To continue assisting US companies with planning for SEC reporting and capital markets transactions into 2023, we offer our annual SEC Desktop Calendar. This calendar provides both the filing deadlines for key SEC reports and the dates on which financial statements in prospectuses and proxy statements must be updated before use (a/k/a financial staleness deadlines).

You can download a PDF of Gibson Dunn’s SEC Desktop Calendar for 2023 at the link below.

https://www.gibsondunn.com/wp-content/uploads/2022/07/SEC-Filing-Deadline-Calendar-2023.pdf.

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The following Gibson Dunn attorneys assisted in preparing this update: Hillary Holmes, Peter Wardle, Lori Zyskowski, and Patrick Cowherd.

© 2022 Gibson, Dunn & Crutcher LLP

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

On July 15, 2022, the United States Court of Appeals for the Second Circuit issued an important decision addressing the scope of scheme liability after Lorenzo v. SEC, 139 S. Ct. 1094 (2019), in securities actions brought under Section 10(b) of the Securities Exchange Act of 1934 and Section 17(a) of the Securities Act of 1933.  In SEC v. Rio Tinto plc (No. 21-2042), the Second Circuit held that Lorenzo did not abrogate existing case law holding that scheme liability requires something beyond misstatements and omissions.

As a result of the Rio Tinto decision, plaintiffs within the Second Circuit will not be permitted to allege a purported “scheme” based on misrepresentations or omissions unless they can point to some additional fraudulent conduct beyond the misstatements or omissions themselves.

Background

The Rio Tinto decision arises out of a securities-fraud suit that the Securities and Exchange Commission (“SEC”) filed in 2017 against mining company Rio Tinto and its former CEO Thomas Albanese and former CFO Guy Elliott.  The underlying fraud claims pertain to the timing of Rio Tinto’s decision to impair an undeveloped, exploratory coal-mining asset in Mozambique that Rio Tinto acquired in August 2011 and recorded as impaired in January 2013.

In March 2019, the district court dismissed the SEC’s scheme liability claims as inactionable under Lentell v. Merrill Lynch & Co., 396 F.3d 161 (2d Cir. 2005), because the sole basis for those claims were alleged misrepresentations and omissions—e.g., statements in Rio Tinto’s 2011 Annual Report, statements in bond-offering documents, statements to shareholders, and the alleged omission of information previously learned about the coal asset.

A few days later, the Supreme Court issued its Lorenzo decision, which expanded the scope of scheme liability to include fraudulent dissemination.  The SEC moved to reinstate its scheme liability claims, arguing that Lorenzo abrogated Lentell’s holding that scheme liability requires fraudulent conduct beyond any misstatements or omissions.  Although the district court denied reconsideration, in 2021 the SEC was granted leave to file an interlocutory appeal with the Second Circuit.

After Lorenzo, Scheme Liability Still Requires Conduct Beyond Misstatements and Omissions

The issue on appeal in Rio Tinto was whether “misstatements and omissions—without more—can support scheme liability” under Rule 10b-5(a) and (c) and related provisions under Section 17.  Slip Op. 5.

Long before Lorenzo, the Second Circuit had held that additional conduct was required.  In Lentell, the Second Circuit held that, “where the sole basis for [scheme] claims is alleged misrepresentations or omissions, plaintiffs have not made out a . . . claim under Rule 10b-5(a) and (c).”  396 F.3d at 177.

In Lorenzo, the Supreme Court expanded scheme liability to encompass “those who do not ‘make’ statements” within the meaning of Rule 10b-5(b), “but who disseminate false or misleading statements to potential investors with the intent to defraud.”  139 S. Ct. at 1099.  The Court noted, however, that “[p]urpose, precedent, and circumstance, could lead to narrowing [the] reach” of the scheme liability provisions “in other contexts.”  Id. at 1101.

Rio Tinto now establishes that “Lentell remains sound” after Lorenzo, Slip Op. 2, meaning that scheme liability still “requires something beyond misstatements and omissions,” id. at 4–5.  The Second Circuit emphasized that “misstatements or omissions were not the sole basis for scheme liability in Lorenzo.  The dissemination of those misstatements was key.”  Id. at 16.

The Second Circuit also provided several reasons why it refused to read Lorenzo more expansively:

• If misstatements or omissions alone were sufficient to constitute a scheme, “the scheme subsections would swallow the misstatement subsections” of Rule 10b-5(b) and Section 17(a)(2), Slip Op. 18;
• “Lorenzo signaled that it was not giving the SEC license to characterize every misstatement or omission as a scheme,” Slip Op. 19 (discussing Lorenzo, 139 S. Ct. at 1103); indeed, “Lorenzo emphasized the continued vitality of” Janus’ limitations on primary liability for making misstatements, id. (discussing Janus Capital Grp., Inc. v. First Derivative Traders, 564 U.S. 135, 142 (2011));
• “An overreading of Lorenzo might allow private litigants to repackage their misstatement claims as scheme liability claims” and thereby evade statutory pleading requirements in misstatement cases, Slip Op. 20 (discussing 15 U.S.C. 78u-4(b)(1)); and
• “[A] widened scope of scheme liability would defeat the congressional limitation on the enforcement of secondary liability” by the SEC alone and would “multiply the number of defendants subject to private securities actions, and render the statutory provision for secondary liability superfluous.” Slip Op. 21–22 (citing 15 U.S.C.  78t(e)).

Conclusion

Rio Tinto is the Second Circuit’s first pronouncement on the scope of scheme liability after Lorenzo—and the most extensively reasoned analysis of the issue by any court yet.  The decision forcefully rejects an expansive interpretation of Lorenzo, while upholding meaningful constraints on primary fraud liability for misstatements when the defendant did not actually “make” the statements or omissions at issue.  The Second Circuit’s decision thereby reaffirms the vitality of a long line of pre-Lorenzo cases that curbed the ability of the SEC and private plaintiffs to repackage deficient misrepresentations and omissions claims as “scheme” claims.  See, e.g., Alpha Capital Anstalt v. Schwell Wimpfheimer & Assocs. LLP, No. 1:17-cv-1235-GHW, 2018 WL 1627266, at *11 (S.D.N.Y. Mar. 30, 2018); SEC v. Lucent Techs., Inc., 610 F. Supp. 2d 342, 361 (D.N.J. 2009); In re Alstom SA Sec. Litig., 406 F. Supp. 2d 433, 475 (S.D.N.Y. 2005).

* * * *

Gibson Dunn represents Rio Tinto plc and Rio Tinto Ltd.  Thomas H. Dupree Jr. argued in the United States Court of Appeals for the Second Circuit on behalf of Rio Tinto on May 19, 2022.

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Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues.  Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Securities Litigation or Appellate and Constitutional Law practice groups, or the authors of this alert:

Mark A. Kirsch – New York (+1 212-351-2662, [email protected])
Richard W. Grime – Washington, D.C. (+1 202-955-8219, [email protected])
Jennifer L. Conn – New York (+1 212-351-4086, [email protected])
Kellam M. Conover – Washington, D.C. (+1 202-887-3755, [email protected])

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

Securities Litigation Group:

Monica K. Loseman – Denver (+1 303-298-5784, [email protected])
Brian M. Lutz – San Francisco/New York (+1 415-393-8379/+1 212-351-3881, [email protected])
Craig Varnen – Los Angeles (+1 213-229-7922, [email protected])

Appellate and Constitutional Law Group:

Thomas H. Dupree Jr. – Washington, D.C. (+1 202-955-8547, [email protected])
Allyson N. Ho – Dallas (+1 214-698-3233, [email protected])
Julian W. Poon – Los Angeles (+ 213-229-7758, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

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

Hundreds of millions of dollars in government recoupments. Supreme Court attention. Potential Congressional legislation. All of this—and more—marked the False Claims Act (FCA) landscape during the first half of 2022, and proved yet again that the FCA is one of the government’s most powerful, and most litigated, enforcement tools.

On the enforcement front, the U.S. Department of Justice (DOJ) announced FCA resolutions totaling more than $500 million during the first half of the year, outpacing last year’s settlements. Among those resolutions were settlements related to fraud under the COVID stimulus programs and novel settlements from DOJ’s nascent “cyber-fraud” initiative, which promises to blur the line between traditional cybersecurity law and traditional FCA claims. DOJ also settled its usual assortment of cases against health care companies and government contractors.

Meanwhile, the Supreme Court agreed to decide yet another FCA case—this time to decide how much control the government retains over FCA litigation pursued by whistleblowers on its behalf—marking the 10th time in the last 15 years that the Supreme Court has decided to clarify aspects of the FCA statutory framework. The Supreme Court’s grant of certiorari adds to a host of important circuit court decisions from the last six months, as well as continued rumblings about potential Congressional action to strengthen the FCA.

With all of these developments, Gibson Dunn is pleased to once again present our mid-year round-up of the critical developments that businesses and practitioners must know about under the FCA.

Below, we summarize recent enforcement activity, then provide an overview of notable legislative and policy developments at the federal and state levels, and finally analyze significant court decisions from the past six months. Gibson Dunn’s recent publications regarding the FCA may be found on our website, including in-depth discussions of the FCA’s framework and operation, industry-specific presentations, and practical guidance to help companies navigate the FCA. And, of course, we would be happy to discuss these developments—and their implications for your business—with you.

I.   NOTEWORTHY DOJ ENFORCEMENT ACTIVITY DURING THE FIRST HALF OF 2022

During the first half of 2022, DOJ announced FCA resolutions totaling more than $500 million. Enforcement activity thus far in 2022 has outpaced that of the first six months of 2021, although many of the resolutions announced this year have been relatively modest in amount. It remains to be seen whether DOJ will match the recoveries obtained during 2021, which included blockbuster settlements stemming from the opioid crisis.

Some of the most notable settlements of the first six months of 2022 came from the continued fallout from COVID and a new DOJ initiative around cyber-fraud.

Specifically, DOJ continues to focus on enforcement actions related to the Paycheck Protection Program (PPP), including actions under the FCA. For example, as detailed below, in February DOJ reached a settlement with a Virginia-based software development company to resolve allegations that the company fraudulently obtained multiple PPP loans in the year 2020.[1] In April, DOJ announced a settlement with a medical provider network, and several individuals, of claims that the company billed for unnecessary telehealth visits and instructed physicians to order certain medical tests without assessing for medical necessity.[2] In addition, DOJ claimed that the company submitted false statements in connection with a PPP loan application, by representing in its PPP loan application that the company was not engaged in unlawful activity. Notably, all four of the qui tam actions resolved by the settlement pre-dated the creation of the PPP program under the CARES Act. In addition to FCA claims, the settlement resolved a claim under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), ostensibly based entirely on the PPP allegations. The addition of this claim follows the approach taken in DOJ’s very first PPP-related settlement in January 2021, which we have covered previously.

DOJ also continues to focus on employing the FCA to respond to cybersecurity threats. In March, DOJ announced its first settlement under the “Cyber Fraud Initiative” that it announced late last year.[3] The Cyber Fraud Initiative was set up to encourage the federal government to pursue fraud claims related to cybersecurity, including claims related to data security practices by health care providers. In this particular settlement, a Florida-based medical services provider agreed to pay $930,000 to resolve allegations that it failed to disclose to the State Department that it had not consistently stored patients’ medical records in a secure electronic medical record system and that it failed to properly obtain certain controlled substances that were manufactured in accordance with federal quality standards. Given the significance of data security in the health care industry, it is not surprising that DOJ’s first settlement under the Cyber Fraud Initiative was with a medical company—but we expect to see DOJ extending the initiative’s efforts broadly across industries in the coming months. Indeed, on July 8, DOJ announced another first-of-its-kind FCA settlement with a defense and aerospace contractor who allegedly misrepresented its compliance with cybersecurity requirements in certain federal government contracts.

Below, we summarize the other most notable settlements from the first half of the year, organized by industry and focused on key theories of liability at issue in the resolutions. As is often the case, FCA recoveries in the health care and life sciences industries dominated enforcement activity during the first half of the year in terms of the number and value of settlements. DOJ, however, also announced notable resolutions in the government contracting and procurement space, described below.

A.   Health Care and Life Science Industries

Settlements to resolve liability under the FCA in the health care and life sciences industries totaled more than $400 million in the first half of 2022.

• On January 11, a California health system agreed to pay $3 million to resolve allegations that it violated the FCA by ordering and submitting referrals for unnecessary genetic testing, leading to the submission of false claims to Medicare for those tests.[4]
• On January 12, a specialized footwear company agreed to pay $5.5 million to settle allegations that the company sold shoe inserts to diabetic patients who received a prescription for the inserts from a physician. According to the government, the company billed Medicare and Medicaid as if the inserts provided to patients were customized, but the inserts actually all came from a generic model. In connection with the settlement, the company entered a three-year corporate integrity agreement, requiring the company to update its policies and hire an independent review organization to monitor the company’s Medicare and Medicaid claims. The settlement also resolved a qui tam suit brought by a former employee; that individual’s share of the recovery was not reported with the settlement announcement.[5]
• On January 31, a health care company agreed to pay more than $13 million to settle allegations that it violated the FCA and AKS by providing initial discounts on the purchase of drugs to physician practices. The government alleged the company used these discounts to persuade the practices to buy federally reimbursable drugs from the company rather than its competitors. According to the government, the company’s upfront discounts ran afoul of the FCA and AKS because they were not tied to any particular sale and were not associated with an earned rebate. The settlement also resolved qui tam suits brought against the health care company, for which the relators received approximately $2.8 million of the settlement.[6]
• On February 9, a hospital agreed to pay $3.8 million to resolve allegations that it violated the FCA and AKS by paying its own cardiologists to cover for, and provide services to, another cardiologist’s patients when that cardiologist was unavailable. The government alleged that the cardiologist, in turn, referred millions of dollars of medical procedures to the hospital. The government asserts the arrangement constituted an unlawful kickback and resulted in the submission of false claims to the government. The settlement also resolved a qui tam suit brought by a former hospital employee; that individual’s share of the recovery was not reported with the settlement announcement.[7]
• On February 15, three Ohio-based health care providers agreed to pay more than $3 million to resolve allegations that the providers submitted bills to Medicare for complex surgeries by an orthopedic surgeon who worked out of each of the providers’ facilities. The government asserted that the surgeon claimed to have performed numerous procedures that he actually did not perform. Even though none of the parties knowingly submitted false claims based on the surgeons’ actions, the government alleged there was sufficient evidence that each provider should have known that the claims were false.[8]
• On March 7, a pharmaceutical company agreed to pay $260 million to resolve allegations that it violated the FCA and AKS by underpaying Medicaid rebates for a particular drug and using a foundation to subsidize patient co-pays. Approximately $234.7 million of the settlement went to resolving the rebate allegations and $26.3 million went toward resolving the kickback claims. In addition to the payment, the pharmaceutical company agreed to a corporate integrity agreement, which includes monitoring provisions focused on Medicaid rebates. The settlement also resolved qui tam suits brought by two whistleblowers, who received almost $30 million of the settlement.[9]
• On March 28, a psychiatrist agreed to pay $3 million to resolve allegations that he violated the FCA by billing the Department of Labor Office of Worker’s Compensation Programs for psychiatric appointments that never took place and double-billing for other sessions. As part of the settlement, the psychiatrist agreed to be excluded from federal health care programs for 25 years.[10]
• On April 6, a health care system and four affiliated entities agreed to pay $20 million to resolve allegations that they violated the FCA by making donations to a local entity which in turn contributed the money to the state’s Medicaid program—the state ultimately paid back the funds to the health care system. The government asserted that, based on this conduct, the government had to make matching Medicaid payments without any actual expenditure by the state. The settlement also resolved a qui tam suit brought by a former hospital reimbursement manager, who received $5 million of the settlement.[11]
• On April 12, a pain management company agreed to pay $24.5 million to resolve allegations that it violated the FCA by submitting claims for unnecessary drug, genetic, and psychological testing. As part of the settlement, the company entered into a corporate integrity agreement with the Office of Inspector General for the Department of Health and Human Services (HHS-OIG) that required the company to maintain a compliance department and submit to ongoing reviews by an independent review organization. The settlement resolved qui tam suits brought by former employees of the company and its affiliates; the relators’ share of the recovery was not reported with the settlement announcement.[12]
• On April 13, a company, its co-founders, and 18 affiliated anesthesia entities agreed to pay $7.2 million to resolve allegations that they violated the FCA and AKS by sharing revenue received from the company’s anesthesia services with the physicians running outpatient surgery centers in order to obtain exclusive anesthesia agreements with the surgery centers. The settlement also resolved a qui tam suit brought by a whistleblower, who received $1.3 million of the settlement.[13]
• On April 29, a hearing aid company agreed to pay $34.4 million to resolve allegations that it violated the FCA by submitting inaccurate claims for reimbursements to the federal government. Some Federal Employees Health Benefits Program plans elect to offer a benefit for hearing aids but require submission of a hearing-loss related diagnosis code supported by a hearing exam by a physician. The government alleged that the company submitted claims for hearing aids containing unsupported diagnosis codes to the Benefits Program.[14]
• On May 9, a home health company agreed to pay $2.1 million to resolve allegations that it violated the FCA by submitting claims for Medicare beneficiaries who were not homebound and did not require certain skilled care. The government also alleged the company submitted claims for services that otherwise did not have a valid or appropriate plan of care and/or did not have requisite in-person encounters to qualify for home health service certification. The settlement resolved allegations brought in a qui tam and a HHS-OIG complaint; the whistleblower’s share of the recovery was not disclosed at the time of the settlement.[15]
• On June 1, a behavioral health care provider agreed to pay $2.1 million to settle claims that it improperly billed claims to Medicaid that were ineligible for reimbursement under the state’s medical clinical coverage policy. The allegations stemmed from a qui tam lawsuit; the whistleblower’s share was not disclosed at the time of the settlement announcement.[16]
• On June 1, a molecular science company agreed to pay over $2.8 million to resolve allegations that it billed Medicare for laboratory tests in violation of Medicare’s 14-Day Rule, which prohibits laboratories from separately billing for certain tests ordered within 14 days of a patient’s discharge from an inpatient or outpatient hospital setting. In addition to submitting purportedly improper claims, the government alleged that the company failed to discourage providers who ordered testing within 14 days after a discharge from canceling the order and placing a new order for testing after the 14-day period had elapsed. The settlement partially resolves one qui tam lawsuit and fully resolves another.[17]
• On June 6, a diagnostics company that provides home sleep testing agreed to pay $3.5 million to resolve FCA and AKS allegations that it billed Medicare and four other federal health care companies for unnecessary home sleep testing. The government alleged that the company’s founder directed employees to submit claims for additional nights of home sleep testing when only one night was necessary to effectively diagnose sleep apnea. The government further alleged that the company improperly multiplied copays received from Medicare beneficiaries and incentivized physicians to refer all home sleep testing services to the company. The settlement agreement requires the company’s founder and vice president to pay $300,000 and $125,000, respectively, and the company and its founder agreed to a corporate integrity agreement. The allegations in the settlement were part of two qui tam [18]
• On June 10, a Los Angeles doctor agreed to pay $9.5 million to resolve FCA allegations that he submitted claims to Medicare for procedures and tests that he never performed and admitted that he intentionally submitted false claims for payment. The settlement amount includes nearly $5.5 million paid as criminal restitution following a guilty plea to health care fraud in a separate criminal matter. The allegations originally stemmed from a qui tam lawsuit filed by a former medical assistant and former IT consultant. The two whistleblowers will receive more than $1.75 million as their share of the recovery.[19]
• On June 21, a managed care health services company and its previously-owned subsidiary agreed to pay $4.6 million to resolve allegations that it billed a joint federal and state Medicaid program for care provided by unlicensed and unsupervised staff. The settlement also resolved allegations that the companies failed to provide and timely document the provision of adequate clinical supervision for clinicians. The settlement resolves a qui tam suit filed by four former employees; the whistleblowers were awarded $810,000 as their share of the recovery.[20]

B.   Government Contracting and Procurement

Settlements to resolve liability under the FCA in the government contracting and procurement space totaled more than $90 million in the first half of 2022.

• On February 23, a kitchen and food service equipment company agreed to pay $48.5 million to resolve allegations that it provided inaccurate information to the government regarding contracts awarded to small businesses. The federal government may set aside certain contracts for various categories of small businesses; and, in some instances, only eligible small businesses may bid on and receive contracts. The government alleged that the company caused federal agencies to award contracts to small businesses that claimed to be run by service-disabled veterans when, in reality, the small businesses served as the face of the contracts, and the company actually provided all of the services. The settlement resolved a qui tam suit brought by a competing company, which received $10.9 million of the settlement.[21]
• On March 7, a construction contractor agreed to pay $10 million to resolve allegations it overbilled the government. The government asserted that the contractor—which was performing work for the Department of Energy—presented false invoices for non-existent materials submitted by a subcontractor to the contractor. According to the government, the contractor’s employees received kickbacks from the subcontractor to submit the claims.[22]
• On March 14, two freight carrier companies agreed to pay $6.9 million to resolve allegations they violated the FCA by inflating bills submitted to the Department of Defense. The government alleged the companies each claimed to have hauled greater weights than they actually carried, which served as the basis for payment under the contract. The settlement resolved a qui tam suit brought by a former employee of one of the companies who received $1.3 million of the settlement.[23]
• On March 21, a package delivery company agreed to pay $5.3 million to resolve allegations that it violated the FCA by submitting inaccurate information regarding time and proof of delivery. Under the company’s contract for mail pick-up and delivery at various Department of Defense and State Department locations domestically and abroad, the company received penalties for mail delivered late or to the wrong location. The government alleged that the company submitted scans of proof of mail and package deliveries that did not accurately reflect when the company actually delivered the packages.[24]
• On May 12, a construction company agreed to pay $2.8 million to settle FCA allegations that the company improperly manipulated a subcontract reserved for service-disabled, veteran-owned small businesses (SDVOSBs). The government awarded the company a contract to develop retirement communities and residential facilities for veterans, a condition of which was to provide subcontracting opportunities to SDVOSBs. The company admitted that it negotiated with a non-SDVOSB for the subcontract and then entered into a subcontract with an SDVOSB for the same work, but with an additional 1.5% fee. The company further admitted that it should have known the SDVOSB was a pass-through for the non-SDVOSB, which provided all of the work under the subcontract. The settlement resolves allegations originally brought in a qui tam lawsuit; the whistleblower received approximately $630,000 for its share of the recovery.[25]
• On May 18, seven South Korean companies agreed to pay $3.1 million to settle FCA and other allegations that they conspired to rig the bidding process for contracts for construction and engineering work on United States military bases in South Korea. The government alleged that, as a result of the anticompetitive behavior, the government paid more for services performed under the contracts than it otherwise would have.[26]
• On May 25, a manufacturing company agreed to pay $3 million to settle allegations that it violated the FCA by knowingly selling technical fabrics to the military that failed to meet required specifications. The company allegedly falsified test results and falsely certified that its military-grade fabrics met all requisite performance specifications set by the military. The company also entered into an agreement with the Defense Logistics Agency to ensure that it remains in compliance with testing requirements going forward. The settlement resolves allegations brought under a qui tam lawsuit; the whistleblower’s share was not disclosed at the time of the settlement announcement.[27]
• On June 2, a manufacturing company and two related entities agreed to pay $5.2 million to resolve allegations that the company violated the FCA by improperly obtaining a contract reserved for small businesses that it was ineligible to receive. The manufacturing company allegedly falsely certified that it was a “small business concern” within the meaning of the Small Business Administration’s regulations so as to receive 22 small business set-aside contracts, even though the company ceased to qualify after its acquisition by a larger company. The company also allegedly falsely certified that it was a “women-owned small business concern.” As part of the settlement agreement, the entities received credit for the company’s voluntary disclosure and cooperation with the government during the investigation.[28]
• On June 14, four companies agreed to pay $13.7 million to resolve FCA and AKS allegations that the companies rigged the bidding process for subcontracts to perform logistics support services for the military in Iraq and that employees entered into arrangements with a foreign contractor under which the companies would receive a kickback for every subcontract awarded to the foreign entity. The government alleged that the employees influenced the federal government to award two subcontracts to the foreign contractor at prices higher than necessary to fulfill the military’s contract requirements, and the government alleged that the companies extended the duration of subcontracts at inflated prices and sought reimbursement of these inflated costs from the U.S. military. The settlement resolves allegations originally brought in a qui tam lawsuit; the whistleblower’s share was not disclosed at the time of the settlement announcement.[29]

C.   Other

Settlements to resolve other types of FCA cases totaled nearly $25 million in the first half of 2022.

• On January 14, a loan servicer agreed to pay $7.9 million to resolve allegations that it violated the FCA by submitting inaccurate claims to the Department of Education. The government alleged that the loan service failed to make required financial adjustments to borrower accounts and improperly treated some ineligible borrowers as eligible for military deferments.[30]
• On April 4, a telecommunications carrier agreed to pay $13.4 million to resolve allegations that it enrolled 175,000 ineligible customers for free cell phones and service under a federal program. The federal government runs the Lifeline Program, which assists low-income individuals with telecommunications needs. According to the government, the carrier failed to monitor subscriptions obtained by a third-party marketing firm who actually enrolled the ineligible customers. The settlement also resolved a qui tam suit brought by a former employee of the marketing firm, who received roughly $450,000 of the settlement.[31]
• On May 27, a for-profit school and its owner agreed to pay over $1 million to settle allegations that they improperly concealed financial information to influence the school’s student loan default rate, which affects an institution’s ability to participate in Title IV programs. The for-profit school and its owner allegedly mailed 154 direct payments to loan servicers on behalf of 102 students to prevent those students from defaulting on their loans and, therefore, counting towards the school’s student loan default rate. The school and its owner allegedly failed to disclose the actual student loan default rate to the Department of Education. The school and its founder also entered into an administrative agreement with the Department of Education.[32]

II.   LEGISLATIVE AND POLICY DEVELOPMENTS

A.   Federal Legislative Developments

As we previously reported, last summer, Senator Chuck Grassley (R-IA), along with a bipartisan group of Senators, introduced a bill to amend the FCA which he subsequently amended last November. Senator Grassley’s proposed amendments were targeted at limiting the implications of the Supreme Court’s decision in Escobar and limiting the government’s ability to dismiss claims brought by relators. Since being reported out of the Senate Judiciary Committee, there has been no indication regarding whether the bill will receive a floor vote.

Time will tell whether the Supreme Court’s decision to take up the Polansky case (which relates to the government’s ability to dismiss claims brought by relators, as covered below in this Alert) has the effect of further delaying or killing the bill’s progress. In the meantime, Senator Grassley filed an amicus curiae brief in support of a certiorari petition in the United States ex rel. Schutte v. SuperValue Inc., which deals with the relevance of a defendant’s subjective beliefs for FCA scienter.[33] Consistent with his statements in the past, Sen. Grassley’s brief focuses on what he sees as the importance of a defendant’s contemporaneous subjective intent, in a professed effort to prevent the same defendant’s “post-hoc” (albeit objectively correct) interpretations of the law from hobbling the government’s efforts to establish scienter.

B.   State Legislative Developments

The first half of 2022 has witnessed significant developments in state-level FCA legislation. Most notably, Colorado expanded its false claims law beyond the realm of Medicaid fraud. The Colorado False Claims Act (CFCA), which became law on June 7, 2022, largely tracks the federal FCA, but with several significant features not found in the federal statute.

First, the CFCA expressly states that “[a] person who acts merely negligently with respect to information is not deemed to have acted knowingly, unless the person acts with reckless disregard of the truth or falsity of the information.”[34] The federal FCA contains neither an express carve-out for negligence (although courts routinely find that it does not satisfy the Act’s scienter requirement), nor any sort of caveat regarding situations in which negligence could still be actionable.

Second, the CFCA contains a distinct framework for assessing reduced damages and penalties for cooperating defendants. The federal FCA grants courts discretion to impose only double damages when a defendant reports information within 30 days of obtaining it, cooperates fully with the government, and discloses the information prior to the commencement of any action under the FCA and without actual knowledge of any FCA investigation. The CFCA, by contrast, requires the imposition of double damages for any defendant who reports information within 30 days of learning it, does so without actual knowledge of the existence of an FCA investigation, and does so while an FCA action is under seal.[35] In the event that a similarly situated defendant reports the information prior to any action being filed under seal, the court is required to impose one-and-one-half the amount of damages.[36] In this way, the CFCA places a premium on companies enhancing their compliance programs to affirmatively identify fraudulent conduct, but arguably incentivizes qui tam relators to act hastily in filing complaints in an effort to lock even cooperating defendants into at least double damages. On another level, the apparently mandatory nature of the reduced damages provisions in cases where defendants make voluntarily self-disclosures could have the effect of making settlement discussions in such cases more efficient by vesting the government with less discretion to negotiate damages multipliers where the other requirements for cooperation credit are otherwise met.

Third, and notably in light of Polansky and the longer history of disputes at the federal level regarding DOJ’s dismissal authority, the CFCA explicitly requires the Colorado Attorney General to consider certain enumerated factors when determining whether to voluntarily dismiss a CFCA action.[37] Those factors are “the severity of the false claim, program or population impacted by the false claim, duration of the fraud, weight and materiality of the evidence, other means to make the program whole, and other factors that the Attorney General deems relevant.”[38] The statute also expressly provides that “[t]he Attorney General’s decision-making process concerning a motion to dismiss and any records related to the decision‑making process are not discoverable in any action.”[39]

Fourth, unlike the federal FCA, the CFCA expressly prohibits a qui tam relator from disclosing—as part of its mandatory disclosure statement served on the State along with a copy of the complaint—”any evidence or information that the person reasonably believes is protected by the defendant’s attorney-client privilege unless the privilege was waived, inadvertently or otherwise, by the person who holds the privilege; an exception to the privilege applies; or disclosure of the information is permitted by an attorney pursuant to [the SEC’s standards of professional conduct], the applicable Colorado Rules of Professional Conduct, or otherwise.”[40]

Elsewhere, other states have been actively considering steps to expand or revise their false claims laws. In Connecticut and Michigan, bills are pending that would—like Colorado’s new law—expand false claims liability beyond Medicaid, although without nearly as much variation on matters of FCA procedure and practice compared to the federal statute as is reflected in the CFCA.[41] New York’s legislature, for its part, on June 3 passed an amendment to the state’s FCA that would expand liability for tax-related claims to include fraudulent failures to file tax returns. As currently written, the New York FCA covers tax-related actions but limits them to the knowing use of false records and statements material to tax obligations.[42] The new bill is now awaiting the governor’s signature.

HHS-OIG provides incentives for states to enact false claims statutes in keeping with the federal FCA. HHS-OIG approval for a state’s FCA confers an increase of 10 percentage points in that state’s share of any recoveries in cases involving Medicaid.[43] Such approval requires, among other things, that the state FCA in question “contain provisions that are at least as effective in rewarding and facilitating qui tam actions for false or fraudulent claims” as are the federal FCA’s provisions.[44] Approval also requires a 60-day sealing provision and civil penalties that match those available under the federal FCA.[45] Consistent with our reporting in prior alerts, the lists of “approved” and “not approved” state statutes remain at 22 and 7, respectively.[46] Michigan is on the “not approved” list, and could remain there even if its FCA amendment passes: the bill entitles qui tam relators to a maximum of 20% of recoveries in intervened cases, whereas the federal FCA caps that amount at 25%.[47] HHS-OIG could well determine that this discrepancy means the Michigan law (if it passes in its current form) is not “at least as effective” as the federal FCA is in rewarding qui tam relators.

III.   CASE LAW DEVELOPMENTS

The big news of the last six months was the Supreme Court’s decision to wade into the FCA waters once more. But the first half of 2022 also saw a number of notable federal appellate court decisions. We cover all of these developments below.

A.   Supreme Court and Multiple Courts of Appeal Consider DOJ’s Dismissal Authority

1.   Supreme Court Grant of Cert

The Supreme Court granted certiorari in United States ex rel. Polansky v. Executive Health Resources, Inc., 17 F.4th 376, 385 (3d Cir. 2021), cert. granted, 142 S. Ct. 2834 (2022), to decide the question of whether the government can dismiss a qui tam realtor lawsuit after declining to litigate, and if it can, what the government must show in order to persuade the district court to dismiss the case. 21-1052, United States, Ex Rel. Polansky v. Executive Health Resources, Inc., https://www.supremecourt.gov/qp/21-01052qp.pdf (last visited July 14, 2022).

The FCA generally provides that the government may dismiss a qui tam, over the objection of a relator, at any time, subject to certain procedures. 31 U.S.C. § 3730. This provision is an important check on runaway whistleblower suits, United States ex rel. Campos v. Johns Hopkins Health Sys. Corp., 2018 WL 1932680, at *8 (D. Md. April 24, 2018), and is a critical feature that courts have relied upon to uphold the constitutionality of the qui tam provisions against constitutional challenges under the delegation clause, United States ex rel. Stilwell v. Hughes Helicopters, Inc., 714 F.Supp. 1084, 1086–93 (C.D. Cal. 1989).

Currently, however, there is a circuit split as to the standard under which a district court may evaluate the government’s decision to dismiss relators’ cases.[48] Some courts have concluded that the government may dismiss virtually any action brought on behalf of the government, with very little scrutiny. Polansky, 17 F.4th at 384–88. Other courts have decided that if the government does not intervene in a relator’s case, the government must first intervene in the lawsuit before seeking to dismiss it under Federal Rule of Civil Procedure 41(a)’s standard. Id. Still other courts have indicated that the government must have some reasonable basis for the decision to dismiss, and ostensibly apply a degree of scrutiny to dismissal decisions. Id.

In Polansky, appellant Jesse Polansky argues that the Supreme Court must adjudicate the “intractable split” on the issue, urging the Court to hold the government to a heightened standard. Id., Pet. at I. Unsurprisingly, respondent Executive Health Resources—seeking to preserve DOJ’s decision to dismiss—contends that the standards are just “slightly different” and that appellant would lose under all of them. Id., Opp. at 1.

FCA practitioners know that the “split” may be more of an illusion than a reality. In practice, district courts almost always agree to dismiss cases where DOJ seeks dismissal, regardless of what jurisdiction they are in and what standard they apply. Indeed, in every Circuit Court case making up the split, the court upheld the government’s dismissal. It is therefore unclear why the Supreme Court decided to hear the case, given the lack of practical differences in the standards. But we will be watching carefully to see whether the Supreme Court strengthens—or weakens—DOJ’s ability to reign-in qui tam lawsuits.

2.   First and Eleventh Circuits Consider the Government’s Dismissal Authority

While the Supreme Court’s grant of cert in Polansky was the big news with regard to the government’s dismissal authority, several circuit courts also issues decisions that bear on DOJ’s control over qui tams.

The FCA provides for a hearing when the Government moves to dismiss a relator’s qui tam action over the relator’s objection. But the statute is silent as to the standards governing that hearing and the courts of appeals have developed different tests for assessing the propriety of such a motion to dismiss. Weighing in on the issue for the first time, the First Circuit held in Borzilleri v. Bayer Healthcare Pharmaceuticals, Inc., 24 F.4th 32 (1st Cir. 2022), that the Government must “always provide its reasons for seeking dismissal” and that the “court’s role is to apply commonly recognized principles for assessing government conduct—the well-established ‘background constraints on executive action.’” Id. at 42. The motion to dismiss should be granted unless the relator can establish that the government’s decision to seek dismissal “transgresses constitutional limitations” or that the government “is perpetrating a fraud on the court.” Id. Further, if the relator seeks discovery to establish the government’s “improprieties” the relator must make a “substantial threshold showing” to support her claims. Id. at 44.

In so holding, the First Circuit, disagreed with the approaches taken by other circuits. For example, the Borzilleri Court held that the Ninth Circuit’s approach, which requires the government to identify a “valid government purpose” for dismissal and to establish a “rational relation between dismissal and accomplishment of the purpose” erred in placing too weighty a burden on the government. Id. at 37, 40 (quoting United States ex rel. Sequoia Orange Co. v. Baird-Neece Packing Corp., 151 F.3d 1139, 1145 (9th Cir. 1998)). The Borzilleri Court likewise rejected the approach taken by the Seventh and Third Circuits, which look to Federal Rule of Civil Procedure 41 for guidance. The First Circuit concluded that Rule 41 was not an “appropriate guide” for the FCA because its primary aim is to protect the defendant from being prejudiced by a plaintiff’s voluntary dismissal, while § 3730(c)(2)(A) hearings are intended to protect the relator’s “unique” interests as an “objecting co-plaintiff.” Id. at 41.

In United States ex rel. Farmer v. Republic of Honduras, 21 F.4th 1353 (11th Cir. 2021), meanwhile, the Eleventh Circuit took up the issue of whether the Government must formally intervene in a qui tam action to move for dismissal, where it has initially declined to intervene. Id. at 1355. There, when relators filed their initial complaint in the qui tam action, the United States declined to intervene. Id. Later, however, after the relators filed an amended complaint adding defendants, the United States—without first filing a motion to intervene in the case—motioned to dismiss the action. Id. The relators challenged the dismissal motion on the ground that the Government was not a party to the suit because it had not formally intervened “for good cause” under 31 U.S.C. § 3730(c)(3), and thereby lacked standing to motion for dismissal. Section 3730 asserts that Courts may allow the Government to later intervene—in a case for which it initially declined intervention—upon a showing of “good cause.” Id. at § 3730(c)(3). However, the Court held that the Government was not required to show “good cause” for late interventions that strictly seek dismissal, explaining that the good-cause subsection “applies only when the [G]overnment intervenes for the purpose of actually proceeding with the litigation,” rather than intervening “for the purpose of settling and ending the case.” Id. at 1356. “[W]hen the Government moves to dismiss an action after having declined to intervene,” the Court continued, “it need provide the Relator only notice and a hearing.” Id. at 1357. Notably, the Eleventh Circuit subsequently voted to rehear the case en banc, and accordingly vacated the initial panel’s opinion.

B.   Public Disclosure Bar and First-to-File

The FCA employs two related rules barring relators from bringing actions in situations where the underlying, alleged wrongdoing has already been disclosed or addressed by someone else. First, the public disclosure bar requires dismissal of FCA cases brought by private litigants where “substantially the same allegations or transactions” underlying the action have already been publicly disclosed, including “in a Federal criminal, civil, or administrative hearing in which the Government or its agent is a party,” unless the relator is an “original source of the information.” 31 U.S.C. § 3730(e)(4). Relatedly, the first-to-file rule prevents private litigants from bringing an action that is “based on the facts underlying” any other action that was pending at the time and brought by a separate litigant. Id. at § 3730(b)(5). There were a number of notable decisions under these bars in the first half of the year.

1.   Eleventh Circuit Considers Public Disclosure and First-to-File Bars

In Cho on behalf of States v. Surgery Partners, Inc., 30 F.4th 1035 (11th Cir. 2022), the Eleventh Circuit considered questions related to both the first-to-file rule and the public disclosure bar.

First, it considered whether an amended complaint filed after a related action was resolved can overcome the first-to-file rule’s applicability to an earlier compliant that was filed while a related case was still pending. Id. at 1038, 1040. In April 2017, relators filed a qui tam action against a private equity firm and its subsidiary for allegedly leading a fraudulent enterprise to submit false claims for reimbursement under Medicare. Id. at 1037, 1039. However, in August 2016, approximately six months before the relators filed their complaint, a different group of relators had filed a related action against one of the same parties—the subsidiary—but not against the parent, private equity firm. Id. at 1039. After the August 2016 action settled and became public, the relators for the April 2017 action filed an amended complaint, which focused the allegations solely on the private equity firm that had not been a party in the separate, but related, action brought by the different relators in the August 2016 action. Id. However, the district court dismissed the second amended complaint, finding that though the amended complaint was filed after the August 2016 case was resolved, the first-to-file rule rendered the entire action dismissible because the initial, April 2017 complaint was filed when the August 2016 suit was still pending. Id.

Under de novo review, the Eleventh Circuit affirmed the district court’s dismissal under the first-to-file rule on appeal. Focusing on the key words “bring” and “action” within section 3730(b)(5) (establishing that “no person . . . may intervene to bring a related action based on the facts underlying [a] pending action”), the Court asserted that the first-to-file rule “turns on the moment the Relators initiated legal proceedings.” Id. at 1040 (emphasis in original). The Court accordingly concluded that the plain text of the FCA “tethers” the first-to-file analysis on the “moment a qui tam action is filed.” Id. at 1042.

The Eleventh Circuit also considered a nuance to the public disclosure bar: what test it should apply when determining whether a pending action is “related” to a later-filed qui tam action. Id. Adopting the same approach used by its sister circuits and the district court below, the Court decided to use the “same material elements” test to assess relatedness. Id. Under this test, two actions are deemed to be related if they “rely on the same ‘essential facts.’” Id. (quoting United States ex rel. Wood v. Allergan, Inc., 899 F.3d 163, 169 (2d Cir. 2018)). Applying this test to the facts at hand, the Court found that the relators’ April 2017 action was adequately “related” to the separate relators’ August 2016 action for the purposes of dismissal, explaining that though the April 2017 complaint named an additional defendant not included in the August 2016 action, the suits were related because the first-to-file bar does not “require[] a necessarily defendant-specific approach[,] . . . particularly where the new defendant is a corporate relative or affiliate of the earlier-named defendants.” Id. at 1043.

2.   Ninth Circuit Considers What Counts as a Public Disclosure

In a pair of cases, the Ninth Circuit considered what public disclosures can trigger the public disclosure bar.

First, the Ninth Circuit addressed whether materials released by a government agency under FOIA can trigger the public disclosure bar in Roe v. Stanford Health Care, No. 20-55874, 2022 WL 796798 (9th Cir. Mar. 15, 2022). In that case, appellant brought a FCA suit alleging that Stanford Health Care engaged in fraudulent Medicare billing. The Ninth Circuit affirmed the district court’s dismissal of appellant’s claims on the basis of the FCA’s public disclosure bar. Appellant’s claims were barred because the “second amended complaint is almost entirely premised on publicly disclosed Medicare data [appellant] obtained through Freedom of Information Act requests,” and because “[t]he other information [appellant] identifies . . . is either irrelevant or already revealed in the data.” Id., at *1. In so holding, the Ninth Circuit joined the vast majority of courts to consider the issue in holding that FOIA disclosures do trigger the public disclosure bar.

Second, in Mark ex rel. United States v. Shamir USA, Inc., No. 20-56280, 2022 WL 327475 (9th Cir. Feb. 3, 2022), the Ninth Circuit considered whether an eyeglass lens manufacturer’s description of its customer rewards program in public promotional materials triggered the FCA’s public disclosure bar. The qui tam relator in this case alleged that Shamir’s customer rewards program violated the AKS and FCA by exploiting the Government’s practice of reimbursing lenses based on the invoice price. Id. at *1. According to the relator, Shamir persuaded eyecare professionals (ECPs) to prescribe Shamir’s lenses by offering discounts and rebates on lenses and subsequently providing the ECPs with invoices purporting to charge full price so that government insurance programs, “rather than Shamir, pa[id] for the ECP discounts.” Id. The district court granted Shamir’s motion to dismiss the relator’s claim, holding that his allegations were precluded by the FCA’s public disclosure bar because they were “substantially similar” to statements Shamir made about its rewards program in promotional materials. Id. For example, in several industry journals, Shamir encouraged ECPs to participate in its rewards program by stating that “they automatically receive rewards back, making it a win-win for everyone,” and offering to develop “personalized YouTube channels” for ECPs to showcase Shamir-manufactured lenses. Id. at *2. According to the district court, these “publicly disclosed facts” announced that the discounts and rebates ECPs received from Shamir “were not deducted from any insurance reimbursement,” thereby foreclosing the relator’s claim. Id. The Ninth Circuit overruled the district court, holding that application of the public disclosure bar was not warranted because the information in the promotional materials “was so innocuous” that no “transaction or allegation of fraud” was publicly disclosed by Shamir in the first place. Id.

C.   Sixth Circuit Finds Inflated Fixed-Price Proposals Sufficient to Satisfy FCA’s Pleading Standard

In United States ex rel. USN4U, LLC v. Wolf Creek Federal Services, Inc., 34 F.4th 507 (6th Cir. 2022), the Sixth Circuit issued a detailed and probing decision that addressed pleading standards for FCA suits. In that case, the relator, USN4U, LLC (USN4U) alleged that Wolf Creek Federal Services, Inc. (Wolf Creek), a federal contractor, “falsely inflated project estimates to the National Aeronautics and Space Administration (NASA) for facilities maintenance projects to be performed by Wolf Creek, resulting in the negotiation of fraudulently induced, exorbitant contract prices,” thereby violating the FCA. Id. at 510.

Wolf Creek provided facilities management maintenance services to the National Aeronautics and Space Administration (NASA) under the terms of an indefinite-delivery indefinite-quantity (IDIQ) contract awarded in 2013 (the NASA Contract). Id. at 510–11. Pursuant to the terms of the NASA Contract, NASA would approve specific projects for Wolf Creek to perform on a firm-fixed price basis. Id. at 511. After Wolf Creek received a work order for the subject task, it was required to submit a proposal for schedule of completion and the total cost of labor and materials, which NASA would evaluate for purposes of negotiating a final firm-fixed price amount. Id. As the Court noted, once the firm-fixed price was established, Wolf Creek’s invoices were required to align with the agreed-upon amount. Id.

Wolf Creek filed a motion to dismiss USN4U’s complaint for failure to state a valid claim, taking the position that “the estimates and project proposals [it submitted] were not ‘claims’ for FCA purposes” and generally contesting the sufficiency of USN4U’s fraud claims more generally. Id. at 512. After USN4U amended its complaint, Wolf Creek filed a second motion to dismiss, “repeating their argument that quotes were not ‘claims’ for purposes of the FCA and further arguing that invoices were not ‘false’ if they matched the quoted amount.” Id. The Court noted that USN4U’s amended complaint included further examples supporting the FCA allegations, including providing a list of employees who admitted to reporting more hours worked than actually completed, as well as “a transcript of a recorded conversation in which several Wolf Creek employees allegedly discussed the fraudulent scheme.” Id.

The district court nevertheless granted Wolf Creek’s second motion to dismiss and denied USN4U’s motion to file a second amended complaint. By the district court’s read, notwithstanding that the work order proposals Wolf Creek submitted to NASA contained quoted prices, the proposals did not constitute “claims” under the FCA, serving only as estimates rather than demands or invoices. Id. at 512–13. Additionally, the district court held that USN4U did not satisfy its burden to plead falsity under the FCA as USN4U’s allegations merely compared the labor costs with industry standards to support its claims of false inflation. Id. at 513. Finally, the district court held that USN4U failed to satisfy its burden to plead fraud in the inducement, citing Wolf Creek’s continued performance under the NASA Contract even after the fraud allegations materialized. Id.

The Sixth Circuit reversed, holding USN4U sufficiently alleged a claim of fraudulent inducement, which is a viable legal theory under the FCA, noting that “FCA liability can be based on a fraudulent premise that caused the United States to enter into a contract,” and finding that USN4U adequately pled its fraudulent inducement claim based on its assertions that “Wolf Creek falsely inflated cost estimates in its work order proposals and thus induced NASA to agree to contracts at that price point.” Id. (internal citation omitted).

Turning next to the elements of an FCA claim, the Court first addressed falsity, finding that reliance on industry standards as the basis for a fraud claim is not presumptively insufficient. See id. at 515. The Court also noted that USN4U provided additional support beyond a comparison with industry standards when it offered evidence of a disparity in billing activity between the employees participating in the scheme and those who did not, an incident where a plumber billed to a project where no plumbing work was required, and a recording transcript in which Wolf Creek employees discussed the practice of using false estimates. Id.

Regarding scienter, the Court found USN4U satisfied the pleading standard through, in addition to the examples discussed herein, USN4U’s submission of a “recorded conversation in which Wolf Creek employees allegedly discussed their knowledge of the falsely inflated cost estimates and labor hours,” noting that an employee stated: “[t]he original estimate that they gave me for hours, they told me they needed about 130 hours of overtime. I upped it like I always do to 164 hrs.” Id. at 516. The employee further stated:

I came back and we started chewing up what you guys had. It was going away so I got nervous and had no intentions of working 40 hrs when I came back. So then I got crazy and started pumping out estimates. And now it[‘]s, if I stay at the rate that I am at right now we will never run out. So the key is to just have it flooded. Inundate the customer with the quotes.

Id. With respect to materiality, the Court found that “Wolf Creek’s falsely inflated estimates could have had the tendency to influence NASA’s contracting decisions,” given that NASA relied on Wolf Creek’s contractual estimate rather than conduct its own research into costs. Id. The Court noted that “[w]hile it is possible, as Wolf Creek suggests, that NASA’s faith in Wolf Creek’s estimates came from its own careful research and consideration of Wolf Cree’s proposals, it is also plausible that NASA trusted and relied exclusively upon Wolf Creek’s estimates, and that NASA ultimately paid Wolf Creek based on its induced belief that the quoted prices were reasonably accurate.” Id. Finally, the Court stated that NASA’s decision to allow Wolf Creek to continue with contract performance after the fraud allegations surfaced was not dispositive or indicative of “actual knowledge” of fraud, and noted that various factors could influence the decision to continue performance, including the desire to avoid prematurely ending a contractual relationship prior to an investigation into the alleged fraud. Id. at 517. The court also noted that the government’s decision not to intervene in a particular case is not considered for purposes of assessing materiality. Id.

Lastly, the Court found that USN4U satisfied the pleading requirements for causation, stating that “NASA asked Wolf Creek for estimates and when it awarded Wolf Creek the contracts, NASA always awarded the contracts for the quoted amount, which could indicate that NASA trusted and relied upon the purported accuracy of Wolf Creek’s estimates when it entered into the contracts at the quoted prices.” Id. at 518. The Court also noted that “NASA plausibly would not have agreed to pay Wolf Creek the quoted amount if NASA knew that it was being grossly overcharged.” Id. The Court accordingly reversed the judgment of the district court and remanded for further proceedings.

D.   Falsity

1.   Ninth Circuit Holds Disagreement in Clinical Judgment Is Insufficient to Establish Falsity

In Holzner v. DaVita Inc., No. 21-55261, 2022 WL 726929 (9th Cir. Mar. 10, 2022), appellant alleged that DaVita Inc. (appellee) provided medically unnecessary products and services and/or unreasonably expensive medications in violation of the FCA.

The Ninth Circuit affirmed the district court’s dismissal of appellant’s claims on the grounds that appellant had not plausibly alleged a false statement in order to establish FCA liability. Id. at *2. The court explained that the complaint “does not contain sufficient facts . . . to state a plausible claim of false or fraudulent billing related to the appellees’ provision of dialysis treatments” and prescription drugs, because the allegations instead “show no more than a disagreement in clinical judgment,” as “[t]he medical literature on which Holzner relies . . . does not establish new guidelines for practitioners or otherwise compel a change of practice among nephrologists.” Id. at *1. As a result, “Holzner has not raised a plausible inference that the nephrologists’ certifications that these interventions are medically necessary—or appellees’ reliance on those certifications—were false or fraudulent.” Id.

In so holding, the Ninth Circuit joins a growing number of appeals courts to consider these issues in recent years. In United States v. AseraCare, Inc., 938 F.3d 1278 (11th Cir. 2019), the Eleventh Circuit similarly held that clinical disagreement is insufficient to establish falsity because the FCA requires the alleged falsehood to be objectively false. Yet the Third Circuit, in United States ex rel. Druding v. Care Alternatives, 952 F.3d 89 (3d Cir. 2020), and the Sixth Circuit, in United States v. Paulus, 894 F.3d 267 (6th Cir. 2018), have rejected the Eleventh and Ninth Circuits’ conclusion that the FCA requires proof of “objective falsity,” and held instead that a difference of medical opinion can be sufficient to show that a statement is false.

2.   District Court Holds That Relator Failed to Satisfy Falsity Element of an FCA Claim Based on Alleged Failure to Comply with State Law

In United States ex rel. Jehl v. GGNSC Southaven LLC, 3:19-CV-091-NBB-JMV, 2022 WL 983644 (N.D. Miss. Mar. 30, 2022), the district court held, inter alia, that the relator failed to satisfy the falsity element of an FCA claim based on the Defendants’ alleged false certification of compliance with state licensure laws. In the complaint, the qui tam relator alleged that the Defendants, who operated a nursing facility in Southaven, Mississippi, violated the FCA by billing Medicare and Medicaid for health care services while certifying that the company complied with Mississippi’s licensure laws for nurses even though its Director of Nursing Services (Director) was not licensed to work as a nurse in the state. Id. at *1. Shortly before she began working for the defendants in Mississippi, the Director obtained a valid multistate nursing license from Virginia based in part on a declaration she submitted averring that Virginia was her primary state of residence (PSOR). Id. at *2. The Virginia multistate license permitted the Director to practice nursing in Mississippi, and the day after the Director began her employment at the Southaven facility, an employee for one of the Defendants confirmed that she held an active Virginia nursing license with a multistate privilege. Id. However, according to the relator, the Director’s multistate license was actually invalid because her claiming of Virginia as her PSOR was false; in fact, the relator continued, the Director’s PSOR was actually Tennessee, as evidenced by her Tennessee driver’s license. Id. The relator argued that because the Director lacked a valid license to practice nursing in Mississippi while employed by the Defendants, their “certifications of compliance with applicable licensure laws in their Medicare and Medicaid reimbursement requests were false within the meaning of the FCA.” Id.

The district court granted the Defendants’ motion for summary judgment, holding that the relator did not possess evidence establishing the FCA’s falsity, knowledge, or materiality elements. Id. at *6. The Centers for Medicare & Medicaid Services’ (CMS) regulations for nursing facilities require such facilities to comply “with all applicable Federal, State, and local laws, regulations, and codes.” 42 C.F.R. § 483.70(b). In CMS’s State Operations Manual, which provides interpretive guidance on CMS’s nursing facility regulations, CMS explains that noncompliance “with Federal, State, and local laws, regulations [and] codes” occurs “only when a final adverse action has been taken by the authority having jurisdiction regarding noncompliance with its applicable laws, regulations, codes and/or standards.” Id. at *4. In this case, undisputed facts showed that during the period when the Director worked at the Southaven facility, neither the Virginia Nursing Board nor any other nursing board had “taken any action, let alone a final adverse action, against [the Director’s] professional license, meaning that under CMS’s clear rules, her nursing license was . . . valid during the entire period of her employment.” Id. at *5. Therefore, as a matter of law, the FCA’s falsity element could not be satisfied because the Defendants’ certifications of compliance with CMS regulations were “demonstrably true and accurate, not false.” Id. at *6. Similarly, the district court concluded that the relator could not satisfy the knowledge element of an FCA claim because the Defendants’ certifications were proper. Id. Further, the district court ruled that the relator could not satisfy the FCA’s materiality element because the CMS regulations that the Defendants allegedly breached, 42 C.F.R. Part 483, contained only “broad certification language” that, under established precedent, cannot support an FCA claim, and the evidence available at summary judgment “show[ed] no linkage between nurse licensure” and government payment of submitted claims. Id.

E.   Materiality

1.   D.C. Circuit Holds That the FCA’s Materiality Inquiry Focuses on the Potential Effect of False Statement When Made

In United States ex rel. Vermont National Telephone Co. v. Northstar Wireless, LLC, et al., 34 F.4th 29, 31 (D.C. Cir. 2022), Vermont National Telephone Company (Vermont Telephone) alleged that several telecommunications companies, including Northstar, SNR, DISH, and affiliated companies (collectively, Defendants), violated the FCA and defrauded the U.S. government of $3.3 billion by manipulating Federal Communications Commission (FCC) rules and falsely certifying their eligibility for discounts on spectrum licenses. The district court dismissed Vermont Telephone’s qui tam suit, relying on the FCA’s “government-action bar” and the FCA’s “demanding materiality standard.” Id. The D.C. Circuit reversed on both grounds.

To apportion licenses allowing companies to use portions of the electromagnetic spectrum to provide television, cell phone, and wireless internet service, the FCC holds auctions that involve a two-step license application process. Id. at 31. The FCC officers allocate “bidding credits” (discounts to cover part of the cost of licenses won at auction) to very small businesses, those with less than $15 million in revenue. Id. at 31, 32. As part of the application process, companies must provide information concerning their eligibility to bid in the auction and certify their eligibility for bidding credits. Id. at 32.

Vermont Telephone alleged that Defendants failed to disclose resale agreements with DISH, which would have increased their attributable revenues beyond the allowable cap for the very small business credits. Id. at 36. Defendants argued that the alleged undisclosed agreements would not have changed the FCC’s ultimate decision to deny bidding credits because the FCC found the Defendants ineligible for the discounts even without disclosure of any resale agreements. Id. at 37.

The D.C. Circuit rejected Defendants’ argument to focus on the “ultimate decision.” Id. Instead, the Court’s materiality analysis focused on the “potential effect of the false statement when it is made,” not on “the false statement’s actual effect after it is discovered.” Id. (internal citation omitted). The Court held that Defendants’ failure to disclose agreements central to their eligibility for discounts was certainly “capable of influencing” the FCC’s eligibility determination and, thus, Vermont Telephone plausibly pleaded materiality. Id. at 36–38. This appears to conflict with language from Escobar that if the Government pays a particular claim in full despite its actual knowledge that certain requirements were violated then “that is very strong evidence” of the immateriality of those requirements. Universal Health Servs., Inc. ex rel. Escobar v. United States, 579 U.S. 176, 195 (2016).

2.   Ninth Circuit Enforces False Certification and Materiality Pleading Requirements

In McElligott v. McKesson Corp., No. 21-15477, 2022 WL 728903, at *1 (9th Cir. Mar. 10, 2022), appellant relators alleged that McKesson “knowingly present[ed], or cause[d] to be presented, a false or fraudulent claim for payment or approval” by making false certifications in violation of the FCA. The Ninth Circuit affirmed the district court’s dismissal of relators’ claims without leave to amend because the complaint failed to plead a claim for express false certification, as there were no allegations that “defendant submitted a claim for payment to the government in which it expressly certified that it had complied with a specific law or provision of the contract with which it knew it had not complied.” Id.

Nor did the relators sufficiently allege that Defendant made implied false certifications. “[T]he second amended complaint does not allege that, in its claims for payment, McKesson made specific representations about the medical supplies it provided that were rendered misleading half-truths by its failure to disclose noncompliance with material statutory, regulatory, or contractual requirements.” Id. Instead, “[a]s far as the complaint reveals, McKesson represented nothing more in its claims for payment than that it delivered certain medical supplies on certain dates,” and “[t]he complaint does not allege that those representations were false.” Id.

The Court also ruled that the relators failed to allege materiality, as “nothing in the complaint gives rise to a reasonable inference that the security of McKesson’s supply chain was material to the government’s decision to pay for medical supplies that McKesson actually delivered.” Id. at *2.

F.   Scienter

1.   Fourth Circuit Struggles in Determining When a Defendant’s Alleged Mistakes of Law Can Establish Scienter

In two recent cases, Fourth Circuit panels divided as to whether a defendant’s alleged misinterpretation of a complex regulation could establish scienter under the FCA.

In the first case, United States ex rel. Sheldon v. Allergan Sales, LLC, 24 F.4th 340 (4th Cir. 2022), Judge Wilkinson, joined by Judge Richardson, affirmed the district court’s dismissal of an FDCA case and imported the scienter standard from the Supreme Court’s Fair Credit Reporting Act decision in Safeco Ins. Co. of America v. Burr, 551 U.S. 57 (2007), into the FCA context. Safeco “set forth a two-step analysis” in determining whether a defendant has acted in reckless disregard of the law. Sheldon, 24 F.4th at 347. First, a court asks “whether defendant’s interpretation was objectively reasonable.” Id. The second step is “determining whether authoritative guidance might have warned defendant away from that reading.” Id. This test is appropriate in FCA cases, reasoned the majority, because the “FCA defines ‘knowingly’ as including actual knowledge, deliberate ignorance, and reckless disregard. . . . [and] Safeco interpreted ‘willfully’ to include both knowledge and recklessness.” Id. at 348.

The court then applied Safeco to the facts. This case concerned the Medicaid Drug Rebate Statute, which requires “manufacturers seeking to have their drugs covered by Medicaid [to] enter into Rebate Agreements with the Secretary of Health and Human Services and provide quarterly rebates to states on Medicaid sales of covered drugs. . . . For covered drugs, the rebate amount is the greater of two numbers: (1) the statutory minimum rebate percentage, or (2) the difference between the Average Manufacturer Price and the Best Price,” the latter of which is essentially “the lowest price available from the manufacture.” Id. at 345.

Plaintiff employee filed a qui tam suit against Forest Laboratories, LLC under the FCA, alleging that Forest gave discounts to customers but failed to account for these discounts in calculating Best Price, resulting in false reports to the government. Id. at 343–44. Forest argued that it correctly, or at least reasonably, interpreted the meaning of “Best Price” and therefore did not knowingly defraud the government.

The majority agreed. Pursuant to the Safeco standard, “[u]nder the FCA, a defendant cannot act ‘knowingly’ if it bases its actions on an objectively reasonable interpretation of the relevant statute when it has not been warned away from that interpretation by authoritative guidance. This objective standard precludes inquiry into a defendant’s subjective intent.” Id. at 348. Forest did not “act knowingly under the FCA” because “Forest’s reading of the Rebate Statute was at the very least objectively reasonable and because it was not warned away from that reading by authoritative guidance.” Id. at 343–44, 347.

Judge Wynn dissented. He accused the majority of “effectively neuter[ing] the False Claims Act . . . by eliminating … two of its three scienter standards (actual knowledge and deliberate ignorance) and replacing the remaining standard with a test (objective recklessness) that only the dimmest of fraudsters could fail to take advantage of.” Id. at 357 (Wynn, J., dissenting). Judge Wynn would not have “imported” Safeco into the FCA, a “vastly different statutory context.” Id. at 361. The Fourth Circuit subsequently granted rehearing en banc, 2022 WL 1467710, but did not vacate the panel opinion.

The second case, United States ex rel. Gugenheim v. Meridian Senior Living, LLC, 36 F.4th 173 (4th Cir. 2022), concerned reimbursement for “personal care services,” including assisting with activities such as eating, dressing, and bathing, that are provided to elderly or disabled adults under North Carolina’s Medicaid program. The program authorizes a certain number of daily “personal care services” for elderly or disabled patients based on a patient’s personal needs. Id. at 175–76. Defendant adult-care homes billed for the authorized hours of personal care services rather than the actual amount of services provided. Id. at 177–78.

Plaintiff attorney filed a qui tam suit against the nursing homes under the FCA, alleging that the homes’ billing schemes violated the rules of the state Medicaid program. The district court granted summary judgment to the home, holding that the plaintiff failed to show that the home’s claims “were materially false or made with the requisite scienter.” Id. at 178.

A divided panel of the Fourth Circuit affirmed. At issue was whether the defendants knowingly submitted false claims to Medicaid. Judge Rushing, joined by Judge Wilkinson, concluded that the defendants did not. Id. at 175. They emphasized that state regulations defining billing for personal care services were unclear and that the defendants plausibly interpreted the regulations as allowing their billing practices. They then held that courts cannot infer scienter when defendants reasonably interpret ambiguous regulations:

We need not determine whether Defendants’ interpretation of [state regulations] is correct. The policy and related guidance from NC Medicaid are sufficiently ambiguous to foreclose the possibility of proving scienter based solely on the clarity of the regulation. We cannot infer scienter from an alleged regulatory violation itself, and we especially will not do so where there is regulatory ambiguity as to whether Defendants’ conduct even violated the policy.

Id. at 181 (quotation marks removed). The court then rejected plaintiff’s alternate argument that the home should “have sought more guidance about an ambiguous regulation” because there was no evidence that the home “knew, or even suspected, that [its] interpretation of [the regulation] was incorrect.” Id. Plaintiff failed to submit “any evidence that Defendants knew, or even suspected, that their interpretation of [the regulation] and the related guidance from NC Medicaid was incorrect (indeed, it may be right).” Id.

Senior Judge Traxler dissented and would have allowed the case to proceed to trial. The plaintiff submitted plausible evidence of overbilling and “that Defendants did next to nothing to educate themselves” about the regulation. Id. at 183 (Traxler, J., dissenting). Thus, “a reasonable jury could find that Defendants failed to make a reasonable and prudent inquiry into how [the regulation] affected their billing method and, instead, buried their heads in the sand to maximize their billings.” Id. at 190.

2.   Fifth Circuit Reiterates Need to Allege Scienter

In United States ex rel. Jacobs v. Walgreen Company, 2022 WL 613160 (5th Cir. March 2, 2022), plaintiff pharmacist filed a qui tam suit against her employer Walgreens under the FCA, alleging that Walgreens submitted false claims for reimbursement to Medicare and Medicaid. The district court dismissed the case for failure to plead fraud with particularity. The Fifth Circuit affirmed in a short opinion.

The court began by describing the pleading requirements of the Act. A plaintiff must plead: “(1) a false statement or fraudulent course of conduct; (2) that was made or carried out with the requisite scienter; (3) that was material; and (4) that caused the government to pay out money (i.e., that involved a claim).” Id. at *1. But the plaintiff did not “plead[] facts supporting an inference that the allegedly fraudulent conduct amounted to anything more than innocent mistake or neglect.” Id. The complaint accordingly failed to state a claim because the FCA does not confer liability “for innocent mistakes or neglect.” Id. Indeed, the allegation that “Walgreens failed to correct certain billing mistakes once it discovered them” was an impermissibly “conclusory allegation[] that [did] not provide specifics as to the ‘who, what, when, where, and how of the alleged fraud.’” Id.

3.   Seventh Circuit Reaffirms Objective Scienter Standard

In United States ex rel. Proctor v. Safeway, Inc., the relator alleged that between 2006 and 2015, Safeway knowingly submitted false claims to government health programs when it reported its “retail” price for certain drugs as its “usual and customary” price, even though many customers paid much less than the retail price due to discount programs. 30 F.4th 649, 652–54 (7th Cir. 2022). The allegations were almost identical to the allegations in United States ex rel. Schutte v. SuperValu, Inc., 9 F.4th 455 (7th Cir. 2021), which we covered in our 2021 Year End False Claims Act Update.

The Seventh Circuit decided SuperValu while Safeway was pending. Safeway, 30 F.4th at 657. In SuperValu, the Seventh Circuit held that the Supreme Court’s decision in Safeco Ins. Co. of America v. Burr, 551 U.S. 47 (2007) applied to the FCA’s scienter provision, meaning that a defendant does not act with “reckless disregard” as long as (1) its interpretation of the relevant statute or regulation is “objectively reasonable” and (2) no “authoritative guidance” warned it away from that interpretation. Id.

The court reached the same conclusion in Safeway, and further explained when guidance is “authoritative.” Id. at 660. In order for guidance to be “authoritative,” it must “come from a source with authority to interpret the relevant text.” Id. In addition to the source, the Seventh Circuit also considers whether that guidance was sufficiently specific to put a defendant on notice that its conduct is unlawful. Id. Accordingly, the court held that a single footnote in a lengthy manual that can be revised at any time is not authoritative guidance. Id. at 663

G.   Sixth Circuit Holds that the Limitations Period for FCA Claims Begins to Run When Retaliation Occurs, Not When Relator Receives Notice

The Sixth Circuit recently reaffirmed that there is “no notice requirement” in the FCA statute of limitations for retaliation claims. El-Khalil v. Oakwood Healthcare, Inc., 23 F.4th 633 (6th Cir. 2022). The statute sets forth a three-year limitations period that begins to run when “the retaliation occurred.” Id. at 635 (quoting 31 U.S.C. § 3730(h)). The Court noted this conclusion is “hardly groundbreaking,” it merely codifies the “standard rule” that the “limitation period begins when the plaintiff ‘can file suit and obtain relief.’” Id. The El-Khalil Court did note, however, that equitable doctrines may toll the limitations period if an employer purposely delays its provision of notice in order to let the limitations period run and deprive the relator of a fair opportunity to bring suit. Id. at 636.

IV.   CONCLUSION

We will monitor these developments, along with other FCA legislative activity, settlements, and jurisprudence throughout the year and report back in our 2022 False Claims Act Year-End Update, which we will publish in January 2023.

____________________________

[1]      See Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Northern Virginia Company Settles False Claims Act Allegations of Improper Paycheck Protection Program Loan (Feb. 11, 2022), https://www.justice.gov/opa/pr/northern-virginia-company-settles-false-claims-act-allegations-improper-paycheck-protection.

[2]      See Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Physician Partners of America to Pay $24.5 Million to Settle Allegations of Unnecessary Testing, Improper Remuneration to Physicians and a False Statement in Connection with COVID-19 Relief Funds (April 12, 2022), https://www.justice.gov/opa/pr/physician-partners-america-pay-245-million-settle-allegations-unnecessary-testing-improper.

[3]      See Press Release, U.S. Atty’s Office for the Eastern Dist. of NY, Contractor Pays $930,000 to Settle False Claims Act Allegations Relating to Medical Services Contracts at State Department and Air Force Facilities in Iraq and Afghanistan (March 8, 2022), https://www.justice.gov/usao-edny/pr/contractor-pays-930000-settle-false-claims-act-allegations-relating-medical-services.

[4]      See Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, UC San Diego Health Pays $2.98 Million to Resolve Allegations of Ordering Unnecessary Genetic Testing (Jan. 11, 2022), https://www.justice.gov/opa/pr/uc-san-diego-health-pays-298-million-resolve-allegations-ordering-unnecessary-genetic-testing.

[5]      See Press Release, U.S. Atty’s Office for the Southern Dist. of FL, Diabetic Shoe Company Agrees to Pay $5.5 Million to Resolve False Claims Act Allegations Regarding “Custom” Shoe Inserts (Jan. 12, 2022), https://www.justice.gov/usao-sdfl/pr/diabetic-shoe-company-agrees-pay-55-million-resolve-false-claims-act-allegations.

[6]      See Press Release, U.S. Atty’s Office for the Dist. of MA, Cardinal Health Agrees to Pay More than $13 Million to Resolve Allegations that it Paid Kickbacks to Physicians (Jan. 31, 2022), https://www.justice.gov/usao-ma/pr/cardinal-health-agrees-pay-more-13-million-resolve-allegations-it-paid-kickbacks.

[7]      See Press Release, U.S. Atty’s Office for the Dist. of NH, Catholic Medical Center Agrees to Pay $3.8 Million to Resolve Kickback-Related False Claims Act Allegations (Feb. 9, 2022), https://www.justice.gov/usao-nh/pr/catholic-medical-center-agrees-pay-38-million-resolve-kickback-related-false-claims-act.

[8]      See Press Release, U.S. Atty’s Office for the Southern Dist. of OH, 3 Central Ohio health providers to pay more than $3 million for improper claims submitted to Medicare and Ohio Bureau of Workers’ Compensation (Feb. 15, 2022), https://www.justice.gov/usao-sdoh/pr/3-central-ohio-health-providers-pay-more-3-million-improper-claims-submitted-medicare-0.

[9]      See Press Release, Office of Public Affairs, U.S. Dep’t of Justice, Mallinckrodt Agrees to Pay $260 Million to Settle Lawsuits Alleging Underpayments of Medicaid Drug Rebates and Payment of Illegal Kickbacks (Mar. 7, 2022), https://www.justice.gov/opa/pr/mallinckrodt-agrees-pay-260-million-settle-lawsuits-alleging-underpayments-medicaid-drug.

[10]    See Press Release, U.S. Atty’s Office for the Eastern Dist. of PA, Philadelphia Psychiatrist to Pay $3 Million to Resolve Allegations of False Workers’ Compensation Claims (Mar. 28, 2022), https://www.justice.gov/usao-edpa/pr/philadelphia-psychiatrist-pay-3-million-resolve-allegations-false-workers-compensation.

[11]    See Press Release, Office of Public Affairs, U.S. Dep’t of Justice, Florida’s BayCare Health System and Hospital Affiliates Agree to Pay $20 Million to Settle False Claims Act Allegations Relating to Impermissible Medicaid Donations (Apr. 6, 2022), https://www.justice.gov/opa/pr/florida-s-baycare-health-system-and-hospital-affiliates-agree-pay-20-million-settle-false.

[12]    See Press Release, Office of Public Affairs, U.S. Dep’t of Justice, Physician Partners of America to Pay $24.5 Million to Settle Allegations of Unnecessary Testing, Improper Remuneration to Physicians and a False Statement in Connection with COVID-19 Relief Funds (Apr. 12, 2022), https://www.justice.gov/opa/pr/physician-partners-america-pay-245-million-settle-allegations-unnecessary-testing-improper.

[13]    See Press Release, U.S. Atty’s Office for the Northern Dist. of GA, Paul D. Weir, John R. Morgan, M.D., Care Plus Management, LLC, and Anesthesia Entities pay $7.2 million to Resolve Kickback and False Claims Act Allegations (Apr. 13, 2022), https://www.justice.gov/usao-ndga/pr/paul-d-weir-john-r-morgan-md-care-plus-management-llc-and-anesthesia-entities-pay-72.

[14]    See Press Release, Office of Public Affairs, U.S. Dep’t of Justice, Hearing Aid Company Eargo Inc. Agrees to Pay $34.37 Million to Settle Common Law and False Claims Act Allegations for Unsupported Diagnosis Codes (Apr. 29, 2022), https://www.justice.gov/opa/pr/hearing-aid-company-eargo-inc-agrees-pay-3437-million-settle-common-law-and-false-claims-act.

[15]    See Press Release, U.S. Atty’s Office for the Southern Dist. of FL, Home Health Company Operating in Florida Pays $2.1 Million to Resolve False Claims Allegations (May 9, 2022), https://www.justice.gov/usao-sdfl/pr/home-health-company-operating-florida-pays-21-million-resolve-false-claims-allegations.

[16]    See Press Release, U.S. Atty’s Office for the Western Dist. of NC, Healthkeeperz, Inc. To Pay $2.1 Million To Resolve False Claims Act Allegations (June 1, 2022), https://www.justice.gov/usao-wdnc/pr/healthkeeperz-inc-pay-21-million-resolve-false-claims-act-allegations.

[17]    See Press Release, U.S. Atty’s Office for the Eastern Dist. of NY, Caris Life Sciences Pays over $2.8 Million to Settle False Claims Act Allegations from Delay in Submission of Genetic Cancer Screening Tests (June 1, 2022), https://www.justice.gov/usao-edny/pr/caris-life-sciences-pays-over-28-million-settle-false-claims-act-allegations-delay.

[18]    See Press Release, U.S. Atty’s Office for the Northern Dist. of IL, Suburban Chicago Home Sleep Testing Company To Pay $3.5 Million To Settle Federal Health Care Fraud Suit (June 6, 2022), https://www.justice.gov/usao-ndil/pr/suburban-chicago-home-sleep-testing-company-pay-35-million-settle-federal-health-care#:~:text=CHICAGO%20%E2%80%94%20A%20suburban%20Chicago%20diagnostics,and%20unnecessary%20home%20sleep%20testing.

[19]    See Press Release, Los Angeles Doctor to Pay $9.5 Million to Resolve Allegations of Fraud Against Medicare and Medi-Cal (June 10, 2022), https://www.justice.gov/usao-edca/pr/los-angeles-doctor-pay-95-million-resolve-allegations-fraud-against-medicare-and-medi.

[20]    See Press Release, U.S. Atty’s Office for the Dist. of MA, Molina Healthcare Agrees to Pay Over $4.5 Million to Resolve Allegations of False Claims Act Violations (June 21, 2022), https://www.justice.gov/usao-ma/pr/molina-healthcare-agrees-pay-over-45-million-resolve-allegations-false-claims-act#:~:text=Molina%20Healthcare%20Agrees%20to%20Pay,Department%20of%20Justice.

[21]    See Press Release, U.S. Atty’s Office for the Northern Dist. of NY, Government Contractor Agrees to Pay Record $48.5 Million to Resolve Claims Related to Fraudulent Procurement of Small Business Contracts Intended for Service-Disabled Veterans (Feb. 23, 2022), https://www.justice.gov/usao-ndny/pr/government-contractor-agrees-pay-record-485-million-resolve-claims-related-fraudulent.

[22]    See Press Release, Office of Public Affairs, U.S. Dep’t of Justice, MOX Services Agrees to Pay $10 Million to Resolve Allegations of Knowingly Presenting False Claims to Department of Energy for Non-Existent Construction Materials (Mar. 7, 2022), https://www.justice.gov/opa/pr/mox-services-agrees-pay-10-million-resolve-allegations-knowingly-presenting-false-claims.

[23]    See Press Release, Office of Public Affairs, U.S. Dep’t of Justice, Freight Carriers Agree to Pay $6.85 Million to Resolve Allegations of Knowingly Presenting False Claims to the Department of Defense (Mar. 14, 2022), https://www.justice.gov/opa/pr/freight-carriers-agree-pay-685-million-resolve-allegations-knowingly-presenting-false-claims.

[24]    See Press Release, Office of Public Affairs, U.S. Dep’t of Justice, UPS to Pay $5.3 Million to Settle False Claims Act Allegations for Falsely Reporting Delivery Times of U.S. Mail Carried Internationally (Mar. 21, 2022), https://www.justice.gov/opa/pr/ups-pay-53-million-settle-false-claims-act-allegations-falsely-reporting-delivery-times-us-0.

[25]    See Press Release, U.S. Atty’s Office for the Northern Dist. of NY, Construction Company Agrees to Pay $2.8 Million to Resolve Allegations of Small Business Subcontracting Fraud (May 12, 2022), https://www.justice.gov/usao-ndny/pr/construction-company-agrees-pay-28-million-resolve-allegations-small-business.

[26]    See Press Release, Office of Public Affairs, U.S. Dep’t of Justice, Seven South Korean Companies Agree to Pay Approximately $3.1 Million to Settle Civil False Claims Act Allegations for Bid Rigging on U.S. Department of Defense Contracts (May 18, 2022), https://www.justice.gov/opa/pr/seven-south-korean-companies-agree-pay-approximately-31-million-settle-civil-false-claims-act.

[27]    See Press Release, U.S. Atty’s Office for the Dist. of WV, United States Attorney Chris Kavanaugh Announces $3,000,000 Settlement in False Claims Act Case Against HEYtex USA (May 25, 2022), https://www.justice.gov/usao-wdva/pr/united-states-attorney-chris-kavanaugh-announces-3000000-settlement-false-claims-act.

[28]    See Press Release, U.S. Atty’s Office for the Dist. of CT, Connecticut Companies Pay $5.2 Million to Resolve Allegations of False Claims Act Violations Concerning Fraudulently Obtained Small Business Contracts (June 2, 2022), https://www.justice.gov/usao-ct/pr/connecticut-companies-pay-52-million-resolve-allegations-false-claims-act-violations.

[29]    See Press Release, Office of Public Affairs, U.S. Dep’t of Justice, KBR Defendants Agree to Settle Kickback and False Claims Allegations (June 14, 2022), https://www.justice.gov/opa/pr/kbr-defendants-agree-settle-kickback-and-false-claims-allegations.

[30]    See Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Loan Servicer Agrees to Pay Nearly $8 Million to Resolve Alleged False Claims in Connection with Federal Education Loans (Jan. 14, 2022), https://www.justice.gov/opa/pr/loan-servicer-agrees-pay-nearly-8-million-resolve-alleged-false-claims-connection-federal.

[31]    See Press Release, U.S. Atty’s Office for the Middle Dist. of FL, TracFone Wireless to Pay $13.4 Million to Settle False Claims Relating to FCC’s Lifeline Program (Apr. 4, 2022), https://www.justice.gov/usao-mdfl/pr/tracfone-wireless-pay-134-million-settle-false-claims-relating-fcc-s-lifeline-program.

[32]    See Press Release, U.S. Atty’s Office for the Dist. of CT, School and Owner Pay Over $1 Million to Resolve Allegations of Attempts to Improperly Influence the School’s Student Loan Default Rate (May 27, 2022), https://www.justice.gov/usao-ct/pr/school-and-owner-pay-over-1-million-resolve-allegations-attempts-improperly-influence.

[33]    Brief for Amicus Curiae Senator Charles E. Grassley In Support of Petitioners, United States ex rel. Tracy Schutte, et al. v. Supervalu Inc., et al., https://www.supremecourt.gov/DocketPDF/21/21-1326/225832/20220519154806836_21-1326%20Amicus%20Brief.pdf.

[34]    Colorado False Claims Act, House Bill 22-1119, https://leg.colorado.gov/sites/default/files/2022a_1119_signed.pdf.

[35]    Id.  

[36]    Id.

[37]    Id.  at § 24-31-1204(1)(b).

[38]    Id.

[39]    Id.

[40]    Id.

[41]    https://www.cga.ct.gov/2022/TOB/S/PDF/2022SB-00426-R02-SB.PDF; http://www.legislature.mi.gov/documents/2021-2022/billintroduced/House/htm/2022-HIB-6032.htm.

[42]    See N.Y. State Fin. L. § 189(1)(g), (4)(a); https://legislation.nysenate.gov/pdf/bills/2021/S8815.

[43]    See https://oig.hhs.gov/fraud/state-false-claims-act-reviews/; 42 U.S.C. § 1396h(a).

[44]    Id.

[45]    Id.

[46]    Id.

[47]    Compare http://www.legislature.mi.gov/documents/2021-2022/billintroduced/House/htm/2022-HIB-6032.htm with 31 U.S.C. § 3730(d)(1).

[48]   See John Elwood, Dismissing False Claims Act cases, promoting prescription fentanyl, and a capital case, SCOTUSBLOG (June 7, 2022, 8:25 PM), https://www.scotusblog.com/2022/06/dismissing-false-claims-act-cases-promoting-prescription-fentanyl-and-a-capital-case/.

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The following Gibson Dunn lawyers assisted in the preparation of this alert: Jonathan M. Phillips, Winston Y. Chan, John D.W. Partridge, James L. Zelenay Jr., Reid Rector, Chelsea B. Knudson, Allison Chapin, Michael R. Dziuban, Tessa Gellerson, Ben Gibson, Katie King, Nick Perry, Becca Smith, Chumma Tum, Mike M. Ulmer, Tim Velenchuk, Blair Watler, and Josh Zuckerman.

Gibson Dunn lawyers regularly counsel clients on the False Claims Act issues. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following members of the firm’s False Claims Act/Qui Tam Defense Group:

Washington, D.C.
Jonathan M. Phillips – Co-Chair, False Claims Act/Qui Tam Defense Group (+1 202-887-3546, [email protected])
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Geoffrey M. Sigler (+1 202-887-3752, [email protected]) 
Lindsay M. Paulin (+1 202-887-3701, [email protected])

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Winston Y. Chan – Co-Chair, False Claims Act/Qui Tam Defense Group (+1 415-393-8362, [email protected])
Charles J. Stevens (+1 415-393-8391, [email protected])

New York
Reed Brodsky (+1 212-351-5334, [email protected])
Mylan Denerstein (+1 212-351-3850, [email protected])
Alexander H. Southwell (+1 212-351-3981, [email protected])
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John D.W. Partridge (+1 303-298-5931, [email protected])
Robert C. Blume (+1 303-298-5758, [email protected])
Monica K. Loseman (+1 303-298-5784, [email protected])
Ryan T. Bergsieker (+1 303-298-5774, [email protected])
Reid Rector (+1 303-298-5923, [email protected])

Dallas
Robert C. Walters (+1 214-698-3114, [email protected])
Andrew LeGrand (+1 214-698-3405, [email protected])

Los Angeles
Nicola T. Hanna (+1 213-229-7269, [email protected])
Timothy J. Hatch (+1 213-229-7368, [email protected])
Deborah L. Stein (+1 213-229-7164, [email protected])
James L. Zelenay Jr. (+1 213-229-7449, [email protected])

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Benjamin Wagner (+1 650-849-5395, [email protected])

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We are pleased to provide you with Gibson Dunn’s Accounting Firm Quarterly Update for Q2 2022. The Update is available in .pdf format at the below link, and addresses news on the following topics that we hope are of interest to you:

• Halting Movement in U.K. Toward New Audit Regime but the U.K. Financial Reporting Counsel Remains Active
• Challenges to SEC (and Other?) Administrative Proceedings Progress
• Commenters Weigh in on SEC’s Climate Change Proposal
• ENABLERS Act Gets Fast-Tracked in the House
• U.S., U.K., and EU Sanctions Prohibit Accounting Services to Russia
• Supreme Court Upholds Arbitrability of Individual PAGA Claims
• Germany Proposes Whistleblower Law and Permits Hague Convention Pre-Trial Discovery
• Other Recent SEC and PCAOB Regulatory Developments

Read More

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In a highly anticipated judgment, the EU’s General Court has confirmed that on the basis of a referral request from a national EEA competition authority, the European Commission can review deals that do not trigger EU merger control thresholds or the merger control thresholds of any EEA Member State. The Court found that the Commission was justified to take jurisdiction over Illumina’s acquisition of Grail following a number of such referral requests. The judgment is a vindication of the Commission’s approach and whilst it brings clarity on this key jurisdictional principle, it will lead to greater uncertainty for merging parties.

The controversy

There is an ongoing global debate about whether deals that risk harming competition fly under competition authorities’ radars because they do not meet the relevant merger notification thresholds. In Europe, Article 22 of the EU Merger Regulation allows national competition authorities from the European Economic Area (EEA) to request the European Commission to examine deals that do not meet the automatic EU turnover thresholds. The Commission previously discouraged such referral requests when the relevant national merger notification thresholds were not met. However, because of a perceived “enforcement gap”, particularly in the digital and pharma sectors and particularly in relation to acquisitions by incumbents of nascent competitors who may have low or even no turnover in Europe, the Commission adopted guidance in March 2021 which changed this approach. Under this guidance, the Commission now encourages referral requests from national competition authorities where deals do not meet the relevant national thresholds but where a merger may harm competition in the EU internal market.

The Commission’s wide jurisdiction upheld

This principle has not been universally accepted and has been challenged in the proposed recent, and high profile, Illumina-Grail transaction. Illumina is a US-based genomics company and Grail is a US-based healthcare company which develops cancer detection tests based on next generation sequencing systems. Illumina’s proposed takeover of Grail was not notifiable at EU level nor in any EEA Member State.

On 19 April 2021, the Commission accepted a referral request from France, which was later joined by requests from Belgium, France, Greece, Iceland, the Netherlands and Norway, to examine the deal. Illumina appealed the Commission’s ability to take jurisdiction to the EU General Court on the basis that the transaction was not notifiable under the merger control laws of any EEA Member State.

In a judgment of 13 July 2022, the General Court upheld the Commission’s approach – this is a significant victory for the Commission with implications for companies considering global deals.

The details of the General Court judgment

First ground of appeal: jurisdiction

The main ground of Illumina’s appeal was that the Commission had no right to take jurisdiction on the basis of the different national referral requests since the relevant merger control thresholds were not triggered in any EEA Member State. The judgment contains an extensive analysis based on “literal, historical, contextual and teleological interpretations of Article 22”, and concludes that Article 22 does give the Commission the right to take jurisdiction in such circumstances.

The Court’s starting point is the language of Article 22 itself, which refers to the possibility for Member States to refer “any concentration” to the Commission which does not meet the automatic EU turnover thresholds, and which affects trade between Member States and threatens to significantly affect competition within the Member State(s) making the request. This is irrespective of the nature of national merger control rules or even their existence. In this regard, the Court also points to Article 22 referring to the fact that a Member State can make the request within 15 working days of the deal being notified or “otherwise being made known” to it – this demonstrates that the provision does not relate solely to deals which are notifiable at Member State level. This logic is further supported by the fact that the initial referral request can subsequently be joined by any Member State, again irrespective of whether the deal is notifiable in its jurisdiction.

The Court also provides a historical rationale, highlighting that one reason for the inclusion of Article 22 in the EU Merger Regulation was to allow Member States which did not have merger control law at the time (such as the Netherlands) to refer deals which may harm competition to be examined by the Commission, but without limiting it to that scenario or one where national merger control thresholds are met. Indeed, the Court stresses that whilst the primary mechanism for the Commission to examine deals is through the relevant EU-related turnover thresholds, Article 22 was designed as a supplementary mechanism to allow the Commission to examine deals which may harm competition but which do not meet those automatic thresholds.

Second ground of appeal: timing

The Court also looked at whether the Commission had acted in accordance with the timing provisions of Article 22. The core question was whether the relevant referral requests had occurred within the Article 22 time limits – these relate to when the respective Member States were “made known” of the deal. Illumina had argued that this date was significantly earlier than 19 February 2021, which was when the Commission invited the Member States to consider making an Article 22 referral request, inter alia because the deal had been publicly announced on 21 September 2020.

The Court did not accept this argumentation. It rather found that the “making known” was the “active transmission” to Member States of information allowing them to make an assessment of whether to make a referral request, and that in this case, that was the invitation letter from the Commission of 19 February 2021. Accordingly, all the referral requests were in time. The Court held that for reasons of legal certainty, the moment of “making known” has to be an objective point in time rather than a subjective criterion such as the public announcement of a deal which would require competition authorities to constantly review such announcements.

The Court did fault the Commission for not sending the invitation letter to Member States in a reasonable time (47 working days from when there was a complaint about the deal, with the Court suggesting that it could have been within 25 working days to mirror the phase one assessment period). However, this was held to not infringe Illumina’s rights of defence since that letter was only a preparatory act not affecting its legal situation, and it had had an opportunity to comment on the referral requests before the Article 22 Decision via which the Commission took jurisdiction.

Third ground of appeal: legitimate expectations

Illumina also argued that the change in the Commission’s Article 22 guidance violated its legitimate expectations – this argument was also dismissed by the Court. In line with existing case-law, the Court held that Illumina had failed to demonstrate that it had obtained specific, precise and actionable assurances from the Commission in relation to either the merger at issue or in relation to mergers that did not fall within the scope of national merger control rules in general. It therefore held that Illumina could not rely on the reorientation of the Commission’s decision-making practice (also noting in this regard that the Commission had previously discouraged rather than precluded notifications under Article 22 where national merger thresholds were not met).

The future

Illumina has already announced that it will appeal today’s judgment to the EU’s highest court, the European Court of Justice. Such an appeal will take at least 18 months but is not suspensory.

Today’s judgment is therefore a comprehensive vindication of the Commission’s approach and will embolden it to invite referrals from Member States where it considers that a deal that would otherwise not be notifiable in the EEA may harm competition. A sense of perspective is important – this does not mean open season for all deals because it is only deals that affect trade between EEA Member States and that threaten to significantly affect competition that can be referred, and the Court itself stressed these limitations. Nevertheless, it is clear that the judgment will lead to greater uncertainty for merging parties because if the argument can plausibly be made that a deal raises a potential competition issue, the Commission may end up examining it even if it is not otherwise notifiable anywhere in the EEA.

There are limits to how much this can be managed in advance. We nevertheless recommend that for such deals, companies and their advisors map out sufficiently in advance credible arguments why their deal will not harm competition and that where it is clear that there is a possibility of a referral request, they engage quickly with both the Commission and the relevant national competition authorities.

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The following Gibson Dunn lawyers prepared this client alert: Nicholas Banasevic, Rachel Brass, Ali Nikpay, Christian Riis-Madsen, Stephen Weissman, Attila Borsos, and Mairi McMartin.

Gibson Dunn’s lawyers are available to assist in addressing any questions that you may have regarding the issues discussed in this update. For further information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Antitrust and Competition practice group:

Antitrust and Competition Group:

Nicholas Banasevic* – Managing Director, Brussels (+32 2 554 72 40, [email protected])

Attila Borsos – Partner, Brussels (+32 2 554 72 10, [email protected])

Christian Riis-Madsen – Co-Chair, Brussels (+32 2 554 72 05, [email protected])

Ali Nikpay – Co-Chair, London (+44 (0) 20 7071 4273, [email protected])

Rachel S. Brass – Co-Chair, San Francisco (+1 415-393-8293, [email protected])

Stephen Weissman – Co-Chair, Washington, D.C. (+1 202-955-8678, [email protected])

* Nicholas Banasevic is Managing Director in the firm’s Brussels office and an economist by background. He is not an attorney and is not admitted to practice law.

© 2022 Gibson, Dunn & Crutcher LLP

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

Palo Alto partner Cassandra Gaedt-Sheckter, New York partner Alexander Southwell, and Denver partner Ryan Bergsieker are the authors of “Insights And Omissions From Calif. Privacy Rules Draft” [PDF] published by Law360 on July 8, 2022.

This client alert provides an overview of shareholder proposals submitted to public companies during the 2022 proxy season, including statistics and notable decisions from the staff (the “Staff”) of the Securities and Exchange Commission (the “SEC”) on no-action requests.

I. Summary of Top Shareholder Proposal Takeaways from the 2022 Proxy Season

In November 2021, the Staff issued Staff Legal Bulletin No. 14L (Nov. 3, 2021) (“SLB 14L”). In SLB 14L, the Staff rescinded Staff guidance and reversed no-action decisions published during the tenure of former Division Director Bill Hinman, upending the Staff’s recent approach to the application of the economic relevance exclusion in Rule 14a-8(i)(5) and the ordinary business and micromanagement exclusions in Rule 14a-8(i)(7). Moreover, SLB 14L indicated that the Staff would take a more expansive view to whether proposals raised significant policy issues that transcended ordinary business and would be more lenient in interpreting proof of ownership letters. The change of administration at the SEC and the issuance of SLB 14L appear to have served as an open season call for shareholder proponents: the number of proposals submitted surged, the percentage of proposals that shareholders were willing to withdraw as a result of negotiations dropped, and the number of proposals excluded through the no-action process plummeted. At the same time, recent amendments to Rule 14a-8 had only a very minor impact on shareholder submissions. As a result, shareholders were presented with more proposals on a wider range of topics with which they disagreed, with overall levels of voting support dropping notably. We discuss these trends and developments in further detail below:

• Shareholder proposal submissions rose again. For the second year in a row, the number of proposals submitted increased. In 2022, the number of proposals increased by 8% from 2021 to 868—the highest number of shareholder proposal submissions since 2016.
• The number of environmental and civic engagement proposals significantly increased, along with a continued increase in social proposals. Environmental and civic engagement proposals increased notably, up 51% and 36%, respectively, from 2021. And social proposals continued to increase, up 20% since 2021 and constituting the largest category of proposals submitted in 2022. In contrast, governance proposals declined 14% and executive compensation proposals declined 27%, each from the number of such proposals submitted in 2021. The five most popular proposal topics in 2022, representing 49% of all shareholder proposal submissions, were (i) climate change, (ii) special meetings, (iii) anti-discrimination and diversity, (iv) independent chair, and (v) lobbying spending and political contributions (which tied for fifth most common proposal topic).
• There was a significant decrease in the number of proposals excluded pursuant to a no-action request. The number of no-action requests submitted to the Staff during the 2022 proxy season decreased 10% from 2021, but nevertheless was higher compared to prior years, up 5% from 2020 and 7% from 2019. Most notably, the overall success rate for no-action requests plummeted to 38%, a drastic decline from success rates of 71% in 2021 and 70% in 2020. The 38% success rate was significantly below even the previous lowest exclusion rate in recent times, which occurred in the 2012 proxy season when the success rate dipped to 66%. Success rates in 2022 declined on every basis for exclusion, with the most drastic decline in success rates for procedural (56% in 2022, down from 84% in 2021), substantial implementation (13% in 2022, compared with 55% in 2021), and ordinary business grounds (24% in 2022, compared with 65% in 2021).
• While the number of proposals voted on increased significantly, overall voting support decreased, including average support for social and environmental proposals.In 2022, just over 50% of all proposals submitted were voted on, compared with 41% of submitted proposals that were voted on in 2021. Despite the increase in proposals voted on, average support for all shareholder proposals voted on decreased to 30.4% in 2022 from 36.3% in 2021. The decrease in average support was primarily driven by decreased support for both social and environmental proposals, with support for social (non-environmental) proposals decreasing to 23.2% in 2022 from 32.8% in 2021 and environmental proposals decreasing to 33.3% in 2022 from 43.5% in 2021. And in line with depressed support overall, the number of shareholder proposals that received majority support in 2022 was 55, down from 74 in 2021. But 2022 did mark the first year that two hot-button social proposals received majority support—multiple proposals requesting reports on gender/racial pay gaps and requesting racial/civil rights audits received majority support after coming close in recent years.
• Written Staff responses to each shareholder proposal no-action request returned mid-season. After discontinuing its longstanding practice of issuing a written response to each shareholder proposal no-action request in 2019, the Staff provided response letters to only 5% of no-action requests during the 2021 proxy season. In December 2021, the Staff announced that it was reconsidering its approach and would return to its historical practice of issuing a response letter for each no-action request. Following its announcement, the Staff immediately ceased communicating its responses via an online chart and commenced issuing response letters to each and every no-action request.
• Recent amendments to Rule 14a-8 appear to have had marginal impact on shareholder submissions. The 2022 proxy season was the first in which the September 2020 amendments to Rule 14a-8 took effect. Despite concerns voiced from some shareholder proponents and other stakeholders (including ongoing litigation over the new rules), the new rules do not appear to have had an appreciable effect on proponent eligibility or to have resulted in a significant increase in proposals eligible for procedural or substantive exclusion. In fact, as noted above, only 38% of no-action requests were successful in excluding shareholder proposals during the 2022 proxy season. The SEC is scheduled to consider proposing amendments to “update certain substantive bases for exclusion of shareholder proposals” under Rule 14a-8 at an open meeting to be held on July 13, 2022.
• Proponents continued to use exempt solicitations in record numbers. Exempt solicitation filings continued to proliferate, with the number of filings reaching a record high again this year and increasing 34% over last year and 70% since 2020. Consistent with prior years, the vast majority of exempt solicitations filed in 2022 were filed by shareholder proponents on a voluntary basis—i.e., outside of the intended scope of the SEC’s rules—in order to draw attention and publicity to pending shareholder proposals.

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The following Gibson Dunn attorneys assisted in preparing this update: Aaron Briggs, Elizabeth Ising, Thomas J. Kim, Julia Lapitskaya, Ronald O. Mueller, Lori Zyskowski, Geoffrey Walter, Victor Twu, Natalie Abshez, Meghan Sherley, and Andrea Shen.

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

Aaron Briggs – San Francisco, CA (+1 415-393-8297, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, [email protected])
Julia Lapitskaya – New York, NY (+1 212-351-2354, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Michael Titera – Orange County, CA (+1 949-451-4365, [email protected])
Lori Zyskowski – New York, NY (+1 212-351-2309, [email protected])
Geoffrey E. Walter – Washington, D.C. (+1 202-887-3749, [email protected])
David Korvin – Washington, D.C. (+1 202-887-3679, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

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

Gibson Dunn’s Supreme Court Round-Up provides summaries of the Court’s opinions from this Term, a preview of cases set to be argued next Term, and other key developments on the Court’s docket.  In the October 2021 Term, the Court heard argument in 63 cases, including 1 original-jurisdiction case.

Spearheaded by former Solicitor General Theodore B. Olson, the Supreme Court Round-Up keeps clients apprised of the Court’s most recent actions.  The Round-Up previews cases scheduled for argument, tracks the actions of the Office of the Solicitor General, and recaps recent opinions.  The Round-Up provides a concise, substantive analysis of the Court’s actions.  Its easy-to-use format allows the reader to identify what is on the Court’s docket at any given time, and to see what issues the Court will be taking up next.  The Round-Up is the ideal resource for busy practitioners seeking an in-depth, timely, and objective report on the Court’s actions.

To view the Round-Up, click here.

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Gibson Dunn has a longstanding, high-profile presence before the Supreme Court of the United States, appearing numerous times in the past decade in a variety of cases.  During the Supreme Court’s 6 most recent Terms, 9 different Gibson Dunn partners have presented oral argument; the firm has argued a total of 15 cases in the Supreme Court during that period, including closely watched cases with far-reaching significance in the areas of intellectual property, separation of powers, and federalism.  Moreover, although the grant rate for petitions for certiorari is below 1%, Gibson Dunn’s petitions have captured the Court’s attention: Gibson Dunn has persuaded the Court to grant 33 petitions for certiorari since 2006.

*   *   *  *

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following attorneys in the firm’s Washington, D.C. office, or any member of the Appellate and Constitutional Law Practice Group.

Theodore B. Olson (+1 202.955.8500, [email protected])
Amir C. Tayrani (+1 202.887.3692, [email protected])
Jacob T. Spencer (+1 202.887.3792, [email protected])
Joshua M. Wesneski (+1 202.887.3598, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

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

Hong Kong partner Brian Gilchrist and associate Celine Leung are the authors of “Electronic Court Process and Remote Hearings in Hong Kong” [PDF] published by Hong Kong Civil Procedure News in June 2022.

Decided June 30, 2022

Grande v. Eisenhower Medical Center, S261247

Yesterday, the California Supreme Court held that an employee who brings an employment class action against a staffing agency and executes a settlement agreement releasing the agency and its agents may bring a second class action against the staffing agency’s client premised on the same violations.

Background: Lynn Grande was assigned to work as a nurse at Eisenhower Medical Center by FlexCare, LLC, a temporary staffing agency. Grande filed a class action against FlexCare, alleging that it underpaid its employees.  The parties reached a settlement and executed a release of claims.

Eight months after the court approved the settlement and entered judgment, Grande filed another wage and hour class action—this time against Eisenhower.  Grande’s claims against Eisenhower were premised on the same violations over which she had sued FlexCare.

FlexCare moved to intervene in this follow-on case, arguing that Grande was precluded from suing Eisenhower because she had settled her claims against FlexCare in the earlier case.  The trial court and the Fourth District Court of Appeal disagreed.  The Court of Appeal held Grande wasn’t precluded from suing Eisenhower because it was neither a released party in the first case nor in privity with FlexCare.  The court expressly disagreed with the Second District’s decision in Castillo v. Glenair, Inc. (2018) 23 Cal.App.5th 262, 266, which held that a class of workers could not “bring a lawsuit against a staffing company, settle that lawsuit, and then bring identical claims against the company where they had been placed to work.”

Issue: May an employee bring an employment class action against a staffing agency, settle the case and release the agency and its agents from liability, and then bring a second class action based on the same alleged violations against the staffing agency’s client?

Court’s Holding:

Yes, on the facts of this case. The settlement agreement releasing FlexCare didn’t name Eisenhower or otherwise suggest that it was meant to include Eisenhower. Nor was FlexCare in privity with Eisenhower, including because Eisenhower would not have been bound by an adverse judgment in the first case against FlexCare. As a result, Grande wasn’t barred from asserting the same claims against Eisenhower in a second case.

Although the release in the settlement agreement between a nurse and her staffing agency didn’t include the hospital where she worked, “future litigants can specify that their releases extend to staffing agency clients—if that result is intended.”

Chief Justice Cantil-Sakauye, writing for the Court

What It Means:

• The Court stated that its decision as to the scope of the settlement agreement was “fact- and case-specific,” but also cast some doubt on “the broader notion that a client is an ‘agent’ of a staffing agency.”
• In drafting settlement agreements, staffing agencies and other employers should consider specifically naming any relevant client, or at least including “clients” among the releasees, as the Court’s opinion preserves employers’ ability to “specify that their releases extend to staffing agency clients—if that result is intended.”

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The Court’s opinion is available here.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the California Supreme Court. Please feel free to contact the following practice leaders:

Litigation Practice

Theodore J. Boutrous, Jr. +1 213.229.7804 [email protected]

Theane Evangelis +1 213.229.7726 [email protected]

Appellate and Constitutional Law Practice

Thomas H. Dupree Jr. +1 202.955.8547 [email protected]	Allyson N. Ho +1 214.698.3233 [email protected]	Julian W. Poon +1 213.229.7758 [email protected]
Blaine H. Evanson +1 949.451.3805 [email protected]	Bradley J. Hamburger +1 213.229.7658 [email protected]	Michael J. Holecek +1 213.229.7018 [email protected]
Daniel R. Adler +1 213.229.7634 [email protected]	Ryan Azad +1 415.393.8276 [email protected]

Related Practice: Labor & Employment

Jason C. Schwartz +1 202.955.8242 [email protected]

Katherine V.A. Smith +1 213.229.7107 [email protected]

Decided June 30, 2022

West Virginia, et al. v. EPA, et al., No. 20-1530;

North American Coal Corp. v. EPA, et al., No. 20-1531;

Westmoreland Mining Holdings LLC v. EPA, et al., No. 20-1778; and

North Dakota v. EPA, et al., No. 20-1780

Today, the Supreme Court held 6-3 that Congress has not delegated broad authority to EPA to substantially restructure the American energy market.

Background: Under the Clean Air Act, the Environmental Protection Agency has authority to regulate emissions of pollutants from power plants by mandating the “best system” for reducing emissions. In 2015, EPA issued the Clean Power Plan, which required existing coal and gas power plants either to reduce their production of electricity or to offset their production by subsidizing the generation of natural gas, wind, or solar energy. The Clean Power Plan, however, was stayed in subsequent litigation and never took effect. In 2019, EPA issued a new rule—the Affordable Clean Energy Rule—that repealed and replaced the Clean Power Plan. EPA reasoned that the Clean Power Plan had exceeded its statutory authority.

After the 2019 rule was challenged in court, the D.C. Circuit vacated the rule and held that EPA had erred in concluding that it lacked authority to impose the Clean Power Plan. EPA subsequently planned to promulgate a new rule.

Issue: Whether the Clean Air Act empowers EPA to transform the electric generation sector.

Court’s Holding:

No. Under the Clean Air Act, Congress has not delegated to EPA broad authority to restructure the energy industry by requiring existing power plants to shift to different forms of energy production.

“[O]ur precedent counsels skepticism toward EPA’s claim that [the Clean Air Act] empowers it to devise carbon emission caps based on a generation shifting approach.”

Chief Justice Roberts, writing for the Court

What It Means:

• The Court concluded that in enacting the Clean Air Act, Congress did not empower EPA to substantially restructure the American electricity market by requiring a shift away from coal and gas power plants to other types of electric generation.
• For the third time in a year, the Court reaffirmed the principle that agency action with vast economic and political significance requires a clear delegation from Congress. Thus, although this decision marks the first time the Court has expressly referred to the “major questions doctrine” in a majority opinion, application of that doctrine is not new. The Court’s repeated application of the major questions doctrine signals a continuing commitment by the Court to limit executive agencies’ regulation of particularly significant matters to circumstances where Congress clearly delegated such regulatory authority to the agency. The Court’s robust application of this doctrine will have potentially significant applications for a wide range of agency actions that assert broad power over important economic and political matters.
• In employing the major questions doctrine to resolve this case, the Court did not defer to EPA’s interpretation of the Clean Air Act. This result follows from the nature of the major questions doctrine, which obligates agencies to identify a clear statement of congressional authorization to justify extraordinary and far-reaching agency regulatory initiatives. In such cases, ambiguity in a statutory grant of authority is fatal to the agency’s regulatory efforts, leaving no room for deference.

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The Court’s opinion is available here.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:

Appellate and Constitutional Law Practice

Thomas H. Dupree Jr. +1 202.955.8547 [email protected]	Allyson N. Ho +1 214.698.3233 [email protected]	Julian W. Poon +1 213.229.7758 [email protected]
Lucas C. Townsend +1 202.887.3731 [email protected]	Bradley J. Hamburger +1 213.229.7658 [email protected]

Related Practice: Environmental Litigation and Mass Tort

Stacie B. Fletcher +1 202.887.3627 [email protected]

Daniel W. Nelson +1 202.887.3687 [email protected]

David Fotouhi +1 202.955.8502 [email protected]

Related Practice: Administrative Law and Regulatory Practice

Eugene Scalia +1 202.955.8673 [email protected]

Helgi C. Walker +1 202.887.3599 [email protected]

Related Practice: Energy, Regulation and Litigation

William S. Scherman +1 202.887.3510 [email protected]

While Public Benefit Corporations (PBCs) have been around for a decade, with the increasing importance of environmental, social, and governance (ESG) considerations, their popularity has grown dramatically. Following the successful IPOs of several PBCs and the conversion of already publicly traded companies to PBCs over the past two years, many corporations are considering if becoming a PBC is right for them. In this webcast, lawyers from Gibson Dunn and Morris Nichols talk about what to consider when deciding if being a PBC is right for you. In particular, they discuss the following:

• How is a PBC different from a traditional corporation?
• How does a corporation become a PBC?
• What are the requirements that come with being a PBC?
• What are the risks and benefits of being a PBC?
• What is the difference between a PBC and a B Corp?

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PANELISTS:

Stephen Glover is a partner in Gibson Dunn’s Washington, D.C. office and has served as Co-Chair of the firm’s Mergers and Acquisitions Practice Group. Mr. Glover has an extensive practice representing public and private companies in complex mergers and acquisitions, strategic alliances and joint ventures, as well as other corporate matters. Mr. Glover’s clients include large public corporations, emerging growth companies and middle market companies in a wide range of industries. He also advises private equity firms, individual investors and others.

Julia Lapitskaya is a partner in Gibson Dunn’s New York office and a member of the firm’s Securities Regulation and Corporate Governance practice group. Ms. Lapitskaya advises clients on a wide range of securities and corporate governance matters, with a focus on SEC and listing exchanges’ compliance and reporting requirements, corporate governance best practices, annual meeting matters, shareholder activism, board and committee matters, ESG and executive compensation disclosure issues, including as part of initial public offerings and spin-off transactions.

Harrison A. Korn is an associate in the Washington, D.C. office of Gibson, Dunn & Crutcher, where he is a member of the firm’s corporate department. His practice focuses on public and private mergers and acquisitions, the formation and operation of private equity and hedge funds, and capital markets and other corporate transactions, as well as general corporate matters, including securities law compliance and corporate governance.

Melissa DiVincenzo is a partner at the Wilmington, Delaware law firm Morris Nichols. Ms. DiVincenzo provides advice on corporate governance matters and private and public corporate transactions, including initial public offerings, mergers, asset sales, domestications, dissolutions and financing transactions. She has a specialized knowledge of Delaware law when structuring transactions and confronting complex or novel corporate issues.

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MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 0.5 credit hour, of which 0.5 credit hour may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit.

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 0.75 hour.

California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.

Gibson Dunn’s summary of director education opportunities has been updated as of July 2022 and is available at the link below. Boards of Directors of public companies find this a useful resource as they look for high quality education opportunities.

This update includes a number of additional opportunities as well as updates to the programs offered by organizations that have been included in our prior summaries.

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The following Gibson Dunn attorneys assisted in preparing this update: Hillary H. Holmes, Elizabeth A. Ising, Peter Wardle, and Justine Robinson. Thank you to summer associate Ruoqi Wei for her assistance with this quarter’s update.

© 2022 Gibson, Dunn & Crutcher LLP

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

China has finally amended its Anti-Monopoly Law, which will come into force on 1 August 2022 (the “Amended AML”).[1] The Amended AML has been more than two years in the making: the State Administration for Market Regulation (“SAMR”) first proposed amendments in early 2020 and a formal draft amendment was submitted to the Standing Committee of the National People’s Congress for a first reading on 19 October 2021 (the “Draft Amendment”).[2]

This client alert summarizes the main changes bought into effect by the Amended AML.

1.  Changes to the Merger Review Process

Review of non-threshold transactions

Article 19 of the Amended AML enables SAMR to require parties to a concentration (where the concentration does not otherwise trigger mandatory reporting obligations) to notify the transaction where “the concentration of undertakings has or may have the effect of eliminating or restricting competition.”[3]  Presumably, the obligation to submit a notification means that parties cannot close the transaction prior to obtaining clearance.

It is hard to say what practical effect Article 19 will have (if any). On the one hand, the introduction of this provision at least signals that SAMR seeks broader powers to review below threshold transactions. On the other hand, SAMR already had the right to review (although it did not have the power to require that parties notify) below threshold transactions under the State Council Regulation on the Notification Thresholds for Concentrations of Undertakings, but such power has rarely been exercised. The significance of Article 19 will be directly influenced by both SAMR’s appetite to formally review below threshold transactions, and its capacity to deal with such cases over and above its mandatory filing caseload.

Introduction of the stop-clock system

The Amended AML grants SAMR the power to suspend the review period in merger investigations under any of the following scenarios: where the undertaking fails to submit documents and materials leading to a failure of the investigation; where new circumstances and facts that have a major impact on the review of the merger need to be verified; or where additional restrictive conditions on the merger need to be further evaluated and the undertakings concerned agree.[4] The clock resumes once the circumstances leading to the suspension are resolved.  As noted in our previous client alert, it seems that this mechanism may be used to replace the “pull-and-refile” in contentious merger investigations.

This stop-clock system may lead to significantly longer investigations.

2.  Changes to the Rules on Anticompetitive Agreements

Abandoning per se treatment for resale price maintenance (“RPM”)

The Amended AML introduces a provision which states that a monopoly agreement between counterparties fixing the price or setting a minimum price for resale of goods to a third party “shall not be prohibited if the undertaking can prove that it does not have the effect of eliminating or restricting competition.”[5]  This provision essentially codifies the landmark 2018 decision of the Supreme People’s Court of China in Hainan Provincial Price Bureau v. Hainan Yutai Scientific Feed Company (“Yutai”).[6] In that case, the SPC addressed the divergent approaches taken by the Chinese antitrust authorities and the Chinese courts in respect of RPM, whereby the former treated RPM agreements as per se illegal, while the latter adopted a “rule of reason” approach. The SPC clarified that although Chinese antimonopoly authorities are able to rely on the presumption that RPM agreements eliminate or restrict competition and thus are illegal, this presumption is rebuttable by the undertaking adducing sufficient evidence to prove that the RPM agreement does not eliminate or restrict competition.

The Amended AML brings the legislation in line with Yutai, meaning that where a plaintiff alleges breach of the AML by way of a RPM agreement, it is open to a defendant to prove that the RPM agreement does not eliminate or restrict competition and therefore is not unlawful.

Safe harbours for vertical monopoly agreements

The Amended AML introduces a “safe harbour” for vertical monopoly agreements, in circumstances where “undertakings can prove that their market share in the relevant market is lower than the standards set by the anti-monopoly law enforcement agency of the State Council and meet other conditions set by the anti-monopoly law enforcement agency of the State Council shall not be prohibited.”[7]  This provision authorises SAMR to determine the threshold for the safe harbour, which we can expect in due course. The scope of the safe harbour under the Amended AML is narrower than that proposed under the Draft Amendment, which applied to both horizontal and vertical monopoly agreements. By contrast, it is clear from the Amended AML that the safe harbour only applies to vertical agreements, including, presumably, RPM agreements.

Cartel facilitators

The Amended AML provides that undertakings “may not organize other undertakings to reach a monopoly agreement or provide substantial assistance for other undertakings to reach a monopoly agreement.”[8]  This provision fills an arguable gap in the current AML, which means that cartel facilitators e.g., third parties that aid the conclusion of anti-competitive agreements or cartels, may be found in breach of the Amended AML.

3.  Increase in Fines Imposed

The Amended AML substantially increases the potential fines that could be imposed on different parties, and creates new fines. These include:

Penalties on cartel facilitators.  As explained above, under the Amended AML cartel facilitators will be liable for their conduct.  They risk penalties of not more than RMB 1 million (~$149,000).[9]

Increased penalties for merger-related conduct.  One of the commonly cited weaknesses of the current AML is the very low fines for parties failing to file or gun jumping (limited to RMB 500,000).  The Amended AML now states that where an undertaking implements a concentration in violation of the AML, a fine of less than 10% of the sales from the preceding year shall be imposed.[10] Where such concentration does not have the effect of eliminating or restricting competition, the fine will be less than RMB 5 million (~$745,000).

Superfine.  The Amended AML introduces a multiplier clause, pursuant to which SAMR can multiply the amount of the fine by a factor between 2 and 5 in case it is of the opinion that the violation is “extremely severe”, its impact is “extremely bad” and the consequence is “especially serious”.[11]  There is no definition of what these terms mean and this opens the door to very significant and potentially arbitrary fines.

Penalties for failure to cooperate with investigation.  Where an undertaking refuses to cooperate in anti-monopoly investigations, e.g. providing false materials and information, or conceals, destroy or transfer evidence, SAMR has the authority to impose a fine of less than 1% of the sales from the preceding year, and where there are no sales or the data is difficult to be assessed, the maximum fine on enterprises or individuals involved is RMB 5 million (~$745,000) and RMB 500,000 (~$75,000) respectively.

Penalties on individuals.  The Amended AML introduces individual liability for legal representatives, principal person-in-charge or directly responsible persons of an undertaking if that person is personally responsible for reaching an anticompetitive agreement. A fine of not more than RMB 1 million (~$149,000) can be imposed on that individual.[12] At this stage, however, cartel leniency is not available to individuals.

Public interest lawsuit.  Finally, under the Amended AML, public prosecutors (i.e. the people’s procuratorate) can bring a civil public interest lawsuit against undertakings they have acted against social and public interests by engaging in anticompetitive conduct.

4.  Further Targeting of the Digital Economy

Regulating the digital economy continues to be a focus of China’s legislative agenda. In 2021, SAMR published specific guidelines on the application of the AML to platforms. The Amended AML further targets the digital economy by adding language which prevents undertakings from “us[ing] data and algorithms, technologies, capital advantages, platform rules, etc. to engage in monopolistic behaviour prohibited by this Law.”[13]  This principle appears to apply to all monopolistic behaviour prohibited by the Amended AML, including monopoly agreements between undertakings, and is not limited to cases of abuse of market dominance.

In respect of abuse of market dominance, the Amended AML specifically adds that “[an] undertaking with a dominant market position shall not use data, algorithms, technologies, platform rules, etc. to engage in the abuse of a dominant market position as prescribed in the preceding paragraph”, which refers to the full list of acts considered to be abuse of dominant position.[14]

__________________________

[1]      Decision of the Standing Committee of the National People’s Congress on Amending the Anti-Monopoly Law of the People’s Republic of China (24 June 2022) available at http://www.npc.gov.cn/npc/c30834/202206/e42c256faf7049449cdfaabf374a3595.shtml.

[2]      National People’s Congress of the People’s Republic of China, “Draft Amendment to the Anti-Monopoly Law” (中华人民共和国反垄断法(修正草案)) (released on October 25, 2021), available at http://www.npc.gov.cn/flcaw/flca/ff8081817ca258e9017ca5fa67290806/attachment.pdf. See our client alert, China Publishes Draft Amendment to the Anti-Monopoly Law, published on 27 October 2021.

[3]      Amended AML, Article 26.

[4]      Draft Amendment, Article 32.

[5]      Amended AML, Article 18.

[6]      See our client alert Antitrust in China – 2019 Year in Review, for more detailed discussion of Yutai.

[7]      Amended AML, Article 18.

[8]      Amended AML, Article 19.

[9]      Amended AML, Article 56.

[10]    Amended AMl, Article 58.

[11]    Amended AML, Article 63.

[12]    Amended AML, Article 62.

[13]    Amended AML, Article 9.

[14]    Amended AML, Article 22.

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

Sébastien Evrard (+852 2214 3798, [email protected])
Hayley Smith (+852 2214 3734, [email protected])

Please also feel free to contact the following practice leaders:

Rachel S. Brass – San Francisco (+1 415-393-8293, [email protected])
Ali Nikpay – London (+44 (0) 20 7071 4273, [email protected])
Christian Riis-Madsen – Brussels (+32 2 554 72 05, [email protected])
Stephen Weissman – Washington, D.C. (+1 202-955-8678, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

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

On June 24, 2022, the Hong Kong Government gazetted the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (“Amendment Bill”)[1]. The Amendment Bill introduces changes to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (“AMLO”)[2], including the introduction of a licensing regime for virtual asset services providers (“VASPs”) and imposing statutory anti-money laundering and counter-terrorist financing (“AML/CTF”) obligations on VASPs in Hong Kong. A Legislative Council Brief on the Amendment Bill (“LegCo Brief”)[3] was also published on the same date, which provides valuable context for its introduction. The Amendment Bill follows the Consultation Conclusions[4] on this subject published by the Hong Kong government’s Financial Services and Treasury Bureau on May 21, 2021, as discussed in our previous alert.[5]

As noted by the LegCo Brief, the Hong Kong government considers its proposed VASP regime to be ‘more rigorous and comprehensive’ than the AML focused VASP regimes introduced in Singapore, the United Kingdom and Japan. To this end, and as discussed further below, the VASP regime is focused not only on AML related considerations but on ensuring adequate investor protection for virtual asset investors. As such, the VASP regime once implemented will not only impose a rigorous licensing regime on VASP operators, but will also criminalise a broad range of crypto-related misconduct, regardless of whether it takes place on a licensed VASP exchange. The regime also provides the SFC with an extensive range of supervisory powers.

I. Scope of proposed licensing regime for VASPs

As foreshadowed by the Consultation Conclusions last year, the Amendment Bill introduces a licensing regime for VASPs which provides that the business of operating a virtual asset (“VA”) service is a “regulated function” requiring a license when undertaken in Hong Kong.[6]

The Amendment Bill defines “VA service” as only including the operation of a VA exchange,[7] which is defined as the provision of services through means of electronic facilities whereby:

• offers to sell or purchase VAs are regularly made or accepted in a way that forms or results in a binding transaction; or
• persons are regularly introduced, or identified to other persons in order that they may negotiate or conclude, or with the reasonable expectation that they will negotiate or conclude sales or purchases of VAs in a way that forms or results in a binding transaction; and
• where client money or client VAs comes into direct or indirect possession of the person providing such a service.

While the scope of services covered by this definition is comparatively narrow in comparison to other crypto licensing regimes such as the Singapore Payment Services Act, we anticipate that this category of “VA service” may be expanded in the future to extend the VASP regime to other crypto-asset activities. This is particularly likely given that the Amendment Bill provides that the amendment of this definition would not require legislative change, but could instead be achieved by the publication of a notice in the Government Gazette by the Secretary for Financial Services and the Treasury.[8]

Further, we note that the above definition included in the Amendment Bill is broader than the definition proposed under the Consultation Conclusions, which contemplated licensing ‘any trading platform which is operated for the purpose of allowing an invitation to be made to buy or sell any VA in exchange for any money or any VA and which comes into custody, control, power or possession of, or over, any money or any VA at any time during the course of its business.’ As noted above, the Amendment Bill’s definition of “VA service” now also captures electronic facilities through which ‘persons are regularly introduced, or identified to other persons in order that they may negotiate or conclude, or with the reasonable expectation that they will negotiate or conclude sales or purchases of VAs in a way that forms or results in a binding transaction’. This is particularly significant to operators of peer-to-peer exchanges, given that this definition appears to capture at least some peer-to-peer platforms where those platforms constitute facilities through which parties are regularly introduced for the purpose of, or with the reasonable expectation of, negotiating or concluding sales of VAs. This is in contrast to the Consultation Conclusions’ statement that peer-to-peer trading platforms that only provide a forum where buyers and sellers of VAs can post their bids and offers “with or without automatic matching mechanisms” will not be covered under the definition of “VA exchange”. As such, it will be important for operators of peer-to-peer exchanges to review their Hong Kong activities and carefully consider whether they do fall within this additional limb of “VA exchange” as included in the Amendment Bill. We anticipate that it also may be necessary to seek further guidance from the SFC regarding their position on peer-to-peer platforms as part of the consultation process which is expected to take place regarding the SFC’s detailed regulatory requirements for the VASP regime. This consultation process is expected to take place during Q3-Q4 2022 once the Amendment Bill has been enacted and prior to the new regime taking effect.

The Amendment Bill has defined a “VA” as a digital representation of value that:

• is expressed as a unit of account or a store of economic value;
• either:
  
  • functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of debt, or for investment purposes; or
  • provides rights, eligibility or access to vote on the management, administration or governance of the affairs in connection with any cryptographically secured digital representation of value; and
• can be transferred, stored or traded electronically.[9]

Interestingly, the Consultation Conclusions did not contemplate the inclusion of the provision of rights, eligibility or access to vote as part of the definition of a “VA”. However, this addition means that governance tokens will likely be considered to be a VA. Further, while not referenced by name in the Amendment Bill or Legco Brief, we consider that, in line with the Consultation Conclusions, the definition of “VA” will capture stablecoins. Finally, while the definition of a VA does not currently cover non-fungible tokens, the Amendment Bill provides that the Secretary for Financial Services and the Treasury may expand the categories of tokens captured by the “VA” definition by publication of a notice in the Gazette.[10]

II. Licensing requirements for licensed VASPs

In order to be eligible for a VASP license, the VASP license applicant must be a locally incorporated company with a permanent place of business in Hong Kong or a company incorporated elsewhere but registered in Hong Kong under the Companies Ordinance (Cap. 622).[11]

An applicant wishing to be licensed as a VASP must demonstrate to the Securities and Futures Commission (“SFC”) that:

• it is a fit and proper person to be licensed to provide the VA service;
• it has at least 2 persons fit and proper to be responsible officers (“ROs”), each of whom are of sufficient authority within the applicant and at least one of whom must be an executive director;
• each director of the applicant is fit and proper; and
• the ultimate beneficial owner of the applicant is fit and proper to be the ultimate beneficial owner of a VASP licensee.[12]

The introduction of the fit and proper test is modelled on the fit and proper requirements for the licensing of regulated activities under the Securities and Futures Ordinance (Cap. 571) (“SFO”).[13] Given this, it is unsurprising that the factors that the SFC will consider in evaluating the fitness and properness of VASP applicants and associated individuals (e.g. ROs, directors and ultimate beneficial owners) are the same as those factors set out in the SFO in relation to licensed corporations and registered institutions. These factors include whether the applicant has been convicted of offences relating to money laundering / terrorist financing, fraud, corruption or dishonesty; the applicant’s financial status or solvency; its experience and qualifications; and its reputation, reliability and integrity.[14] Therefore, we recommend referring to the SFC’s Fit and Proper Guidelines[15] to understand the matters that the SFC will likely consider in evaluating whether a person is fit and proper in relation to a VASP licensee.

III. Licensing conditions and AML/CTF requirements

The Amendment Bill provides that the SFC may impose a range of licensing conditions on a VASP licensee, including, but not limited to, requirements in relation to:

• Financial conditions (e.g. capital requirements);
• Risk management policies and procedures;
• Anti-money laundering and counter-terrorism financing policies and procedures;
• Management of client assets;
• Financial reporting and disclosure;
• Virtual asset listing and trading policies;
• Market abuse policies;
• Cybersecurity; and
• Avoidance of conflicts of interest.[16]

We anticipate further details regarding the nature of these licensing conditions will be provided by the SFC in its forthcoming consultation on the detailed regulatory requirements applicable to VASPs (as referred to above). However, it is interesting to note that the list of license conditions included in the Amendment Bill does not include categories of clients to whom the VASP licensee may provide services. This is in contrast to the LegCo Brief’s statement that, in order to promote investor protection, the licensing regime will, at the initial stage, stipulate that VASPs can only provide services to professional investors (“PIs”) and that this restriction would be imposed by the SFC as a license condition (which is in keeping with the approach taken by the SFC to imposing the same restriction on certain licensed corporations). We consider that the use of the phrase “initial stage” and taking this approach to the imposition of the PI only restriction (rather than enshrining it in the legislation itself) suggests that the SFC may possibly allow expansion of VASP services to retail investors down the track when VA markets become more mature and regulated. This would be a welcome development for the virtual asset industry and would bring the Hong Kong regime into line with comparable regimes globally, including the Singapore regime.

The Amendment Bill also provides that licensed VASPs must comply with the AMLO’s requirements such as customer due diligence and record keeping requirements (e.g. Schedule 2 of the AMLO).[17]

IV. Key offences under the new VASP regime

The Amendment Bill also creates a significant new enforcement regime applicable to those providing VA services in Hong Kong or to the Hong Kong public. In particular, the Amendment Bill proposes that carrying on a business of providing a VA service without a license would be an offence punishable on conviction on indictment to a fine of HK$5 million and 7 years imprisonment, and in the case of a continuing offence, a further fine of HK$100,000 for every day during which the offence continues.

The Amendment Bill also introduces the following range of other offences punishable by significant fines and/or imprisonment:

• the offence of active marketing of a VA service by unlicensed persons, whether in Hong Kong or elsewhere, to the public of Hong Kong. This offence in particular is likely to have a significant impact on crypto exchanges based outside of Hong Kong and without a Hong Kong presence “on the ground” but which market their services to the Hong Kong public, including through, for example, Chinese language advertising;[18]
• the offence of making false or misleading statements in connection with an application for the grant of a license;
• the offence of making fraudulent or reckless misrepresentations with the intention to induce others to invest in VAs; and
• the offence of employing any deceptive or fraudulent device, scheme or act, directly or indirectly, in a transaction involving VA. We anticipate that this offence in particular will have a broad remit, given that it appears likely to extend to market manipulation and/or insider dealing in relation to virtual assets on the basis that such activities involve fraudulent and/or deceptive conduct.

Importantly, the offences of making fraudulent or reckless misrepresentations or employing deceptive or fraudulent devices, schemes or acts are not limited to transactions on licensed VASPs and as such will capture all individuals and/or firms engaging in this type of conduct with a substantial nexus to Hong Kong.

Finally, in the case of non-compliance with the statutory AML/CFT requirements, the licensed VASP and its ROs commit offences and upon conviction, each is liable to a fine of HK$1 million and 2 years  imprisonment. Further, licensed VASPs and ROs in contravention may also face disciplinary actions, including suspension or revocation of licenses.

V. Supervisory powers granted to the SFC over licensed VASPs

The Amendment Bill also provides the SFC with broad supervisory powers over licensed VASPs, these include the power to enter business premises of the licensed VASP and its associated entities for conducting routine inspections of business records;[19] to request the production of documents and other records;[20] to investigate non-compliances and impose disciplinary sanctions against licensed VASPs in contravention.[21]

The Amendment Bill also provides the SFC with a significant range of additional powers in relation to licensed VASPs, including:

• the power to appoint an auditor to investigate into the affairs of a licensed VASP and its associated entities if it has reasons to believe that the licensed VASP, or any of its associated entities, has failed to comply with provisions of the AMLO, code or guideline published under AMLO, or any licensing conditions imposed by the SFC;[22] and
• allowing the SFC to provide assistance to overseas regulators in investigations of any contraventions of VA requirements outside of Hong Kong. This is likely to be particularly significant given the global remit of many crypto businesses;[23] and
• powers to impose prohibitions or restrictions on the operation of a licensed VASP in a range of circumstances, including where the SFC considers the VASP not be fit and proper, or where there is a risk of dissipation of client assets.[24]

The Amendment Bill also provides the SFC with the power to seek certain orders from the Court of First Instance (“CFI”) in relation to contraventions of the VASP regime, including contraventions of the AMLO, any notice given under the AMLO or any conditions of a license granted under the AMLO.[25] This includes, significantly, the power to apply to the CFI for an order compelling a person who has been, is or may become, involved in the commission of the aforementioned contraventions, to take any step that the CFI directs, including to restore parties to any transaction to the position in which they were before the transaction was entered into.[26] This could expose persons who are the subject of such orders to liability to provide significant investor compensation in relation to losses suffered as a result of contraventions of the AMLO. However, the Amendment Bill notably does not give the SFC the power to seek such orders in relation to contraventions of codes and guidelines issued under the AMLO, in contrast to the power being sought by the SFC at present in its current consultation on amendments to its power to seek certain orders from the CFI under section 213 of the SFO.

VI. Timing

The first reading of the Amendment Bill was due to take place on June 29, but that first reading has now been rescheduled to July 6, 2022, with the provisions relating to the VASP regime due to take effect on March 1, 2023.

While the Amendment Bill provides for transitional arrangements for providers of VA services, these transitional arrangements do not extend to the offences set out above in relation to fraudulent conduct in relation to transactions in VAs, which will take effect from March 1, 2023.

While the Consultation Conclusions had contemplated a transitional period of 180 days for providers of VA services, the Amendment Bill provides that:

• there will be a transitional period for the first 12 months for any corporation carrying on a business of operating a VA exchange in Hong Kong prior to March 1, 2023 (i.e. regardless of whether they apply for a license); and
• corporations carrying on a business of operating a VA exchange in Hong Kong immediately prior to March 1, 2023 that file an application for a VA in the first 9 months (i.e. license by December 1, 2023) will be deemed to be licensed from the day after the expiry of the 12 month transitional period (i.e. March 2, 2024) until the SFC has made a decision to either approve or reject their license application, or the license applicant withdraws their application.

As such, prospective license applicants should ensure that they are operating in Hong Kong prior to March 1, 2023 to ensure that they are entitled to these transitional arrangements.

_________________________

   [1]   Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022, available at: https://www.gld.gov.hk/egazette/pdf/20222625/es32022262516.pdf

   [2]   Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615), available at: https://www.elegislation.gov.hk/hk/cap615

   [3]   Legislative Council Brief Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (June 22, 2022), published by the Financial Services and the Treasury Bureau, available at: https://www.fstb.gov.hk/fsb/en/legco/docs/AML(A)Bill%202022_legco%20brief_e%20(Issue).pdf

   [4]   Consultation Conclusions on Public Consultation on Legislative Proposal to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong (May 2021), published by the Financial Services and the Treasury Bureau, available at: https://www.fstb.gov.hk/fsb/en/publication/consult/doc/consult_conclu_amlo_e.pdf

   [5]   Licensing Regime for Virtual Asset Services Providers in Hong Kong, published by Gibson, Dunn and Crutcher (June 7, 2021), available at: https://www.gibsondunn.com/licensing-regime-for-virtual-asset-services-providers-in-hong-kong/#_ftn1

   [6]   Section 53ZRD(3), Amendment Bill

   [7]   Schedule B, Amendment Bill

   [8]   Section 53ZTL, Amendment Bill

   [9]   Section 53ZRA(1), Amendment Bill

  [10]   Section 53ZRA(4)(a), Amendment Bill

  [11]   Section 53ZRK(3)(a), Amendment Bill

  [12]   Section 53ZRK(3)(b), Amendment Bill

  [13]   See Section 129(1), Securities and Futures Ordinance (Cap. 571), available at: https://www.elegislation.gov.hk/hk/cap571

  [14]   Section 53ZRJ, Amendment Bill

  [15]   See SFC Fit and Proper Guidelines (January 2022), available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/fit-and-proper-guidelines/Fit-and-Proper-Guidelines.pdf

  [16]   Section 53ZRK(5), Amendment Bill

  [17]   Section 53ZRR, Part 3, Division 2, Paragraph 34, Amendment Bill

  [18]   We anticipate that the SFC will take a similar approach to “active marketing” in this context as it does to “active marketing” for the purposes of section 115 of the SFO. See, e.g., the SFC’s FAQ on this topic, available at: https://www.sfc.hk/en/faqs/intermediaries/licensing/Actively-markets-under-section-115-of-the-SFO#9CAC2C2643CF41458CEDA9882E56E25B

  [19]   Part 2, Division 2, Clause 11(1B), Amendment Bill

  [20]   Part 2, Division 2, Clause 11(3), Amendment Bill

  [21]   Section 53ZSO, Amendment Bill

  [22]   Section 53ZSG, Amendment Bill

  [23]   Part 2, Division 2, Clause 18(13B) and (13C), Amendment Bill

  [24]   Sections 53ZSX, 53ZSY, 53ZSZ and 53ZT, Amendment Bill

  [25]   See our previous alert on this topic – Hong Kong SFC Consults on Significant Reforms to the SFO Enforcement Provisions, published by Gibson, Dunn and Crutcher (June 14, 2022), available at: https://www.gibsondunn.com/hong-kong-sfc-consults-on-significant-reforms-to-the-sfo-enforcement-provisions/

  [26]   Section 53ZTG, Amendment Bill

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The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, Arnold Pun, and Jane Lu.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Crypto Taskforce ([email protected]) or the Global Financial Regulatory team, including the following authors in Hong Kong:

William R. Hallatt (+852 2214 3836, [email protected])
Grace Chong (+65 6507 3608, [email protected])
Emily Rumble (+852 2214 3839, [email protected])
Arnold Pun (+852 2214 3838, [email protected])
Becky Chung (+852 2214 3837, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

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

It is a well-recognized principle of international law that judicial power ends at the respective state’s border. Consequently, courts need to request judicial assistance if they wish to obtain evidence outside of their jurisdiction. Previously, German courts receiving a request for pre-trial discovery from a common-law jurisdiction would not execute this request – regardless of its content or origin. Due to a recent amendment to Germany’s Implementing Act to the Hague Convention on the Taking of Evidence Abroad in Civil or Commercial Matters (“Hague Evidence Convention”)[1], this situation may change in the future, thus, allowing for pre-trial discovery if certain conditions are met. Nevertheless, due to detailed prerequisites needed to execute a request, Germany is still taking a rather hesitant approach towards pre-trial discovery compared to other jurisdictions.

Status quo ante

In Germany, questions of judicial assistance for courts located outside of the European Union and regarding the taking of evidence are governed by the Hague Evidence Convention.[2] The Convention entered into force on October 7, 1972. Designed as a “bridge between common and civil law”[3], it established standardized procedures for handling Letters of Request to collect evidence abroad. As of today, 64 countries have become a contracting party to the Convention, including the US, the UK, China, the Russian Federation and a majority of European states.[4]

The Convention covers all types of taking evidence, including pre-trial discovery of documents. Nevertheless, due to concerns about invasive requests from common-law jurisdictions, the Hague Conference on Private International Law decided to allow Contracting States to declare a reservation regarding pre-trial discovery (Article 23).[5] So far, 28 countries have asserted an absolute, non-particularized reservation, while 19 states have declared that they would only execute a request within the meaning of Article 23 if it fulfilled certain requirements.[6]

When Germany joined the Hague Evidence Convention in 1977, it also decided to make use of Article 23, opting for a general, non-particularized reservation. In the following, it adopted the Implementing Act to the Hague Convention of 15 November 1965 on the Service Abroad of Judicial and Extrajudicial Documents in Civil or Commercial Matters and the Hague Convention of 18 March 1970 on the Taking of Evidence Abroad in Civil or Commercial Matters (“Implementing Act”). Section 14 of the Implementing Act provided that requests for mutual assistance relating to proceedings under Article 23 of the Convention shall not be executed.[7] Consequently, any requests concerning pre-trial discovery would not be carried out in Germany[8] – until now.

The new German rule

On January 19, 2022, the Federal Ministry of Justice submitted a draft amending the Implementing Act. The bill was passed by the Bundestag and the Bundesrat and will enter into force on July 1, 2022.[9] It includes a revision of Section 14 of the Implementing Act, converting the previous absolute reservation under Article 23 of the Hague Evidence Convention to a qualified, particularized one. The new Section 14 of the Implementing Act will provide that courts shall execute requests for mutual assistance on pre-trial discovery of documents if the following five requirements are met:

1. 1. The documents to be produced are specified in detail,
   2. the documents to be produced are of direct and clearly identifiable importance for the proceedings in question and their outcome,
   3. the documents to be produced are in the possession of a party involved in the proceedings,
   4. the request does not violate essential principles of German law, and,
   5. in case the documents to be produced contain personal data, the requirements for transfer to a third country pursuant to Chapter V of Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of individuals with regard to the processing of personal data, on the free movement of such data and repealing Directive 95/46/EC (General Data Protection Regulation) (“GDPR”) are met.[10]

With the amendment, Germany follows a recommendation of the Special Commission of the Hague Conference on Private International Law that has been reviewing the Evidence Convention and its application.[11] The Commission stated that the purpose of Article 23, namely “to ensure that a request for the production of documents [is] sufficiently substantiated so as to avoid requests whereby one party merely seeks to find out what documents may generally be in the possession of the other party to the proceeding”[12], could easily be achieved with a particularized declaration similar to the one submitted by the UK.[13] Germany had already tried to introduce an almost identical version of the new Section 14 in 2017 but withdrew the amendment from the bill at the last minute. At the time, the Judicial Affairs Committee doubted the benefit of the proposed rule and justified the withdrawal by arguing that the taking of evidence aimed at stating which documents were in one’s possession (“Ausforschungsbeweis”) was inadmissible[14] – even though such requests were (also) excluded in the 2017 draft and the German Federal Constitutional Court had explicitly stated in 2007 that pre-trial discovery per se was constitutional and did not violate fundamental principles of German law.[15] The unsatisfactory state of limbo since then has now been rectified by the modification.

Still, the recent amendment shows that Germany is taking a rather critical approach towards pre-trial discovery, defining more detailed and extensive requirements than the UK or other jurisdictions. Nevertheless, looking closely at the new provision, only one requirement may lead to blatant restrictions of document production. While the first two conditions reflect the basic rationale of the UK declaration to prevent unreasonable ‘fishing expeditions’, the fourth and fifth prerequisite are merely declaratory. Article 12 lit. b of the Evidence Convention already provides that a court may refuse execution of a request if it would prejudice the state’s sovereignty or security, thus containing an ordre public-reservation. Furthermore, German courts may also refer to potential violations of German local law to turn down a request pursuant to Article 11 of the Convention. Similarly, compliance with the GDPR as prescribed in Section 14 No. 5 of the Implementing Act is required within the EU in any case, thus creating no additional obstacles.[16]

The most significant limitation to pre-trial discovery requests, however, is the exclusion of third parties not involved in the proceedings (No. 3). No other Contracting State has issued a similar declaration. German civil procedure law does not recognize such a restriction either: In domestic proceedings, third parties can be obliged to produce documents pursuant to Section 142 of the German Code of Civil Procedure.[17] As a result, the Implementing Act’s new provision ultimately contradicts the German legislator’s intention to eliminate fundamental differences in obtaining evidence in domestic and international cases.[18]

Implications for future proceedings

The recent amendment will enable German courts to execute pre-trial discovery requests from foreign courts. Currently, Australia, Barbados, India, Syria, Seychelles, Singapore, South Africa, Sri Lanka, the UK and the US utilize this type of evidence taking and are Contracting States to the Evidence Convention.[19] Among these, requests from the US and the UK most likely have the greatest practical relevance.[20]

It remains to be seen whether Germany’s change in direction will have a significant impact on future transnational litigation. In the past, instead of referring to the Hague Evidence Convention, foreign courts often applied their own procedure law extraterritorially to fulfill pre-trial discovery requests in Germany.[21] It is unlikely that the recent amendment will put a halt to this practice. As it happens, the previous draft to the Implementing Act from 2017 had expressed the hope that an amendment would lead US courts to preferentially refer to the Hague Convention because they could count on an effective and fast execution of their requests. Whether this will actually happen is debatable – and quite possibly, somewhat naïve. Be that as it may, the new German Implementing Act offers foreign courts and parties an additional route to deal with pre-trial discovery request in Germany – and ultimately furthers the Hague Convention’s initial objective to strengthen the often shaky bridge between civil and common law.

_______________________

   [1]   Gesetz zur Ausführung des Haager Übereinkommens vom 15. November 1965 über die Zustellung gerichtlicher und außergerichtlicher Schriftstücke im Ausland in Zivil- oder Handelssachen und des Haager Übereinkommens vom 18. März 1970 über die Beweisaufnahme im Ausland in Zivil- oder Handelssachen [AusfG HZÜ/HBÜ] [Implementing Act to the Hague Convention of 15 November 1965 on the Service Abroad of Judicial and Extrajudicial Documents in Civil or Commercial Matters and to the Hague Convention on the Taking of Evidence Abroad in Civil or Commercial Matters], Dec. 22, 1977, BGBl. I at 3105, last amended Jan. 11, 2017, BGBl. I at 1607, see https://www.justiz.nrw.de/Bibliothek/ir_online_db/ir_htm/65_70_ausfuehrungsgesetz.htm.

   [2]   Evidence requests from one EU member state court to another are governed by the European Evidence Regulation (EU) 2020/1783, see https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32020R1783.

   [3]   See Hague Conference on Private International Law, Conclusions and Recommendations adopted by the Special Commission on the Practical Operation of the Hague Apostille, Evidence and Service Conventions (28 October to 4 November 2003),  p. 7, available at https://www.hcch.net/en/publications-and-studies/details4/?pid=3121&dtid=2.

   [4]   For an up-to-date status report on the Convention, see https://www.hcch.net/en/instruments/conventions/status-table/?cid=82.

   [5]   Article 23 Hague Evidence Convention: A Contracting State may at the time of signature, ratification or accession, declare that it will not execute Letters of Request issued for the purpose of obtaining pre-trial discovery of documents as known in Common Law countries, see https://assets.hcch.net/docs/dfed98c0-6749-42d2-a9be-3d41597734f1.pdf.

   [6]   See Regierungsentwurf [Cabinet Draft], Bundestag Drucksachen [BT] 20/1110, p. 34, available at https://dserver.bundestag.de/btd/20/011/2001110.pdf.

   [7]   § 14 AusfG HZÜ/HBÜ: (1) Rechtshilfeersuchen, die ein Verfahren nach Artikel 23 des Übereinkommens zum Gegenstand haben, werden nicht erledigt [free translation: Requests for mutual assistance concerning proceedings under Article 23 of the Convention shall not be executed.].

   [8]   See Oberlandesgericht Frankfurt [Higher Regional Court Frankfurt], Order dated May 16, 2013 – 20 VA 4/13, BeckRS 2013, 12264.

   [9]   See Gesetzesbeschluss [Law Decree], Bundesrat Drucksachen [BR] 225/22, Article 23, available at https://www.bundesrat.de/SharedDocs/drucksachen/2022/0201-0300/225-22.pdf?__blob=publicationFile&v=1.

  [10]   § 14 AusfG HZÜ/HBÜ-E: Rechtshilfeersuchen, die ein Verfahren nach Artikel 23 des Übereinkommens zum Gegenstand haben, werden nur erledigt, wenn 1. die vorzulegenden Dokumente im Einzelnen genau bezeichnet sind, 2. die vorzulegenden Dokumente für das jeweilige Verfahren und dessen Ausgang von unmittelbarer und eindeutig zu erkennender Bedeutung sind, 3. die vorzulegenden Dokumente sich im Besitz einer an dem Verfahren beteiligten Partei befinden, 4. das Herausgabeverlangen nicht gegen wesentliche Grundsätze des deutschen Rechts verstößt und, 5. soweit personenbezogene Daten in den vorzulegenden Dokumenten enthalten sind, die Voraussetzungen für die Übermittlung in ein Drittland nach Kapitel V der Verordnung (EU) 2016/679 des Europäischen Parlaments und des Rates vom 27. April 2016 zum Schutz natürlicher Personen bei der Verarbeitung personenbezogener Daten, zum freien Datenverkehr und zur Aufhebung der Richtlinie 95/46/EG (Datenschutz-Grundverordnung) (ABl. L 119 vom 4.5.2016, S. 1; L 314 vom 22.11.2016, S. 2; L 127 vom 23.5.2018, S. 2; L 74 vom 4.3.2021, S. 35) erfüllt sind [no official translation available].

  [11]   See Hague Conference on Private International Law, Conclusions and Recommendations of the Special Commission on the Practical Operation of the Hague Apostille, Service, Taking of Evidence and Access to Justice Conventions (2 to 12 February 2009), p. 9, available at https://www.hcch.net/en/publications-and-studies/details4/?pid=4694&dtid=2.

  [12]   Id. at 7.

  [13]   “In accordance with Article 23 Her Majesty’s Government declare that the United Kingdom will not execute Letters of Request issued for the purpose of obtaining pretrial discovery of documents. Her Majesty’s Government further declare that Her Majesty’s Government understand ‘Letters of Request issued for the purpose of obtaining pre-trial discovery of documents’ for the purposes of the foregoing Declaration as including any Letter of Request which requires a person: a. to state what documents relevant to the proceedings to which the Letter of Request relates are, or have been, in his possession, custody or power; or b. to produce any documents other than particular documents specified in the Letter of Request as being documents appearing to the requested court to be, or to be likely to be, in his possession, custody or power.”, see https://www.hcch.net/en/instruments/conventions/status-table/notifications/?csid=564&disp=resd.

  [14]   See Regierungsentwurf [Cabinet Draft], Bundestag Drucksachen [BT] 18/11637, p. 4.

  [15]   See Bundesverfassungsgericht [BVerfG] [Federal Constitutional Court], Order dated January 24, 2007 – 2 BvR 1133/04, BeckRS 2009, 71201, para. 15; a few years later, the court affirmed the decision and further stated that submitting to pre-trial discovery would not prevent recognition of the decision in Germany, see Order dated November 3, 2015 – 2 BvR 2019/09, BeckRS 2015, 55670, para. 43.

  [16]   For an overview of the GDPR, see https://www.gibsondunn.com/the-general-data-protection-regulation-a-primer-for-u-s-based-organizations-that-handle-eu-personal-data/.

  [17]   § 142 Code of Civil Procedure [ZPO]: (1) The court may direct one of the parties or a third party to produce records or documents, as well as any other material, that are in its possession and to which one of the parties has made reference. […] (2) Third parties shall not be under obligation to produce such material unless this can be reasonably expected of them, or to the extent they are entitled to refuse to testify pursuant to sections 383 to 385 [official translation]; the Max Planck Institute for Procedural Law and the Max Planck Institute for Private International Law have criticized the new version of the Implementing Act for this exact reason, see https://www.mpipriv.de/1496224/20222903-gemeinsame-stellungnahmen-zweier-max-planck-institute-fuer-das-bmj.

  [18]   See Regierungsentwurf [Cabinet Draft], Bundestag Drucksachen [BT] 20/1110, p. 34.

  [19]   Id. at 22.

  [20]   Post-Brexit, the European Evidence Regulation no longer applies to judicial assistance requests. Instead, these issues are now governed by the Hague Evidence Convention. Disclosure pursuant to Part 31 of the UK Civil Procedure Rules qualifies as pre-trial discovery within the meaning of Article 23 of the Evidence Convention.

  [21]   Societe Nationale Industrielle Aerospatiale v. U.S. Dist. Ct., 482 U.S. 519, 533, 539 (1987), holding that the Evidence Convention serves only as an optional supplement to the Federal Rules of Civil Procedure which provide ample means to obtaining evidence if the parties are subject to the court’s jurisdiction.

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

Finn Zeidler – Frankfurt (+49 69 247 411 530, [email protected])
Annekathrin Schmoll – Frankfurt (+49 69 247 411 533, [email protected])

Please also feel free to contact the following practice leaders:

Transnational Litigation Group:
Susy Bullock – London (+44 (0) 20 7071 4283, [email protected])
Perlette Michèle Jura – Los Angeles (+1 213-229-7121, [email protected])
Andrea E. Neuman – New York (+1 212-351-3883, [email protected])
William E. Thomson – Los Angeles (+1 213-229-7891, [email protected])

© 2022 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 Hong Kong Court of Final Appeal (the “CFA”) [1] has recently confirmed that for the purpose of winding up foreign companies in Hong Kong, the requirement that the winding up must benefit the petitioner can include commercial pressure (in other words, leverage) to achieve the repayment of an undisputed debt.

The CFA’s reaffirmation of the threshold requirements for the court to exercise its jurisdictions, and in particular its clarification regarding the benefit requirement, is welcome. It demonstrates the court’s willingness in adopting a pragmatic approach in assessing whether it would be useful to entertain a winding-up petition in respect of a foreign company.

1. Factual Background and Procedural History in Hong Kong Courts

The Appellant was a PRC company listed in Hong Kong, and the Appellant and Respondent entered into a joint venture agreement. Following a dispute that led to an arbitral award against the Appellant, the Respondent served a statutory demand on the Appellant for the debt payable under the award. The Appellant failed to pay any part of the amounts demanded and sought an injunction to prevent the Respondent from presenting a winding-up petition as a creditor.

The Appellant’s case was that the Respondent could not satisfy the three core requirements for the court to exercise its jurisdiction to wind up a foreign-incorporated company when it is unable to pay its debts. The Appellant did not accept that the 2nd requirement was met, namely whether the winding-up order would benefit the petitioner. In particular, it did not accept that leverage (namely commercial pressure to achieve the repayment of an undisputed debt) could satisfy the 2nd requirement, as any benefit does not arise “as a consequence of the winding-up order being made”, but rather, would only be realised “if the winding-up order is either avoided or discharged”.

At the Court of First Instance, the Judge held that leverage created by the prospect of a winding-up petition constitutes sufficient benefit for the petitioner for the purposes of the 2nd requirement. The Court of Appeal upheld the Judge’s decision that there was a “real possibility of benefit” for the petitioner in making a winding-up order against the Appellant.

2. Nature of the Three Requirements for Winding Up Foreign-Incorporated Companies

The three “core requirements” previously approved by the CFA [2] which must be satisfied before a Hong Kong court will exercise its jurisdiction to wind up a foreign-incorporated company are that:

1. 1. 1. 1. There must be a sufficient connection with Hong Kong;
         2. There must be a reasonable possibility that the winding-up order would benefit those applying for it; and
         3. The court must be able to exercise jurisdiction over one or more persons in the distribution of the company’s assets.

The CFA noted that the three requirements are not derived from statutory provisions and should not be approached through the ordinary rule of statutory construction. Rather, they are self-imposed judicial restraints on the exercise of the court’s jurisdiction (discretion) but not on the existence of the jurisdiction (which is entirely statutory). The CFA therefore considered that it would be more appropriate to characterise these requirements as “threshold requirements” rather than “core requirements”.

3. “Benefit” under the 2nd Threshold Requirement

3.1. General Nature of ‘Benefit’ under the 2nd Threshold Requirement

The CFA held that a “pragmatic approach” should be adopted in assessing whether it would be useful to entertain a winding-up petition in respect of a foreign company. Whilst the benefit the petitioning creditors can rely on will vary case-by-case, the CFA made the following observations:

• There is no doctrinal justification for confining the relevant benefit narrowly to the distribution of assets by the liquidator in the winding up of the company;
• It is sufficient that the benefit would be enjoyed solely by the petitioner;
• There is also no doctrinal justification requiring the relevant benefit to come from the assets of the company;
• There are cases where even though there was nothing for the liquidator to administer, the courts did not find any difficulty in finding benefit so long as some useful purpose serving the legitimate interest of the petitioner can be identified;
• The benefit need not be monetary or tangible in nature; and
• The fact that a similar result could be achieved by other means does not preclude a particular benefit from being relied upon.

3.2. Leverage as a Legitimate Benefit

With this “pragmatic approach” in finding benefit in mind, the CFA held that leverage is a relevant benefit as it is a proper purpose for a creditor’s winding-up petition. The benefit is derived from the invocation of the court’s winding-up procedures. In finding leverage as a legitimate benefit, the CFA also made a few observations:

Undisputed/Disputed Debt

The distinction between disputed and undisputed debt is important. The presentation of a winding-up petition, where the debt is disputed, may amount to an abuse of process of the court given that there is often a real and substantial dispute of facts.

Statutory Demand Mechanism

Additionally, the CFA observed that the statutory demand mechanism [3] provides a convenient method for creditors to seek repayment of an undisputed debt through presenting a winding-up petition. Non-compliance with the statutory demand operates as conclusive proof of the company’s inability to pay its debts (irrespective of whether the company is, in fact, insolvent) for the purpose of establishing the court’s jurisdiction to make a winding-up order, and the CFA observed that case law recognises the propriety of the use of a winding-up petition as a means of applying commercial pressure to seek payment of undisputed debt. Thus, there is no reason to exclude leverage as a relevant benefit under the 2nd requirement.

“Real” Leverage

The CFA also held that the leverage must be “real” and its significance depends on the potential impact of a winding-up order. Where the foreign company has no incentive to avoid a winding-up order, there is not much leverage. However, in this case, the leverage stemmed from the adverse consequences on the listing status of the foreign company which the court found to be real and significant.

4. Comity Argument: Forum Conveniens Only a Factor but Not a Requirement

The Appellant also raised a further comity argument arguing that winding up a foreign company is only justified when the jurisdiction of incorporation cannot fulfil its function making it necessary to “fill the lacuna”. The CFA observed that the Appellant was attempting to impose an additional requirement for the court to exercise its jurisdiction and held that if sufficient connection is established under the 1st requirement, any such forum conveniens issue should only be a factor (rather than an essential requirement) that the court can consider in deciding if a winding-up order should be made.

5. Conclusion

It is clear from the CFA’s judgment that for the purpose of winding up foreign companies in Hong Kong, the 2nd requirement that the winding up must benefit the petitioners can include commercial pressure to achieve the repayment of an undisputed debt.

On the other hand, the CFA also usefully clarifies that whilst the court is prepared to adopt a pragmatic approach, any such leverage must be real and significant and that contrary to the view of the Court of First Instance, any moderation of this 2nd requirement is not appropriate.

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[1] Shandong Chenming Paper Holdings Limited v Arjowiggins HKK 2 Limited [2022] CFA 11. A copy of the judgment of the Court of Final Appeal is available here. The judgment in the Court of Appeal ([2020] HKCA 670) is available here. The judgment in the Court of First Instance (HCMP 3060/2016) is available here.

[2] In Kam Leung Sui Kwan v Kam Kwan Lai (2015) 18 HKCFAR 501, more commonly referred to as the “Yung Kee” case.

[3] Section 327(4)(a) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap.32). Under this section, a company is deemed unable to pay its debts if the company has failed to respond satisfactorily to a creditor’s written demand (by way of payment or otherwise) after 3 weeks of its service.

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

Brian Gilchrist (+852 2214 3820, [email protected])
Elaine Chen (+852 2214 3821, [email protected])
Alex Wong (+852 2214 3822, [email protected])
Rebecca Ho (+852 2214 3824, [email protected])

© 2022 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 Uyghur Forced Labor Prevention Act (“UFLPA” or “Act”)—and its stringent import restrictions—took effect on June 21, 2022.[1] The Act, the latest effort by the United States concerning the Uyghur population in China’s Xinjiang Uyghur Autonomous Region (the “XUAR” or “Xinjiang”), greatly increases the showing that companies need to make to prove that goods produced in the XUAR, in full or in part, are entitled to entry into the United States. All products manufactured in the region or produced by a list of entities that have now been designated by the interagency Forced Labor Enforcement Task Force (“FLETF”) are presumptively barred from entry into the United States unless the importer can present “clear and convincing” evidence that the product has not been tainted by the use of forced labor.[2]

As U.S. Customs and Border Protection (“CBP”) begins to enforce the Act, importers of certain products and products that may incorporate raw materials or manufactured parts or components that are suspected to have touchpoints with the XUAR or with several of China’s “anti-poverty alleviation” programs should be aware of heightened diligence and supply chain tracing requirements necessary to rebut the UFLPA’s presumptive import ban on XUAR-linked shipments.

I. Background

As we have shared in past client alerts, the UFLPA is the latest in a long line of U.S. executive and legislative efforts targeting alleged forced labor in the supply chains of goods entering the United States.

For nearly a century, the 1930 Tariff Act has authorized CBP to prevent the importation of “[a]ll goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part in any foreign country by . . . forced labor” by issuing Withhold Release Orders (“WROs”).[3] CBP’s authority under the Tariff Act was strengthened in 2016 when Congress eliminated a loophole that allowed importation of merchandise made with forced labor if the merchandise was not also available in the United States in quantities sufficient to meet U.S. consumptive demand.[4]

More recently, the U.S. reaffirmed its broad commitment to preventing imports tainted by forced labor in the 2020 United States-Mexico-Canada Agreement (“USMCA”). Under this free trade agreement, each North American country agreed to “prohibit the importation of goods into its territory from other sources produced in whole or in part by forced or compulsory labor.”[5] To oversee the implementation of this commitment, former President Trump issued an executive order creating the FLETF, chaired by the Secretary of Homeland Security and including representatives from the Departments of State, Treasury, Justice, Labor, and the Office of the U.S. Trade Representative.[6]

The measures described above target forced labor wherever it occurs, but, in recent years, the U.S. has focused increasingly on allegations of forced labor and other human rights abuses in the XUAR. New legislation authorized sanctions for these alleged abuses in 2020,[7] and, in 2021, CBP’s heightened scrutiny of imports from the XUAR led to a region-wide WRO affecting cotton and tomato imports[8] and an additional WRO targeting silica-based products from Xinjiang.[9]

After passing both houses of Congress with broad bipartisan support, President Biden signed the UFLPA into law on December 23, 2021.[10] The UFLPA represents the U.S.’s most forceful effort to date to address this issue in the XUAR. Experts estimate that the UFLPA will have an impact on the global economy “measured in the many billions of dollars.”[11]

The Act’s reach is broad, presumptively banning the importation of “any goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part in” the XUAR, as well as those produced by a number of entities identified by the FLETF.[12] To rebut this presumptive ban, importers must show: (1) their compliance with all of the Act’s implementing regulations and FLETF’s due diligence guidance,[13] (2) that they responded “completely and substantively” to all agency inquiries,[14] and (3) “clear and convincing evidence” that their goods were not produced with forced labor.[15]

II. FLETF Enforcement Strategy

The Act requires the FLETF to promulgate an enforcement strategy[16] which will include specific guidance to importers regarding due diligence, the amount and type of evidence that importers will need to show to rebut the Act’s presumption, and what entities will be presumptively barred.[17] In the months following the UFLPA’s enactment, the FLETF solicited input from the public to inform its eventual Enforcement Strategy,[18] holding a public hearing,[19] and receiving 180 written comments from U.S. and foreign businesses, industry associations, civil society, academics, and private individuals.[20] After the close of this public comment period, the FLETF published its enforcement strategy and submitted it as a report to Congress on June 17, 2022.[21] To supplement this strategy, CBP published “Operational Guidance for Importers“ on June 13, 2022.[22]

A. The UFLPA Entity Lists

In addition to presumptively prohibiting imports originating, in whole or in part, in the XUAR, the UFLPA’s rebuttable presumption extends to goods, wares, articles, and merchandise produced by various entities identified by the FLETF in its enforcement strategy.[23] These include entities that work with the XUAR government to recruit, transport, or receive alleged forced labor from the XUAR, as well as entities that participate in “poverty alleviation” and “pairing-assistance” programs in the XUAR.[24] These PRC government-administered labor programs reportedly target Uyghurs, Kazakhs, Kyrgyz, Tibetans, and other persecuted groups, placing them in farms and factories in the XUAR and across China. Workers in these schemes are reportedly subjected to systemic oppression through forced labor.[25] In “pairing-assistance” programs, for example, Chinese companies are reportedly encouraged to create satellite factories in the XUAR that then rely on internment camps for low-skilled labor.[26] The FLETF found that indicators of forced labor are particularly strong across the four sectors it has identified as high-priority sectors for enforcement under the UFLPA: apparel, cotton, silica-based products, and tomatoes.[27]

The UFLPA Entity List[28] that the FLETF published on June 17 remains relatively narrow, including only entities subject to existing WROs or listed to the Department of Commerce Bureau of Industry and Security’s (“BIS”) Entity List for their use of forced labor.[29] Notably, no downstream solar cell or solar module producers have been added to the UFLPA Entity List at this time, which was a specific concern raised by some in the solar industry.[30] A number of Chinese polysilicon firms, however, are listed.

However, the Act requires the FLETF to update the UFLPA Entity List at least annually, and the whole-of-government approach that the FLETF will be taking to identify new entities suggests that the FLETF could be aggressive in its designation of new Chinese entities linked to forced labor violation allegations going forward.

B. Priority Sectors for Enforcement

As part of its enforcement strategy, the UFLPA requires the FLETF to identify a list of “high-priority sectors for enforcement,” which the statute indicates must include cotton, tomatoes, and polysilicon.[31]

The enforcement strategy published on June 17, 2021 does not stray significantly from the statutorily mandated list of high-priority sectors. It expands this list slightly to include:

1. 1. 1. 1. Apparel;
         2. Cotton and cotton products;
         3. Silica-based products (including polysilicon); and
         4. Tomatoes and downstream products.

However, since there is no de minimis exception in the Act, importers of a wide range of products may find their products the target of a potential exclusion order, detention or seizure.  To illustrate, in its report to Congress, CBP notes that these silica-based products may include aluminum alloys, silicones, and polysilicon, which are themselves used in building materials, automobiles, petroleum, concrete, glass, ceramics, electronics, and solar panels, among other goods. Especially for importers with final products or with products that may have any of the foregoing as material inputs, importers will need to be familiar with and meet the evidentiary burden in reference to the entire supply chain, no matter how small or remote a supplier’s input may be to a final product.[32]

For XUAR-linked cotton, tomatoes, and polysilicon, CBP has published specific guidance on supply chain documentation that may be necessary to overcome the UFLPA’s rebuttable presumption against importation. While this recommended documentation varies slightly across the three sectors, at a high level, CBP recommends the following:

1. 1. 1. 1. Documentation showing the entire supply chain;
         2. A flow chart mapping all steps of the procurement and production processes;
         3. Maps of the region(s) where the production processes occur; and
         4. A list of all entities involved in each step of the production processes, with citations denoting the business records used to identify each upstream entity with whom the importer did not directly transact.

The CBP’s enforcement of the UFLPA’s presumptive import ban on each of these high-priority sectors will have a substantial effect on global supply chains involving these products. More than 40 percent of the world’s polysilicon, a quarter of its tomato paste, and a fifth of its cotton supplies originate in the XUAR.[33] Industry groups from these targeted sectors have already begun to prepare for increased scrutiny and mitigate the threat of supply shortages by developing industry-wide standards for supply chain traceability.[34] Even these standards, however, may not be sufficient to overcome the presumption that products which incorporate any amount of material sourced from the XUAR have been produced with prohibited labor inputs.

C. Guidance on Effective Due Diligence & Supply Chain Tracing

As a key element of their rebuttal to the UFLPA’s presumption, importers must show that they have complied with CBP and FLETF guidance on due diligence, including effective supply chain tracing and supply chain management practices. In its enforcement strategy, the FLETF outlines critical elements of this due diligence process, while also raising concerns that effective diligence may not always be possible in the XUAR.

1. Effective Due Diligence

The FLETF strategy refers largely to the Department of Labor’s Comply Chain program[35] in defining the elements of an effective due diligence system. These elements include:

1. 1. 1. 1. Engaging stakeholders and partners;
         2. Assessing risks and impacts;
         3. Developing a code of conduct;
         4. Communicating and training across the supply chain;
         5. Monitoring compliance;
         6. Remediating violations;
         7. Independent reviews; and
         8. Reporting performance and engagement.

However, FLETF raises concerns that some of these elements may not be possible when dealing with goods made in the XUAR or made using the labor of workers from certain PRC labor schemes. For example, the FLETF notes that importers may be unable to sufficiently engage with stakeholders, such as employees of its suppliers, or conduct credible audits due to restrictions on access to Xinjiang and reported government surveillance and coercion that renders witnesses unable to speak freely about working conditions.[36] At a minimum, because of these concerns, audits of compliance by suppliers and subcontractors in the XUAR must “go beyond traditional auditing.” The FLETF suggests that importers may need to use technology or partnerships with civil society to collect evidence to rebut the presumption, but does not provide more concrete guidance on the what technology and partnerships will be deemed by CBP to provide credible evidence.[37]

Additionally, an importer’s ability to conduct due diligence and remediate violations may be limited by Chinese laws, such as the PRC’s Anti-Foreign Sanctions Law. In fact, the FLETF received written comments from industry groups reporting that the Chinese government had retaliated against Chinese companies for complying with U.S. requirements to eliminate supply chain inputs from the XUAR.[38]

2. Effective Supply Chain Tracing

At a minimum, importers seeking to rebut the UFLPA’s presumption must conduct a complete mapping of the supply chains that provide inputs to their products, “up to and including suppliers of raw materials used in the production of the imported good or material.”[39] Per the FLETF enforcement strategy, effective supply chain mapping must go beyond a mere list of names of suppliers and their sub-tiers and include accounts of the conditions under which work is being done on the inputs at each step in the sourcing process.[40]

In addition to mapping, the FLETF strategy emphasizes the importance of identity preservation and segregation to prevent the commingling of inputs at any point in the supply chain. This risk is particularly high for importers whose suppliers source raw or partially processed material inputs from both Xinjiang and areas outside of the XUAR. Without strong identity preservation or segregation protocols, these importers risk their shipments being detained because of the difficulty of verifying that their supply chain uses only non-Xinjiang inputs.

3. Effective Supply Chain Management Measures

The FLETF defines “supply chain management measures” as those measures “taken to prevent and mitigate identified risks of forced labor.”[41] Such measures may involve processes to vet potential suppliers for forced labor prior to contracting or outlining specific consequences for a supplier’s breach of its forced labor commitments. Practically speaking, the design and implementation of these measures will require robust information systems to manage and regularly update supply chain data.

Notably, however, an importer’s ability to demand these supply chain management measures may be limited by the leverage it holds over its suppliers and its visibility into its supply chains. Therefore, importers with static supply chains involving long-term fulfillment contracts may be better positioned to enforce such measures than those participating in one-time transactions involving a supply chain with frequently changing inputs.

D. Guidance on the “Clear and Convincing” Standard

Neither the FLETF’s enforcement strategy nor CBP’s operational guidance clearly define the contours of the “clear and convincing” standard for evidence necessary to rebut the UFLPA’s presumption. In a series of unrecorded webinars, however, CBP officials have stated that they view this standard as higher than a preponderance of the evidence standard and will require a much greater showing than the current standard required for WROs.[42] CBP indicated that it would model its interpretation of this “clear and convincing evidence” standard on the Countering America’s Adversaries Through Sanctions Act (“CAATSA”) which it also applies to enforce import prohibitions on North Korea.[43]

As in the UFLPA, under CAATSA, only “clear and convincing evidence” can rebut the presumption that all North Korean labor is forced labor.[44] CBP interprets CAATSA’s “clear and convincing” standard to mean “highly probable,”[45] suggesting that the burden will only be met “if the material [] offered instantly tilt[s] the evidentiary scales in the affirmative when weighed against the evidence . . . offered in opposition.”[46]

Under this standard, much evidence which might have been sufficient under the WRO standard will not be adequate to rebut the presumption of exclusion. For example, while CBP staff indicated that supplier audits might be relevant evidence in determining whether forced labor was used while producing detained goods,[47] audits are likely insufficient on their own to overcome UFLPA’s presumption.[48] Amidst allegations of surveillance and harassment of auditors in the XUAR, employees may not feel free to fully discuss their employers, working conditions, or governmental programs, and local suppliers might limit the access of auditors to the premises.[49] As such, CBP staff implied that even third-party audits will be presumptively defective unless the company presents sufficient evidence to convince the agency of the audit’s independence and effectiveness.[50] Amidst these uncertainties, it is more likely that CBP will find that no one piece of evidence is sufficient on its own, and that importers’ efforts to support their arguments with multiple pieces of evidence will be more likely to be accepted as compelling by CBP.[51]

Furthermore, the fact that a product has received an exception to the presumption in the past is not a guarantee that the same supply chain will be approved in the future. While CBP stated that evidence of past exceptions is clearly relevant and should be submitted to the agency, it has not given any definitive rule regarding past exceptions.[52] However, this does imply that importers using more regular supply chains, involving the same suppliers and sub-tier suppliers over time, will be able to more easily provide clear and convincing evidence than will importers using less-regular supply chains.

III. Enforcement Procedures

A. Enforcement Timeline

The UFLPA’s changes to CBP’s mandate and authorities became effective on June 21, 2022.  Going forward, CBP will review each shipment for UFLPA applicability on a case-by-case basis, based on the UFLPA Entity List and a variety of other sources.

The UFLPA’s shortened timeline for CBP’s identification of dispositioning of potentially problematic imports places a premium on supplier planning and preparation. Under UFLPA, CBP derives its detention authority from 19 CFR § 151.16, making the timeline for enforcement much shorter than under the preexisting WROs.[53] As opposed to the 90-day period under a WRO, importers whose shipments have been detained pursuant to the UFLPA have only 30 days to challenge this detention.

After a shipment has been presented for examination, CBP will have five days, excluding weekends and holidays, to determine whether the shipment should be released or detained.[54] If CBP determines that a shipment falls within the scope of the UFLPA—either based on links to the XUAR or to listed entities—CBP will issue a detention notice instructing the importer to submit information rebutting the UFLPA’s presumption.[55] After 30 days, CBP is required to issue a final ruling on the goods’ admissibility.[56]

Because of this accelerated timeline for review, CBP has emphasized that importers should be prepared to submit evidence in support of their requests promptly and in accessible formats, noting that submitting documentation in English will facilitate an efficient review.[57] In turn, CBP will attempt to prioritize requests from importers who are Customs Trade Partnership Against Terrorism (CTPAT) Trade Compliance members in good standing.[58]

If CBP issues a final ruling excluding the shipment, the importer may protest that decision within 180 days.[59] CBP then has 30 days to respond to the protest, after which it will be deemed denied.[60] Having exhausted this administrative procedure, importers then have 180 days from the denial of the protest to file a court action challenging CBP’s ultimate decision.[61]

Certain shipments determined to be in violation of the UFLPA may be subject to seizure and forfeiture.[62] In an unrecorded webinar on June 7, 2022, however, CBP officials indicated that seizure would only occur in cases of obvious fraud, as opposed to good faith mistakes.[63]

B. Challenging Detention of a Shipment

An importer whose shipment has been detained pursuant to the UFLPA can pursue two different claims to obtain the release of their merchandise: (1) that the shipment is not subject to the UFLPA, and (2) that the shipment is entitled to an exception from the UFLPA.

Though both can result in a released shipment, these two claims apply in very different situations. The former arises when an importer alleges that their shipment does not contain any inputs linked to the XUAR or entities on the UFLPA Entity List. In contrast, the latter arises if the importer can prove that—even though the shipment is linked to the XUAR or an entity of the UFLPA entity list—no part of the shipment was produced with forced labor.

1. For Imports Not Subject to the UFLPA

A shipment is considered outside the scope of the UFLPA’s rebuttable presumption if both the imported goods and their inputs are “sourced completely from outside Xinjiang and have no connection to the UFLPA Entity List.”[64]

CBP’s operational guidance indicates that importers looking to establish that a shipment is not subject to the UFLPA must make showings under both of the following categories of evidence: (1) supply chain mapping information, and (2) evidence that the goods were not mined, produced, or manufactured wholly or in part in the XUAR. The former should include evidence pertaining to the overall supply chain, as well as to merchandise or any component thereof as well as to the miner, producer, or manufacturer. CBP’s guidance provides non-exhaustive examples of the types of evidence that might satisfy these requirements.

2. For Imports Subject to UFLPA’s Rebuttable Presumption

In contrast, shipments are subject to the UFLPA if they contain goods that are either “mined, produced, or manufactured wholly or in part in” the XUAR or produced wholly or in part by an entity on the UFLPA entity. These shipments will only be released if the importer requests an “exception” to the UFLPA and can demonstrate (1) their compliance with all of the Act’s implementing regulations and FLETF’s due diligence guidance,[65] (2) that they responded “completely and substantively” to all agency inquiries,[66] and (3) “clear and convincing evidence” that their goods were not produced with forced labor.[67]

To meet these requirements, CBP states that an importer must make a showing under each of the following categories of evidence:

1. 1. 1. 1. Due Diligence System Information
         2. Supply Chain Tracing Information
         3. Information on Supply Chain Management Measures
         4. Evidence Goods Originating in China Were Not Mined, Produced, or Manufactured Wholly or In Part by Forced Labor

In its guidance, CBP provides a non-exhaustive list of evidence that may be able to satisfy these requirements. If CBP determines that this evidence is “clear and convincing,” the presumption will be rebutted and the goods will be released under an exception to the Act. Within 30 days of any decision to grant an exception to the UFLPA, CBP must submit a publicly available report to Congress, outlining the evidence supporting this exception.[68] However, importers may seek to have certain information withheld from the public report pursuant to any applicable exemptions contained in the Freedom of Information Act.[69]

C. Predicting Enforcement Strategies and Trends

While the government has expressed an intent to enforce the UFLPA to its fullest extent, CBP resources are finite. In the immediate future, therefore, we expect to see enforcement focused on the UFLPA Entity List and on the four sectors identified by the FLETF as high-priority sectors: apparel, cotton, silica-based products, and tomatoes. Beyond these key sectors, CBP’s early enforcement attention will likely be focused by media reporting, Congressional scrutiny, and civil society tips.

Even U.S. companies not in any of these immediately prioritized enforcement sectors must, however, remain mindful of their supply chain exposure to the XUAR and be prepared to focus compliance program resources on their supply chains. This is especially true as enforcement of the UFLPA expands with the availability of new technologies, additional funding for UFLPA enforcement, and increased collaboration among enforcement agencies, industry groups, and civil society.

1. Enhanced Supply Chain Tracing Technologies

Given the ever-increasing complexity of global supply chains, effective identification of shipments subject to the UFLPA will require sophisticated supply chain tracing technologies. Accordingly, the FLETF enforcement strategy instructs CBP to prioritize a wide range of technological capabilities. These include:

• Advanced search engines that would allow CBP to more easily link known forced labor violators with related businesses, including shell companies and layered ownership structures;
• Foreign corporate registry data that would allow CBP to map the structures or multinational companies and networks;
• Scanning, translation, and data extraction of non-text-searchable documents;
• Remote sensors to support digital traceability of raw materials sourced from Xinjiang; and
• Enhanced modeling tools and machine leaning.[70]

As CBP acquires and refines these technologies, the agency will be able to expand enforcement of the UFLPA beyond shipments most obviously tied to listed entities and high-priority sectors in the XUAR.

2. Increased Funding for UFLPA Enforcement

Despite its intention to enforce the UFLPA robustly, CBP’s resources are finite. Various funding requests included in the FLETF’s enforcement strategy, however, indicate how the agency may scale its enforcement of the Act in the coming years.

In addition to budget requests related to the tracing technology discussed above, the strategy focuses largely on three areas for increased spending, both at CBP and at DHS: staffing, strategy and coordination, and outreach.[71] Notably, the strategy indicates that CBP has already received funding to create 65 additional positions, as well as funding to cover overtime, to ensure sufficient staffing to enforce the UFLPA.[72] Likewise, funding for strategy efforts will allow DHS to engage with international partners and coordinate other U.S. government initiatives related to Chinese forced labor.[73]

3. Inter-Agency Collaboration and Stakeholder Engagement

Lastly, the FLETF enforcement strategy emphasizes the need for coordination and collaboration with relevant stakeholders in order to effectively enforce the UFLPA. This collaboration will span the private sector, civil society, and other government agencies.

FLETF has indicated an intention to host a number of joint-interagency meetings and working-level meetings with both NGOs and the private sector to discuss UFLPA enforcement on at least a biannual basis.[74] While these meetings may allow industry groups to voice concerns with the UFLPA’s impact on their business, they will also facilitate NGO tips about forced labor in supply chains beyond the UFLPA’s high-priority sectors.

Moreover, increased interagency coordination may lead to the designation of additional entities to the UFLPA Entity List and the identification of additional high-priority enforcement sectors. For example, the Department of Labor regularly produces detailed reports on Goods and Products Produced by Forced or Indentured Child Labor. Although FLETF has focused UFLPA enforcement on apparel, cotton, silica-based products, and tomatoes, these Department of Labor reports already list a number of other products tainted by forced labor in China, such as bricks, electronics, and artificial flowers. Increased communication between the Department of Labor and the FLETF could lead to these additional sectors being designated as high-priority.

IV. Expected PRC Response

The PRC government has long denied any allegations of forced labor in the XUAR and has  viewed foreign attempts to address this issue as attacks on Chinese sovereignty.[75] Immediately following the passage of the UFLPA in December 2021, the PRC Ministry of Foreign Affairs reiterated these concerns, characterizing the act as “violat[ing] international law” and “grossly interfer[ing] in China’s internal affairs.”[76] In light of these comments, the PRC government is likely to view U.S. enforcement of the Act as an escalation of this perceived attack on Chinese sovereignty.

Given this strong reaction from Beijing, it is likely that China may implement new countersanctions and increase enforcement of its existing blocking statute, described in detail in our previous alert. By creating significant legal consequences for Chinese persons who comply with prohibited extraterritorial applications of foreign law, enforcement of this blocking statute will have the added effect of making effective diligence in the XUAR even more challenging. U.S. importers may be left unable to gather from their Chinese suppliers the documentation necessary to satisfy the UFLPA’s high evidentiary standard.

Notably, the increased tension between the U.S. and China caused by the UFLPA coincides with the continued economic isolation of Russia. In coming months, we can expect China to continue to be pushed closer toward Russia and the small group of non-aligned countries that have remained neutral with respect to Russia.

Despite the prospect of countersanctions and increased trade between China and Russia, neither the Biden administration nor the U.S. Congress are likely to be sympathetic to Chinese concerns about the UFLPA’s reach. Instead, robust enforcement of the UFLPA can be expected to continue, motivated by bipartisan support for forced labor initiatives and U.S. concerns about China’s position as an economic and strategic competitor. Companies with substantial resources may be able to leverage changes to their supply chains to comply with the UFLPA’s demands. Still, they may consider bifurcated supply chains, with one supply chain leading to the Chinese market and the other destined for the U.S. and other jurisdictions where forced labor initiates are on the rise. Companies with fewer resources, however, may be forced to source their raw materials and other inputs from other jurisdictions.

__________________________

   [1]   U.S. Customs & Border Prot., Fact Sheet: Uyghur Forced Labor Prevention Act of 2021 (2022), https://www.cbp.gov/sites/default/files/assets/documents/2022-Jun/UFLPA%20Fact%20Sheet_FINAL.pdf.

   [2]   Uyghur Forced Labor Prevention Act, Pub. L. No. 117-78, § 3(a), (b)(2) (2021).

   [3]   19 U.S.C. § 1307.

   [4]   Pub. L. No. 114-125 § 910 (2016)

   [5]   United States-Mexico-Canada Agreement art. 23.6, Dec. 10, 2019, Pub. L. 116-113 (2020).

   [6]   Exec. Order No. 13923, 85 Fed. Reg. 30587 (2020).

   [7]   Uyghur Human Rights Policy Act, Pub. L. No. 116-145 (2020).

   [8]   Press Release, CBP Issues Region-Wide Withhold Release Order on Products Made by Slave Labor in Xinjiang, U.S. Customs & Border Prot. (Jan. 13, 2021), https://www.cbp.gov/newsroom/national-media-release/cbp-issues-region-wide-withhold-release-order-products-made-slave?language_content_entity=en.

   [9]   Press Release, The Department of Homeland Security Issues Withhold Release Order on Silica-Based Products Made by Forced Labor in Xinjiang, U.S. Customs and Border Prot. (Jun. 24, 2021), https://www.cbp.gov/newsroom/national-media-release/department-homeland-security-issues-withhold-release-order-silica?language_content_entity=en.

  [10]   Uyghur Forced Labor Prevention Act, Pub. L. No. 117-78 (2021).

  [11]   Ana Swanson, Companies Brace for Impact of New Forced Labor Law, NY Times (Jun. 22, 2022), https://www.nytimes.com/2022/06/22/us/politics/xinjiang-uyghur-forced-labor-law.html?smid=em-share.

  [12]   Pub. L. No. 117-78 § 3(a) (2021).

  [13]   Id. § 3(b)(1)(A).

  [14]   Id. § 3(b)(1)(B).

  [15]   Id. § 3(b)(2).

  [16]   Id. § 2(c).

  [17]   Id. § 2(e).

  [18]   Notice Seeking Public Comments on Methods To Prevent the Importation of Goods Mined, Produced, or Manufactured With Forced Labor in the People’s Republic of China, 87 Fed. Reg. 3567 (Jan. 24, 2022).

  [19]   FLETF Public Hearing on the Uyghur Forced Labor Prevention Act, Regulations.gov, https://www.regulations.gov/document/DHS-2022-0001-0192 (last visited June 10, 2022).

  [20]   Report to Congress, Strategy to Prevent the Importation of Goods Mined, Produced, or Manufactured with Forced Labor in the People’s Republic of China at 8, U.S. Dep’t of Homeland Sec. (Jun. 17, 2022), https://www.dhs.gov/sites/default/files/2022-06/22_0617_fletf_uflpa-strategy.pdf (hereinafter “FLETF Enforcement Strategy”).

  [21]   Id.

  [22]   Uyghur Forced Labor Prevention Act: Operational Guidance for Importers, U.S. Customs & Border Prot. (Jun. 13, 2022), https://www.cbp.gov/sites/default/files/assets/documents/2022-Jun/CBP_Guidance_for_Importers_for_UFLPA_13_June_2022.pdf (hereinafter “CBP Operational Guidance for Importers”).

  [23]   Pub. L. 117-78 § 3(a) (2021).

  [24]   Id. at § 2(d)(2)(B).

  [25]   Xinjiang Supply Chain Business Advisory (Jul. 2, 2020, updated Jul. 13, 2021), U.S. Department of the Treasury, https://home.treasury.gov/system/files/126/20210713_xinjiang_advisory_0.pdf (joint advisory by Departments of Treasury, State, Commerce, Labor, and Homeland Security and the Office of the U.S. Trade Representative).

  [26]   FLETF Enforcement Strategy at 19.

  [27]   Id. at 18.

  [28]   UFLPA Entity List, U.S. Dep’t of Homeland Sec., https://www.dhs.gov/uflpa-entity-list (last visited Jun. 22, 2022).

  [29]   FLETF Enforcement Strategy at 22.

  [30]   Kelly Pickerel, Solar industry prepares for Uyghur Forced Labor Prevention Act implementation, Solar Power World (Jun. 20, 2022), https://www.solarpowerworldonline.com/2022/06/solar-industry-prepares-for-uyghur-forced-labor-prevention-act-implementation/.

  [31]   Pub. L. 117-78 § 2(d)(2)(B)(viii) (2021).

  [32]   Jane Luxton, Imports From China: The Clock Is Ticking On Implementation Of Uyghur Forced Labor Prevention Act, Lewis Brisbois (June 9, 2022), https://lewisbrisbois.com/newsroom/legal-alerts/imports-from-china-the-clock-is-ticking-on-implementation-of-uyghur-forced-labor-prevention-act?utm_source=Mondaq&utm_medium=syndication&utm_campaign=LinkedIn-integration.

  [33]   Swanson, supra note 11.

  [34]   See, Solar Supply Chain Traceability Protocol, Solar Energy Industries Assoc., https://www.seia.org/research-resources/solar-supply-chain-traceability-protocol (last visited Jun. 22, 2022).

  [35]   Comply Chain, U.S. Dep’t of Labor, https://www.dol.gov/ilab/complychain/ (last visited Jun. 22, 2022)

  [36]   FLETF Enforcement Strategy at 42, 44.

  [37]   Id. at 44.

  [38]   United States Council for International Business Comment to the Forced Labor Enforcement Task Force, Regulations.gov, 29 (Mar. 10, 2022), https://downloads.regulations.gov/DHS-2022-0001-0137/attachment_1.pdf.

  [39]   FLETF Enforcement Strategy at 45.

  [40]   Id. at 46.

  [41]   Id.

  [42]   Angela M. Santos et al., Uyghur Forced Labor Prevention Act Is Coming… Are You Ready?: CBP Issues Hints at the Wave of Enforcement To Come, NAT. L. REV. (June 2, 2022), https://www.natlawreview.com/article/uyghur-forced-labor-prevention-act-coming-are-you-ready-cbp-issues-hints-wave.

  [43]   Webinar with CBP staff (June 7, 2022). TJ Kendrick noted that “there is not much difference [between CAATSA and UFLPA] except we have a UFLPA strategy,” Joanne Colonnello referred to “several [CBP] rulings” regarding clear and convincing evidence (including on CAATSA) and Elva Muneton confirmed Kendrick and Colonnello’s observations.

  [44]   Countering America’s Adversaries Through Sanctions Act FAQs, DHS, February 11, 2021 (accessed: https://www.dhs.gov/news/2021/02/11/countering-america-s-adversaries-through-sanctions-act-faqs). Find CAATSA § 302A at 22 U.S.C. § 9241(a) and find a side-by-side comparison of the relevant sections of CAATSA and UFLPA in the Appendix.

  [45]   Id. See also, Poof Apparel Application for Further Review, HQ H317249, Protest No. 4601-21-125334 (Mar. 5, 2021), available at https://rulings.cbp.gov/ruling/H317249).

  [46]   Colorado v. New Mexico, 467 U.S. 310, 316 (1984) (finding in an equitable apportionment case that Colorado failed to meet the “clear and convincing” standard). Cited in Poof Apparel Application for Further Review, HQ H317249, Protest No. 4601-21-125334 (Mar. 5, 2021), available at https://rulings.cbp.gov/ruling/H317249).

  [47]   Luxton, supra note 32.

  [48]   Webinar with CBP staff (June 7, 2022).

  [49]   Alexandra Stevenson & Sapna Maheshwari, ‘Escalation of Secrecy’: Global Brands Seek Clarity on Xinjiang, New York Times (May 29, 2022), https://www.nytimes.com/2022/05/27/business/cotton-xinjiang-forced-labor-retailers.html.

  [50]   Webinar with CBP staff (June 7, 2022).

  [51]   See, e.g., 545231, Application for Further Review of Protest 1303-92-100212, U.S. Customs & Border Prot. (Nov. 5, 1993), https://rulings.cbp.gov/ruling/545231.

  [52]   Id.

  [53]   Santos et al., supra note 42. Furthermore, future actions taken under the current XUAR WROs will follow the UFLPA timeline. Webinar with CBP staff (June 7, 2022).

  [54]   19 C.F.R. § 151.16(b) (2022).

  [55]   Santos et al., supra note 42.

  [56]   19 C.F.R § 151.16(e) (2022).

  [57]   CBP Operational Guidance for Importers at 10.

  [58]   Id. at 9–10.

  [59]   19 C.F.R. § 174.12(e) (2022).

  [60]   Id. § 151.16(g).

  [61]   Santos et al., supra note 42.

  [62]   See 19 U.S.C. § 1595a; 19 C.F.R. Part 171

  [63]   Webinar with CBP staff (June 7, 2022). Joanne Colonnello cited as an example of obvious fraud a shipment from Malaysia where, upon opening the box, CBP could see a label stating “made with Xinjiang cotton.”

  [64]   FLETF Enforcement Strategy at 49.

  [65]   Id. § 3(b)(1)(A).

  [66]   Id. § 3(b)(1)(B).

  [67]   Id. § 3(b)(2).

  [68]   FLETF Enforcement Strategy at V.

  [69]   CBP Operational Guidance for Importers at 8.

  [70]   FLETF Enforcement Strategy at 31.

  [71]   Id. at 35–39.

  [72]   Id. at 37.

  [73]   Id. at 36.

  [74]   Id. at 53.

  [75]   China tells U.N. rights chief to respect its sovereignty after Xinjiang comments, Reuters (Sep. 11, 2018), https://www.reuters.com/article/us-un-rights-china/china-tells-u-n-rights-chief-to-respect-its-sovereignty-after-xinjiang-comments-idUSKCN1LR0L0.

  [76]   Press Release, Foreign Ministry Spokesperson’s Statement on US’ Signing of the So-called Uyghur Forced Labor Prevention Act, Ministry of Foreign Affairs of the PRC (Jan. 24, 2021), https://www.fmprc.gov.cn/mfa_eng/xwfw_665399/s2510_665401/2535_665405/202112/t20211224_10475191.html.

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The following Gibson Dunn lawyers assisted in preparing this client update: Sean Brennan, Christopher Timura, Judith Alison Lee, Adam M. Smith, Fang Xue, and Perlette Jura.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s International Trade or Environmental, Social & Governance (ESG) practice groups:

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In C v D [2022] HKCA 729, the Court of Appeal[1] confirmed the lower court’s decision that a dispute over a multi-tiered dispute resolution clause, which stipulates that the parties must first negotiate in good faith before resorting to arbitration, should be resolved by the arbitral tribunal and is not open to attack at the local courts. As the Court of Appeal itself succinctly summarised:

“…the question of whether the pre-arbitration procedural requirement …has been fulfilled is a question intrinsically suitable for determination by an arbitral tribunal, and is best decided by an arbitral tribunal in order to give effect to the parties’ presumed intention to achieve a quick, efficient and private adjudication of their dispute by arbitrators chosen by them on account of their neutrality and expertise.”

This decision is of general significance to arbitration law both in Hong Kong and internationally. From a local perspective, this judgment represents the highest authority in Hong Kong which recognises and draws a distinction between “jurisdiction” (namely whether the arbitral tribunal has the jurisdiction) and “admissibility” (namely whether the claim should be admissible to be heard by the arbitral tribunal). It seeks to align the Hong Kong court’s position with that adopted by other jurisdictions such as Singapore, United Kingdom and the United States, so as to ensure that Hong Kong does not fall out of line with major international arbitration centres like London or Singapore.

From an international view point, this decision is also important given that Hong Kong is an UNCITRAL Model law (the “Model Law”) jurisdiction with arbitration legislation similar to that of other Model Law jurisdictions. As it is common to have dispute resolution clauses in commercial contracts requiring that parties negotiate before commencing arbitration, this decision will also be relevant and persuasive in other jurisdictions which adopt the Model Law.

A. Introduction

Under the agreement in question, the dispute resolution provision mandates the parties to, in good faith,  resolve dispute by negotiation. Either party may through written notice refer a dispute to the Chief Executive Officers (“CEOs”) of the parties for resolution, and the CEOs shall then meet and attempt to resolve such dispute. It is only when a dispute cannot be resolved amicably within 60 business days that such dispute shall be referred to arbitration.

However, after an initial letter from the CEO of one party, C, to the Chairman of the other party, D, there was no further correspondence from D and neither party referred the dispute to the respective CEOs for negotiation. Instead, D commenced arbitration and C in turn claimed that the arbitral tribunal did not have jurisdiction to hear the dispute as there was no prior negotiation between the parties.

The arbitral tribunal issued an award (the “Partial Award”) in favour of D (the party who commenced the arbitration) and rejected C’s contention that the arbitral tribunal had no jurisdiction to hear the dispute. C then commenced proceedings in the High Court seeking a declaration that the Partial Award was made without jurisdiction hence not binding on C, and sought an order that the Partial Award be set aside under section 81 of the Arbitration Ordinance (Cap. 609, the “Ordinance”) which in turn refers to Article 34 of the Model Law.

Relevantly, Article 34 allows for the setting aside of an arbitral award if: “the award deals with a dispute not contemplated by or not falling within the terms of the submissions to arbitration” (Article 34(2)(a)(iii)) or “the composition of the arbitration tribunal or the arbitral procedure was not in accordance with the agreement of the parties” (Article 34(2)(a)(iv)).

At the Court of First Instance level, the Judge identified the main question for determination to be whether D had complied with the dispute resolution clause provided for in the agreement is a question of admissibility of the claim or a question of the tribunal’s jurisdiction, and does that question fall within section 81 of the Ordinance (hence Article 34 of Model law)?

The Judge held that: (i) notwithstanding that the Ordinance draws no distinction between “jurisdiction” and “admissibility”, C’s objection concerns the admissibility of the claim but not the jurisdiction of the tribunal, and hence such objection does not fall under Article 34(2)(a)(iii); and (ii) Article 34(2)(a)(iv) is also not applicable, as it concerns the way in which the arbitration was conducted but not the contractual procedures before the arbitration. In the appeal, C contends that these rulings are wrong.

B. The Court of Appeal’s decision

1. 1. 1st Main Ground – jurisdiction vs. admissibility and Article 34(2)(a)(iii) of the Model Law

The Court of Appeal noted that there is a substantial body of judicial and academic jurisprudence which supports the drawing of a distinction between “jurisdiction” and “admissibility” for the purpose of determining whether an arbitral award is subject to review by the court under Article 34(2)(a)(iii). Even though such distinction is not found in the language of Article 34(2)(a)(iii), it can be given recognition in the course of statutory construction, namely that a dispute which goes to the admissibility of a claim (but not jurisdiction of the tribunal) should be regarded as a dispute “falling within the terms of the submissions to arbitration”.

C also argued that its objection is in any event “jurisdictional” in nature, and the parties intend that there is no obligation to arbitrate unless the condition precedent has been satisfied. The Court of Appeal considered this to be oversimplifying matters, as the true and proper question is whether the parties’ intention (or agreement) that the question of fulfilment of such condition precedent is a matter to be determined by the arbitral tribunal, and as such falls “within the terms of the submissions to arbitration”. In other words, one has to look at whether an objection is “targeted at the tribunal” or “targeted at the claim”.

In this case, since C was not saying that D’s claim cannot be referred to arbitration but that the reference was premature, such objection was targeted “at the claim” but not “at the tribunal” and only goes to the “admissibility” of the claim. The Partial Award therefore was not subject to review by the court under Article 34(2)(a)(iii) and this ground of appeal was rejected.

For the sake of completeness, the Court of Appeal also mentioned that its conclusion would not have changed even if the distinction between “jurisdiction” and “admissibility” is disregarded. The Court of Appeal took the view that because the dispute resolution provision provides for “any” dispute which cannot be resolved amicably within 60 business days to be referred to arbitration, there is no reason to confine the scope of arbitrable disputes to substantive disputes, and exclude from it disputes on whether the pre-arbitration procedural requirement has been fulfilled.

1. 2. 2nd Main Ground – applicability of Article 34(2)(a)(iv) of th Model Law

This ground was not the focus of the appeal, and C seeks to argue that the phrase “arbitral procedure” as used in Article 34(2)(a)(iv) can encompass pre-arbitration condition precedent, and whether a condition precedent to arbitration is part of “arbitral procedure” depends on the intention of the parties, in particular whether they intended non-satisfaction of such condition precedent to bar arbitration altogether.

The Court of Appeal considered that since it has come to the conclusion that the parties intended the question of fulfillment of the pre-arbitration procedural requirement to be determined by arbitration, it follows that it was not their intention that non-satisfaction of such requirement would bar arbitration altogether and this ground was similarly dismissed.

C. Conclusion and Key Takeaways

Careful consideration during the negotiation and drafting stage of the contract: The Court of Appeal recognises that ultimately what goes to the issue of “jurisdiction” and what goes to the issue of “admissibility” is controlled by the parties’ agreement, given that arbitration is a consensual process and the parties determine the scope of the disputes which may be submitted to arbitration. If the parties wish to make satisfaction of a pre-arbitration condition precedent something which goes to the arbitral tribunal’s jurisdiction, explicit and unambiguous language should be used to indicate such intention in order to avoid any future dispute, although careful consideration should be given in making such a decision, bearing in mind the extra time and costs which may be involved in the court’s review of jurisdictional matters.

Other consequences of non-satisfaction of pre-arbitration condition precedent: The fact that  non-satisfaction of a contractual procedure before the arbitration will not bar arbitration does not mean that such clause is not important. The non-satisfaction can still have significant practical consequences, such as the arbitration proceedings being stayed pending the fulfillment of the contractual procedure, or the party who does not fulfill such contractual procedure could potentially face sanction on costs.

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   [1]   A copy of the judgement of the Court of Appeal is available here:
https://legalref.judiciary.hk/lrs/common/search/search_result_detail_frame.jsp?DIS=144748&QS=%2B%7C%28CACV%2C387%2F2021%29&TP=JU

The judgment of the Court of First Instance ([2021] HKCFI 1474) is available here:
https://legalref.judiciary.hk/lrs/common/search/search_result_detail_frame.jsp?DIS=136552&QS=%2B%7C%28HCCT%2C24%2F2020%29&TP=JU

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

Brian Gilchrist (+852 2214 3820, [email protected])
Elaine Chen (+852 2214 3821, [email protected])
Alex Wong (+852 2214 3822, [email protected])
Rebecca Ho (+852 2214 3824, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

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

On February 15, 2022, the Federal Supreme Court of the Republic of Iraq (“Iraq”) issued a sweeping decision upending the existing legal framework governing the oil sector in the country (“Court Decision”).[1]  The Government of Iraq has since taken numerous steps to implement the decision, which may have significant and far-reaching repercussions on international oil companies operating under petroleum contracts with the Kurdistan Regional Government (“KRG”).

The Court Decision, among other things, purports to (i) repeal the Kurdistan Region Oil and Gas Law (No. 22 of 2007) based on which the KRG has entered into Production Sharing Contracts (“PSCs”) with international oil companies, (ii) rule that the Federal Ministry of Oil is entitled to pursue the nullification of any contracts entered into by the KRG with third parties regarding oil exploration, extraction, export and sale, (iii) rule that the Ministry of Oil and the Federal Board of Supreme Audit are entitled to review and revise any oil contracts entered into by the KRG, and (iv) order the KRG to hand over to the federal government all oil production it has extracted from oilfields.

In response to the Court Decision, the KRG Prime Minister reaffirmed the KRG’s commitment to its contracts with international oil companies and emphasized that the KRG will not relinquish any of its rights.[2]  In addition, on May 30, 2022, Kurdistan’s Judicial Council released a statement challenging the legality of the Court Decision and the validity and competence of the Court itself.[3]

While the Court Decision does not automatically terminate contracts with international oil companies, the Government of Iraq has indicated that it intends to force the cancellation or substantial revision of such contracts.  On February 26, 2022, the Oil Minister of Iraq issued an order creating a committee with the purpose of executing the Court Decision.[4]  On March 24, 2022, the Oil Minister issued an order to the KRG to send for its review copies of all oil and gas contracts it has entered into since 2004.[5]  The Oil Minister has also proposed establishing a state-owned regional oil company that would manage oil assets in the KRG and that would be overseen by the Government of Iraq.[6]  More recently, the Oil Ministry has also commenced proceedings with several international oil companies, summoning such companies to appear before the Court in Baghdad on June 5, 2022.[7]  While the date of the initial hearing was postponed in order to allow for the summons to be perfected, the proceedings are ongoing.[8]

Such interference by the Iraqi Government seems all but certain to lead international oil companies to commence legal proceedings against Iraq if the matter is not resolved promptly.  The affected investors are expected to seek redress before international fora, in particular, contract-based arbitrations under the terms of the PSCs and, in parallel, treaty-based arbitrations under applicable international investment agreements.  Given the number of international oil companies operating in the Kurdistan Region pursuant to long-term contracts with the KRG (over 30), Iraq’s exposure to damages claims could well reach tens of billions of dollars.

I. Contract Claims under Production Sharing Contracts

Iraq could be held contractually liable for breaching the PSCs by taking any action to either terminate or modify these agreements.  It could also be held liable for violating the stabilization clause (contained within the KRG Model PSC (“Model PSC”)) if it takes any measure altering the fiscal or economic conditions resulting from laws or regulations in force on the date of signature of these agreements.[9]

Iraq could be contractually on the hook since, as a matter of Iraqi constitutional law, the KRG is a constituent subdivision of Iraq.[10]  In the circumstances, international and/or English legal principles such as attribution or alter ego are likely to be relevant (English law being the applicable law stipulated in the Model PSC).h .[11]  In this regard, Claimants could in particular point to a recent decision by the High Court of Justice in England which found, in connection with breaches of two oil and gas PSCs, that acts by the KRG “were done in exercise of the sovereign authority of the state of Iraq.”[12]

Investors are expected to initiate arbitrations seated in London, England, and governed by the London Court of International Arbitration (“LCIA”) Rules, as expressly provided for in the Model PSC.[13]  Notably, the Model PSC broadly defines the scope of “disputes” to cover, among other things, any dispute as to the “existence,” “validity,” “enforceability,” or “termination” of the contract.[14]

II. Treaty Claims under Applicable International Investment Agreements

Iraq has also entered into several Bilateral Investment Treaties (“BITs”) and multilateral Treaties with Investment Provisions (“TIPs”) that provide substantive protections to investors and commit Iraq to resolving disputes through arbitration.  For example, the Japan-Iraq Bilateral Investment Treaty (“BIT”) protects against “expropriation” and “arbitrary measures” and affirms that investors are to be afforded both “fair and equitable treatment” and “full protection and security.”[15]  Similarly, investors who are nationals of a member State of the Organization of the Islamic Conference (“OIC”) can initiate arbitration pursuant to the OIC Investment Agreement.  The OIC Investment Agreement both protects nationals of OIC Member States against expropriation and allows such nationals, through its most-favored-nation provision, to avail themselves of substantive protections contained in other investment treaties to which Iraq is a party.[16]

III. Conclusion

The international oil companies impacted by the Court Decision have numerous legal avenues for seeking redress as a result of the substantial harm they may suffer.  It is therefore very possible that Iraq will find itself subject to numerous claims in the range of tens of billions of dollars (if not more) before international fora for years to come due to the Court Decision and the Government’s actions to implement that decision.

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[1]   Federal Minister of Oil and Ali Shadad Fares v. Minister of Natural Resources of the Kurdistan Region and Speaker of Parliament of the Kurdistan Region, Supreme Court of the Republic of Iraq, 59/Federal/2012 unified with 110/Federal/2019 (15 February 2022).

[2]   Press Conference of Masrour Barzani, Prime Minister of the Kurdistan Region of Iraq, 3 March 2022.

[3]   Statement of the Judicial Council of the Kurdistan Region of Iraq No. 1511, 30 May 2022.  The KRG maintains that the Court was not properly constituted as the Federal Supreme Court capable of determining matters of constitutional law.

[4]   Iraq Oil Reporter, Uncertainty Deepens After Landmark Ruling Against Kurdistan’s Oil Sector, 8 March 2022, accessible: https://www.iraqoilreport.com/news/uncertainty-deepens-after-landmark-ruling-against-kurdistans-oil-sector-44651/

[5]   Iraq Oil Reporter, Uncertainty Deepens After Landmark Ruling Against Kurdistan’s Oil Sector, 8 March 2022, accessible: https://www.iraqoilreport.com/news/uncertainty-deepens-after-landmark-ruling-against-kurdistans-oil-sector-44651/

[6]   Iraq Oil Reporter, Baghdad Launches Legal Action Against Kurdistan’s Oil Companies, 2 June 2022, accessible here.

[7]   Iraq Oil Reporter, Kurdistan Opens New Front in Baghdad Legal Battles, 9 June 2022, accessible: https://www.iraqoilreport.com/news/kurdistan-opens-new-front-in-baghdad-legal-battles-44896/

[8]   Iraq Oil Reporter, Kurdistan Opens New Front in Baghdad Legal Battles, 9 June 2022, accessible: https://www.iraqoilreport.com/news/kurdistan-opens-new-front-in-baghdad-legal-battles-44896/

[9]   Model Production Sharing Contract, Kurdistan Regional Government, Article 43.

[10]   See Constitution of the Republic of Iraq, Article 117.

[11]   Model Production Sharing Contract, Kurdistan Regional Government, Article 43; See Chevron Bangladesh Block Twelve, Ltd. and Chevron Bangladesh Blocks Thirteen and Fourteen, Ltd. v. People’s Republic of Bangladesh, ICSID Case No. ARB/06/10, Award (17 May 2010); Perenco Ecuador Limited v. Republic of Ecuador and Petroecuador, ICSID Case No. ARB/08/6, Decision on Jurisdiction (30 June 2011).

[12]   Dynasty Company for Oil and Gas Trading Limited v. Kurdistan Regional Government of Iraq and Dr. Ashti Hawrami, English High Court of Justice 2021 EWHC 953 (Comm) (23 April 2021).

[13]   Model Production Sharing Contract, Kurdistan Regional Government, Article 42.1.

[14]   Model Production Sharing Contract, Kurdistan Regional Government, Article 42.1.

[15]   Agreement between Japan and the Republic of Iraq for the Promotion and Protection of Investments, 25 February 2014, Articles 5(1), 5(2), and 5(3).

[16]   OIC Agreement, Articles 8 and 10.

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

Rahim Moloo – New York (+1 212-351-2413, [email protected])
Jeff Sullivan QC – London (+44 (0) 20 7071 4231, [email protected])
Abdallah Salam – New York (+1 212-351-2355, [email protected])

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

International Arbitration Group:
Cyrus Benson – London (+44 (0) 20 7071 4239, [email protected])
Penny Madden QC – London (+44 (0) 20 7071 4226, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

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