities will write to all eligible businesses with information on how to claim this grant. More information here. |
| 14. Business Rates Holiday for Nurseries | Nurseries in England that provide Early Years Foundation Stage do not have to pay business rates for the 2020-21 tax year.
Local authorities will automatically apply the business rate holiday to relevant business rates bills for the 2020-21 tax year. More information here. |
[1] Some aspects of business support are devolved. Separate schemes may apply in Scotland, Wales and Northern Ireland.
This client update was prepared by Michelle Kirschner, Mark Sperotto, Attila Borsos, Anne MacPherson, Amar Madhani, and Martin Coombes.
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 outbreak. For additional information, please contact your usual contacts or any member of the Firm’s Coronavirus (COVID-19) Response Team. In the UK, the contact details of the authors and other key practice group lawyers are as follows:
The Authors:
Michelle M. Kirschner – London, Financial Institutions (+44 (0)20 7071 4212, mkirschner@gibsondunn.com)
Mark Sperotto – London, Private Equity (+44 (0)20 7071 4291, msperotto@gibsondunn.com)
Attila Borsos – Brussels, Antitrust (+32 2 554 72 11, aborsos@gibsondunn.com)
Anne MacPherson – London, Senior Transactional PSL (+44 (0)20 7071 4134, amacpherson@gibsondunn.com)
Martin Coombes – London, Financial Institutions (+44 (0)20 7071 4258, mcoombes@gibsondunn.com)
Amar Madhani – London, Private Equity and Real Estate (+44 (0)20 7071 4229, amadhani@gibsondunn.com)
London Key Contacts:
Sandy Bhogal – London, Tax (+44 (0)20 7071 4266, sbhogal@gibsondunn.com)
Thomas M. Budd – London, Finance (+44 (0)20 7071 4234, tbudd@gibsondunn.com)
Gregory A. Campbell – London, Restructuring and Finance (+44 (0)20 7071 4236, gcampbell@gibsondunn.com)
James A. Cox – London, Employment (+44 (0)20 7071 4250, jcox@gibsondunn.com)
Patrick Doris – London, Litigation & Data Protection (+44 (0)20 7071 4276, pdoris@gibsondunn.com)
Christopher Haynes – London, Corporate (+44 (0)20 7071 4238, chaynes@gibsondunn.com)
James R. Howe – London, Private Equity (+44 (0)20 7071 4214, jhowe@gibsondunn.com)
Anna Howell – London, Energy, Oil & Gas (+44 (0)20 7070 4241, ahowell@gibsondunn.com)
Charles Falconer, QC – London, Litigation (+44 (0)20 7071 4270, cfalconer@gibsondunn.com)
Jeremy Kenley – London, M&A, Private Equity & Real Estate (+44 (0)20 7071 4255, jkenley@gibsondunn.com)
Penny Madden, QC – London, Arbitration (+44 (0)20 7071 4226, pamadden@gibsondunn.com)
Ali Nikpay – London, Antitrust (+44 (0)20 7071 4273, anikpay@gibsondunn.com)
Philip Rocher – London, Litigation (+44 (0)20 7071 4202, procher@gibsondunn.com)
Selina S. Sagayam – London, Corporate (+44 (0)20 7071 4264, ssagayam@gibsondunn.com)
Alan A. Samson – London, Real Estate & Real Estate Finance (+44 (0)20 7071 4222, asamson@gibsondunn.com)
Jeffrey M. Trinklein – London, Tax (+44 (0)20 7071 4264, jtrinklein@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
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On 3 April 2020, the UK Financial Conduct Authority (“FCA”) published a statement setting out its expectations of FCA solo-regulated firms under the Senior Managers and Certification Regime (“SMCR”) during the COVID-19 outbreak. This client alert provides FCA solo-regulated firms with an overview of the FCA’s SMCR-related expectations.
What are the responsibilities of senior management during the current outbreak?
The FCA has previously stated that it does not require firms to have a single senior manager responsible for their coronavirus response. Rather, firms should allocate these responsibilities in the way which best enables them to manage the risks they face. The FCA’s latest statement notes that senior managers are responsible for risks in their areas of responsibility and should be considering:
- where the current situation might lead to emerging risks, and
- how it affects existing risks, along with the controls used to manage them.
Does my firm need to make changes to statements of responsibilities?
The FCA recognises that some firms may need to make temporary arrangements to cover absences or change senior manager responsibilities in light of the COVID-19 outbreak. However, the FCA has stated that it wants to minimise the burden to firms at this time and does not intend to enforce the requirement on firms to submit updated statements of responsibilities provided that the change is:
- is made to cover multiple sicknesses, or other temporary changes in responsibilities in direct response to the pandemic, and
- is temporary and expected to revert to the firm’s previous arrangements.
However, the FCA does expect allocations (even if temporary) to be clearly documented internally to ensure that those within the firm understand who is responsible for what. This must be made available to the FCA on request. Furthermore, firms’ internal records should aim to keep a “running commentary” of their senior manager population and their responsibilities during this period. The FCA has stated that this includes keeping statements of responsibilities, role profiles and, if applicable, responsibilities maps up-to-date. The FCA does not expect firms to notify it of such temporary arrangements using Form D.
Firms that are classified as “fixed portfolio” firms should supply the FCA with timely detail of the changes they would normally include in updated statements of responsibilities. Firms should also update their FCA supervisors of any furloughing of one or more senior managers.
What if my firm needs to make temporary arrangements for senior management functions?
The FCA intends to issue a Modification by Consent to the “12 week rule” to support firms using temporary arrangements during the crisis. The 12 week rule permits an individual to cover for a senior manager without FCA approval where the absence is temporary or reasonably unforeseen and the appointment is for less than 12 consecutive weeks. If temporary arrangements last longer than 12 weeks as a result of the COVID-19 outbreak, firms can notify the FCA that they consent to a modification of the 12 week rule. In these cases, temporary arrangements can be extended up to 36 weeks.
Under the modification, firms will also be able to allocate the prescribed responsibilities of the absent senior manager to the individual who is standing in for the absent Senior Manager. Usually, prescribed responsibilities can only be allocated to another FCA approved senior manager under this rule. However, if possible, the FCA still expects firms to do this. Firms should still allocate to the most senior person responsible for that activity or area, who has sufficient authority and an appropriate level of knowledge and competence to carry out the responsibility properly. The “temporary” manager will require access to the governance forums they need to exercise their responsibilities.
The FCA expects firms to clearly document these responsibilities, however temporary, including on relevant statements of responsibilities and, if applicable, responsibilities maps.
What notifications does my firm need to make?
The FCA does not expect firms to submit the updated statement of responsibilities of the absent senior manager or of senior managers who take on the responsibilities of the absent manager. However, the FCA does expect allocations to be clearly documented internally. Although, the FCA has stated that, if applicable, the firm’s responsibilities map should reflect the responsibilities of those non-senior managers with temporary responsibilities taken on under the 12 week rule.
What is the position regarding furloughed senior managers?
The FCA has previously noted that senior managers may be considered key workers. However, there may be circumstances where a senior manager has been furloughed. Unless such a senior manager is permanently leaving their position, the senior manager will retain their FCA approval and will not be required to re-apply for approval on their return to work.
To the extent that a firm is subject to the “Overall Responsibility” rule, the responsibilities of the furloughed senior manager must be allocated to another senior manager. If the firm is relying on the 12 week rule, the replacement does not need not be a senior manager.
Does my firm need to re-allocate prescribed responsibilities?
If a firm has furloughed a senior manager, that senior manager’s prescribed responsibilities should be re-allocated to another senior manager. However, if a temporary replacement has been appointed under the 12 week rule, the proposed modification by consent allows the firm to re-allocate prescribed responsibilities to the temporary replacement, even if the replacement is not a senior manager.
The FCA has stated that individual performing “required function” (for example, Compliance Oversight and MLRO) should only be furloughed as a last resort. Where an individual holding a required function is furloughed, the firm should replace that individual until their return. If the replacement is temporary, firms can use the 12 week rule to arrange cover. The FCA’s rules regarding who can hold certain functions still apply. For example, executives should not be allocated an oversight role.
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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 pandemic. For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team, the Gibson Dunn lawyer with whom you usually work, or the authors:
Authors: Michelle Kirschner and Martin Coombes
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.