The UK, and the international economy, have faced momentous challenges in the past year. The UK economy shrank 11 per cent – the largest drop in over 300 years – and, according to last month’s figures from the UK’s Office for Budget Responsibility, its debt level is set to balloon to £394 billion in 2020 – the highest recorded level of borrowing in the UK since 1944 and equivalent to 19% of GDP. Conversely, however, interest rates on government debt are at a historic low and are expected to remain so for some time.

The Chancellor vowed in October to make “hard choices” that are needed to “balance the books” and to address the high levels of national debt incurred during the COVID-19 coronavirus pandemic. However, the International Monetary Fund warned the Chancellor that now is not the appropriate time to balance the books. The economic outlook for the UK remains highly uncertain and its success depends upon a multitude of factors, including the effectiveness and timing of vaccines, the outcome of the Brexit negotiations and the response of businesses and households to these events. Whilst the UK Government does expect relatively rapid economic recovery in the UK, the costs of COVID-19 combined with the head wind pressures from a post-Brexit world undoubtedly will put pressure on the UK economy, at least in the near term. Another tension is the desire to attract investment (by way of illustration, see the two consultations mentioned below). It is inevitable that revenues will need to be raised, though not necessarily as soon as 2021. As the Autumn Statement was cancelled this year, it remains to be seen how UK tax policy may change in response.

In the meantime, however, there have been plenty of incremental proposed (and actual) changes to the UK, and the international, tax landscape. Following a positive reception to an initial consultation on the UK asset holding company (“AHC”) regime, the UK government recently launched a second stage consultation on more detailed design features of a new AHC regime (including targeted changes to the UK real estate investment trust regime). The government is also currently consulting on new legislation relating to “UK property rich” collective investment vehicles and their investors for UK capital gains tax purposes, broadly designed to address administrative burdens borne by specified investors under existing rules. We will cover these topics and address any published outcomes of these consultations in our next Quarterly Alert (together with the recent OECD publications on transfer pricing and the impact of COVID-19).

CONTENTS

A. INTERNATIONAL AND UK DEVELOPMENTS

I. BEPS 2.0 – OECD Blueprints

II. OECD consultation on dispute resolution mechanics

III. Updates to the Directive on Administrative Cooperation (DAC)

IV. UK developments

V. UK and EU VAT updates

B. NOTABLE CASES

I. Blackrock HoldCo 5 LLC v HMRC [2020] UKFTT 443 (TC)

II. Dunsby v HMRC [2020] UKFTT 0271 (TC) and Bostan Khan v HMRC [2020] UKUT 168 (TCC) (2 June)

III. Bluejay Mining plc [2020] UKFTT 473 (TC)

A. International and UK developments

I. BEPS 2.0 – OECD Blueprints

In October, the OECD’s Inclusive Framework (the “IF”) released blue-prints for its Pillar I and Pillar II initiatives – addressing respectively, (a) new nexus rules for the digital economy and (b) “top-up tax” mechanics to secure an international minimum tax rate. The blueprints focus on technical aspects of the proposals and illustrate that the proposals are becoming increasingly complex. They also acknowledge that there are many points on which political agreement has yet to be reached. It remains to be seen whether the IF’s aim of reaching consensus on both Pillar I and II by mid-2021 remains achievable.

Pillar I[1]

Pillar I focuses on the allocation of taxing rights (rather than the tax base itself) and seeks to redistribute taxing rights to so-called “market jurisdictions” (i.e. jurisdictions into which a group’s “in scope” services and products are supplied and/or its users are located). The blueprint does not seek to fit this new “nexus” rule into the existing international tax framework, but rather, layers it over the framework.

Though much remains to be agreed politically, the blueprint sets out the direction of travel for many technical aspects of the proposals:

Scope: The proposals will apply to: (a) “automated digital services” businesses, including social media platforms, online search engines and cloud computing businesses and (b) “consumer facing businesses” (i.e. retail businesses). Some IF members favour a staggered introduction of the rules, with delayed implementation for consumer facing businesses.
Thresholds: It is proposed that the new nexus rules would only apply to global businesses with revenue from “in-scope” activities above certain (yet to be politically agreed) thresholds both: (a) globally and (b) in jurisdictions that don’t currently tax the relevant income (on existing residence / permanent establishment principles). The former threshold is expected to be set at c.€750 million.
Exclusions: Blanket carve-outs are proposed for the financial industry (asset managers, insurers, pension funds, and banks), the extractives and natural resources industries, and international airlines and shipping.
Calculation of tax base: The amount of income available to be allocated to market jurisdictions (so called “Amount A”) is not determined on the basis of principles. Rather, (once a political decision is reached on the various thresholds) its calculation is intended to be a highly mechanical exercise. In high level terms:
- Amount A is intended to represent the group’s global “excess profit” from in-scope activities – i.e. income exceeding an agreed level of profitability, which would be calculated using agreed formulae (that would vary by industry). Determining the level at which “excess profit” is set is likely to be highly contentious.
- The starting point for the calculation would be the group’s consolidated accounts, with the various formulae (to calculate the tax base, and the allocations) being applied to figures set out therein. Where a group has both in-scope and out-of-scope activities, it is proposed that taxpayers prepare additional “segmented” accounts (but that losses from out-of-scope activities could not be set against profits from in-scope activities). This raises the prospect that businesses could be subject to additional tax in multiple jurisdictions, even if they are loss-making overall.
Nexus: It is proposed that Amount A would only be shared between market jurisdictions in which the group has an “active and sustained participation”. This would be tested by reference to revenue generated in that jurisdiction over a certain number of (yet to be decided) years. It is contemplated that, for consumer facing businesses, market jurisdictions may need to meet higher thresholds (of revenue and/or other qualitative factors) to meet this test.
Novel “dispute prevention” mechanisms: In expanding the pool of jurisdictions to which taxing rights are awarded, the proposals materially increase the scope for double taxation. The blueprint recognises this – and that existing dispute resolution processes (such as mutual agreement procedures, discussed further below) may be ill-equipped to resolve disputes between tax authorities regarding their rights to tax “in scope” income. The blueprint therefore focuses on novel “dispute prevention processes”. In particular, the blueprint contemplates that many aspects of the proposals (including the amount of income to be allocated to market jurisdictions generally, and to specific jurisdictions in particular) would, for each in-scope taxpayer, be subject to advance review both by (a) the tax authorities of interested jurisdictions and (b) if there is disagreement, panel(s) of representatives from tax administrations in IF member states. Such innovation is to be welcomed. Nevertheless, concerns have been raised about the practicality of such measures. In the absence of willingness and (perhaps more significantly) means on the part of tax authorities to allocate resources to the proposals, demand for pre-agreement is likely to outstrip capacity, with taxpayers potentially suffering the cost of double taxation whilst they wait.
Implementation: The blueprint contemplates that the proposals would be implemented via a multi-lateral instrument (an “MLI”). Past experience with 2018’s MLI (giving effect to BEPS 1.0 initiatives) illustrates that, in practice, implementation of MLIs is highly staggered. To prevent businesses facing significant double taxation risks during such a transitional period, it is hoped that streamlined implementation can be achieved.
Matters for political decision: In addition to the points raised above, swathes of the proposal remain subject to political agreement – not least: (a) whether Pillar A will be introduced on a mandatory or (as the US proposes) optional basis (as to which, see our July Tax Quarterly Alert) and (b) the various thresholds and percentages inherent in the proposed calculations.

The complexity of the new rules is apparent, even at this relatively early stage of the process. With such an ambitious project, some degree of complexity (and additional compliance burden) was unavoidable. Nevertheless, it seems likely that this has been exacerbated by the early choice not to fit Pillar I proposals within existing tax frameworks (e.g. by expanding the traditional concept of a physical “permanent establishment” to accommodate digital presences). Moreover, the significant risk of double taxation inherent in the project’s aims has led the IF to favour a model based on formulae (offering certainty) over principles (offering flexibility). While such certainty may be welcome in the short term, it is not without challenges. Though not acknowledged by the blueprint, it seems likely, for example, that the various thresholds and percentages intrinsic to the rules would need to be refreshed every 5-10 years in response to inflation, the changing fortunes of particular industries, and human ingenuity as to the various means by which value can be created. As such, even if consensus can be reached next year, it is unlikely to be the end of the multinational political decision making on which the rules rely.

Pillar II[2]

In contrast to Pillar I, Pillar II expressly aims to increase the amount of tax paid by certain multinational groups. It would do so by introducing an international minimum effective tax rate. The level at which this would be set has yet to be agreed between IF members.

The blueprint gives significant shape to the proposal:

Scope: The blueprint contemplates that Pillar II would, in any given year, only apply to groups with a consolidated gross revenue in excess of €750 million (in the immediately preceding fiscal year).
Exclusions: In good news for the investment management industry, it is proposed that certain types of entities heading multinational groups (such as investment entities, sovereign wealth funds and pension funds) would be exempt – although the proposals could apply to entities lower down the ownership chain. However, (in contrast to Pillar I) it appears that there is limited political will for including a broader carve out.
The blueprint largely focuses on two proposed “top-up” tools:
- The income inclusion rule (the “IIR”): The IIR gives the jurisdiction in which the group’s parent is resident the power to levy a “top-up” income tax, on the parent, in respect of the difference between the group’s effective tax rate and the (yet to be agreed) minimum rate. The proposal is supported by a “switch-over rule” which would effectively disapply obstacles to such taxing rights in double tax treaties.
- The “undertaxed payments rule” (the “UTPR”): Broadly, the UTPR empowers source jurisdictions to apply withholding tax to, or deny a deduction for, related party payments which are not taxed (or are subject to low tax) on receipt. This proposal is supported by the “subject to tax rule”, which would amend treaties to give effect to source countries’ new taxing rights.
A key element of both proposals is the manner in which the group’s effective tax rate (the “ETR”) is calculated:
- Blending: The IF appears to have rejected an approach based on “global blending”, which would have calculated the ETR at group level. Instead, the IIR favours “jurisdictional blending” – which requires groups to calculate the ETR for each jurisdiction in which they have a taxable presence. While the blueprint moots the possibility of certain simplification processes (such as a safe harbour where the ETR (calculated for county-by-country reporting purposes) is a certain level above the minimum tax rate) it acknowledges that such proposals are in their infancy. Indeed, even with simplification methods, a jurisdiction-focused approach is likely to result in a significant compliance burden (particularly when compared to the simplicity offered by global blending).
- Financial accounts as a starting point: Interestingly, notwithstanding the preference for jurisdictional blending, the blueprint proposes that the ETR be calculated using the parent’s consolidated accounts. Many taxpayers had favoured simpler alternatives, including: (a) a “proxy” ETR calculation, based on consolidated accounts only (which, while divorced from the tax actually paid, would minimise the compliance burden) or (b) an ETR calculation based on the tax actually paid in each jurisdiction (which would align the proposals with the economic reality, and use information that taxpayers are already required to prepare at a local level). The proposed approach creates particular difficulties for many businesses in the financial industry, for whom there are often material mismatches between the consolidated accounting, and tax, position. Examples include insurers (who are often taxed on a fundamentally different basis than ordinary corporate income taxpayers) and issuers of additional tier 1 capital instruments and other hybrid instruments. Under the proposals, such businesses could be subject to additional tax in circumstances where their actual ETR is above the minimum level.
- Measures to address tax volatility: The IF recognise “the principle that Pillar II proposals should not seek to impose additional tax where a low ETR is merely a product of timing differences in the recognition of income or the imposition of taxes”. The blueprint therefore proposes certain mechanics to address these points, such as the right to carry forward “excess” ETR (over the minimum rate) and off-set it against a low ETR in subsequent years. However, it is contemplated that this carry-forward right may be limited to seven years.
- IIR substance carve outs: Similar to another notable erosion rule, the US’ “global intangible low-taxed income rule (“GILTI”), the blueprint contemplates that certain types of income would be carved out of the ETR calculation. These include payroll taxes, and (a fixed amount of) income from fixed assets. This is, the blueprint notes, because Pillar II “focuses on excess income, such as intangible-related income, which is most susceptible to base erosion”. Nevertheless, the narrow scope of the exclusion omits many additional sources of income which are not “mobile”, including income from traditional non-digital businesses which rely on a fixed establishment and a local consumer base.
Other matters addressed in the blueprint include:
- Interaction between IIR and UTPR: The blueprint notes the IF’s intention that the UTPR operate as a “backstop” to the IIR, applying only where the parent’s jurisdiction of residence has not implemented the IIR. However, the blueprint’s proposals do not quite achieve this stated aim. In particular, the blueprint contemplates that the UTPR could apply to payments made to a parent entity that is subject to the IIR, if the ETR in its jurisdiction of residence is below the minimum rate. This raises the prospect that parent entities could be subject to both the IIR and the UTPR, creating the potential for multiple layers of tax, and a heavy compliance burden.
- Implementation: The blueprint proposes that treaty changes needed to implement the switch-over-rule and the subject-to-tax rule would be implemented via an MLI signed and ratified by IF members. As regards the IIR and the UTPR, it is contemplated that the OECD would produce draft legislation for implementation by IF member states. While the latter approach is designed to limit the difficulties that would be created by mismatches in implementation (such as increased compliance costs and an enhanced risk of double taxation) such differences are likely unavoidable. As regards the risk of double tax in particular, (in contrast to Pillar I) the blueprint signals an intent to rely solely on existing dispute resolution procedures. The weaknesses in these processes (discussed further below) have raised concerns as to whether this goes far enough.
- Matters for political decision: Key elements, however, remain subject to political agreement. These include (a) the rate at which the minimum tax will be set and (b) the interaction between Pillar II proposals and (broadly equivalent) base erosion taxes (such as the US’ GILTI and the base erosion anti-abuse tax). On the latter point in particular, it is hoped that a sensible agreement can be reached to minimise double tax risk.

The IF has been subject to intense pressure to reach a consensus on the proposals – not least from the EU, who have threatened to introduce equivalent measures if the IF cannot reach agreement – and possibly even if they do (see further our July Tax Quarterly Alert). Nevertheless, given the significant, once-in a-generation, changes contemplated by the blueprints, the short period of public consultation (which ran for two months to 14 December) is notable. It is hoped that the IF can resist pressure to hurry these significant projects, increase taxpayer engagement and take the time needed to develop proposals that best achieve the aims of: (a) imposing tax only where there is economic under-taxation and (b) minimising the compliance burden on taxpayers.

II. OECD consultation on dispute resolution mechanics

In November, the OECD published a consultation document on mechanisms to make double tax treaty dispute resolution procedures more effective. Proposals include implementing a requirement for tax authorities to submit to binding arbitration where they cannot otherwise reach agreement within two years (so called “MAP arbitration”). The effectiveness of treaty dispute resolution mechanisms is set to take on increased significance for certain UK taxpayers. Earlier this month, the UK government announced the repeal of two EU directives which provide for MAP arbitration where tax authorities from EU member states cannot reach agreement on tax treaty disputes. The process will therefore no longer apply to disputes under the UK’s treaties with 11 EU jurisdictions (including Italy, Denmark, Poland and Romania).

Double tax treaty disputes arise where a taxpayer has been taxed by two states, each of whom believes that the treaty between them entitles them to do so. Such disputes are currently resolved through “mutual agreement procedures” (so called “MAP”) – a process by which the relevant tax authorities, through discussion, attempt to resolve disagreements about the effect of the relevant treaty. Though the outcome of the dispute will determine the amount of tax the taxpayer must pay, and to whom, the taxpayer is not party to the discussions.

MAP’s weaknesses are well known. For example:

It relies on tax authorities reaching agreement: The process can be inherently uncertain. Though treaty provisions require tax authorities to “endeavour to resolve” the dispute, the taxpayer bears the risk that they will not, and that the relevant double tax will not be relieved.
It is time consuming: Recent figures from the OECD indicate that on average, transfer pricing cases take 30.5 months to resolve via MAP, while other cases take 22 months[3]. Interestingly, in 2019, the UK was the jurisdiction with the fastest resolution of cases via MAP (taking an average of 21 months for transfer pricing cases and 6 months for other cases). These figures are likely to increase going forward, with taxpayer requests for MAP having doubled since 2016.

The Consultation

The consultation asks stakeholders to “share any general comments on their experiences with, and views on, the status of dispute resolution and suggestions for improvement”. However, in contrast to the approach to Pillar I dispute resolution processes (described above), it does not seek to challenge the primacy of MAP, or to address its weaknesses with significant reforms. Some key issues with MAP, such as the above-mentioned delays, are not addressed at all.

Rather, narrow changes to existing systems and procedures are proposed. These centre around possible steps to strengthen the minimum standards that IF members have (since 2016) committed to adhere to on the subject (the “Minimum Standards”), and include mandatory:

Programmes for bilateral advance transfer pricing agreements, pursuant to which taxpayers seek advance clearance from tax authorities that their arrangements will be treated as arm’s length. Interestingly, the consultation acknowledges that many jurisdictions already have such programmes in place. Moreover, those that do not would be exempt if they have only a minimal number of transfer pricing MAP cases.
Training on international tax issues for tax authorities’ auditors and examination personnel (with a view to preventing excessive adjustments likely to give rise to disputes).
Suspension of tax collection while MAP is on-going (if/to the extent that such measures apply to domestic challenges).
Rules enabling MAP agreements to be implemented, notwithstanding domestic time limits (where the matter is not addressed in the terms of the treaty itself).
MAP arbitration.

Importantly, the proposals put forward in the consultation do not represent IF consensus, and therefore function as mere discussion points. Some proposals are, accordingly, disappointingly modest in their aims (e.g. (a) and (b) above). Others (such as those at (c) and (d) above) do not seek to fix dispute resolution mechanisms themselves, but instead seek to accommodate MAP’s weaknesses (perhaps recognising that support for an effective alternative remains quite a way off). While this is helpful in the short-term, it does not represent a long term solution.

In particular, the consultation strikes a pessimistic note on the likelihood of achieving consensus on mandatory MAP arbitration, noting that “a number of [IF members] have clearly indicated that MAP arbitration raises several issues around constitutional and sovereignty concerns, [and] practical issues including cost, capacity and resource constraints, which is why they do not support its inclusion into the Minimum Standard and consider it very difficult to move away from such position”. The statement is informed, no doubt, by the less than enthusiastic response to such provisions in the 2018 MLI, with all but 33 of the signatories opting out.

Nevertheless, as tax laws become ever more complicated, the scope for disagreement grows. Tax treaties will increasingly fail in their objective of preventing double tax if tax authorities have the option of merely “agreeing to disagree”. Indeed, this problem will be amplified if/ when Pillar I and II proposals take effect. It is therefore hoped that, once BEPS 2.0 processes wind down, the OECD will refocus its attention (and its resources) on this fundamental issue.

Brexit

Unfortunately, global reluctance to embrace MAP arbitration is likely to gain increasing significance for certain UK taxpayers. Earlier this month, the UK government announced that it would repeal UK laws that give effect to two EU directives that provide for MAP arbitration in disputes between EU tax authorities[4]. From 1 January 2021, applications for MAP thereunder will not be accepted. Many EU jurisdictions have, like the UK, opted into the MLI’s MAP arbitration provisions, or otherwise have bilateral treaties with the UK that include such provisions. The repeal will not impact taxpayers’ positions under those double tax treaties. However the UK’s treaties with Italy, Poland, Denmark, Romania, Czech Republic, Croatia, Slovakia, Bulgaria, Estonia, Latvia and Lithuania do not provide for MAP arbitration, and these jurisdictions have not opted into the MLI’s arbitration provisions. If a taxpayer is subject to double tax in the UK and any one of these jurisdictions, they will face an increased risk that any MAP proceedings, if initiated, will not be resolved. It remains to be seen whether the UK will seek to renegotiate the relevant bilateral treaties.

III. Updates to the Directive on Administrative Cooperation (DAC)

(i) DAC 6 update

See our Gibson Dunn presentation on DAC 6 here.

The first UK DAC 6 reporting deadline, on 30 January 2021, is fast approaching. As a result, parties to cross border arrangements are increasingly focusing their thinking on the practical implications of mandatory reporting obligations, with DAC 6 provisions starting to feature in contractual arrangements. Other recent developments include the publication of further guidance from HMRC on the application of the DAC 6 in the UK, and the removal of the Cayman Islands from the EU’s non-cooperative tax jurisdictions list (though unanswered questions remain with respect to whether certain payments to the Cayman Islands will be subject to DAC 6 reporting obligations in the UK).

The EU Council Directive 2011/16 (as amended), known as DAC 6, requires intermediaries (or failing which, taxpayers) to report, and tax authorities to exchange, information regarding certain cross-border tax arrangements with an EU nexus. Due to the COVID-19 coronavirus pandemic, the implementation of DAC 6 was deferred (on an optional basis). Certain jurisdictions, such as Germany and Finland, chose to proceed as planned, with mandatory reporting beginning in July. The UK opted to defer, and the first UK reporting deadlines, beginning on 30 January 2021, are now fast approaching (for further detail, see our July 2020 Quarterly Update here). (It’s worth noting in particular that DAC 6 obligations will be unaffected by, and will remain in force following, the end of the Brexit transition period).

In the meantime, DAC 6 developments continue. Of particular note has been the recent (widely anticipated) removal of the Cayman Islands from the EU list of non-cooperative jurisdictions, which might be short-lived as its removal provoked further discussions and even calls for it to be re-added to the list (primarily on the basis of the secrecy laws of the jurisdiction and the scale of offshore financial activities taking place there). One of the many adverse tax implications of being on the list is that a DAC 6 reporting obligation can be triggered if the recipient of a deductible cross-border payment, between associated enterprises, is resident in a jurisdiction on the list. Unfortunately, it is not yet clear how this development interacts with the deferral of reporting in the UK – in particular whether such payments to a Cayman recipient while Cayman was on the list (between 18 February 2020 and 6 October 2020) are required to be reported to HMRC. The point will be particularly relevant to those sectors which regularly use Cayman vehicles in investment structuring and it is hoped that HMRC will clarify the point before the reporting deadline for transactions in the period (being 30 January 2021 for reportable transactions after 30 June 2020, and 28 February 2021, for transactions on or before 30 June 2020 where the first step in implementation was taken on or after 25 June 2018).

HMRC has, however, published updated guidance on other aspects of the rules. The revised guidance:

Confirms that an arrangement that otherwise concerns only one jurisdiction will not be considered “cross-border” solely because an intermediary involved in that arrangement is located in a different jurisdiction.
Confirms that a non-UK, non-EU branch of a UK resident company, that provides aid, assistance or advice in respect of a reportable arrangement, will be subject to UK reporting obligations. However, HMRC would therefore not usually expect a DAC 6 report to be made where local data laws would restrict the ability to report, unless transactions were being actively routed through a branch in order to avoid DAC 6 reporting obligations.
Addresses, in particular, the triggers for reporting (the so called “hallmarks”) which incorporate transfer pricing concepts. For example, as regards the hallmark for arrangements involving:
- the use of unilateral safe harbour rules, HMRC has confirmed that (a) safe harbour rules agreed by jurisdictions on a bilateral or multilateral basis (such as OECD agreements) and (b) arrangements that have been properly priced on an arm’s length basis (even if they also happen to fall within a safe harbour rule) should not be in scope;
- the transfer, between associated enterprises, of “hard-to-value intangibles” (i.e. those for which no reliable comparables exist and projections of future cash flows or income therefrom are “highly uncertain”), HMRC has confirmed that the degree of uncertainty must be higher than a normal level of uncertainty. While helpful, unfortunately, the subjective nature of the clarification leaves residual uncertainties as to how this is to be applied in practice; and
- intragroup cross-border transfers of functions, risks or assets (where the earnings before interest and taxes (“EBIT”) of the transferor, are decreased by 50%), HMRC has provided additional guidance on the calculation of EBIT.

Given the impending reporting deadline, attention is now being focused toward the more practical aspects of mandatory reporting obligations. For example, trends are developing toward addressing reporting obligations in relevant contractual arrangements (including fund investor side letters and tax deeds in an M&A context). In addition, there continue to be substantive differences in how key aspects of DAC 6 have been implemented in different jurisdictions, including the applicability of hallmarks and the operation of legal professional privilege.

(ii) DAC 7 update

Consensus has been reached on DAC 7, paving the way for the bolstering of information-gathering powers of tax administrations regarding income generated via the digital platform economy. The main aim is to provide better cooperation across tax administrations, whilst keeping business compliance costs to a minimum through providing a common EU reporting standard.

EU member states recently “reached consensus” on the proposed amendment (published on 15 July 2020) to Council directive 2011/16/EU (“DAC 7”) which requires the automatic exchange of information on revenues generated by sellers on digital platforms. In a departure from previous iterations, which focused on direct taxes, DAC 7 will also cover VAT. (For further information on its scope, see our April Tax Quarterly Alert. This update was tweeted by Benjamin Angel, Director of Direct Taxation at the European Commission’s Directorate-General for Taxation and Customs Union: “Consensus reached on DAC 7…DAC 7 will ensure that tax administrations get information from platforms on transactions done by users in Member States, be the platforms located within the EU or outside.”[5] It is unclear when DAC 7 will become law, but it is expected in the very near term, as work has already begun on the next amendments to Council Directive 2011/16/EU – DAC 8 (see below).

(iii) DAC 8: proposal for the automatic exchange of information relating to crypto-assets

Work has begun on “DAC 8” – the next version of the European Council Directive on Administrative Cooperation in the Field of Taxation (Council Directive 2011/16/EU). The proposals form part of EU efforts to create a framework for the (regulatory and tax) automatic exchange of information mechanics of crypto-assets. Feedback on the EU’s proposals is requested by 21 December 2020. Following a public consultation period (anticipated in the first quarter of 2021), the European Commission expects to publish legislation in the third quarter of 2021.

Last year, European Commission President, Ursula von der Leyen, emphasized the need for “a common approach with Member States on cryptocurrencies to ensure we understand how to make the most of the opportunities they create and address the new risks they may pose.”[6] The European Commission elaborated on that plan in mid-November, publishing a roadmap for bringing crypto-assets and e-money within the scope of existing automatic exchange of information mechanics. It is proposed that this would be achieved via a further amendment to the Directive on Administrative Cooperation in the field of taxation (a proposed “DAC 8”). If implemented, current information reporting and exchange regimes (such as the exchange of information on financial accounts reported by financial institutions) would extend to crypto-assets (as well as intermediaries for these assets, such as crypto-exchanges and brokers).

Crypto assets are digital assets based on distributed ledger technology (“DLT”) and cryptography. DLT is a decentralised database used to record, share and synchronise the transaction of assets. The European Commission roadmap acknowledges that income derived from crypto-assets could be subject to taxation – a view widely held by tax authorities internationally. HMRC, for example, first published (non-binding) guidance on how it considers UK tax law applies to arrangements involving crypto-assets back in 2014. This guidance was subsequently updated, and supplemented, with guidance for businesses on the taxation of crypto-assets in 2019. Indeed last month, HMRC announced (at the OECD’s virtual Global Blockchain Policy Forum) its plans to soon release an entire manual of guidance on the subject.

However, the ability of tax authorities to ensure the appropriate application, and proper enforcement, of tax legislation to (and to transactions in) crypto-assets is hindered by two key issues which DAC 8 aims to tackle:

First, the lack of information at national tax authority levels about the use of crypto-assets and e-money: As crypto-assets and e-money (and relevant intermediaries such as crypto-exchanges and brokers) are not fully covered by the existing provisions of DAC, tax authorities: (a) have to rely on taxpayers’ ordinary course self-assessment obligations and (b) (notwithstanding the international reach of crypto-asset technology) have limited tools to exchange any information which is reported between them. Moreover, there are inherent difficulties in identifying and taxing these new assets in the same way as more traditional assets, including (as identified by the Commission) “[t]he lack of centralised control for crypto assets, its pseudo-anonymity, valuation difficulties, hybrid characteristics and the rapid evolution of the underlying technology as well as their form…” [7]
Second, the exclusion of crypto-assets and e-money from the scope of existing EU legislation, resulting in ‘disparity in sanctions applied’ thereunder to crypto-assets and e-money on one hand, and more traditional assets and currencies on the other.

The above concerns reflect that lack of information on crypto-assets and e-money is a major stumbling block for tax authorities and that, unless addressed, this will likely undermine the integrity of other information exchange initiatives in place to tackle tax evasion, such as the exchange of information from financial institutions on financial accounts set up by DAC 2 in 2014. Among other measures, the proposals would address this gap by extending DAC2 obligations to crypto-assets, and those who facilitate the holding of, and transactions in, them (e.g. exchanges and brokers). Feedback on the proposals was sought by 21 December 2020, to be followed by a public consultation in the first quarter of 2021, and the publication of an amending Directive in the third quarter.

IV. UK developments

(i) Fundamental changes to UK capital gains tax proposed in report published by Office of Tax Simplification

In November 2020, the Office of Tax Simplification (“OTS”) published the first of two reports on their review of the UK capital gains tax (“CGT”) regime, recommending significant changes. If implemented, the changes could potentially result in material changes to liabilities for UK taxpayers. Any recommendations adopted could be implemented as early as March 2021, when the Spring Budget is expected.

The OTS is the independent adviser to the government on simplifying the UK tax system. In response to a request from the Chancellor in July 2020, the OTS carried out a review of UK CGT, with the aim of identifying the policy design of, and the principals underpinning, CGT and then exploring opportunities to address any areas where the present rules distort behavior or do not meet their policy intent. The first report addressing the policy design and principles underpinning CGT was published in November (the “Report”) and a second, technical report, is expected in early 2021. Whilst there has been a lot of media coverage of certain aspects of the OTS review (and certain areas that it highlights for review), it is important to note that the objective of the OTS is to set out a framework of policy choice about the design of tax.

The OTS formulated their Report by reference to four policy areas: (1) rates and boundaries; (2) the Annual Exempt Amount; (3) capital transfers, and (4) business reliefs.

The proposals focus on the liabilities of individuals, but cover neither the attribution of offshore gains to UK resident individuals, nor the CGT implications of an individual’s arrival or departure from the UK. The CGT treatment of trusts was also not addressed.

Eleven recommendations were made, with the most fundamental proposals related to addressing the disparity between the current rates of CGT (generally 20%) and income tax (from 20% to 45% for higher income earners). This discrepancy is correctly highlighted as one of the main sources of complexity in the area of individual taxation. Given that CGT rates are lower, individuals can be incentivised to arrange their affairs so as to re-characterise income as capital gains. There is, accordingly, a raft of complex UK anti-avoidance legislation targeting such re-characterisation techniques, such as the “transactions in securities rules” (which operate to tax a profit as income, rather than as a chargeable gain subject to CGT) and the “transactions in UK land” provisions (which seek, broadly, to ensure that profit arising in the context of trading transactions involving certain disposals of interests in UK real estate will be taxed as income, rather than chargeable gains). The areas that the Report indicates would most notably benefit from a greater convergence of the income tax and CGT rates are: (a) share-based remuneration, and (b) the accumulation of retained earnings in smaller owner-managed companies.

The Report does, however, also highlight the many arguments against raising CGT – in particular: (i) the inappropriateness of taxing an increase in value that is due simply to inflation, and (ii) a CGT rate increase may incentivise taxpayers to hold assets or otherwise alter commercial strategies in relation to in-scope assets.

The Report notes that, if the government did increase CGT rates, further knock-on amendments would be required in other aspects of the relevant tax legislation, including the anti-avoidance provisions referred to above, and there would be a case for considering a greater degree of flexibility in the use of capital losses.

Other proposals of interest in the OTS report include:

a lowering of the annual exempt amount (£12,300 in tax year 2020-21) to a de minimis amount (on the basis that it is an ineffective means to achieve its stated objective of compensating for inflation, because it does not take holding periods or asset values into account). Instead, the OTS propose a broader exemption for personal effects (with only specific categories of assets being taxable).
the replacement of Business Asset Disposal Relief (formerly Entrepreneurs’ Relief – which, by way of reminder, reduces the CGT rate to 10% on the disposal of assets and shares meeting certain conditions) with a relief more focused on retirement.

It is not clear whether (and if so, to what extent) the UK government will adopt the recommendations from this Report or the OTS.

(ii) Finance Bill 2021 – updates following consultation responses

The UK government has published draft legislation for the Finance Bill 2021, alongside explanatory notes, responses to consultations and other supporting documents (see our previous July 2020 Quarterly Update for list of tax policy consultations). Certain draft provisions for the Finance Bill 2021 were published in July 2020, at which point there was intended to be an Autumn Budget later in 2020. This was however cancelled as a result of the COVID-19 pandemic, and on 12 November, the government instead published further draft legislation, (without a budget). Consultation on the draft legislation will close on 7 January 2021, with the Finance Bill 2021 expected to be introduced to Parliament in spring 2021 and to receive royal assent in summer 2021. Notably, the publication of further legislation in spring 2021 raises the possibility that further new legislation will be introduced in 2021 with a very short consultation window.

(a) LIBOR withdrawal

Following its consultation, over the summer, on the potential tax implications of the withdrawal of the London Interbank Offered Rate (“LIBOR”), HMRC has published its response, together with updated guidance for businesses and new draft guidance for individuals. The guidance, which should provide UK taxpayers with a path to circumvent potential adverse tax impacts of the withdrawal, will be welcomed by affected parties.

The publication of LIBOR is expected to cease after the end of 2021, such that parties to financial instruments, with a term beyond 2021, that reference LIBOR (so called “legacy contracts) will need to be amended to refer to (or replaced with contracts that refer to) one of several alternate reference rates.

The consultation aimed: (i) to seek views on how the several UK statutory references to LIBOR should be amended as a result of the LIBOR withdrawal and (ii) to identify the tax impacts that could arise from the reform of LIBOR (and other benchmark rates). With only a few references to LIBOR in the tax legislation (dealing with treatment of certain leases), on 12 November 2020, HMRC published draft legislation for inclusion in the Finance Bill 2020/21 to ensure the leasing provisions continue to function as intended. Helpfully, the draft legislation also introduces a power to allow any unintended tax consequences arising from the transition away from LIBOR (and other benchmark rates) to be addressed separately in secondary legislation.

HMRC has also produced guidance (updated on 12 November 2020 following responses to the consultation) that explains its view on the tax implications of amending financial instruments to respond to the benchmark reform. As discussed in our previous Alert, the guidance (published in draft form in March):

confirms that any amounts recognised in taxpayers’ profit and loss statements as a result of such amendments will generally be taxed / relieved in the usual way; and
addresses other potential tax implications, confirming, among other things that (a) amendments to legacy contracts would not generally be treated as giving rise to a new contract – provided amendments are on (broadly) economically equivalent terms, and (b) in such circumstances, provisions requiring taxpayers to test the economic reasonableness of the contracts’ terms (such as transfer pricing, distributions and stamp duty relief, provisions) would not generally need to be revisited.

The guidance has now additionally been updated to:

provide comfort that HMRC would generally treat amendments to financial contracts pursuant to (or on terms which mirror) market standard documentation (such as ISDA’s IBOR Fallbacks Protocol) as constituting amendments on economically equivalent terms, (and hence as not generally giving rise to a new contract) – irrespective of whether amendments were booked as a new trade in internal systems;
confirm that amendments to financial contracts via (or on terms which mirror) such market standard documents should generally be considered arm’s length for transfer pricing purposes;
confirm that the VAT treatment of one-off additional payments, made in connection with transition-related amendments, will follow the treatment of the underlying supply (and hence will generally be exempt for most financial transactions); and
confirm that relief can be sought, under existing provisions of the hybrid mismatch rules, if differences in the tax treatment of the transition across relevant jurisdictions gives rise to timing mismatches.

In addition, HMRC published guidance for individuals, mirroring the position set out in the business guidance and additionally confirming that amendments to financial instruments would not generally give rise to a disposal for capital gains tax purposes.

It is worth noting that the tax treatment described above, and in the guidance, would not generally apply where taxpayers respond to LIBOR’s withdrawal by replacing, rather than amending, legacy contracts. Nevertheless, for those taxpayers that opt to amend legacy contracts (on economically equivalent terms), the guidance should provide a path to minimising the tax implications of transition, and will be welcome relief for affected parties.

(b) Amendments to the hybrid and other mismatches regime

On 12 November 2020, HMRC published its response to its consultation on certain aspects of the UK hybrid and other mismatches regime, together with some draft legislation to amend the rules, explanatory notes and a policy paper summarising other proposed legislative changes to be included in the Finance Bill 2021. The majority of measures will be welcomed by businesses. However, certain aspects of the regime continue to represent a missed opportunity to address certain instances where tax deductions are disallowed even in the absence of an economic mismatch.

The UK hybrid and other mismatches regime was introduced in 2017 to counter arrangements that give rise to hybrid mismatch outcomes and generate a tax mismatch. As mentioned in our previous April and July Tax Quarterly Alerts, HMRC consulted on certain aspects of the regime over the summer, particularly:

the rules applying to “double deductions”, and the application of section 259ID income (a provision introduced in 2018 which broadly takes account of certain taxable income where there is no corresponding deduction);
the definition of “acting together” (for the purposes of rules which broadly, aggregate the interests of persons acting together when testing whether parties to arrangements are under sufficient “commonality of ownership” to fall within the scope of the regime); and
the application of the regime to certain categories of exempt investors in hybrid entities.

On 12 November 2020, HMRC published its response to the consultation, draft legislation and a policy paper summarising proposed new legislation to be included in the Finance Bill 2021. As the consultation process welcomed broader views on the UK hybrid regime, the scope of the policy paper details wider reforms and further draft legislation can be expected at some point in the future. Certain measures (noted with an asterisk* below) are proposed to take effect retrospectively from 1 January 2017.

Whilst the majority of measures are intended to be helpful, some aspects continue to represent a missed opportunity to address certain instances where tax deductions are disallowed in the absence of an economic mismatch. A non-exhaustive list of key proposed measures is set out below:

Changes will be made to provide reliefs to certain categories of taxpayer:
- The definition of “acting together” will be amended to exclude cases where: (i) a party has a direct or indirect equity stake in a paying entity no greater than 5%, including votes and economic entitlements*, and (ii) any investor holds less than 10% of a partnership that is a collective investment scheme (not dissimilar to Luxembourg’s implementation of anti-hybrid mismatch rules), which will take effect from the date of Royal Assent of the Finance Bill 2021. The changes, will be welcome news to investment managers, and funds, focusing on portfolio interests.
- Counteractions will be prevented under certain parts of the rules where the recipient of a relevant payment is a tax exempt investor (akin to a qualifying institutional investor within the UK substantial shareholding exemption rules). It is intended that this will apply from the date of Royal Assent of the Finance Bill 2021.
- Counteractions will be prevented where payments are made to and from entities taxed as securitisation vehicles under the UK securitisation regulations*.
Amendments will be made to address the application of reliefs where there is dual inclusion income (broadly a single amount of ordinary income that is recognised twice for tax purposes where the relevant entities and jurisdictions involved correspond to those that benefit from a double deduction)
- Section 259ID will be repealed*. Instead, the definition of dual inclusion income will be widened to include income that is brought into account for tax purposes in the UK without generating a tax deduction in any other jurisdiction (e.g. payments from a US parent to a UK subsidiary that is disregarded for US federal income tax purposes). This treatment will only apply where that outcome would not have arisen but for the hybridity of the UK recipient which gives rise to a counteraction under the UK hybrid rules*.
- A new surrender mechanism for “surplus” dual inclusion income is to be introduced. This will allow entities within a group relief group to surrender dual inclusion income, for set-off against doubly deductible amounts elsewhere in the group. It is intended that this will apply from 1 January 2021.
- In our April Tax Quarterly Alert, we discussed potential issues with the current application of the double deduction mismatch rules (where section 259ID does not obviously apply). In particular, we considered a scenario where an intra-group payment by a US parent company to a UK subsidiary (that is disregarded for US federal income tax purposes) may give rise to a disallowance, under the UK hybrid rules, for an otherwise deductible expense incurred by the UK subsidiary – resulting in taxation on profits it does not economically possess. The example highlighted a broader issue with HMRC’s previous “fix” introduced in 2018 by section 259ID, which is highly narrow in its application. The above changes address the issues raised in the example, albeit with one caveat – that this treatment will only be available where the inclusion/no deduction treatment was created by the same element of hybridity as the double deduction under consideration. So, where a US parent makes a payment to its disregarded UK subsidiary, the new treatment will be available (i.e. it would have been the disregarded status of the UK subsidiary which gives rise to the inclusion/no deduction mismatch). Whilst the widened definition of dual inclusion income will be helpful for certain taxpayers, for others it will not. Common structures where UK subsidiaries that have been checked open incur costs from third parties, whilst only receiving reimbursement from another subsidiary or sister company that is also checked open, but resident in neither the US nor the UK, continue to face economic double taxation. That is unfortunate, particularly given that other countries (such as Ireland) have adopted a more pragmatic approach to the implementation of their hybrid regimes to prevent such an outcome occurring for taxpayers (and consistent with the OECD principle that double taxation should be avoided).
More generally:
- The carry forward treatment of illegitimate overseas deductions (amounts for which it is reasonable to suppose that (part of) a hybrid entity’s double deduction amount is deducted under non-UK law for a taxable period from the income of any person, excluding the investor) under the hybrid rules is to be amended, so that where a relief is used by a multinational or dual resident company to set against its own single inclusion income, the relief will not be permanently denied in the subsidiary or branch. The amendments will take effect from the date of Royal Assent of the Finance Bill 2021.
- Acknowledging that the interaction of the US Dual Consolidated Loss rules with Part 6A of the hybrid rules should not operate to deny loss relief in both jurisdictions, HMRC in its response to the consultation has indicated that the new surrender mechanism and changes to the definition of illegitimate overseas deductions above should simplify the economic effects of the US rules. HMRC guidance is also expected to be published in the future to clarify the interaction. The imported mismatch rule, will be amended so that: (i) condition E (which previously required the overseas regime to apply similar provisions to the relevant part of the UK rules) will instead test whether an overseas regime seen as a whole is equivalent to the UK hybrid rules and prevents any counteraction if it is (to apply from the date of Royal Assent of the Finance Bill 2021); and (ii) condition F (which provided taxpayers with a degree of protection against a counteraction by allowing consideration of UK tax attributes to mitigate against a foreign mismatch payment) will be repealed*.

The draft legislation published to date only relates to the double deduction rules, and the application of section 259ID income. Although a timeline was not provided by HMRC, further draft legislation can be expected at some point in the future to address the remaining measures in the policy paper. HMRC has also indicated it will provide further clarification of certain points in forthcoming updates of its guidance on the hybrid regime.

Despite the many proposed changes, certain requests from consultation respondents have been explicitly rejected. These include the addition of a tax avoidance motive to the regime, an exclusion for small and medium-sized enterprises and the treatment of the US global intangible low-taxed income (GILTI) rules as an equivalent regime (so as to prevent a UK counteraction where a GILTI charge applies).

Given the scale of the hybrid and other mismatches rules and respective HMRC guidance, there has understandably been criticism of the UK’s overly mechanical approach (as opposed to a more principles based approach taken by certain other EU jurisdictions).

(c) Delay in the implementation – uncertain tax treatment rules

A proposed new obligation for businesses to notify HMRC of uncertain tax positions taken in their tax returns has been delayed until April 2022.

HMRC consulted, over the summer, on a proposed new requirement for large businesses to notify HMRC where they have adopted an uncertain tax treatment (an uncertain tax treatment being one where the business believes that HMRC may not agree with their interpretation of the legislation, case law or guidance). The proposals are designed to improve HMRC’s ability to identify tax treatments adopted by large businesses that do not stand up to legal scrutiny. In part, this is intended to aid HMRC’s efforts to open an inquiry into relevant tax positions before the statutory deadlines have passed.

The consultation concluded on 27 August 2020, and attracted strong criticism from respondents for the level of ambiguity inherent in the proposed reporting requirement (in effect requiring a judgement as to what action HMRC might take in relation to any tax position – across the full range of UK taxes). The proposals were originally due to apply to tax returns filed after April 2021, but have now been delayed until April 2022. Helpfully, HMRC appears to have now accepted the original proposal was perhaps too subjective and difficult for businesses to assess. Consequently, it is looking at ways to make the definition more objective and straightforward to comply with, whilst minimising the administrative impact on businesses.

Businesses will understandably be relieved that HMRC is revisiting the proposals in light of critical responses to the consultation. In addition, the delay provides respite from a potentially costly administrative burden at an uncertain time for many businesses.

(d) Extension of the annual investment allowance

The UK government has announced an extension, until 1 January 2022, to the £1 million annual investment allowance for capital allowances purposes. The allowance gives relief for 100% of expenditure qualifying for capital allowances, up to the threshold, in the tax year the expenditure is incurred. The allowance was previously increased to a maximum of £1 million (from £200,000) for a 2-year period, but was due to expire at the end of 2020. The announcement will be welcome news for businesses, who may be incentivised to increase capital investment at a time where managing short-term liabilities may have otherwise been more in focus.

V. UK and EU VAT updates

(i) UK VAT grouping – Establishment, Eligibility and Registration Call for Evidence

In August, HM Treasury published a call for evidence (“CfE”) to gather stakeholders’ views on certain elements of the UK VAT grouping rules. Feedback has been sought, in particular, on (a) the interaction of the UK’s establishment rules with other EU Member States’ and the application of the rules to overseas branches; (b) possible compulsory VAT grouping; and (c) grouping eligibility criteria for limited partnerships and Scottish limited partnerships.

VAT Grouping

Broadly, VAT grouping rules enable “eligible entities”[8] under common control to register for VAT as a group, and be treated as a single taxable entity for VAT purposes. A VAT group files one VAT return through the group’s representative member and supplies made between VAT group members are disregarded for UK VAT purposes. The purpose of VAT grouping is to allow administrative efficiency and while the purpose of the mechanism is not to achieve VAT savings, in practice, in some circumstances, VAT grouping supports this result.

Establishment provisions

The UK applies a “whole establishment” approach to VAT grouping. This means that “fixed establishments” (broadly akin to branches) of eligible persons, whether in the UK or abroad, are treated as part of the UK VAT group. This contrasts with other EU countries’ “establishment only” provisions, which the UK does not utilise. The “establishment only” rules provide that where an entity has “fixed establishments”[9] (or “branches”) in multiple jurisdictions, it is only the establishment in the country in which the VAT group is based that can be included in that VAT group.

Differences in VAT grouping rules have led to additional administrative and operational complexities for businesses. The document therefore calls for feedback on the benefits of adopting the “establishment only” provisions.

If the UK adopted the “establishment only” approach, only UK fixed establishments of foreign companies could be within a UK VAT group. This means that overseas branches of that foreign company could not join the UK VAT group – with the effect that supplies from foreign headquarters to a UK branch or a UK branch to foreign headquarters would be subject to VAT.

For entities/groups making exempt or partially exempt supplies, any input VAT incurred in connection with supplies from non-UK branches of the head-office (or other members of the group) would be irrecoverable (or partially irrecoverable), representing an actual cost for these groups. For those making solely taxable supplies, any input VAT incurred in connection with those supplies will be recoverable – albeit, that there may be a cash flow impact if periods of account are not aligned.

The CfE notes that an “establishment only” approach may reduce the administrative burden as groups will only then have to account for a reverse charge for VAT, and would not have to engage with anti-avoidance provisions introduced to prevent abuse of the existing rules (which the CfE contemplates would be repealed if the UK moved toward an “establishment only” approach). It is arguable whether the benefit of removing the anti-avoidance provisions will outweigh the additional administrative requirements that will come from adopting an “establishment only” approach – particularly for groups heavily reliant on internal supplies. Under the latter approach, compliance burdens may equally arise from the requirement to charge and account for VAT on certain recharges of staff costs, and any other supplies made between branches that are currently part of a UK VAT group.

Implications of Skandia[10]

As a result of the Court of Justice of the European Union’s (“CJEU’s”) judgment in Skandia, the UK introduced an exception to the “whole establishment” approach, effective 1 January 2016. Under this exception, if the overseas branch is a member of a VAT group in its local jurisdiction (which applies an “establishment only” approach to VAT grouping), then the UK head office and the overseas branch cannot be treated as the same taxable person, and VAT is applied to supplies made between them.

The call for evidence seeks feedback on the potential reversal of the UK’s changes to the VAT grouping rules following Skandia, acknowledging that the application of Skandia is administratively onerous for businesses. While this reversal would alleviate some VAT costs and compliance burdens for taxpayers, these benefits would be significantly outweighed by the costs associated with the introduction of any of the other proposals suggested in the CfE.

Compulsory VAT grouping

VAT grouping in the UK is currently optional for entities that meet the relevant control and establishment conditions. In particular, corporate groups can choose: (a) whether or not to form a VAT group and (b) which eligible entities in a corporate group should be a part of that VAT group.

In certain jurisdictions, however, VAT is compulsory for specific sectors. The government states that compulsory VAT grouping can offer administrative benefits, and level the playing field for businesses who would then all operate under the same VAT treatment.[11] The CfE seeks feedback on the introduction of compulsory VAT grouping into the UK.

Concerns have been raised, in particular, that compulsory VAT grouping is an “inflexible” approach, which will have significant adverse commercial consequences because of enforced joint and several liability that attaches to membership. It is notable that the recent introduction of compulsory grouping in Luxembourg is widely considered to have been unsuccessful, as a result of inflexibilities and resultant commercial difficulties.

Eligibility criteria

For VAT purposes, in a UK fund context (where the fund vehicle is typically either a limited partner (“LP”) or a Scottish limited partnership (“SLP”)):

1. The activities of the general partner (the “GP”) of the LP / SLP are treated as the activities of the fund vehicle (i.e. the LP / SLP, as applicable). The fund vehicle is therefore generally able to form a VAT group with the investment manager for the fund (as the GP will usually be part of the same investment management group as, and eligible to be grouped for VAT purposes with, the investment manager) allowing investment management supplies to be made to the fund free from VAT.
2. Since last year, LPs and SLPs have been entitled (but not required) to join a VAT group if the LP / SLP controls all the entities in the VAT group. “Control”, in this context, is tested by reference to whether the LP / SLP would, if it was a body corporate, be the holding company of the entities – a test which is itself determined by reference to voting rights / ability to appoint directors. Generally, this enables the fund LP / SLP (acting through the GP) and accordingly, the investment manager, to also be part of a VAT group with the fund’s portfolio companies.

The CfE acknowledges the position described in paragraph (a) above, noting that the current VAT grouping rules enable LPs / SLPs to receive supplies from entities other than the GP free of VAT – notwithstanding that the GP typically has limited rights to the profits / assets of the funds – which are held, by fund investors, outside of the VAT group. The CfE therefore: (a) contemplates limiting LPs’ / SLPs’ ability to join VAT groups, by imposing a requirement for common beneficial ownership and control, and (b) asks for stakeholders’ views on the impact of such changes.

It was the combination of the rules in (a) and (b) above that led to the decision in Melford[12] (discussed in our April Tax Quarterly Alert). By way of recap, in Melford: (a) the fund’s investment manager was grouped with the fund vehicle but (b) the parties had chosen not to include the underlying portfolio entities in the VAT group. As a result, (a) the investment manager was able to provide taxable supplies to the portfolio companies (thereby improving its recovery position) but (b) the fund was able to receive investment management services from the investment manager free from VAT (as those supplies were between members of the same VAT group, and hence disregarded). It is therefore possible that the result in Melford may have been the trigger for the CfE – with HMRC possibly seeking to (a) gauge whether/how to change existing rules to prevent the outcome achieved by the taxpayers in Melford, and (b) collect information regarding the collateral damage of the alternative approaches.

If this is indeed the case, it seems likely that restricting current fund grouping arrangements would cause material harm. In a funds context (or where an LP / SLP otherwise serves as a collective investment vehicle), if the proposals in the CfE were implemented, the fund vehicle LP / SLP would no longer be eligible to join a VAT group with:

its GP and investment manager, with the effect that VAT would be payable by the LP / SLP on investment management services received from the investment manager; or
the fund’s portfolio companies, with the effect that VAT would be payable by the portfolio companies on any investment management services received from the LP / SLP.

This would increase compliance costs, and it’s possible that at least some of the VAT payable by the fund LP / SLP, and/or the portfolio entities, may be irrecoverable. The proposals would, therefore, increase the cost of using UK fund structures. For existing funds in particular, these costs would not have been assumed at the time the fund was set up, or reflected in economic modelling (and accordingly, may distort results).

Next steps

It is expected that the proposals mooted in the CfE would, if implemented, give rise to an increase in VAT costs for many UK taxpayers, in particular, for fund structures and financial services groups. UK VAT groups should continue to monitor this consultation process. We would expect further dialogue from HMRC in respect of this CfE over the coming months.

(iii) Input VAT recovery for financial services provided to customers outside the UK

The Chancellor has announced that from 1 January 2021 (following the end of the Brexit- transition period), the VAT recovery position of UK financial and insurance service providers will not be restricted as a result of their making supplies to persons belonging outside the UK. Legislation to give effect to the proposals has not yet been published.

In order to obtain full recovery of input VAT incurred on costs, either: (a) the relevant costs must be directly related to the provision of taxable supplies or (b) the costs must form part of general overheads (and may be only partially recoverable to the extent the taxpayer makes exempt supplies). Financial services are generally exempt for UK VAT purposes. Accordingly, input VAT incurred in connection with the provision of financial services is currently generally irrecoverable.

In November, HMRC announced proposals which, broadly (if implemented), would mean that UK providers of financial services and insurance (including intermediary) services would be able to recover input VAT incurred on: (i) financial and insurance services supplied to customers belonging outside the UK (including to persons belonging in the EU) or directly related to an export of goods; or (ii) the making of arrangements for these supplies.

Supplies to UK customers will remain exempt for UK VAT purposes. Accordingly, UK financial and insurance businesses that make supplies to both UK and non-UK customers will need to calculate input VAT recovery in accordance with the partial exemption method.

As a result of the announcement, financial and insurance groups may wish to reconsider their intragroup VAT planning, particularly where the UK VAT group includes entities with EU branches (to whom the UK VAT group currently makes non-taxable supplies). Depending on their particular circumstances, it may be the case that the UK VAT group’s recovery position could be improved by de-grouping such UK entities, with a view to recognising the supplies made to its EU branch for VAT purposes.

From a documentation perspective, it is important that suppliers maintain evidence to support the input VAT claimed, including invoices and any relevant correspondence establishing the connection between the input VAT claimed and supplies made to EU. Given the potential benefits of the proposed changes (if they are implemented), maintaining documentation and monitoring internal processes will become increasingly important.

(iv) VAT treatment of termination fees – HMRC issues revised guidance

HMRC has changed its position on the VAT treatment of termination charges and compensation payments, following the CJEU’s judgements in Meo and Vodafone Portugal. HMRC’s new position, set out in HMRC’s Revenue and Customs Brief 12/20 , states that charges arising from early contract termination will generally be subject to VAT. Notably, this includes payments described as compensation or liquidated damages.

HMRC has changed its position on the VAT treatment of termination charges and compensation payments, following the CJEU’s judgements in Meo and Vodafone Portugal. HMRC’s new position, set out in HMRC’s Revenue and Customs Brief 12/20[13], states that charges arising from early contract termination will generally be subject to VAT. Notably, this includes payments described as compensation or liquidated damages.

Prior to Brief 12/20, which was published in September, payments arising out of early contract termination were generally treated as outside the scope of VAT. In particular, payments would only be outside the scope of VAT to the extent that the termination payment, or the payment of liquidated damages, was contemplated in the relevant contract between the parties.

Following the CJEU’s decision in Meo[14] and Vodafone Portugal,[15], HMRC has revised this position, now concluding that payments by a customer for early termination or cancellation of a contract in fact constitutes consideration for the original supply that the customer had contracted for. The new position applies to cases where the original contract contemplates such a payment, as well as cases where a separate agreement (outside of the original contract) is reached.

In Meo, the CJEU held that early termination charges (in the case at issue, under a telecom contract) reflect consideration for the supply of the original services, regardless of whether the customer uses that supply or not. More recently, in Vodafone Portugal, the CJEU confirmed that this would be the case even where the payment is not calculated by reference to the value of the services that would have been provided under the contract (but for the termination). HMRC’s guidance confirms that, for the payment to be subject to VAT, there just needs to be a “direct link” between the termination payment and a taxable supply.

Rate of VAT

While we would expect the VAT treatment of termination payments to match the VAT treatment of the underlying supplies, it is not entirely clear whether this will be the case or whether such payments will be standard-rated. Further clarification is expected on this point.

Retrospective effect

Brief 12/20 states that any taxable person that has failed to account for VAT to HMRC on such termination payments should correct the error. This implies that HMRC intends the guidance to apply retrospectively. While it is not mentioned, we would expect the general VAT time limits for correcting past errors to apply. Consequently, termination payments received in accounting periods that ended within the past four years should be reviewed. If an adjustment is required, the supplier will need to pay the VAT due to HMRC and amend their VAT returns. (HMRC has not stated whether it intends to charge interest and/or penalties on any late-paid VAT where an adjustment is required. However, we would expect further clarification from HMRC on this point).

Suppliers should, in such circumstances, consider whether the contractual terms underlying the supply would enable them to pass the VAT cost on to their counterparty. However, even if counterparties are required, under such contracts, to bear the cost of such VAT, given the passage of time, there may be practical difficulties in recovering these amounts, particularly given the current economic climate. Looking forward, early termination and compensation clauses should be drafted to account for VAT costs and potential VAT adjustments.

Particular applications

Property-related transactions

The revised guidance will likely have a significant impact on property-related contracts. The VAT position of landlords, property managers and developers should be reviewed where termination payments have been charged. Past and future payments for breaking a commercial lease will likely be subject to UK VAT, where the landlord has opted to tax the property. Similarly, for residential developers, termination payments incurred in connection with certain construction-related services (e.g. architect fees, surveyor costs, supervisory services), where these services do not constitute a single “design and build” contract, may attract UK VAT at the standard rate. It is expected that payments for breach of contract, such as dilapidation payments, will remain outside the scope of VAT.

M&A break-up fees

There is a question as to whether the guidance extends to “break-fees” – a common compensatory clause in an M&A context, which requires one party to compensate the other if the agreement does not complete. This so-called “break-fee” is typically calculated as a percentage of the consideration that would have been payable had completion occurred. We consider it likely that:

Where the contract provides for the seller (or the target) to pay the break-fee, the fee should not be subject to VAT. This is on the basis that the payment is disconnected from the consideration for the supply (that would otherwise have been made) under the contract – as that consideration would have come from the buyer, rather than the seller.
If the break-fee is payable by the buyer, it is possible that the payment may be subject to VAT. However, the circumstances do differ from those contemplated in HMRC’s updated guidance – which describes the early termination of a supply that has (to some extent at least) taken place. A break fee, in contrast, is payable in circumstances where completion never occurred, and no supply was ever made from the seller to the buyer. On that basis, HMRC may take the view that break fees are outside the scope of VAT, even if payable by the buyer. In any event, if the contract was for the sale of shares, that supply would have been exempt from VAT, and the same treatment should extend to the break-fee.

Brexit

On 31 December 2020, the Brexit transition period will come to an end and the legal consequences of the UK’s decision to leave the EU will take effect. This will have implications from a tax perspective – irrespective of whether a no-deal Brexit can be avoided. While the UK direct tax, and transfer tax, consequences are expected to be minimal, there will be some changes to national insurance contribution and VAT rules. Most significantly, customs duties may apply on the importation of a range of goods into the UK from the EU customs market (and vice versa). Indeed, the consequences are not limited to UK tax: leakage may be suffered on investment structures involving the UK and any of Germany, Italy and / or Portugal and certain EU resident subsidiaries of UK resident companies may face obstacles in accessing US double tax treaties.

Although the UK left the EU on 31 January 2020, from a tax perspective at least, the effect will not be felt until the end of the transition period, at 11pm on 31 December 2020. A non-exhaustive list of the key changes that will then take effect are set out below.

UK direct tax

The legal effects of Brexit will be minimised by the European Union Withdrawal Act 2018 (the “Withdrawal Act”). Broadly, the Withdrawal Act provides: (a) for EU law to be retained as a part of UK domestic law (except to the extent specifically repealed by the UK parliament) and (b) for EU case law, handed down prior to the end of the transition period, to remain binding for UK legal (and tax) purposes – to the extent not overruled by a decision of the UK Supreme Court or (as is proposed) High Court[16]. As a result, significant changes to UK direct taxes are not expected on 31 December.[17]

Nevertheless, there will be changes (and practical difficulties too). While it seems likely that the UK parliament may be keen to exercise these new powers, the enthusiasm of the UK courts remains to be seen. In the recent Volkerrail[18] case, the First Tier Tribunal opted to disapply certain UK tax provisions (restricting the surrender of losses between UK resident, and UK branches of EU resident, taxpayers) on grounds of incompatibility with EU law. Should HMRC appeal, it may present one of the first opportunities to test the High Court’s interest in exercising their freedom to depart from the CJEU. Moreover, following the end of the transition period, UK courts will no longer be able to refer questions about the application of EU law to the CJEU. Last week’s referral from the Upper Tribunal to the CJEU in Gallagher[19] (regarding the compatibility with EU law of territorial limitations on UK relief for intra-group transfers) is likely to be the last of its kind. Thus, even if retained EU laws remain on UK statute books, there is scope for conflicting applications in the EU and the UK– bringing an inherent risk of double taxation and enhanced compliance costs.

UK transfer taxes

Certain provisions of EU law prevent a 1.5% stamp duty / stamp duty reserve tax charge applying: (a) on issuances of securities into a clearing system or depositary receipt system in connection with the raising of capital or (b) on transfers of securities into such systems which are integral to such capital raising. The UK government has confirmed that these reliefs, which are frequently relied upon in capital markets transactions, will be retained.

Social security contributions

EU regulations[20], which prevent internationally mobile workers from paying social security contributions in more than one EU member state, will cease to apply from 31 December. (For existing arrangements, a slight extension has been provided for “so long as the [arrangements] continue without interruption”). The UK has introduced legislation which (broadly) attempts to replicate the positon under the regulations. However, as (most) EU member states have not reciprocated, the risk of double tax continues. The UK has, however, secured a bilateral agreement with Ireland, and intends to pursue similar agreements with other member states.

VAT

Under current rules, goods imported into the UK from the EU (and vice versa) are generally subject to acquisition VAT – which the importer accounts for by way of reverse charge (if registered for VAT purposes). From the end of the transition period, such imports will instead be subject to import VAT (which under current rules, must be accounted for immediately). The UK government has introduced legislation, to take effect from 31 December, to ensure that this change does not accelerate the time at which importers must account for VAT. Equivalent treatment will be extended to imports from non-EU jurisdictions as well.

Customs duties

The cost of the UK’s departure from the EU is likely to be most apparent in the context of customs duties. From 31 December 2020, (except to the extent otherwise agreed) customs duties, at rates determined by applicable World Trade Organisation (“WTO”) trading terms, will apply on goods imported into the UK from the EU (and vice versa). The UK published its WTO trading terms (the so-called “UK Global Tariff”) in May[21]. That contemplates that approximately 60% of items will be tariff-free, with the remaining 40% attracting duties at an average rate of approximately 6%. The EU, meanwhile, will apply its “Common External Tariff” (which imposes duties at an average rate of approximately 7%) to imports from the UK. Even if a “no-deal Brexit” can be avoided, any agreement under consideration at the moment is unlikely to be sufficiently expansive to materially improve this position. As the EU is the UK’s largest global trading partner, the economic impact is expected to be significant.

European tax

The UK’s departure from the EU may also impact taxpayers’ position under the laws of EU member states. In particular, taxpayers will need to consider whether they can continue to access reliefs available under (a) the EU Interest and Royalties Directive[22] (the “IRD”), which generally prevents withholding tax arising on intra-group payments of interest and royalties and (b) the EU Parent / Subsidiary Directive[23], which generally prevents withholding tax and direct tax applying on dividend payments (in each case, between EU-resident companies). Interestingly, the UK Withdrawal Act operates to preserve the benefit of these EU tax reliefs for EU taxpayers transacting with UK taxpayers. Unfortunately, this position has not been reciprocated by EU member states. As a result, even if treaty relief is available, (a) dividends paid from German entities to UK entities will now be subject to German withholding tax of at least 5%, (b) intra-group interest and royalties paid between UK- and Italian- resident companies will generally be subject to withholding tax of at least 10% and 8%, respectively and (ii) intra-group interest and royalties paid between UK- and Portuguese- resident companies will generally be subject to withholding tax of at least 10% and 5%, respectively (in each case subject to any domestic reliefs).

Finally, for EU-resident subsidiaries of UK-resident companies, access to treaty relief under their residence jurisdiction’s treaty with the US may be impeded. This is because their parent would no longer be a resident of an EC / EEA member state for the purposes of the “derivative benefits” exemption to the limitation of benefits article in the treaty. For further information, see our Client Alert on the subject.

Going forward

The Withdrawal Agreement’s retention of EU retained law will, to some extent, smooth the end of the transition period. However, significant portions of retained EU law cannot fully maintain the status quo, because this would require reciprocity from EU member states. It is therefore hoped that the UK government will continue to engage with EU member states (bilaterally if necessary) to remove (or at least reduce) leakage on EU/UK transactions.

More generally, from the end of the transition period, it can be expected that EU and UK tax law will begin to diverge. The extent of this divergence, and the substantive areas in which UK policy and legislation will depart from the EU, remain to be seen. Nevertheless, (particularly in the administratively-heavy field of VAT) it seems likely that the mere fact of such divergence will generate increased compliance costs for pan-European businesses.

B. Notable Cases

I. Blackrock HoldCo 5 LLC v HMRC [2020] UKFTT 443 (TC)

HMRC sought to disallow UK tax deductions for all of the interest payable on $4 billion worth of loans pursuant to UK and international transfer pricing rules and the unallowable purpose rule contained in the Corporation Tax Act 2009. The First-tier Tribunal rejected HMRC’s arguments and found for the taxpayer in respect of both issues. However, it is likely that HMRC will appeal the decision.

This case arose following HMRC’s decision to disallow the deduction by BlackRock Holdco 5 LLC (“LLC5”) of loan relationship debits in respect of interest payable on $4 billion worth of loan notes issued by LLC5 to its parent company, Blackrock Holdco 4 LLC (“LLC4”), under each of the unallowable purpose and transfer pricing rules.

Background

LLC5 appealed HMRC’s decision in the First-tier Tribunal (“FTT”) and the following issues were identified in the appeal:

Was a / one of the main purpose[s] of LLC5 being a party to the loan relationships with LLC4 to secure a tax advantage for LLC5 or any other person?
What amount of any debit is attributable to the main purpose of securing a tax advantage (if any) on a just and reasonable apportionment? (issues 1 and 2 being the “Unallowable Purpose Issue”)
Do the loans between the LLC5 and LLC4 differ from those which would have been made between independent enterprises? (the “Transfer Pricing Issue”)

The dispute with HMRC arose from the acquisition structure of the US part of Barclays Global Investors business (“BGI US”) in December 2009. Blackrock Holdco 6 LLC, (“LLC6”), LLC4 and LLC5 were incorporated on 16 September 2009 and LLC 4 elected to be a disregarded entity for US tax purposes and as such interest accruing to it from the acquisition would not be taxed in the US.

On 31 March 2012, LLC5 entered into a loan agreement with LLC6, pursuant to which LLC6 loaned $92,640,000 to LLC5. . LLC5 used these funds to make the interest payments due on certain tranches of the loan notes. On 30 September 2012, LLC5 entered into a loan agreement with LLC6, pursuant to which LLC6 loaned $92,728,008 to LLC5. LLC5 used these funds to make the interest payments due to LLC4 in September 2012 on certain tranches of the loan notes.

LLC5 filed company tax returns for accounting periods ending 30 November 2010 to 31 December 2015 and claimed deductions on its interest expenses under the loan notes for the relevant accounting periods.

For each of the returns, HMRC concluded that “no amount of the interest payable or the finance charges/or the payment to vary the terms of loan notes/or the other finance costs [by LLC5 in respect of the Loan Notes in the return period] is deductible for UK tax purposes and no amount may be included within the non-trade deficits arising on loan relationships as recorded on the company tax return for the period.”

Unallowable Purpose Issue

The relevant provisions of the Corporation Taxes Act 2009 as applicable at the time of the transaction provided are contained in sections 441 and 442. In summary, Section 441 provided that a company may not bring into account any debits which on a “just and reasonable apportionment” is attributable to an unallowable purpose. Section 442 provided that a loan relationship of a company has an unallowable purpose if a party to the relevant loan relationship entered into a transaction which included a purpose (“the unallowable purpose”) which is not amongst the business or other commercial purposes of the company. Section 442 further provided that a tax avoidance purpose is only regarded as a business or other commercial purpose of the company if it is not “(a) the main purpose for which the company is a party to the loan relationship or, as the case may be, enters into the related transaction, or (b) one of the main purposes for which it is or does so”. References to a tax avoidance purpose are references to any purpose which consists of securing a tax advantage for the company or any other person.

Tax advantage is construed widely under the Corporation Tax Act 2010 as “a relief from tax or increased relief from tax…”

The FTT quoted a number of cases in relation to the identification of the “purpose” of a company.[24] The FTT went on to state that it was common ground that the deduction of loan relationship debits in respect of interest is a tax advantage and that it is the subjective purpose of LLC5 that is to be considered in order to determine whether securing a tax advantage was the “main purpose” or “one of the main purposes” of its loan relationship with LLC4. The FTT considered the evidence of a board member of LLC5 who stated that he had not taken account of any UK tax advantage in the decision to proceed with the relevant transaction. The FTT adopted the reasoning of the House of Lords in Mallalieu v Drummond, and stated that it was necessary to look beyond the conscious motives of LLC5 and take into account the inevitable consequences of entering into the loan relationship with LLC4 – one of which was the securing of a tax advantage. The FTT concluded that there was both a commercial and tax purpose in entering into the relevant loans and as such it was necessary to consider a “just and reasonable apportionment”. The FTT followed the obiter comments of Judge Beare in Oxford Instruments UK 2013 Limited v HMRC and concluded that as the tax advantage purpose had not increased the debits, on a “just and reasonable basis”, all of the relevant debits arising in respect of the relevant loans should be apportioned to the commercial main purpose rather than the tax advantage main purpose.

The Transfer Pricing Issue

The FTT considered whether the terms of the loans entered into between LLC5 and LLC4 differ from those which would have been made between independent enterprises, taking account of all relevant information, including:

(a) Would the parties have entered into the loans on the same terms and in the same amounts if they had been independent enterprises?

(b) If the answer to question (a) is negative, would they, as independent enterprises, have entered into the loans at all, and if so, in what amounts, at what rate(s) of interest, and on what other terms?

The FTT took into account the analysis of expert witnesses on behalf of LLC5 (the “Joint Statement”) and HMRC (the “Gaysford Statement”) relating to transfer pricing. Both the Joint Statement and the Gaysford Statement agreed that it would have been possible for LLC5 to execute a $4 billion debt transaction in December 2009 with an independent enterprise at similar interest rates to the actual transaction that took place between LLC5 and LLC4, but subject to different terms and conditions that independent lenders would have required to manage the credit risks appropriately.

The FTT stated that although paragraph 1.42 of the Organisation for Economic Co-operation and Development (OECD) Guidelines[25] recognises that, “it may be helpful to understand the structure and organisation of the group and how they influence the context in which the taxpayer operates”, it is clear from the OECD Guidelines that a separate entity approach should be adopted. This approach is outlined in paragraph 1.6 of the OECD Guidelines as follows: By seeking to adjust profits by reference to the conditions which would have obtained between independent enterprises in comparable transactions and comparable circumstances (i.e. in “comparable uncontrolled transactions”), the arm’s length principle follows the approach of treating the members of an MNE [multinational enterprise] group as operating as separate entities rather than as inseparable parts of a single unified business. The FTT noted that such an approach is also consistent with the UK tax legislation, namely section 147(1)(a) Taxation (International and Other Provisions) Act 2010, which concerns the transaction or series of transactions made or imposed between “any two persons”. Accordingly, the FTT stated that the transactions to be compared are the actual transaction, a $4 billion loan by LLC4 to LLC5 and the hypothetical transaction, a $4 billion loan by an independent lender to LLC5 having regard to the covenants which such an independent lender would have required. The FTT concluded that, given the expert evidence, even though an independent enterprise would not have entered into the relevant loan on the same terms as the actual transaction it would, subject to various covenants, have entered into the relevant loans on the same terms as the parties in the actual transaction.

II. Dunsby v HMRC [2020] UKFTT 0271 (TC) and Bostan Khan v HMRC [2020] UKUT 168 (TCC) (2 June)

The First Tier Tribunal and the Upper Tribunal (“UT”) recently considered and applied the Ramsay principle of statutory interpretation in two separate cases: Dunsby v Revenue and Customs Commissioners [2020] UKFTT 271 (TC) and B Khan v HMRC [2020] UKUT 168 (TCC) (2 June), respectively. Its application in these cases sheds some light on limitations of the principle, including that the UK courts will not recharacterise a composite transaction if the purposive interpretation of relevant tax legislation does not require it.

Briefly, the facts in Dunsby were as follows: the appellant (“D”) was the sole original shareholder and director of a company (the “Company”). D and the Company implemented a tax avoidance scheme (sold to them by a promoter) that was, in the words of the FTT, designed to allow shareholders in trading companies with distributable profits to receive those profits free of income tax. Broadly, the scheme involved the Company issuing a single share in a new class (the “S share”) to a non-UK resident, unconnected recipient (“G”). In exchange for a small subscription amount (£100), the holder of the S share had the right to receive income profits and distributions, but had no voting rights. The return of capital of the S share was limited to its nominal value. G created a Jersey trust (the “Trust”) and transferred the S share to the trustee. The terms of the trust essentially provided a de minimis hurdle payment for a charity; a de minimis hurdle payment for G and the majority of any further income (98%) would be received on trust for the benefit of D (0.5.% and 1.5% of the further income would go to a charity and G, respectively). The Company declared a single dividend payment in respect of the S Share. D did not pay income tax on the amount received. HMRC (by way of a closure notice) amended D’s self-assessment tax return – D appealed. The FTT dismissed the appeal, finding that the payment from the Company would be treated as income (and therefore taxable as income) received by D (either under the settlements anti-avoidance legislation, or – if that was the incorrect basis – under the transfer of assets abroad legislation). HMRC successfully argued that the receipt was to be treated as income to D under the settlements legislation.

What is particularly interesting about the judgment, however, is the FTT’s application of Ramsay to arguments proposed by HMRC. The FTT (in dismissing one of HMRC’s arguments) set out that it would be an incorrect interpretation of the Ramsay principle to, when applying tax legislation to a factual scenario, simply disregard transactions or elements of transactions which had no commercial purpose. Such an approach was dismissed by the FTT as “going too far”. In Dunsby, HMRC had tried to argue an interpretation that ignored the true facts of the arrangement. The payments from the Company were in accordance with company law treatment of the transactions. When applying tax legislation to a set of facts, two steps are required: (i) determine on a purposive basis the precise transaction the provisions are to apply to; and (ii) apply that tax legislation to the transaction identified. The Ramsay principle was whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically (Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46 at [35]). Whilst the taxpayer was unsuccessful in this case, Dunsby serves as a reminder as to some of the limits of the Ramsay principle, frequently used by HMRC in defending its position.

The UT in B Khan[26] considered – and dismissed – arguments put forward by HMRC based on the Ramsay principle. The case concerned the tax treatment of the sale of a target company (the “Company”) to an individual (“K”) and of subsequent payments made from the Company. K acquired 100% of the Company for £1.95 million plus the net asset value of the Company. Immediately following the acquisition, the Company bought back 98 of the total 99 shares for consideration of £1.95 million. HMRC issued a closure notice, amending K’s tax return by increasing the income tax due (on the basis that the buy-back of the 98 shares was a taxable distribution and subject to income tax).

K’s (unsuccessful) appeal to the UT was based on the grounds that the FTT erred in failing to recognise the “true substance” of the transaction, which K asserted was that it was a composite transaction pursuant to which K, in return for entering into the various transactions, received the remaining share in the Company without £1.95 million distributable reserves. On this basis K (unsuccessfully) asserted that his income tax liability should have been calculated on his net receipt of the single share (rather than the single share, plus £1.95 million).

Of note with respect to the Ramsay principle, the FTT considered whether the construction of a tax statute, using a purposive statutory interpretation, required the court to consider solely one element of a composition transaction or, on the other hand, the whole of the transactions viewed together as a composite. The UT considered a line of case law that sets out what it considers to be the modern approach to the interpretation of taxing statutes (Barclays Mercantile Business Finance Ltd v Mawson [2005] STC 1; UBS AG and DB Group Services v HMRC [2016] UKSC 13; Inland Revenue Commissioners v Wesleyan and General Assurance Society (1946) 30 TC 11). The UT found that, whilst the process of statutory construction may reveal the relevance or otherwise of the economic effect of transactions, it should not be assumed that economically equivalent transactions should be taxed in the same way. The UK courts will not re-characterise a composite transaction if the purposive interpretation of relevant tax legislation does not require it.

III. Bluejay Mining plc [2020] UKFTT 473 (TC)

HMRC denied Bluejay Mining plc (“Bluejay”) credit for input VAT incurred for the relevant VAT accounting period on the basis that Bluejay, a holding company, was not making taxable supplies to its subsidiaries for consideration and/or that there was no economic activity being carried on by Bluejay. The FTT instead found that Bluejay was carrying on an economic activity and allowed the appeal.

Bluejay is a UK incorporated holding company which is listed on the Alternative Investment Market. It operates in the mineral exploration and mining industry. Bluejay’s business model broadly consisted of Bluejay identifying a possible mining project following which the necessary exploration licence would be acquired by a locally resident subsidiary. Bluejay would provide technical services to the local subsidiary and would loans the funds to pay for such services to the local subsidiary. If and when the project is successful or the licences and relevant assets are sold to another company which is willing and able to take the project to exploitation, the intracompany debt is repaid.

As explained by the FTT, HMRC’s position was that Bluejay’s central activity is to make a return through investing by buying shares in foreign mining companies. It also supplies technical services to its foreign subsidiaries. HMRC contended that in order to be able to claim input tax in relation to supplies of the services to the subsidiaries, Bluejay needed to be able to show that those services are supplied in return for a consideration. It also needed to show that those services are provided for the purpose of generating income on a continuing basis from the provision of those services, i.e., that it is carrying on an economic activity. Accordingly, HMRC’s position was that the purpose of the provision of the services was not to generate income on a continuing basis but to enhance the value of Bluejay’s investment in the subsidiary, and, as such, the services did not amount to an economic activity. The FTT noted that HMRC’s position required a re-characterisation of the contracts between Bluejay and its subsidiaries as HMRC were arguing that the “contracts as drafted do not represent the economic and commercial reality of the situation”.

The FTT concluded that the contracts do reflect the underlying economic and commercial reality of the transactions. The FTT stated that it was important that “the contract for services provides that invoices are to be settled within 30 days of the invoice being submitted and I cannot see this as anything other than consideration for the services rendered”.

In relation to the question as to whether Bluejay was carrying on an economic activity, the FTT considered the case of Polysar Investments Netherlands v Inspecteur der Invoerrechten en Accijnzen C-60/90[27] in the Court of Justice of the European Union (“CJEU”) and concluded that it is necessary to examine the actual services provided to a subsidiary in order to establish if the holding company is carrying on an economic activity. The FTT concluded that Bluejay was carrying on an activity when supplying technical services to its subsidiaries. It remains to be seen whether HMRC will appeal the decision.

____________

[1] The Pillar 1 blueprint is available here: https://www.oecd.org/tax/beps/tax-challenges-arising-from-digitalisation-report-on-pillar-one-blueprint.pdf

[2] The Pillar II blueprint is available here: https://www.oecd.org/tax/beps/tax-challenges-arising-from-digitalisation-report-on-pillar-two-blueprint.pdf

[3] https://www.oecd.org/tax/dispute/mutual-agreement-procedure-statistics.htm and https://www.oecd.org/tax/dispute/mutual-agreement-procedure-2019-awards.htm

[4] Directive (EEC) 90/463 on the elimination of double taxation in connection with the adjustment of associated enterprises (the so-called “Union Arbitration Convention”) and Directive (EU) 2017/1852 on tax dispute mechanisms in the EU (the so-called “Arbitration Directive”)

[5] https://twitter.com/benjaminangelEU/status/1330223479300497410

[6] Mission letter of President-elect Von der Leyen to Vice-President Dombrovskis, 10 September 2019. https://ec.europa.eu/commission/sites/beta-political/files/mission-letter-valdis-dombrovskis-2019_en.pdf

[7] European Commission Inception Impact Assessment. Ref. Ares(2020)7030524 – 23/11/2020 https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12632-Tax-fraud-evasion-strengthening-rules-on-administrative-cooperation-and-expanding-the-exchange-of-information

[8] “Eligible entities” are generally bodies corporate, but can also include individuals, partnerships and Scottish partnerships, in certain circumstances.

[9] For UK VAT purposes, a “fixed establishment” is an ‘establishment other than the business establishment, which has the human and technical resources necessary for providing or receiving services permanently present’ (HMRC VAT Notice 741A).

[10] Skandia America Incorporation (USA), filial Sverige v Skatteverket (Case C-7/13) EU:C:2014:2225 (17 September 2004) (Advocate General: M. Wathelet).

[11] https://www.gov.uk/government/publications/vat-grouping-establishment-eligibility-and-registration-call-for-evidence

[12] Melford Capital General Partner v Revenue and Customs Commissions [2020] UKFTT 6 (TC)

[13] https://www.gov.uk/government/publications/revenue-and-customs-brief-12-2020-vat-early-termination-fees-and-compensation-payments/revenue-and-customs-brief-12-2020-vat-early-termination-fees-and-compensation-payments

[14] MEO – Serviços de Comunicações e Multimédia SA v Autoridade Tributária e Aduaneira (Case C-295/17) EU:C:2018:942 (22 November 2018) (Advocate General: J. Kokott).

[15] Vodafone Portugal – Comunicações Pessoais, SA v Autoridade Tributária e Aduaneira (Case C-43/19)EU:C:2020:465 (11 June 2020) (Advocate General: G. Pitruzzella)

[16] Although the UK government has announced that it intends for the UK High Court to also have such power, legislation is not yet in place. Cases decided by the CJEU after 31 December 2020 will be merely persuasive authorities in UK proceedings.

[17] Following the end of the transition period, UK courts will no longer be able to refer questions about the application of EU law to the CJEU. In what may well be the last such referral for UK tax purposes, the UK’s Upper Tribunal this week referred questions to the CJEU about the compatibility of certain UK tax provisions (relating to reliefs for intra-group transfers) with EU law. The responses of the CJEU will only be relevant for transfers taking place prior to 31 December 2020.

[18] Volkerrail Plant Ltd and others v HMRC [2020] UKFTT 476 (TC)

[19] Gallaher Ltd v HMRC [2020] UKUT 354 (TCC). The responses of the CJEU will only be relevant for transfers taking place prior to 31 December 2020.

[20] Regulations (EC) No. 883/2004 and 987/2009

[21] For further information see https://www.gov.uk/guidance/uk-tariffs-from-1-january-2021

[22] Council Directive 2003/49/EC

[23] Council Directive 2011/96/EU

[24] House of Lords case of Inland Revenue Commissioners v Brebner 1967 2 AC 18 as authority that it is the company’s subjective purposes that mattered. The case of Mallalieu v Drummond (Inspector of Taxes) 1983 2 AC 861 as authority that when identifying a “subjective purpose”, such purpose can be wider than the conscious motive of the person concerned. In the case of Oxford Instruments UK 2013 Limited v HMRC 2019 UKFTT 254 (TC), Judge Beare considered the extent to which on a “just and reasonable apportionment” how much of any debit is attributable to an unallowable purpose whereby there are one or more commercial main purposes. Judge Beare stated that “as long as the company can show that it had one or more commercial main purposes unrelated to any tax advantage in entering into, and remaining party to, that loan relationship, and that the relevant debits would have been incurred in any event, even in the absence of the company’s tax advantage main purpose in so doing, then none of the relevant debits should be apportioned to the tax advantage main purpose”. Judge Beare’s comments on this issue did not form part of the court’s conclusion on the facts of that particular case but provides a helpful analysis.

[25] Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations approved by the OECD on 22 July 2010

[26] B Khan v HMRC [2020] UKUT 168 (TCC) (2 June)

[27] In Polysar, the CJEU stated as follows: “It does not follow from that judgment, however, that the mere acquisition and holding of shares in a company is to be regarded as an economic activity, within the meaning of the Sixth Directive, conferring on the holder the status of a taxable person… It is otherwise where the holding is accompanied by direct or indirect involvement in the management of the companies in which the holding has been acquired, without prejudice to the rights held by the holding company as shareholder”.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the Tax Practice Group or the authors:

Sandy Bhogal – London (+44 (0)20 7071 4266, [email protected])

Benjamin Fryer – London (+44 (0)20 7071 4232, [email protected])

Bridget English – London (+44 (0)20 7071 4228, [email protected])

Fareed Muhammed – London (+44(0)20 7071 4230, [email protected])

Barbara Onuonga – London (+44 (0)20 7071 4139,[email protected])

Aoibhin O’ Hare – London (+44 (0)20 7071 4170, [email protected])

Avi Kaye – London (+44 (0)20 7071 4210, [email protected])

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

On December 22, 2020, Congress passed the content of a pending bill, H.R. 6196, the “Trademark Modernization Act of 2020,” as part of its year-end virus relief and spending package.[1] The Act includes various revisions to the Lanham Act, 15 U.S.C. §§ 1051 et seq., intended to respond to a recent rise in fraudulent trademark applications. Among other things, the Act seeks to create more efficient processes to challenge registrations that are not being used in commerce, including by establishing new ex parte proceedings. The Act also seeks to unify the standard for irreparable harm with respect to injunctions in trademark cases, in light of inconsistencies that have emerged across federal courts after the Supreme Court’s decision in eBay v. MercExchange, LLC, 547 U.S. 388 (2006). We briefly summarize these key features of the Act below.

Presumption of Irreparable Harm. Section 6 of the Act provides that a “plaintiff seeking an injunction shall be entitled to a rebuttable presumption of irreparable harm” upon a finding of a violation or a likelihood of success on the merits, depending on the type of injunction sought.[2] That language effectively reinstates the standard that most courts applied in trademark cases until the Supreme Court’s decision in the patent case, eBay v. MercExchange, LLC, 547 U.S. 388 (2006). Before eBay, courts generally treated proof of likelihood of confusion as sufficient to establish both a likelihood of success on the merits and irreparable harm. In eBay, however, the Supreme Court concluded that courts deciding whether an injunction should issue must consider only “traditional equitable principles,” which do not permit “broad classifications.” Id. at 393. In light of that decision, some courts determined that liability for trademark infringement no longer presumptively supported injunctive relief and that irreparable injury had to be shown independently.[3] This Act resolves the division among the courts following eBay and clarifies that a rebuttable presumption of irreparable harm applies for trademark violations.
New Ex Parte Processes. Section 5 of the Act creates two new ex parte cancellation proceedings, designed to address concerns that the trademark register is becoming overcrowded with marks that have not been used in commerce properly, as the Lanham Act requires.[4] The first creates a new Section 16A to the Lanham Act, that allows for ex parte expungement of a registration that has never been used before in commerce.[5] The second creates a new Section 16B to the Lanham Act that allows for ex parte reexamination of a registration where the mark was not in use in commerce at the time of either the first claimed use, or when the application was filed.[6] The Act further authorizes the Director to promulgate regulations regarding the conduct of these proceedings.[7]
Changes to the Examination Process. The Act establishes two notable updates to the trademark examination process: first, it formalizes the process by which third-parties can submit evidence to the United States Patent and Trademark Office concerning a given application; second, it provides the Office with greater authority and flexibility to set the deadlines by which trademark applicants must respond to actions taken by the examiner.
- Third-Party Evidence: The Act effectively codifies the longstanding informal practice by which third parties submit evidence to the Office regarding the registrability of a mark during the examination process. Section 3 expressly permits the submission of this evidence and also establishes new formalities concerning the process to do so—including by requiring that the submitted evidence include a description identifying the ground of refusal to which it relates, and by providing the Office with the authority to charge a fee for the submission.[8]
  The Act also imposes a two-month deadline for the Office to act on a third-party submission,[9] which should incentivize third-parties to submit relevant evidence to the examiner before he or she makes any decision on an initial application.
- Response Times: Section 4 of the Act amends the Lanham Act’s provision that imposes a six month deadline for an applicant to respond to an examiner’s actions during the application process.[10]
  Specifically, Section 4 grants the Office the authority to determine, by regulation, response periods for different categories of applications, so long as the period is between 60 days and six months.[11]

It remains to be seen how the Office will interpret the Act and what procedures it will promulgate. It is also an open question whether the new ex parte and examination procedures created by the Act will address Congress’ underlying concerns that the register has become overcrowded with fraudulent registrations obtained by foreign entities, especially from China.[12] But it is clear that the Act will open up new fronts for administrative proceedings to challenge registered trademarks, and create new weapons for those who believe they are or would be affected by a pending application or registration. At the same time, the restoration of a formal presumption of irreparable harm in trademark infringement cases will make it procedurally easier for trademark owners to enjoin uses of confusingly similar marks and avoid consumer confusion about the source of a good or service.

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[1] See Office of Congressman Hank Johnson, Congressman Johnson’s Bipartisan, Bicameral Trademark Modernization Act Becomes Law, available at https://hankjohnson.house.gov/media-center/press-releases/congressman-johnson-s-bipartisan-bicameral-trademark-modernization-act (Dec. 22, 2020).

[2] The Act also clarifies that this amendment “shall not be construed to mean that a plaintiff seeking an injunction was not entitled to a presumption of irreparable harm before the date of the enactment of this Act.” H.R. 6196 § 6(a).

[3] See, e.g., Herb Reed Enters., LLC v. Fla. Entm’t Mgmt., Inc., 736 F.3d 1239, 1249 (9th Cir. 2013) (reading eBay as signaling “a shift away from the presumption of irreparable harm” and holding that a plaintiff must separately establish irreparable harm for a preliminary injunction to issue in a trademark infringement case); Salinger v. Colting, 607 F.3d 68, 78 n.7 (2d Cir. 2010) (suggesting that eBay’s “central lesson” that courts should not “presume that a party has met an element of the injunction standard” applies to all injunctions); see also Voice of the Arab World, Inc. v. MDTV Med. News Now, Inc., 645 F.3d 26, 31 (1st Cir. 2011) (questioning whether, after eBay, irreparable harm can be presumed upon a finding of likelihood of success on the merits of an infringement claim).

[4] See H.R. 6196 § 5(a); House Report Section C.1 (explaining the intent behind the new proceedings).

[5] H.R. 6196 § 5(a).

[6] Id. § 5(c).

[7] Id. § 5(d) (providing that the Director “shall issue regulations to carry out” the new “sections 16A and 16B” “[n]ot later than one year after the date of the enactment of this Act.”).

[8] See H.R. 6196 § 3(a) (“A third party may submit for consideration for inclusion in the record of an application evidence relevant to a ground for refusal of registration. The third-party submission shall identify the ground for refusal and include a concise description of each piece of evidence submitted in support of each identified ground for refusal. Within two months after the date on which the submission is filed, the Director shall determine whether the evidence should be included in the record of the application. The Director shall establish by regulation appropriate procedures for the consideration of evidence submitted by a third party under this subsection and may prescribe a fee to accompany the submission.”).

[9] Id.

[10] See 15 U.S.C. § 1062(b).

[11] See H.R. 6196 § 4.

[12] See, e.g., Tim Lince, Fraudulent Specimens at the USPTO: Five Takeaways from Our Investigation – Share Your Experience, World Trademark Rev. (June 19, 2019), https://www.worldtrademarkreview.com/brand-management/fraudulent-specimens-uspto-five-takeaways-our-investigation-share-your (reporting on investigation of nearly 10,000 US trademark applications filed in May 2019 with many seemingly fraudulent specimens originating from China).

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please feel free to contact the Gibson Dunn lawyer with whom you usually work in the firm’s Intellectual Property, Fashion, Retail, and Consumer Products, or Media, Entertainment and Technology practice groups, or the following authors:

Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Alexandra Perloff-Giles – New York (+1 212-351-6307, [email protected])
Doran J. Satanove – New York (+1 212-351-4098, [email protected])

Please also feel free to contact the following practice leaders:

Intellectual Property Group:
Wayne Barsky – Los Angeles (+1 310-552-8500, [email protected])
Josh Krevitt – New York (+1 212-351-4000, [email protected])
Mark Reiter – Dallas (+1 214-698-3100, [email protected])

Media, Entertainment and Technology Group:
Scott A. Edelman – Los Angeles (+1 310-557-8061, [email protected])
Kevin Masuda – Los Angeles (+1 213-229-7872, [email protected])
Orin Snyder – New York (+1 212-351-2400, [email protected])

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

The substantive provisions of Hong Kong’s Competition Ordinance (“Ordinance”) came into force in December 2015. This note looks at the main achievements in the first five years and some of the challenges laying ahead.

The main achievements of the Hong Kong Competition Commission (“Commission”) are first and foremost building up—from scratch—a competent and trustworthy institution. The Commission has hired seasoned enforcers from overseas with impeccable reputations which has brought immediate credibility to the Commission. It has embarked on a wide range of educational activities, including seminars, advertising and publishing guidelines detailing its enforcement priorities and interpretation of the Ordinance. The Commission has also adopted a world-class leniency programme to facilitate the prosecution of cartels, its main priority. The Commission proceeded to win its first case in court thereby confirming that it is a force to be reckoned with.

Nevertheless, it is still early days and the Commission will face significant challenges in the next few years. The Competition Tribunal (“Tribunal”)’s decision in the Nutanix case that the criminal standard of proof applies where the Commission seeks to have financial penalties imposed is likely to limit the Commission’s enforcement activities to clear cut cartel cases, and prevent enforcement actions in relation to most cases of abuses of substantial market power. Also, while the Tribunal has vindicated the Commission’s decision to also prosecute individuals, the Tribunal still needs to rule on the level of fines that may be imposed on individuals. This will have a direct impact on the Ordinance’s deterrent effect and on incentives to self-report under the leniency policy.

Further, it remains to be seen whether the Government and the legislature will have any appetite to revise the Ordinance in order to foster more competition and give more teeth to the Ordinance. Among possible changes are an extension of the merger control regime, currently limited to the telecommunications sector, to apply generally to all sectors. Observers are also calling for an increase in the level of fines and the introduction of stand-alone private litigation.

1. The Competition Ordinance in a Nutshell

The Ordinance prohibits three types of conduct:

agreements and concerted practices having the object or effect of preventing, restricting or harming competition (“First Conduct Rule”);
abuses of a substantial degree of market power having the object or effect of preventing, restricting or harming competition (“Second Conduct Rule”); and
mergers in the telecommunications sector that are likely to have the effect of substantially lessening competition (“Merger Rule”).

The Commission does not have the power to impose sanctions on its own, but must apply to the Tribunal for that purpose. The Tribunal has wide-ranging powers, including the authority to impose fines of up to 10% of the Hong Kong turnover per year of infringement (up to a maximum of 3 years), impose a cease and desist order, disqualify directors, and award damages.[1]

A private party cannot bring a stand-alone action before the Tribunal. Instead, the Tribunal must first rule on the legality of the alleged contravention in proceedings commenced by the Commission, after which time, a private party can commence a follow-on action for damages.[2]

2. Cartels

The Commission has from the start made it clear that prosecuting cartels would be a priority. The adoption of a leniency regime was an important step towards that goal. The initial leniency programme, while a step in the right direction, contained too many disincentives to self-report cartel conduct. In 2020, the Commission brought major changes to its leniency policy and adopted what is clearly a world-class framework. In addition, the Commission attracted highly experienced officials from foreign competition agencies reinforcing the level of credibility of its leniency programme.

It is unclear at this stage to what extent the new leniency programme has been successful. As with other leading regimes, it is likely that additional cases resulting in high financial penalties (or penalties on individuals) are necessary before companies widely see the benefit of self-reporting in Hong Kong.

2.1 The Leniency Programme

Section 80 of the Ordinance grants the Commission the ability to enter into a “leniency agreement”.

Under the Leniency Policy for Undertakings, leniency is available for the first cartel member that either reports participation in a cartel which the Commission is not already investigating (known as Type 1 applicant) or provides substantial assistance to an ongoing investigation by the Commission (known as Type 2 applicant).[3] In exchange for a successful applicant’s cooperation with the Commission, the Commission will agree not to take any proceedings against it before the Tribunal in relation to the reported conduct. Because the Tribunal may only impose pecuniary penalties on application by the Commission, successful leniency applicants will therefore receive full immunity from pecuniary sanctions.[4]

For successful Type 1 applicants only, the Commission will also agree not to require the applicant to admit to a contravention of the First Conduct Rule. Because follow-on actions may only be initiated in Hong Kong after the Tribunal or another Hong Kong court has made a decision that an act is a contravention of a conduct rule, or when a person has made an admission to the Commission that the person has contravened a conduct rule, this will protect successful Type 1 leniency applicants from follow-on damages claims in Hong Kong. Type 2 applicants, on the other hand, may be require to admit to a contravention, potentially exposing them to follow-on damages claims.

The Leniency Policy for Individuals allows individuals to self-report anticompetitive conduct, in exchange for the Commission not initiating any proceedings against the leniency applicant in relation to the reported conduct.[5]

The Cooperation Policy establishes a framework by which cooperating cartel members that are not the first to report may receive a discount on the penalty that the Commission would otherwise recommend to the Tribunal.[6] The policy lays out several “bands” of discounts on the recommended pecuniary penalty based on the order in which participating undertakings express their interest in cooperating. Undertakings assigned to Band 1 will receive a discount of between 35% and 50% of the recommended penalty; those assigned to Band 2 will receive a discount of between 20% and 40%; and those assigned to Band 3 will receive a discount of up to 25%. The Commission will “ordinarily” assign the first undertaking to express its interest to cooperate to Band 1. Later applicants will be assigned to Band 2 or 3, depending on the order in which they came forward. The Commission may recommend a discount of up to 20% if an undertaking cooperates with the Commission only after enforcement proceedings against it have commenced. Finally, the Cooperation Policy offers an additional “leniency plus” discount: if a cooperating undertaking finds that, in addition to the first cartel, it has engaged in a completely separate cartel and enters into a leniency agreement with the Commission for its role in the second cartel, the Commission will apply an additional discount of up to 10% on the undertaking’s recommended pecuniary penalty for its role in the first cartel.

2.2 Enforcement Actions at the Tribunal

The Commission has initiated six enforcement actions before the Tribunal and they all concern cartel conduct. Decisions have been issued in two actions and the remaining four are pending as of the date of this article.

Competition Commission v Nutanix Hong Kong Limited and others: In its first enforcement action before the Tribunal, the Commission alleged that a supplier of IT equipment (Nutanix) had engaged in bid rigging with four of its distributors and resellers in relation to a tender conducted by the YWCA.[7] In particular, in order to ensure that YWCA would receive the required number of valid bids in order to award the contract, Nutanix had asked several of its distributors and resellers to submit a dummy bid. The Tribunal ruled in favor of the Commission, except in relation to one of the resellers for which it decided that the isolated conduct of the employee who prepared the dummy bid could not be attributed to its employer. The Tribunal imposed fines totalling about HKD 7 million and the defendants were ordered to pay the Commission’s costs for about HKD 9 million. This case is now before the Court of Appeal.

The main lesson from this decision is that the Tribunal confirmed that where the Commission seeks to have financial penalties imposed, the criminal standard of proof will apply. The Commission therefore has to demonstrate “beyond a reasonable doubt” that an infringement has taken place. This is likely to have a major impact on the Commission’s enforcement powers as it will make it very difficult for the Commission to have financial penalties imposed where the infringement does not have the “object” of restricting competition but only a possible “effect”. This would include, for example, most abuses of substantial market power, some forms of exchange of information, or agreements between competitors that have some pro-competitive effects. The Commission’s enforcement powers against these types of conduct may be limited to obtaining a cease and desist order, which should be subject to the civil standard of the balance of probabilities, which may not have a strong deterrent effect.

A second lesson from that case is that an employer does not enjoy privilege against self-incrimination with regard to statements made by its employees in the competition law context.[8] Section 45(2) of the Ordinance provides that no statements made by a person in responding to the Commission’s requests for information is admissible against that person in proceedings. The Tribunal found that, where the Commission’s requests for information are addressed to a natural person, the responses given by the individual are personal to him and do not bind his employer, such that the individual, and not the employer, is liable for any false or misleading answers. As such, the individual could not be perceived to be acting on behalf of his employer when he attends an interview before the Commission, even if he attends the interview with the employer’s lawyers. The Tribunal’s decision limits the beneficiary of the statutory protection against self-incrimination under Section 45(2) to the person compelled to attend before the Commission.

Finally, this case shows that although fines may be on the low side, the costs of defending a case before the Tribunal are significant. The defendants have likely spent over a combined USD 20 million to defend themselves (solicitors, barristers, experts,…), in addition to paying part of the Commission’s costs. The high cost of litigation in Hong Kong is a significant incentive to comply with the law or to promptly self-report problematic conduct.

Competition Commission v W. Hing Construction Company Limited and others: In April 2020, the Tribunal issued its second dispositive judgment and found that ten decoration contractors entered into a market sharing and price fixing agreement, in contravention of the First Conduct Rule, regarding the decoration works at a public rental housing estate.[9] Importantly, in this case, the Tribunal set out the methodology that it will follow when imposing fines on undertakings in breach of the prohibition on cartel conduct. The methodology is similar to the approaches taken in the UK and the EU. The Tribunal followed, by and large, the recommendations of the Commission but emphasized that while that there were strong public interest in facilitating cooperation by parties, at the same time that the Tribunal, as an independent Tribunal, is not bound by any recommendation of the Commission.

In particular, the Tribunal adopted a four-step approach in calculating the fine: (1) determining the base amount; (2) making adjustments for aggravating, mitigating and other factors; (3) applying the ceiling which a penalty may not exceed under the Ordinance; and (4) applying any fine reductions based on cooperation or an inability to pay. However, it should be noted that it remains unclear how the framework adopted by the Tribunal would apply in case of fines on individuals. Moreover, the facts did not require the Tribunal to assess a recommendation by the Commission on the fine reductions based on a party’s cooperation pursuant to the Commission’s Cooperation and Settlement Policy.

The noteworthy development in the four other pending cases is that the Commission decided to enforce the Ordinance against individuals. In Competition Commission v Kam Kwong Engineering Company Limited and others, the Commission commenced proceedings against three decoration contractors and two individuals at the Tribunal alleging that the parties entered into a market sharing and price fixing agreement regarding the decoration works at a subsidized sale flats housing estate.[10] Three of the parties admitted to the contravention and entered into a settlement with the Commission, which was approved by the Tribunal in July 2020.

In Competition Commission v Fungs E & M Engineering Company Limited and others, the Commission commenced proceedings against six decoration contractors (and three involved individuals) alleging that the parties entered into a market sharing and price fixing agreement regarding the decoration works at a public rental housing estate.[11] In this case, one of the involved directors admitted liability for a contravention of the First Conduct Rule and the Tribunal issued its first ever director disqualification order against that director, prohibiting him from serving as a director for one year and ten months.

In Competition Commission v Quantr Limited and another, the Commission issued its first infringement notices to Quantr Limited and Nintex Proprietary Limited alleging that the two companies exchanged information regarding the intended fee quotes in relation to a bidding exercise organized by Ocean Park.[12] Nintex accepted the Commission’s infringement notice and committed to comply with the requirements imposed by the Commission, which resulted in the Commission not commencing proceedings against Nintex. Quantr disputed the infringement notice and the Commission commenced proceedings against it and its sole director. In November 2020, Quantr and its sole director entered into a settlement with the Commission, where is admitted to a contravention of the First Conduct Rule and agreed to pay pecuniary penalty.

In Competition Commission v T.H. Lee Book Company Limited and others, the Commission commenced proceedings against three publishing companies (and one of their directors) alleging that the companies engaged in price fixing, market sharing, and/or bid-rigging in relation to tenders for the supply of textbooks to primary and secondary schools in Hong Kong.[13]

3. Other Nonmerger Enforcement Actions taken by the Commission

3.1 Court cases

On 21 December 2020, the Commission initiated its first abuse of market power case before the Tribunal. It alleged that Linde had a substantial degree of market power in the medical gases supply market in Hong Kong and that it had committed a breach of the Second Conduct Rule by refusing to supply a competitor in the downstream market of medical gas pipeline system maintenance, in what seems an essential facility case. It is unclear at this stage when the case will be heard.

3.2 Block Exemptions

Section 15 of the Ordinance grants the Commission the ability to issue “block exemption orders” to exempt a particular category of agreements because they enhance overall economic efficiency.

Vessel Sharing Agreements Block Exemption.[14] The Hong Kong Liner Shipping Association, which represents most shipping lines in Hong Kong, applied for a block exemption order in relation to liner shipping agreements, including vessel sharing agreements (“VSA”) and voluntary discussion agreements (“VDAs”).

The Commission granted a block exemption in relation to VSAs. These are operating arrangements between shipping lines in relation to the provision of liner shipping services, including the coordination of joint operation of vessel services, and the exchange or charter of vessel space (these agreements are commonly called “alliances”, “consortia”, “slot charter agreements” joint services agreements” or “slot swap agreements”). The block exemption is subject to the following conditions: (i) parties to a particular VSA do not have a combined market share in excess of 40%, (ii) the VSA does not authorize or require its members to engage in price fixing, capacity or sale limitations, market/customer allocation, and (iii) parties can withdraw from a VSA without penalty or unreasonable notice period.

However, the Commission’s block exemption order does not extend to VDAs. These are agreements between carriers in which parties discuss commercial issues relating to a particular trade, including prices (freight rates and surcharges), agreements on recommended freight rates and surcharges, and exchanges of commercial information (such as statistics on costs, capacity, deployment, etc.). The Commission considered that exchanges of future price intentions and an agreement on recommended prices constituted infringements by object of the First Conduct Rule and could not benefit from a block exemption.

3.3 Decisions

Section 9(1) of the Ordinance empowers the Commission to issue a decision that the First Conduct Rule does not apply to a particular agreement because one of more exclusions or exemptions in the Ordinance apply.

Code of Banking Practice.[15] A series of banks applied to the Commission for a decision that the Code of Banking Practice (“Code”) issued by the Hong Kong Association of Banks (“HKAB”) and endorsed by the Hong Kong Monetary Authority (“HKMA”) was exempted from the First Conduct Rule because it was adopted to comply with legal requirements, a ground for exemption under the Ordinance. After a detailed assessment of the regulatory framework and the specific language in the Ordinance, the Commission concluded that agreeing to the Code is not the result of a legal requirement and that the application of the First Conduct Rule is therefore not excluded. However, the Commission indicated that it had no current intention to pursue an investigation or enforcement action in respect of the Code. The Commission noted indeed that the Code is intended to promote good banking practices through setting out minimum standards, that the Code has been formulated with input and support from the Consumer Council, the HKMA and other public bodies, and was endorsed by the HKMA.

Pharmaceutical Sales Survey.[16] The Hong Kong Association of the Pharmaceutical Industry (“HKAPI”) applied for a decision that a proposed arrangement to conduct and publish a survey comprising data on the sales of prescriptions and over-the-counter pharmaceutical products in Hong Kong did not infringe the First Conduct Rule, including because such exchange of information will enhance economic efficiency. The Commission ruled against the HKAPI, finding that the proposed exchange of information was not excluded or exempted from the First Conduct Rule under the efficiency exclusion.

In particular, the Commission took issue with the proposed exchange of product level sales data, this is sales data for specific, named products by sector (government, private, trade and Macau) grouped by supplier or according to the ATC3 class. The proposed survey would have been published on a quarterly basis, one month after the end of each quarter. According to the Commission, the exchange of product level sales data would enhance transparency on the market and reduce independent decision-making and/or facilitate coordination. In particular, the Commission considered that quarterly data published one month after the end of the quarter did not constitute “historical data”.

The exchange of other data was considered as unlikely to raise concerns, such as the exchange of total sales data per company (unless a particular company only has one product on the market). In addition, the Commission did not object to the exchange of sales data per ATC3 category, unless a particular class only included a limited number of products or competitors.

The precedential value of this decision may be limited. Indeed, as the Commission itself recognized, assessing the competition concerns relating to an exchange of information require consideration of the context of the exchange and can differ depending on the products, markets and characteristics of the information exchange in question. Therefore, the analysis in the decision may not apply to exchanges of information in other contexts.

3.4 Commitments

Section 60 of the Ordinance allows the Commission to accept commitments from undertakings in exchange for terminating an investigation or not initiating proceedings before the Tribunal.

Seaport Alliance.[17] The Commission accepted commitments in relation to the Seaport Alliance (“Alliance”). This was a cooperative joint venture by four of the five terminal operators at Kwai Tsing Container Terminal. The purpose of the joint venture was to pool and share their capacity, coordinate prices, commercial terms and customer allocation, and sharing profit and losses. In essence, this was a model similar to the “metal-neutral” joint ventures in the airlines business.

The Commission considered that the Alliance was likely to result in anticompetitive effects as it eliminated competition between the largest operators at Kwai Tsing, covered between 80-90% of all the throughput at that port and the remaining operator had limited ability to expand capacity to operate as an alternative to the Alliance. As such, the Alliance’s members would be able to increase prices or decrease service levels.

In order to address the Commission’s concerns, the Alliance proposed a series of behavioural commitments. In essence, the Alliance agreed to (i) cap the charges for services to customers and maintain a minimum service level, (ii) maintain reciprocal overflow arrangements with the remaining port operator, and (ii) eliminate cross-directorships in specified other ports in Mainland China.

Online Travel Agents.[18] The Commission accepted commitments from three large online travel agents operating in Hong Kong, namely Booking.com, Expedia.com and Trip.com, in respect of the agreements entered into between the online travel agents and hotels. These agreements included provisions requiring hotels to provide the same or better room price, room condition and room availability to the online travel agents as the hotel provided to other third party sales channels.

The Commission considered that these provisions, which were akin to most-favoured nation clauses, were likely to have the effect of softening competition between travel agents by reducing the incentives for travel agents to lower the commission charged. As an effect of these provisions, hotels have limited incentives to offer better terms to new or smaller travel agents who seeks to attract business by charging less commission, as the hotels would have to offer the same terms to the three online travel agents pursuant to the abovementioned provisions.

In order to address the Commission’s concerns, the three online travel agents dropped these provisions. As a result, the Commission terminated its investigation.

4. Private Litigation

Private litigation is limited under the Ordinance. Parties can only initiate a case before the Tribunal after the Tribunal has ruled that an infringement has taken place. As an exception to that rule, private parties can raise defences based on the Ordinance in any litigation before the Court of First Instance. In that case, there is a possibility to transfer the case (or parts of it) to the Tribunal. For example, in Taching Petroleum Company, Limited and Shell Hong Kong Limited v Meyer Aluminium Limited [19], Taching and Shell commenced proceedings in the Hong Kong High Court against Meyer to recover outstanding unpaid invoices in relation to the supply of diesel. In defending such proceedings, Meyer alleged that Taching (a reseller of Sinopec diesel) and Shell had breached the First Conduct Rule by colluding to, inter alia, fix prices and exchange price information (the “Defence”), possibly with other suppliers. Meyer referred to a series of parallel price announcements by Taching and Shell. The case was transferred from the Hong Kong High Court to the Tribunal and the case remains pending before the Tribunal. Whilst the Defence was transferred to the Tribunal for determination and set down for trial in late 2020, as a result of the introduction by Meyer of expert evidence, along with other interlocutory applications, which the Tribunal largely determined against Meyer and which are subject to possible appeals, the trial has been adjourned to a future date. The Tribunal did allow expert evidence, but limited to “whether the uniformity in the pricing mechanisms and adjustments of Taching and Shell between January 2011 and June 2017 could be better explained on the hypothesis of collusion or on the hypothesis of independent conduct”.

Meyer’s claims of a conspiracy seems inconsistent with the findings of the Commission in its autofuel market study in which it came essentially to the conclusion that there was no evidence of collusion among suppliers of gasoline despite the similarity in retail prices and the fact that suppliers would increase/decrease prices at the same time.[20] Although the Tribunal should be commended for allowing Meyer to state its case, it seems that the various procedures amount to a waste of resources. If Shell and Taching prevail, Meyer risks being faced with a costs claim that is without proportion to the amounts at stake.

5. Mergers

The Merger Rule only applies to the telecommunications sector. Therefore, the Communications Authority (“CA”) will ordinarily take the lead in enforcing the Merger Rule.

There is no mandatory pre-closing notification system so there is no need to obtain approvals from the CA in order to close a transaction. The CA may initiate a preliminary investigation within thirty days after becoming aware that a merger took place. If, after carrying out that investigation, the CA has reasonable cause to believe that a merger could be in breach of the Ordinance, it has six months (starting from the day it became aware of the merger or the day the merger closed, whichever is the later) to initiate proceedings before the Tribunal to stop the merger process or unwind the merger. Merger parties can voluntary notify their merger to obtain (confidential) informal advice. This is likely to be a process of limited value because the CA will not reach out to third parties to obtain their views. Parties may also apply for a decision that their transaction does not breach the Ordinance but the CA is only required to consider such application if the merger raises essentially novel questions. Finally, the CA is empowered to accept commitments from the merger parties.

Enforcement activity in the merger space has been limited. The only decision relates to a merger between two fixed network operators, Hong Kong Broadband Network Limited and WTT HK Ltd, essentially a 4-to-3 merger. The CA initiated a preliminary investigation into the merger but the merger parties offered a set of commitment to address the concerns raised by the CA.[21] These commitments included (i) an obligation to facilitate access to non-residential buildings where both merging parties have already installed their own communications lines, and (ii) an obligation to continue to provide wholesale inputs to downstream rivals (e.g. mobile backhaul services).

Looking forward, the key issue is whether Hong Kong will extend the scope of the Merger Rule and adopt a cross-sector prohibition on anticompetitive mergers.

____________________

[1] Part 6 and Schedule 3 of the Ordinance.

[2] See Section 110 of the Ordinance.

[3] Leniency Policy for Undertakings Engaged in Cartel Conduct (Revised April 2020 version).

[4] Section 93(1) of the Ordinance.

[5] Leniency Policy for Individuals Involved in Cartel Conduct (April 2020 version).

[6] Cooperation and Settlement Policy for Undertakings Engaged in Cartel Conduct (April 2019 version).

[7] Competition Commission v Nutanix Hong Kong Limited and others (CTEA1/2017) [2019] HKCT 2.

[8] Competition Commission v Nutanix Hong Kong Ltd and Others (CTEA1/2017) [2017] 5 HKLRD 712.

[9] Competition Commission v W. Hing Construction Company Limited and others (CTEA2/2017) [2020] 2 HKLRD 1229, [2020] HKCT 1.

[10] Competition Commission v Kam Kwong Engineering Company Limited and others (CTEA1/2018) [2020] 4 HKLRD 61, [2020] HKCT 3.

[11] Competition Commission v Fungs E & M Engineering Company Limited and others (CTEA1/2019) [2020] HKCT 9.

[12] Competition Commission v Quantr Limited and another (CTEA1/2020) [2020] HKCT 10; Commitment to Comply with Requirements of Infringement Notice issued to Nintex Proprietary Limited by Competition Commission, 16 January 2020.

[13] Competition Commission v T.H. Lee Book Company Limited and others (CTEA2/2020).

[14] Competition (Block Exemption For Vessel Sharing Agreements) Order 2017.

[15] Commission Decision under section 11(1) of the Competition Ordinance in respect of the Code of Banking Practice, 15 October 2018.

[16] Commission Decision under section 11(1) of the Competition Ordinance in respect of a proposed pharmaceutical sales survey, 26 September 2019.

[17] Commitments by Modern Terminals Limited and HPHT Limited (Case EC/03AY), 30 October 2020.

[18] Commitment by Booking.com B.V., 13 May 2020; Commitment by Expedia Lodging Partner Services Sarl, 13 May 2020; and Commitment by Trip International Travel (Hong Kong) Limited and Ctrip.com (Hong Kong) Limited, 13 May 2020.

[19] [2018] HKCFI 2095, [2019] HKCFI 515, [2019] HKCT 1 and [2019] HKCT 2.

[20] Report on Study into Hong Kong’s Auto-fuel Market, 4 May 2017.

[21] Notice of Acceptance by the Communications Authority of Commitments Offered by Hong Kong Broadband Network Limited, HKBN Enterprise Solutions Limited and WTT HK Limited under Section 60 of the Competition Ordinance in relation to the Proposed Acquisition of WTT Holding Corp. by HKBN Ltd., 17 April 2019.

The following Gibson Dunn lawyers assisted in the preparation of this client update: Sébastien Evrard, Winson Chu, Bonnie Tong and Adam Ismail.

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

Sébastien Evrard (+852 2214 3798, [email protected])
Kelly Austin (+852 2214 3788, [email protected])
Winson S. Chu (+852 2214 3713, [email protected])
Bonnie Tong (+852 2214 3762, [email protected])

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

Paris partner Pierre-Emmanuel Fender is the author of “Weathering the Covid-19 Crisis in France,” [PDF] published in the Europe, Middle East and Africa Review 2020 by Global Restructuring Review in December 2020.

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

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

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

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

Commission Decision

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

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

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

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

General Court

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

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

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

Conclusions

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

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

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

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

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

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

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

Commission Decision

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

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

General Court

The General Court rejected all three pleas in their entirety.

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

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

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

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

Conclusions

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

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

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

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

Commission Decision

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

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

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

General Court

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

Conclusions

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

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

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

____________________

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

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

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

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

[5] See Paragraph 118 of the Judgment.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

[28] Refer to Paragraph 105 of the Judgment.

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

[30] Refer to Paragraph 147 of the Judgment.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For additional information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition Practice Group, or the following authors in Brussels:

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

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

On December 11, 2020, Congress fulfilled its constitutional obligation “to provide for the common defense,”[1] passing for the 60th consecutive year the National Defense Authorization Act (“NDAA”), H.R. 6395. Buried on page 1,238 of this $740.5 billion military spending bill is an amendment to the Securities Exchange Act of 1934. That amendment gives the Securities and Exchange Commission, for the first time in its history, explicit statutory authority to seek disgorgement in federal district court. It also doubles the current statute of limitations for disgorgement claims in certain classes of cases. The amendment appears to be a direct response to recent Supreme Court decisions limiting the SEC’s authority.

Although the Exchange Act does not by its terms authorize the SEC to seek “disgorgement” for Federal Court actions, the agency has long requested this remedy, and courts have long awarded it under their power to grant “equitable relief.”[2] In Liu v. SEC, 140 S. Ct. 1936 (2020), however, the Supreme Court made clear that while disgorgement could qualify as “equitable relief” in certain circumstances, to do so, it must be bound by “longstanding equitable principles.”[3] Generally, under Liu, disgorgement cannot be awarded against multiple wrongdoers under a joint-and-several liability theory, and any amount disgorged must be limited to the wrongdoer’s net profits and be awarded only to victims, not to the U.S. Treasury. And just three years earlier, in Kokesh v. SEC, 137 S. Ct. 1635 (2017), the Court added other limitations on the SEC’s ability to seek disgorgement, holding that disgorgement as applied by the SEC and courts is a “penalty” and therefore subject to the same five-year statute of limitations as the civil money penalties the SEC routinely seeks.[4]

The SEC has not responded positively to either decision, particularly Kokesh. Chairman Clayton stated that he is “troubled by the substantial amount of losses” he anticipated the SEC would suffer as a result of the five-year statute of limitations applied in Kokesh.[5] And for that reason, he has urged Congress to “work with” him to extend the statute of limitations period for disgorgement.[6]

Section 6501 of the NDAA appears to grant the SEC its wish, at least in part. The bill authorizes the SEC to seek “disgorgement . . . of any unjust enrichment by the person who received such unjust enrichment,” establishing that the SEC has statutory power to seek disgorgement in federal court. And it provides that “a claim for disgorgement” may be brought within ten years of a scienter-based violation—twice as long as the statute of limitations after Kokesh. As one Congressman put it in reference to a similar provision in an earlier bill, this “legislation would reverse the Kokesh decision” by allowing the SEC to seek disgorgement for certain conduct further back in time.[7] The proposed amendment would apply to any action or proceeding that is pending on, or commenced after, the enactment of the NDAA.

If enacted, the NDAA will likely embolden the SEC on numerous levels. It will, for instance, likely encourage the agency to charge scienter-based violations to obtain disgorgement over a longer period. It also will likely incentivize the SEC to use this authority to eschew the equitable limitations placed on disgorgement in Liu and even to apply that expanded conception of disgorgement retroactively to pending cases. It is not clear, however, whether courts would go along. If Congress, for example, had wanted to free the SEC from all equitable limitations identified in Liu, it could have said so explicitly. Courts may be especially reluctant if, as the SEC may claim, the disgorgement provision of the NDAA can be applied retroactively. Because the “[r]etroactive imposition” of a penalty “would raise a serious constitutional question,”[8] the courts would not lightly find that disgorgement had slipped Liu’s equitable limitations, the one thing potentially keeping disgorgement from “transforming . . . into a penalty” after Liu.[9]

We will continue to monitor the NDAA, which is currently awaiting the President’s signature or veto. Although the President has threatened to veto the bill over unrelated provisions, Congress likely has enough votes to override that veto.[10]

____________________

[1] U.S. Const. pmbl.; see also U.S. Const. art. I, § 8, cls.12–14.

[2] 15 U.S.C. § 78u(d)(5); see Liu v. SEC, 140 S. Ct. 1936, 1940–41 (2020).

[3] Liu, 140 S. Ct. at 1946.

[4] The Supreme Court’s cabining of the SEC’s disgorgement authority to “longstanding equitable principles” in Liu raised at least some doubt whether SEC disgorgement continued to be a “penalty” for statute of limitations purposes under Kokesh.

[5] Jay Clayton, Chairman, SEC, Keynote Remarks at the Mid-Atlantic Regional Conference (June 4, 2019), https://www.sec.gov/news/speech/clayton-keynote-mid-atlantic-regional-conference-2019.

[6] Id.

[7] 165 Cong. Rec. H8931 (daily ed. Nov. 18, 2019) (statement of Rep. McAdams), https://www.congress.gov/116/crec/2019/11/18/CREC-2019-11-18-pt1-PgH8929.pdf.

[8] Landgraf v. United States, 511 U.S. 244, 281 (1994).

[9] Liu, 140 S. Ct. at 1944.

[10] Lindsay Wise, Senate Approves Defense-Policy Bill Despite Veto Threat, Wall St. J. (Dec. 11, 2020), https://www.wsj.com/articles/senate-advances-defense-policy-bill-despite-trump-veto-threat-11607703243.

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

Barry R. Goldsmith – New York (+1 212-351-2440, [email protected])
Helgi C. Walker – Washington, D.C. (+1 202-887-3599, [email protected])
M. Jonathan Seibald – New York (+1 212-351-3916, [email protected])
Brian A. Richman – Washington, D.C. (+1 202-887-3505, [email protected])

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

Securities Enforcement Group:
Barry R. Goldsmith – New York (+1 212-351-2440, [email protected])
Richard W. Grime – Washington, D.C. (+1 202-955-8219, [email protected])
Mark K. Schonfeld – New York (+1 212-351-2433, [email protected])

Administrative Law and Regulatory Group:
Helgi C. Walker – Washington, D.C. (+1 202-887-3599, [email protected])

White Collar Defense and Investigations Group:
Joel M. Cohen – New York (+1 212-351-2664, [email protected])
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On December 14, 2020, the United States imposed sanctions on the Republic of Turkey’s Presidency of Defense Industries (“SSB”), the country’s defense procurement agency, and four senior officials at the agency, for knowingly engaging in a “significant transaction” with Rosoboronexport (“ROE”), Russia’s main arms export entity, in procuring the S-400 surface-to-air missile system. These measures were a long-time coming—under Section 231 of the Countering America’s Adversaries Through Sanctions Act (“CAATSA”) of 2017, the President has been required to impose sanctions on any person determined to have knowingly “engage[d] in a significant transaction with a person that is part of, or operates for or on behalf of, the defense or intelligence sectors of the Government of the Russian Federation.” This includes ROE, and Turkey’s multi-billion dollar S-400 transaction with ROE has been public knowledge for at least three years. Indeed, in 2017, we forecasted that the deal would “test both the power of [Section 231]’s deterrence and potentially Congress’s patience.”

That the President only imposed the sanctions now demonstrates that despite Congress’ increasing appetite for being involved in sanctions implementation—which has historically been the province of the Executive—the legislative branch has limited ability to push the Executive to impose sanctions even when requiring such measures by law. Moreover, it also demonstrates that, as we have discussed in prior updates, the President retains meaningful discretion when deciding whether to impose congressionally-mandated sanctions because all similar “mandatory” sanctions measures are triggered only after the Executive makes a “determination” of “significance.” At least in the context of sanctions, “[t]he President shall impose . . .” turns out not to have the meaning in practice that Congress arguably thinks it means. Under CAATSA, the President needs to “determine” that a transaction was “significant”—two discretionary gating requirements that can be used to delay the imposition of measures if the Executive chooses. This flexibility was also used by the Obama Administration with respect to certain mandated Iran sanctions; and we fully expect the incoming Biden Administration to rely on a similar flexibility as it deems fit when calibrating its foreign policy.

Since the deal with ROE was announced, the United States has repeatedly pressured Turkey, a U.S. ally and member of the North Atlantic Treaty Organization (“NATO”), to abandon the plan—going so far as to remove Ankara from its F-35 stealth fighter development and training project—but had thus far refused to impose the Section 231 sanctions. The United States has not been so restrained with respect to China. In September 2018, the Trump Administration imposed Section 231 sanctions on a Chinese entity—the Equipment Development Department (“EDD”)—for facilitating China’s acquisition of the identical S-400 equipment. Despite U.S. efforts at deterrence with respect to Turkey, President Erdogan proceeded with formally acquiring the S-400 system in July 2019 and reportedly began its testing in October 2020.

The Sanctions Imposed

The four SSB executives who have been sanctioned (“SSB Executives”)—Dr. Ismail Demir (President), Faruk Yigit (Vice President), Serhat Gencoglu (Head of Department of Air Defense and Space), and Mustafa Alper Deniz (Program Manager for Regional Air Defense Systems Directorate)—have been added to the Specially Designated Nationals and Blocked Persons List (“SDN List”) managed by the Treasury Department’s Office of Foreign Assets Control (“OFAC”). Any of their assets under U.S. jurisdiction are blocked and U.S. persons are prohibited from engaging in nearly any transaction with them—including as counterparties on contracts (see OFAC FAQ 400).

The sanctions imposed on SSB are more complex and are novel enough that OFAC was compelled to construct a new Non-SDN Menu-Based Sanctions (“NS-MBS”) List solely for SSB (and any subsequent entity subject to similar sanctions). The Administration chose to fully sanction China’s EDD and added the entity to the SDN List in September 2018—so the new list structure was not needed at that time.

Section 231 of CAATSA requires the imposition of at least five of the 12 “menu-based” sanctions described in Section 235. The five menu-based sanctions imposed on SSB are:

Prohibition on granting U.S. export licenses and authorizations for any goods or technology transferred to SSB (CAATSA Section 235(a)(2));
Prohibition on loans or credits by U.S. financial institutions to SSB totaling more than $10 million in any 12-month period (CAATSA Section 235(a)(3));
Prohibition on U.S. Export-Import Bank assistance for exports to SSB (CAATSA Section 235(a)(1));
Requirement for the United States to oppose loans benefitting SSB by international financial institutions (CAATSA Section 235(a)(4)); and
Full blocking sanctions and visa restrictions (CAATSA Section 235(a)(7), (8), (9), (11), and (12)) on the SSB Executives.

While the designation of the four SSB Executives is impactful for them personally—and potentially for SSB to the extent any or all are directly involved in dealings—the most meaningful restriction for SSB itself is likely to be the prohibition on the granting of U.S. export licenses under Section 235(a)(2). Pursuant to this prohibition, the State Department’s Directorate of Defense Trade Controls (“DDTC”) and the Commerce Department’s Bureau of Industry and Security (“BIS”) announced that they will not approve any export license or authorization applications where SSB is a party to the transaction. However, even this restriction may be less than it seems. In our experience, SSB is rarely identified as a party to export licenses, which more typically identify a more specific Turkish Armed Forces component, companies owned by SSB, or joint ventures these companies might form with non-Turkish defense contractors. Moreover, DDTC clarified that it will construe the prohibition to not include temporary import authorizations, existing export and re-export authorizations, and licenses involving subsidiaries of SSB—although any licenses submitted in relation with SSB subsidiaries will be “subject to a standard case-by-case review, including a foreign policy and national security review.” Furthermore, because many of the existing export authorizations have four- and ten-year terms, it may be many years before any change in DDTC or BIS treatment of SSB-associated licensing requests have a practical impact on SSB or the Turkish Armed Forces. Notwithstanding these facts, it is possible that the mere listing of SSB will prove impactful—and it is also possible that, if Turkey continues its activities, the regulations could become stricter and additional designations (including to the SDN List) could be imposed.

Conclusion and Implications

The sanctions imposed on SSB mark the first time that CAATSA measures have been imposed against a member of the NATO alliance. According to the State Department, the Administration’s “actions are not intended to undermine the military capabilities or combat readiness of Turkey or any other U.S. ally or partner, but rather to impose costs on Russia in response to its wide range of malign activities.” That might explain why the menu-based sanctions chosen, while consequential, do not go so far as to add SSB to the SDN List. This was not the first time the Trump Administration sanctioned major Turkish actors. It is, however, a far more nuanced approach than that the Trump Administration took in October 2019 when it sanctioned the Turkish defense and natural resources ministries (and their ministers) in connection with Ankara’s military operations in Syria (see our October 18, 2019 Client Update). In that case, the entities and individuals were added to the SDN List—and then promptly de-listed a short time later following a ceasefire in Syria.

The SSB sanctions may have a longer life under the Biden Administration. Not only is the new administration likely to be more keen on imposing meaningful measures against Russia, but also Congress is seeking to tie the Executive’s hands further with respect to the CAATSA sanctions. On December 11, 2020, Congress passed the National Defense Authorization Act for the Fiscal Year 2021 (“NDAA FY 2021”). Though President Trump has threatened to veto the bill, it has passed both Houses of Congress with a veto-proof majority. Section 1241 of NDAA FY 2021 requires the President to impose sanctions on persons involved in Turkey’s S-400 deal, under Section 231 of CAATSA, within 30 days. The bill further provides that the sanctions cannot be terminated without reliable assurances that Turkey no longer possesses and will not possess the S-400 “or a successor system” (a reference to an S-500 missile system Turkey and Russia have talked about since May 2019). This would require a public reversal of Turkey’s defense policies and acquisitions, which seems unlikely in the near term. As such, there may not be a colorable statutory basis to lift the sanctions. Indeed, rather than indicating a retreat from its S-400 purchase, immediately following the sanctions decision, the Turkish Ministry of Foreign Affairs issued a statement that Turkey “will retaliate in a manner and timing it deems appropriate” and urged the United States “to reconsider this unfair decision.” Considering Turkey’s status as a NATO ally and the presence of U.S. forces in Turkey, the Biden Administration will almost certainly face pressures in the early days to articulate its view of the bilateral relationship going forward.

The following Gibson Dunn lawyers assisted in preparing this client update: Judith Alison Lee, Ron Kirk, Adam M. Smith, Chris T. Timura, Stephanie L. Connor, Audi Syarief, and Claire Yi.

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

United States:
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, [email protected])
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, [email protected])
Jose W. Fernandez – New York (+1 212-351-2376, [email protected])
Marcellus A. McRae – Los Angeles (+1 213-229-7675, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [email protected])
Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Ben K. Belair – Washington, D.C. (+1 202-887-3743, [email protected])
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, [email protected])
Laura R. Cole – Washington, D.C. (+1 202-887-3787, [email protected])
Jesse Melman – New York (+1 212-351-2683, [email protected])
R.L. Pratt – Washington, D.C. (+1 202-887-3785, [email protected])
Samantha Sewall – Washington, D.C. (+1 202-887-3509, [email protected])
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, [email protected])
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, [email protected])
Claire Yi – Washington, D.C. (+1 202.887.3644, [email protected])
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, [email protected])

Asia and Europe:
Fang Xue – Beijing (+86 10 6502 8687, [email protected])
Qi Yue – Beijing – (+86 10 6502 8534, [email protected])
Joerg Bartz – Singapore – (+65 6507 3635, [email protected])
Peter Alexiadis – Brussels (+32 2 554 72 00, [email protected])
Attila Borsos – Brussels (+32 2 554 72 10, [email protected])
Nicolas Autet – Paris (+33 1 56 43 13 00, [email protected])
Susy Bullock – London (+44 (0)20 7071 4283, [email protected])
Patrick Doris – London (+44 (0)207 071 4276, [email protected])
Sacha Harber-Kelly – London (+44 20 7071 4205, [email protected])
Penny Madden – London (+44 (0)20 7071 4226, [email protected])
Steve Melrose – London (+44 (0)20 7071 4219, [email protected])
Matt Aleksic – London (+44 (0)20 7071 4042, [email protected])
Benno Schwarz – Munich (+49 89 189 33 110, [email protected])
Michael Walther – Munich (+49 89 189 33-180, [email protected])
Richard W. Roeder – Munich (+49 89 189 33-160, [email protected])

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

This fall saw numerous important privacy-related legal developments for companies that do business in the United States, Europe, and globally. In the U.S., California voters approved the California Privacy Rights Act, which places new requirements on companies that collect the personal information of California residents just two years after the California Consumer Privacy Act became the first-of-its-kind comprehensive U.S. privacy law. These changes in California law are occurring in parallel with the emergence of new privacy and cybersecurity laws and enforcement in New York, and the prospect of similar privacy legislation in a number of additional U.S. states. In Europe, the Court of Justice of the European Union struck down one mechanism for ensuring the security of data transferred from Europe to the United States (the Privacy Shield), and cast doubt on the long-term validity of another (the Standard Contractual Clauses). The European Data Protection Board thereafter issued guidance on additional mechanisms companies that rely on the Standard Contractual Clauses may take when transferring data out of Europe, and drafts of new versions of the Clauses were released for public comment. In this webcast, a panel of Gibson Dunn attorneys from around the world address these rapidly-changing developments and offer guidance on practical steps companies can take to come into compliance with these far-reaching new privacy requirements.

View Slides (PDF)

PANELISTS:

Ahmed Baladi – Partner, Paris

Ryan Bergsieker – Partner, Denver

Patrick Doris – Partner, London

Amanda Aycock – Associate Attorney, New York

Cassandra L. Gaedt-Sheckter – Associate Attorney, Palo Alto

Alejandro Guerrero – Of Counsel, Brussels

Vera Lukic – Of Counsel, Paris

The COVID-19 pandemic has caused unprecedented changes in daily life, disruption to businesses and the economy, as well as dramatic market volatility. As a follow up to the webinar conducted in May 2020, in this webinar, Gibson Dunn and Cornerstone Research will provide an update on COVID-19-related securities litigation filed since the pandemic began and corporate best practices, including the following topics:

Trends in COVID-19-related securities and derivative lawsuits
Issues for companies to consider in preparing risk disclosures and discussing forward looking projections
Best practices for Board of Directors oversight
Economic analyses that are particularly relevant for COVID-19 related securities actions

View Slides (PDF)

PANELISTS:

Jennifer L. Conn is a partner in the New York office of Gibson, Dunn & Crutcher. She is a member of Gibson Dunn’s Litigation, Securities Litigation, Securities Enforcement, Appellate, and Privacy, Cybersecurity and Consumer Protection Practice Groups. Ms. Conn has extensive experience in a wide range of complex commercial litigation matters, including those involving securities, financial services, accounting, business restructuring and reorganization, antitrust, contracts, and information technology. In addition, Ms. Conn is an Adjunct Professor of Law at Columbia Law School, lecturing on securities litigation.

Avi Weitzman is a litigation partner in the New York office of Gibson, Dunn & Crutcher. He is a member of the White Collar Defense and Investigations, Crisis Management, Securities Enforcement and Litigation, and Media, Entertainment and Technology Practice Groups. Mr. Weitzman is a nationally recognized trial and appellate attorney, with experience handling complex commercial disputes in diverse areas of law, white-collar and regulatory enforcement defense, internal investigations, and securities litigations. Prior to joining Gibson Dunn, Mr. Weitzman served for seven years as an Assistant United States Attorney in the Southern District of New York, primarily in the Securities and Commodities Fraud Task Force and Organized Crime Unit.

Lori Benson is a Senior Vice President and heads Cornerstone Research’s New York office. Over the course of her more than twenty years with the firm, she has prepared strategy and expert testimony in all aspects of complex commercial litigation, including trials, arbitrations, settlements, and regulatory inquiries. Ms. Benson has consulted on a wide range of cases including securities class actions, market manipulation, valuation, asset management and fixed income securities disputes.

Yan Cao is a Vice President at Cornerstone Research’s New York office. Dr. Cao specializes in issues related to financial economics and financial reporting across a range of complex litigation and regulatory proceedings. Her experience covers securities, market manipulation, M&A, risk management, and bankruptcy matters. Dr. Cao has fifteen years of experience consulting on securities class actions that cover a wide variety of industries, with a focus on financial institutions. She has also worked on regulatory investigation and enforcement matters led by the SEC, the CFTC, the DOJ, the NY Fed, and state AGs. Dr. Cao is a Chartered Financial Analyst (CFA) and a Certified Public Accountant.

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

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

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

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

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

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

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

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

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

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

On December 8, 2020, the U.S. House of Representatives passed the Criminal Antitrust Anti-Retaliation Act of 2019.[1] Sponsored by Republican Senator Chuck Grassley and co-sponsored by Democratic Senator Patrick Leahy, the bill prohibits employers from retaliating against certain employees who report criminal antitrust violations internally or to the federal government. Similar legislation has previously been passed unanimously by the Senate in 2013, 2015, and 2017; each time, the legislation stalled in the House.[2] This time, however, the legislation has been adopted with overwhelming support in the Senate and the House.[3] The bipartisan bill now awaits the President’s signature.

Overview of the Criminal Antitrust Anti-Retaliation Act

If signed into law, the bill would amend the Antitrust Criminal Penalty Enhancement and Reform Act of 2004 to protect employees who report to the federal government—or an internal supervising authority—criminal antitrust violations, acts “reasonably believed” by the employee to be criminal antitrust violations, and other criminal acts “committed in conjunction with potential antitrust violations,” such as mail or wire fraud.[4] The bill also protects employees who “cause to be filed, testify in, participate in, or otherwise assist” federal investigations or proceedings related to such criminal violations.[5] Notably, the bill’s expansive definition of “employee,” which could be read to include contractors, sub-contractors, and agents, may extend these protections to a broader population than a company’s own employees.

If an employee faces retaliation, such as discharge, demotion, suspension, threat, or harassment, he or she can file a complaint with the Secretary of Labor. If the Secretary of Labor does not issue a final decision within 180 days of filing, the employee can file a civil action in federal court. If the employee prevails, the employer would have to (1) reinstate the employee with the same seniority status, (2) pay back pay plus interest, and (3) compensate the employee for special damages (including litigation costs and attorney’s fees).

The bill would not protect employees who “planned and initiated” the criminal violations, or who “planned and initiated an obstruction or attempted obstruction” of federal investigations of such violations.[6] Further, the bill would not offer protection for reporting civil antitrust violations, unless they are also criminal violations.[7] And unlike Dodd-Frank, the bill would not provide reporting employees with a percentage of any monetary sanctions eventually collected by the Department of Justice (“DOJ”).[8]

Implications of the Criminal Antitrust Anti-Retaliation Act

The most immediate effects of the Criminal Antitrust Anti-Retaliation Act will be experienced by companies involved in criminal antitrust investigations. An employee who has engaged in a criminal antitrust violation may later claim to be a whistleblower after cooperating with an internal or government investigation into their own conduct. The bill does not provide clear guidance for an employer in these circumstances, though it is reasonable to assume alignment with existing whistleblower protections under the Sarbanes-Oxley Act of 2002 and other similar federal whistleblower statutes. Companies will understandably want to consider appropriate remedial personnel actions against the employees engaged in the wrongdoing, but should seek assistance from counsel to minimize the risk that the bill’s whistleblower protections are unintentionally triggered.

Additionally, companies may encounter situations in which employees seek to invoke the bill’s whistleblower protections by reporting unfounded allegations of criminal antitrust conduct when they anticipate termination for other reasons. Experienced labor and employment counsel will be familiar with this fact pattern from existing whistleblower laws (e.g., False Claims Act, Sarbanes-Oxley Act) and can provide invaluable guidance in helping to navigate a specific scenario. Still, companies will benefit from having robust, documented procedures for responding to whistleblower allegations, and implementing processes for assessing quickly whether reporting parties have good faith, credible bases for their allegations. For further guidance on whistleblower best practices, consult our April 6, 2020 guidance on this topic.[9]

A question that remains to be answered is whether the law’s exceptions ultimately limit its utility. In January 2017, the Antitrust Division injected uncertainty into its Corporate Leniency Policy by reserving the right to exclude certain “highly culpable” individuals from the scope of the immunity afforded to successful applicants.[10] Unfortunately, the Division did not define “highly culpable,” and left individuals uncertain about whether they could be prosecuted despite self-reporting and cooperating with the government. The Criminal Antitrust Anti-Retaliation Act introduces similar unpredictability by excluding from its protections individuals who “planned and initiated” the conduct.[11] Courts may ultimately be called upon to help clarify this standard, but until that time, employees may be hesitant to entrust themselves to the bill’s whistleblower protections.

The new whistleblower protections also subject companies to a heightened risk that employees will report to DOJ before reporting internally—potentially exposing employers to criminal liability for activities they may not even know are occurring, and depriving them of the opportunity to self-report. This “agency first” approach aligns with the SEC’s amendments to its whistleblower program earlier this year.[12] The Antitrust Division has an existing leniency policy for individuals that provides incentives for self-reporting, a program that was referenced in the Division’s widely read no-poach policy issued in October 2016.[13] However, the policy has been rarely used—the corporate leniency policy offers a more practical avenue for individuals to cooperate through their employer’s application.[14] The new whistleblower protections would open an additional pathway for DOJ to encourage these types of direct reports from a company’s employees. In some instances, the evidence disclosed by a company’s employee could be sufficient to preclude the company itself from later applying for protection under the Corporate Leniency Policy. Companies will therefore need to be vigilant in educating employees about internal conduits for reporting suspected violations and in conducting timely internal investigations to determine whether employee allegations have merit.

___________________

[1] H.R. 8226, 116^th Cong. (2020).

[2] Julie Arciga, Congress Approves New Antitrust Whistleblower Protections, Law360, https://www.law360.com/articles/1335665/congress-approves-new-antitrust-whistleblower-protections.

[3] 166 Cong. Rec. S5904-05 (daily ed. Oct. 17, 2019); 166 Cong. Rec H7007-09 (daily ed. Dec. 08, 2020).

[4] H.R. 8226, 116^th Cong. (2020).

[5] Id.

[6] Id.

[7] Id.

[8] Whistleblower Program, U.S. Securities and Exchange Commission, http://www.sec.gov/spotlight/dodd-frank/whistleblower.shtml.

[9] When Whistleblowers Call: Planning Today for Employee Complaints During and After the COVID-19 Crisis, available at: https://www.gibsondunn.com/when-whistleblowers-call-planning-today-for-employee-complaints-during-and-after-the-covid-19-crisis/.

[10] U .S. Department of Justice, Antitrust Division, “Frequently Asked Questions about the Antitrust Division’s Leniency Program and Model Leniency Letters” (Jan. 26, 2017), available at https://www.justice.gov/atr/page/file/926521/download.

[11] H.R. 8226, 116^th Cong. (2020).

[12] SEC Amends Whistleblower Rules, available at: https://www.gibsondunn.com/sec-amends-whistleblower-rules/.

[13] Antitrust Guidance for Human Resources Professionals, U.S. Department of Justice Antitrust Division, October 2016, available at: https://www.justice.gov/atr/file/903511/download. The Division’s Guidance is analyzed here: https://www.gibsondunn.com/antitrust-agencies-issue-guidance-for-human-resource-professionals-on-employee-hiring-and-compensation/.

[14] Leniency Policies for Individuals, U.S. Department of Justice, https://www.justice.gov/atr/individual-leniency-policy.

The following Gibson Dunn lawyers prepared this client alert: Daniel Swanson, Rachel Brass, Scott Hammond, Jeremy Robison, Chris Wilson and Anna Aguillard.

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

Antitrust and Competition Group:

Washington, D.C.
Adam Di Vincenzo (+1 202-887-3704, [email protected])
Scott D. Hammond (+1 202-887-3684, [email protected])
Kristen C. Limarzi (+1 202-887-3518, [email protected])
Joshua Lipton (+1 202-955-8226, [email protected])
Richard G. Parker (+1 202-955-8503, [email protected])
Cynthia Richman (+1 202-955-8234, [email protected])
Jeremy Robison (+1 202-955-8518, [email protected])
Andrew Cline (+1 202-887-3698, [email protected])
Chris Wilson (+1 202-955-8520, [email protected])

New York
Eric J. Stock (+1 212-351-2301, [email protected])
Lawrence J. Zweifach (+1 212-351-2625, [email protected])

Los Angeles
Daniel G. Swanson (+1 213-229-7430, [email protected])
Samuel G. Liversidge (+1 213-229-7420, [email protected])
Jay P. Srinivasan (+1 213-229-7296, [email protected])
Rod J. Stone (+1 213-229-7256, [email protected])

San Francisco
Rachel S. Brass (+1 415-393-8293, [email protected])
Caeil A. Higney (+1 415-393-8248, [email protected])

Dallas
Veronica S. Lewis (+1 214-698-3320, [email protected])
Mike Raiff (+1 214-698-3350, [email protected])
Brian Robison (+1 214-698-3370, [email protected])
Robert C. Walters (+1 214-698-3114, [email protected])

Brussels
Peter Alexiadis (+32 2 554 7200, [email protected])
Attila Borsos (+32 2 554 72 11, [email protected])
Jens-Olrik Murach (+32 2 554 7240, [email protected])
Christian Riis-Madsen (+32 2 554 72 05, [email protected])
Lena Sandberg (+32 2 554 72 60, [email protected])
David Wood (+32 2 554 7210, [email protected])

Frankfurt
Georg Weidenbach (+49 69 247 411 550, [email protected])

Munich
Michael Walther (+49 89 189 33 180, [email protected])
Kai Gesing (+49 89 189 33 180, [email protected])

London
Patrick Doris (+44 20 7071 4276, [email protected])
Charles Falconer (+44 20 7071 4270, [email protected])
Ali Nikpay (+44 20 7071 4273, [email protected])
Philip Rocher (+44 20 7071 4202, [email protected])
Deirdre Taylor (+44 20 7071 4274, [email protected])

Hong Kong
Kelly Austin (+852 2214 3788, [email protected])
Sébastien Evrard (+852 2214 3798, [email protected])

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

In one of the most anticipated rulings of recent years, on 11 December 2020 the UK Supreme Court handed down judgment in Merricks v Mastercard, dismissing (by a majority) Mastercard’s appeal against the criteria established by the Court of Appeal for the certification of class actions by the UK’s Competition Appeal Tribunal (“CAT”). The case is a landmark £14 billion opt-out collective proceeding which was started in 2016. The application for a Collective Proceedings Order will now be remitted to the CAT to be re-heard.

Mr Merricks’ application was only the second to come before the CAT since the ability for a class representative to commence opt-out US-style class actions was introduced into the Competition Act 1998 by the Consumer Rights Act 2015. Unlike opt-in actions, which require potential claimants to explicitly sign-up, in opt-out actions anyone who falls within the scope of the proposed class definition will automatically be treated as a member of the class unless they explicitly withdraw.

In order to grant a Collective Proceedings Order, the CAT must be satisfied that the following four requirements are met: (i) it is just and reasonable for the applicant to act as the class representative; (ii) the application is brought on behalf of an identifiable class of persons; (iii) the proposed claims must raise common issues (that is, they raise the same, similar or related issues of fact and law); and (iv) the claims must be suitable to be brought in collective proceedings.

Background

In 2007, the European Commission (“EC”) found that Mastercard had violated European Union competition laws in relation to the setting of multi-lateral interchange fees (“MIFs”) that were charged between banks for transactions using Mastercard issued credit and debit cards (the “EC Decision”).

In September 2016, Mr Merricks applied to the CAT for a Collective Proceedings Order (“CPO”) on an opt-out basis under section 47B of the Competition Act 1998 in reliance on the EC Decision (the “Application”). The Application was made on behalf of all individuals over the age of 16 who had been resident in the UK for a continuous period of at least three months and who, between 22 May 1992 and 21 June 2008, purchased goods or services from merchants in the UK which accepted Mastercard (approximately 46 million consumers). The proposed class included all purchasers from those merchants during the relevant period regardless of whether or not they used a Mastercard payment card to make the purchase. Mr Merricks alleged that Mastercard’s unlawful conduct resulted in merchants paying higher MIFs which merchants passed-on to consumers by increasing the prices for the products or services they provided. The damages sought from Mastercard were estimated at over £14 billion.

CAT Judgment (Walter Hugh Merricks CBE v MasterCard Incorporated & Ors [2017] CAT 16)

In considering the requirements for certification, the CAT held that the expert methodology proposed by an applicant to calculate alleged loss had to: (i) offer a realistic prospect of establishing loss on a class-wide basis so that, if the overcharge by Mastercard was eventually established at the full trial of the common issues, there was a means by which to demonstrate that it was common to the class (i.e., that passing on to the consumers who were members of the class had occurred); and (ii) the methodology could not be purely theoretical or hypothetical, but had to be grounded in the facts of the particular case and there had to be some evidence of the availability of the data to which the methodology was to be applied.

The CAT refused Mr Merricks’ Application for two main reasons: (i) a perceived lack of data to operate the proposed methodology for determining the level of pass-on of the overcharges to consumers; and (ii) the absence of any plausible means of calculating the loss of individual claimants so as to devise an appropriate method of distributing any aggregate award of damages.

Court of Appeal Judgment (Walter Hugh Merricks CBE v MasterCard Incorporated & Ors [2019] EWCA Civ 674)

In April 2019 the Court of Appeal allowed an appeal by Mr Merricks on both issues. As to the first issue, the Court of Appeal held that:

Demonstrating pass-on to consumers generally satisfies the test of commonality of issues necessary for certification (i.e., it was not necessary to analyse pass-on to consumers at a detailed individual level).
At the certification stage, the CAT should only consider whether the proposed methodology is capable of establishing loss to the class as a whole.
There should not be a mini-trial at the certification stage and it was not appropriate to require the proposed representative to establish more than a reasonably arguable case. There had been no requirement to produce all the evidence or to enter into a detailed debate about its probative value and the expert evidence had been exposed to a more vigorous process of examination than should have taken place.
Certification is a continuing process and the CAT can revisit the appropriateness of the class action after pleadings, disclosure, and expert evidence are complete.

As to the second issue, the Court of Appeal held that:

An aggregate award of damages is not required to be distributed on a compensatory basis and it is only necessary at the certification stage for the CAT to be satisfied that the claim is suitable for an aggregate award. Distribution is a matter for the trial judge to consider following the making of an aggregate award.

The Court of Appeal’s judgment was therefore viewed to have “lowered the bar” to certification by comparison with the narrower approach that the CAT had originally taken. Mastercard was granted permission to appeal the judgment to the Supreme Court.

Supreme Court Judgment

Mastercard’s appeal was heard in May 2020 and the Supreme Court had to consider two main issues:

What is the legal test for certification of claims as eligible for inclusion in collective proceedings?
What is the correct approach to questions regarding the distribution of an aggregate award at the stage at which a party is applying for a CPO?

Delivering the majority judgment, Lord Briggs emphasised that the collective proceedings regime is “a special form of civil procedure for the vindication of private rights, designed to provide access to justice for that purpose where the ordinary forms of individual civil claim have proved inadequate for the purpose” and that it follows that “it should not lightly be assumed that the collective process imposes restrictions upon claimants as a class which the law and rules of procedure for individual claims would not impose”.

With this in mind, on the first main issue, Lord Briggs ruled that, when the CAT is considering the question as to whether claims are suitable to be brought using the collective proceedings procedure, the question that must be answered is whether the claims are more suitable to be brought as collective claims rather than individual claims. In particular, if difficulties identified with the claims forming the basis of the collective proceedings were themselves insufficient to deny a trial to an individual claimant who could show an arguable case to have suffered some loss, then those same difficulties should not be sufficient to lead to a denial of certification for collective proceedings.

As to whether the certification stage should involve an assessment of the underlying merits of the claim, Lord Briggs emphasised that, “the certification process is not about, and does not involve, a merits test”. The Court recognised an exception to this general approach only in circumstances where: (i) a proposed defendant brings a separate application for strike-out (or an applicant seeks summary judgment); or (ii) where the court is required to assess the strength of the proposed claims in the context of a choice between opt-in and opt-out proceedings.

In relation to the second main issue, Lord Briggs made clear that the compensatory principle of damages was “expressly, and radically, modified” by the collective proceedings regime and, where aggregate damages were to be awarded, the ordinary requirement to assess loss on an individual basis was removed. A central purpose of the power to award aggregate damages in collective proceedings is to avoid the need for individual assessment of loss. In particular, there will be cases where the mechanics of approximating individual loss are so difficult and disproportionate (for example because of the modest amounts likely to be recovered by individuals in a large class) that some other method may be more reasonable, fair and just. As to whether it is necessary for an applicant to demonstrate that evidence needed to calculate loss is available, Lord Briggs was clear that “the fact that data is likely to turn out to be incomplete and difficult to interpret, and that its assembly may involve burdensome and expensive processes of disclosure are not good reasons for a court or tribunal refusing a trial to an individual or to a large class who have a reasonable prospect of showing they have suffered some loss from an already established breach of statutory duty”. In reaching this conclusion, Lord Briggs noted that incomplete, or difficulties interpreting, data are everyday issues for the courts and that, even if the task of quantifying loss was very difficult, “it is a task which the CAT owes a duty to the represented class to carry out, as best it can with the evidence that eventually proves to be available”.

In their dissenting judgment, Lord Sales and Lord Leggatt agreed with the majority about the point on the compensatory principle, but otherwise considered that the CAT made no error of law in its assessment that the claims were not suitable for collective proceedings. In their view, the CAT’s decision to refuse certification should have been respected on that separate ground and they raised concerns that the approach of the majority risked undermining the CAT’s role as a gatekeeper for these types of actions.

Comment

It remains to be seen to what extent the Supreme Court’s judgment will affect the UK’s fledgling class action regime. However, whilst the majority judgment has provided much needed clarification as to what is the correct approach for the CAT to take when considering whether claims are suitable for collective proceedings, the dissenting judges have warned that the approach set out in the majority judgment has the potential to “very significantly diminish the role and utility of the certification safeguard”. If they are correct, this will lead to an increase in large scale opt-out collective actions being commenced in the UK.

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

Philip Rocher (+44 (0) 20 7071 4202, [email protected])
Doug Watson (+44 (0) 20 7071 4217, [email protected])
Susy Bullock (+44 (0) 20 7071 4283, [email protected])
Dan Warner (+44 (0) 20 7071 4213, [email protected])
Kirsty Everley (+44 (0) 20 7071 4043, [email protected])

UK Competition Litigation Group:
Patrick Doris (+44 (0) 20 7071 4276, [email protected])
Steve Melrose (+44 (0) 20 7071 4219, [email protected])
Ali Nikpay (+44 (0) 20 7071 4273, [email protected])
Sarah Parker (+44 (0) 78 3324 5958/+44 (0) 20 7071 4073, [email protected])
Deirdre Taylor (+44 (0) 20 7071 4274, [email protected])

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

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

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

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

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

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

I. Deciding Who Decides: Should Employers Mandate Vaccination?

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

A. Why Require the Vaccine?

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

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

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

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

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

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

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

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

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

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

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

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

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

B. Why Make the Vaccine Optional?

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

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

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

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

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

II. Playbook For Employer Vaccine Policies

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

A. Assess the Right to Require Vaccinations

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

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

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

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

B. Make a Plan to Process Exemption Requests

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

1. Medical Exemptions

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

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

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

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

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

2. Religious Exemptions

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

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

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

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

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

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

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

C. Build Buy-In and Plan for Conflict Diffusion

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

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

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

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

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

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

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

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

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

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

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

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

F. Be Aware of Labor Law Issues

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

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

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

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

* * *

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

___________________

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

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

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

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

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

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

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

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

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

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

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

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

[13] See discussion infra.

[14] 29 U.S.C. § 654.

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

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

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

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

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

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

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

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

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

[24] See id.

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

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

[27] Id.

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

[29] Id.

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

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

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

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

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

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

[36] 29 U.S.C. § 157.

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

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

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

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

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

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

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

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

A recent Judgment of the Court of Justice of the European Union (“Court of Justice”) in Case Groupe Canal + v. Commission (“Judgment”) provides some clarity about the sorts of commitments that defendants can give to reach a settlement with the European Commission (“Commission”) in order to avoid it adopting a Decision under Article 101(1) TFEU.[1] In its Judgment of 9 December 2020, the Court of Justice held that the Commission, when accepting commitments from defendants to overcome concerns in competition proceedings under the procedure set forth in Article 9 of Regulation 1/2003,[2] must take due account of the impact of those commitments on the position of third parties where the commitments require the defendant not to respect existing contractual obligations with third parties. This is, essentially, a proportionality test and requires the Commission to accept commitments only if they are necessary to remedy the perceived harm and if they do not have a disproportionately harmful effect on third parties.

I. Background

On 13 January 2014, the Commission opened a formal investigation into licensing agreements for the distribution of content entered into between several major US film studios (including Paramount Pictures International ltd and its parent company, Viacom Inc., together referred to as “Paramount”) on the one hand, and European pay-TV broadcasters including Sky UK Ltd and Sky plc (together referred to as “Sky”) and Groupe Canal + SA (“Canal +”), on the other.

In July 2015, the Commission adopted a Statement of Objections[3] regarding the enforceability of certain clauses in the licensing agreements concluded between Paramount and Sky and other broadcasters, namely:

restrictions on Sky’s ability to respond favourably to unsolicited requests from consumers resident in the EEA but outside the United Kingdom and Ireland, to provide access to television distribution services; and
the prohibition on broadcasters established in the EEA but outside the UK or Ireland to respond favourably to unsolicited requests from consumers resident in the United Kingdom or in Ireland.

The Commission took the preliminary view that these clauses prevented broadcasters from providing their services across EU Member State borders, and led to a situation of absolute territorial exclusivity. This was capable of constituting a restriction of competition under Article 101(1) TFEU and Article 53 of the EEA Agreement because they partitioned the European Single Market into a series of national markets.

The Commitments

In April 2016, in an attempt to meet the Commission’s concerns about the restrictive effects of its arrangements, Paramount offered the following commitments,[4] to apply throughout the territory of the EEA:[5]

when licensing its film output for pay-TV to a broadcaster in the EEA, Paramount would not (re-)introduce contractual obligations which prevented or limited a pay-TV broadcaster from responding to unsolicited requests from consumers within the EEA but outside the pay-TV broadcaster’s licensed national territory (the “Broadcaster Obligation”);
when licensing its film output for pay-TV to a broadcaster in the EEA, Paramount would not (re-)introduce contractual obligations which required Paramount to prohibit or limit pay-TV broadcasters located outside the licensed territory from responding to unsolicited requests from consumers within the licensed territory (the “Paramount Obligation”);
Paramount would not seek to bring an action before a court or tribunal for the violation of a Broadcaster Obligation in an existing agreement licensing its film output for pay-TV; and
Paramount Pictures would not act upon or enforce a Paramount Obligation in an existing agreement licensing its film output for pay-TV.

Consistent with its administrative practice, the Commission sought comments on the proposed commitments from interested third parties, including Canal +. It then adopted a Decision on 26 July 2016 accepting the commitments offered by Paramount (the “Commitment Decision”).[6]

On appeal at first instance

As an exclusive licensee in France prior to the Commitment Decision being adopted, Canal + brought an action for the annulment of the Commitment Decision before the General Court of the European Union (“General Court”). The General Court dismissed Canal +’s action, holding that the commitments offered by Paramount were not binding on Paramount’s contracting partners (including Canal +) and that the rights of third parties were not violated because civil proceedings before national courts were still available to them.[7]

Grounds of appeal before the Court of Justice

Canal + appealed to the Court of Justice, arguing that:

by adopting the Commitment Decision, the Commission had misused its powers and was trying to circumvent the need for legislation to address the issue of geo-blocking within the EEA;
the relevant clauses in the licensing agreements were lawful under Article 101(1) TFEU and there were therefore no grounds for adopting the Commitment Decision;
the Commission had wrongly analysed the impact of the contested licensing clauses on the EEA as a whole and, in doing so, had failed to conduct individual assessments of their impact on a country-by-country basis;
the General Court erred in law in its assessment of the effects of the Commitment Decision on the contractual rights of third parties by not taking sufficient account of the fundamental legal principle of proportionality.

II. Judgment of the Court of Justice

The Court of Justice upheld the General Court’s findings with respect to the first three pleas raised on appeal.[8] However, it found that the General Court had failed to take into account sufficiently the contractual rights of third parties when adopting commitments decisions.

The Court of Justice first recalled that a commitment decision adopted on the basis of Article 9 of Regulation 1/2003 is only binding on the undertakings that have actually offered commitments. As a result, the Commitment Decision could not lead to third parties – in this case, Canal + – being bound by those commitments. Therefore, by making the commitments binding on a contracting party that had not consented to the commitments in question, the Commission was considered to have interfered with Canal +’s contractual freedom. In doing so, the Commission was considered to have exceeded its powers under Article 9 of Regulation 1/2003.

In arriving at this conclusion, the Court of Justice overturned the General Court’s finding that the third party could seek redress before a national court to enforce its contractual rights. The Court of Justice referred to the Masterfoods Case,[9] which held that the effectiveness of EU law is a fundamental legal principle[10] which must not be undermined by private parties being encouraged to approach national courts to dilute the effectiveness of EU law, as applied by the Commission in the exercise of its competition law powers.[11] The same principle is found in Article 16(2) of Regulation 1/2003, which provides that “[w]hen competition authorities of the Member States rule on agreements, decisions or practices under Article 81 or Article 82 of the Treaty [now Articles 101 or 102 TFEU] which are already the subject of a Commission decision, they cannot take decisions which would run counter to the decision adopted by the Commission”.

The Court of Justice declined to refer the case back to the General Court for the error of law to be rectified. Instead, the Court annulled the Commission Decision[12], holding that “by adopting the decision at issue, the Commission rendered the contractual rights of the third parties meaningless, including the contractual rights of Groupe Canal + vis-à-vis Paramount, and thereby infringed the principle of proportionality”.[13]

III. Implications of the Case

This is the first case in which a commitment decision has been overturned by the European courts. As such, it provides an important clarification as to the scope of commitments that parties under investigation can offer and that the Commission can accept. In practical terms, it limits the scope of commitments that the Commission can extract.

First, the Judgment confirms the principle established in the Alrosa Case, in which the Court held that “the fact that the individual commitments offered by an undertaking have been made binding by the Commission does not mean that other undertakings are deprived of the possibility of protecting the rights they may have in connection with their relations with that undertaking”.[14] However, it should not be forgotten that in Alrosa, the Court found that the Commission had not contravened the principle of proportionality – rather, it found that the General Court had been wrong to link the principle of proportionality in the context of commitment decisions adopted under Article 9 of Regulation 1/2003 to the test for proportionality for infringement decisions adopted under Article 7 of Regulation 1/2003.[15] By appearing to take the view that the doctrine of proportionality has a different scope depending on whether the Commission is adopting a commitments decision under Article 9 or an infringement decision under Article 7, the Court seems to have created an elusive shifting standard by which to apply a doctrine usually considered to be universal in its significance.[16]

In this Judgment, the Court has brought some clarity to that problematic distinction. A commitment decision short-circuits the usual procedure for infringement decisions, given that a commitment decision does not reach definitive conclusions about the legality or otherwise of the conduct in question. The procedure for commitment decisions is nevertheless still designed to ensure the effective application of Community law by allowing the Commission to take action in a more expedited manner than would otherwise be the case under the much more cumbersome procedure for infringement decisions. This trade-off means that commitments are limited to unilateral obligations agreed by defendants and there is no full investigation.

Second, it is not the case that the Commission is inexperienced in the handling of multi-party proceedings involving commitments relating to contractual obligations designed to put alleged anti-competitive conduct to an end. The Cannes Agreement[17] and Container Shipping[18] Cases are two clear examples of the Commission interfering with contractual relations, as are a series of multi-party JVs in the airline sector.[19] The Commission might be justifiably concerned, however, that its decision-making capacity will be impaired if it must in each case take into account third party contractual arrangements before agreeing commitments, especially if it has already consulted with third parties in a stakeholder consultation on the suitability of the commitments.

Third, the Commission and General Court clearly erred in finding that third parties could have recourse to national courts to enforce their contractual rights. The availability of such a remedy would clearly call into question the enforceability of the commitments, and would therefore undermine the principle that EU law must be implemented effectively. Insofar as the Court’s Ruling is based on the principle that national courts must refrain from adopting a decision that would contradict a binding Commission Decision, it is difficult to find fault with the Court’s logic.

In conclusion, it may be expected that the Commission will respond to the Court’s Canal+ Judgment by demanding more information and greater legal certainty in relation to commitments which might interfere with the contractual rights of third parties. In addition, the Commission may take the view that the Court, by asking it to pay greater attention to the rights of third parties in its proportionality analysis, has made commitment decisions too susceptible to legal challenge. If that is the case, the Commission may feel that it has little option other than to pursue infringement decisions more aggressively rather than seeking settlements under Article 9.

_____________________

[1] Judgment of 9 December 2020, Groupe Canal + v. Commission, Case C-132/19 P, EU:C:2020:1007.

[2] Council Regulation (EC) 1/2003 of 16 December 2002 on the implementation of the rules on competition laid down in Articles 81 and 82 of the Treaty, OJ L 1, 4.1.2003, pp. 1-25. Regulation 1/2003 sets out the procedural rules which the Commission must respect in pursuing an infringement action under Articles 101-102 TFEU. According to Article 9 of Regulation 1/2003, where the Commission takes the preliminary view that an infringement of the competition rules has taken place, the suspected undertakings can offer commitments to meet the concerns expressed by the Commission. If considered satisfactory, the Commission may by decision render these commitments binding on the undertakings concerned in a Decision.

[3] This is a preliminary assessment setting out the Commission’s views that an infringement of EU competition rules has taken place.

[4] Commitments by Paramount in Case AT.40023 – Cross-border access to pay-TV, 22.04.2016, available at: https://ec.europa.eu/competition/antitrust/cases/dec_docs/40023/40023_4638_3.pdf.

[5] At the time, the EU consisted of 28 Member States (including the United Kingdom) and the three additional jurisdictions of Norway, Iceland and Lichtenstein, which collectively constitute the European Economic Area (EEA).

[6] Commission Decision of 26 July 2016 in Case AT.40023 – Cross-border access to pay-TV adopted pursuant to Article 9 of Regulation 1/2003.

[7] Judgment of 12 December 2018, Groupe Canal + v Commission, T-873/16, EU:T:2018:904, paras. 93-98.

[8] Namely: (i) the Commission had not misused its powers on the issue of geo-blocking given that the legislative process relating to geo-blocking had thus far not resulted in the adoption of a legislative text, and this process was without prejudice to the powers conferred on the Commission under Article 101 TFEU and Regulation 1/2003; (ii) the licensing clauses under Article 101(1) TFEU were unlawful insofar as they eliminated the cross-border provision of broadcasting services and granted broadcasters absolute territorial protection; and (iii) the impact of the licensing clauses over the entire EEA territory was appropriate, without there being a necessity for the Commission to analyse those commitments on an individual basis. One would have thought that the simpler avenue for the Court of Justice would have been to agree with the appellant that the Commission had erred by not assessing each national exclusivity in terms of their competitive impacts, rather than accepting that the Commission was entitled to consider the competitive impacts of the territorial grants of exclusivity in their entirety over the territory of the EEA. By so holding, it would arguably have been more straightforward for the Court to conclude that the interference of the commitments with the appellant’s contractual right was “disproportionate” under the fourth plea.

[9] Judgment of 14 December 2000, Masterfoods and HB, C-344/98, EU:C:2000:689, para. 51.

[10] The principle of effectiveness is enshrined in Article 19 TEU, in Article 47 of the Charter of Fundamental Rights of the European Union and in numerous cases such as in the Judgment of 13 March 2007, Unibet, Case C-432/05, EU:C:2007:163. In the Judgment of 27 March 2014, Saint-Gobain Glass France SA, Joined Cases T-56/09 and T-73/06 EU:T:2014:160, paragraph 83, the General Court further emphasised that “the judicial review of the decisions adopted by the Commission in order to penalise infringements of competition law that is provided for in the Treaties and supplemented by Regulation No 1/2003 is consistent with that principle”.

[11] The doctrine of effective application of EU law is itself based on the doctrine of “sincere cooperation” between EU institutions and the Member States, as found in Article 4(3) TEU, which provides the legal basis for many of the provisions contained in Regulation 1/2003.

[12] In accordance with Article 61(1) of the Statute of the Court of Justice of the European Union.

[13] Judgment of 9 December 2020, Groupe Canal + v. Commission, C-132/19 P, EU:C:2020:1007, para. 123.

[14] Judgment of 29 June 2010, Commission v. Alrosa, C-441/07 P, EU:C:2010:377, paragraph 49.

[15] See Judgment of 29 June 2010, Commission v. Alrosa, C-441/07 P, EU:C:2010:377, paragraph 47, where the Court of Justice held that there is no reason that would explain “why the measure which could possibly be imposed in the context of Article 7 of Regulation No 1/2003 should have to serve as a reference for the purpose of assessing the extent of the commitments accepted under Article 9 of the regulation, or why anything going beyond that measure should automatically be regarded as disproportionate”.

[16] The principle of proportionality is a general principle of EU law provided in Article 5(4) TEU. This principle regulates the exercise of powers by the European Union, by requiring that the actions taken by the EU are limited to what is necessary to achieve the objectives set in the Treaties.

[17] Commission Decision of 04.10.2006 in Case AT.38681 – Cannes Agreement. The commitments offered by the Parties consisted of: (i) ensuring that collecting societies could continue to give rebates to record companies; and (ii) the removal of a non-competition clause.

[18] Commission Decision of 07.07.2016 in Case AT.39850 – Container Shipping. The commitments offered by 14 container liner shipping companies aimed to increase price transparency for customers and to reduce the likelihood of coordinating prices. See also Commission Decision of 16 September 1998 in Case no IV/35.134 – Trans-Atlantic Conference Agreement, in which the Commission imposed an obligation on the infringing undertakings to inform the customers with whom they had concluded joint service contracts that those customers were entitled to renegotiate the terms of those contracts or to terminate them forthwith.

[19] Commission Decision of 23.05.2013 in Case AT.39595 – Continental/United/Lufthansa/Air Canada; Commission Decision of 14.07.2010 in Case AT.39596 – American Airlines/British Airways Plc/ Iberia Líneas Aéreas de España; and Commission Decision of 12.05.2015 in Case AT.39964 – Air France/KLM/Alitalia/Delta. In these cases, the affected airlines committed to making slots available in order to facilitate the entry or expansion of competitors, and to enter into agreements in order to allow competitors to offer more attractive services.

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

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

On December 7, 2020, the Foreign Affairs Council of the Council of the European Union, adopted Decision (CFSP) 2020/1999 (the Council Decision) and Regulation (EU) 2020/1998 (the Council Regulation) concerning restrictive measures against serious human rights violations and abuses, which together establish the first global and comprehensive human rights sanctions regime to be enacted by the European Union (the EU) (the EU Human Rights Sanctions).

The EU Human Rights Sanctions will allow the EU to target individuals and entities responsible for, involved in or associated with serious human rights violations and abuses and provides for the possibility to impose travel bans, asset freeze measures and the prohibition of making funds or economic resources available to those designated.

The adoption of the EU Human Rights Sanctions emphasizes that the promotion and protection of human rights remain a cornerstone and priority of EU external action and is expected to contribute towards progressing global human rights by strengthening the international community’s ability to hold individuals and entities accountable for decisions or actions that lead to blatant or systematic human rights violations.

Background

The need for adopting a regime that specifically addresses serious human rights violations worldwide has long been the subject of debate in the EU.

In November 2018, the Dutch Government launched preliminary discussions among EU member states for a specific human rights sanctions regime. In March 2019, the European Parliament adopted a resolution calling “for the swift establishment of an autonomous, flexible and reactive EU-wide sanctions regime”. However, it was only in December 9, 2019, that the Council of the European Union formally reflected on how to improve the EU’s toolbox when it comes to addressing human rights violations, and the EU High Representative announced the launch of preparatory work on a possible sanctions regime.

More recently, on September 16, 2020, in her State of the Union Address, European Commission President Ursula von der Leyen prompted member states to “be courageous and finally move to qualified majority voting – at least on human rights and sanctions implementation”. She not only recalled that the EU Parliament had already called for a “European Magnitsky Act” many times, but also announced that the European Commission “will now come forward with a proposal”.

Moving towards this goal, on November 17, 2020, the European Council approved conclusions on the EU Action Plan on Human Rights and Democracy 2020-2024 which set out the EU’s priorities in this field and contained a commitment to developing a new EU global human rights sanctions regime.

It is important to note that the enactment of the EU Human Rights Sanctions comes after the adoption of the U.S. Magnitsky Act of 2012, and its 2016 expansion, the U.S. Global Magnitsky Human Rights Accountability Act (collectively, the Magnitsky Act), which was the first legal instrument worldwide addressing human rights violations through sanctions. Since then, Canada, Estonia, Latvia, Lithuania and the United Kingdom (for more details on the UK regime please see Gibson Dunn Client Alert of July 9, 2020) have also adopted Magnitsky-like sanctions regimes. Other countries, including Japan and Australia, are also considering adopting similar legislation.

Scope of application

Mirroring the Magnitsky Act, the new sanctions regime will provide the EU with a legal framework to target natural and legal persons, entities and bodies – including state and non-state actors – responsible for, involved in or associated with serious human rights violations and abuses worldwide, regardless of where these might have occurred.

The EU Human Rights Sanctions applied to acts such as genocide, crimes against humanity and other serious human rights violations or abuses, such as torture, slavery, extrajudicial killings, arbitrary arrests or detentions. Other human rights violations or abuses can also fall under the scope of the sanctions regime where those violations or abuses are widespread, systematic or are otherwise of serious concern as regards the objectives of the common foreign and security policy set out in Article 21 of the Treaty on European Union.[1]

Notably, contrary to the U.S. and Canadian sanctions regimes, and similarly to the United Kingdom human rights sanctions regime, the list of human rights violations does not include corruption.

Restrictive measures

Under the EU Human Rights Sanctions designated human rights offenders can be targeted by travel bans (applying to individuals) and asset freezes (applying to both individuals and entities). In addition, individuals and entities in the EU will be forbidden from making funds available, either directly or indirectly, to the designated individuals or entities. Further, it is prohibited to participate, knowingly and intentionally, in activities the object or effect of which is to circumvent EU Human Rights Sanctions.

Similarly to other EU sanctions regimes, under the EU Human Rights Sanctions, the competent authorities of the member states may authorize the release of certain frozen assets and the provision of certain funds and economic resources on the basis of humanitarian grounds.

Member states may also grant exemptions from travel restrictions where travel is justified on the grounds of an urgent humanitarian need, in order to facilitate a judicial process or on grounds of attending intergovernmental meetings, where a political dialogue is conducted that directly promotes the policy objectives of restrictive measures, including the ending of serious human rights violations and abuses.

Procedural Aspects

Following the structure of existing sanctions programs, the EU Human Rights Sanctions were introduced by the Council of the European Union through a Council Decision (setting out key principles binding to the member states) and a Council Regulation (with more detailed provisions that are directly binding to any person subject to the EU’s jurisdiction).

It will now be for the Council of the European Union, acting upon a proposal from a member state or from the High Representative of the EU for Foreign Affairs and Security Policy, to establish, review and amend the list of those individuals and entities that are subject to EU Human Rights Sanctions. Designating an individual or an entity will require a significant degree of consensus, as the Council of the European Union can only proceed with designations on the basis of unanimity among all member states.

Enforcing the EU Human Rights Sanctions, including determining the applicable penalties for the infringement of the restrictive measures, falls within the competency of member states.

Outlook

Human rights violations have already been subject to EU sanctions, imposed on the basis of a sanctions framework linked to specific countries, conflicts or crises.[2] Linking the possibility of sanctioning human rights violations to specific countries or conflicts, however, limited the EU’s ability to respond swiftly whenever a new crisis emerged.

EU Human Rights Sanctions are expected to confer more flexibility and speediness to the EU’s response to significant human rights violations. Since EU Human Rights Sanctions put the emphasis on the individual responsibility of designated persons and entities (rather than on their nationality), it dissociates to a certain extent the geographical link between the perpetrator of a human rights violation and third countries. This provides the EU with the opportunity to proceed with designations, without necessarily entailing political, economic and strategic conflicts with third countries.

U.S. Secretary of State Mike Pompeo said that the U.S. “welcomes” the EU’s sanctions regime, calling it a “groundbreaking accomplishment” and encouraging the EU “to adopt its first designations as soon as possible”.

Additionally, despite welcoming the EU’s move, several civil society organizations called for additional rules to also target corruption.

The adoption of the restrictive measures under the EU Human Rights Sanctions means that companies active in the EU will be obliged to freeze the assets of designated human rights offenders and must not make funds or economic resources available to them. Further, it will limit access to the EU by imposing travel bans on those designated.

Although no specific individual or entity have yet been designated under EU Human Rights Sanctions, companies active in the EU should be mindful of this new sanctions regime and take it into consideration in their compliance efforts.

____________________

[1] Such violations may, inter alia, include: (i) trafficking in human beings, as well as abuses of human rights by migrant smugglers as referred to in that Article; (ii) sexual and gender-based violence; (iii) violations or abuses of freedom of peaceful assembly and of association; (iv) violations or abuses of freedom of opinion and expression and; (v) violations or abuses of freedom of religion or belief.

[2] See, for instance, Council Regulation (EU) 36/2012 concerning restrictive measures in view of the situation in Syria (including the continued brutal repression and violation of human rights by the Government of Syria); Council Regulation (EU) 2016/44 concerning restrictive measures in view of the situation in Libya (including serious human rights abuses); Council Regulation (EU) 2017/2063 concerning restrictive measures in view of the situation in Venezuela (including the continuing deterioration of human rights).

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

Attila Borsos – Brussels (+32 2 554 72 11, [email protected])
Patrick Doris – London (+44 (0) 20 7071 4276, [email protected])
Michael Walther – Munich (+49 89 189 33-180, [email protected])
Richard W. Roeder – Munich (+49 89 189 33-160, [email protected])
Maria Francisca Couto – Brussels (+32 2 554 72 31, [email protected])
Vasiliki Dolka – Brussels (+32 2 554 72 01, [email protected])

International Trade Group:

Europe and Asia:
Peter Alexiadis – Brussels (+32 2 554 72 00, [email protected])
Attila Borsos – Brussels (+32 2 554 72 10, [email protected])
Nicolas Autet – Paris (+33 1 56 43 13 00, [email protected])
Susy Bullock – London (+44 (0)20 7071 4283, [email protected])
Patrick Doris – London (+44 (0)20 7071 4276, [email protected])
Sacha Harber-Kelly – London (+44 (0)20 7071 4205, [email protected])
Penny Madden – London (+44 (0)20 7071 4226, [email protected])
Benno Schwarz – Munich (+49 89 189 33 110, [email protected])
Michael Walther – Munich (+49 89 189 33-180, [email protected])
Richard W. Roeder – Munich (+49 89 189 33-160, [email protected])
Fang Xue – Beijing (+86 10 6502 8687, [email protected])
Qi Yue – Beijing (+86 10 6502 8534, [email protected])

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Decided December 10, 2020

Rutledge v. Pharmaceutical Care Management Ass’n, No. 18-540

Today, the Supreme Court held 8-0 that ERISA does not preempt an Arkansas statute regulating the rates at which pharmacy benefit managers reimburse pharmacies for prescription drug costs.

Background:
Section 514(a) of the Employee Retirement Income Security Act of 1974 (“ERISA”) preempts state laws that “relate to” employee benefit plans. 29 U.S.C.§ 1144(a). In 2015, Arkansas adopted a law, Act 900, to regulate the rates and procedures by which pharmacy benefit managers (“PBMs”) reimburse pharmacies for the costs of drugs administered on behalf of benefit plans. The Pharmaceutical Care Management Association, the trade association representing PBMs, filed suit alleging that ERISA preempted Act 900.

The Eighth Circuit held that Act 900 is preempted because it has an impermissible “connection with” ERISA plans by interfering with central plan functions and nationally uniform plan administration, and also because it impermissibly “refers to” plans by regulating PBMs administering benefits for the plans.

Issue:
Does ERISA preempt Arkansas’ Act 900 regulating the rates and reimbursement procedures of pharmacy benefit managers?

Court’s Holding:
ERISA does not preempt Arkansas’ Act 900. Act 900 merely affects costs without dictating plans’ choices of benefit structure, either directly or indirectly. It has neither an impermissible connection with nor a reference to ERISA plans.

“Act 900 is merely a form of cost regulation . . . [that] applies equally to all PBMs and pharmacies in Arkansas. As a result, Act 900 does not have an impermissible connection with an ERISA plan.”

Justice Sotomayor, writing for the Court

What It Means:

The Court’s decision may lead to further state regulation of PBMs, which are engaged by the majority of employers to deliver prescription-drug benefits. Dozens of other states have already passed similar laws regulating PBM pricing, and more could follow. Today’s decision could lead to new litigation over whether other states’ laws are sufficiently distinguishable from Arkansas’ Act 900 to be preempted.
The Court’s decision also could lead to new attempts by states to regulate other aspects of plan administration, including other third-party administrators beyond the PBM context. Third parties—including claims administrators, external reviewers, and healthcare provider networks—play a vital role in many aspects of modern plan administration.
In a concurrence, Justice Thomas reiterated his previously expressed doubts about the Court’s ERISA preemption doctrine, which he believes has departed from the text of the statute.

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

Allyson N. Ho
+1 214.698.3233
[email protected]

Mark A. Perry
+1 202.887.3667
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Helgi C. Walker
+1 202.887.3599
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Lucas C. Townsend
+1 202.887.3731
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Bradley J. Hamburger
+1 213.229.7658
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Related Practice: Employee Benefits

Richard J. Doren
+1 213.229.7038
[email protected]

Heather L. Richardson
+1 213.229.7409
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Geoffrey M. Sigler
+1 202.887.3752
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Daniel J. Thomasch
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Gibson Dunn provides a discussion regarding the latest developments and trends in anti-money laundering and sanctions laws, regulations, and enforcement. This webcast includes a particular focus on international AML developments, including the increasing overlap between sanctions and AML enforcement. We also discuss updates related to the FinCEN files, FinCEN’s new enforcement guidance, virtual currency, marijuana-related businesses, and sports betting. With respect to sanctions, we cover the increasing complexity of complying with the growth in both traditional U.S. sanctions and newer export controls. We also analyze the mounting challenges for companies seeking to navigate global compliance stemming from the enforcement of “counter-sanctions” imposed by China, the European Union, and others.

View Slides (PDF)

MODERATOR:

F. Joseph Warin is co-chair of Gibson Dunn’s global White Collar Defense and Investigations Practice Group, and chair of the Washington, D.C. office’s 200-person Litigation Department. Mr. Warin’s group is repeatedly recognized by Global Investigations Review as the leading global investigations law firm in the world. Mr. Warin is a former Assistant United States Attorney in Washington, D.C. He is ranked annually in the top-tier by Chambers USA, Chambers Global, and Chambers Latin America for his FCPA, fraud and corporate investigations experience. Among numerous accolades, he has been recognized by Benchmark Litigation as a U.S. White Collar Crime Litigator “Star” for ten consecutive years (2011–2020).

PANELISTS:

Stephanie L. Brooker is co-chair of Gibson Dunn’s Financial Institutions Practice Group and member of the White Collar Group. She is the former Director of the Enforcement Division at FinCEN, and previously served as the Chief of the Asset Forfeiture and Money Laundering Section in the U.S. Attorney’s Office for the District of Columbia and as a DOJ trial attorney for several years. Ms. Brooker represents multi-national companies and individuals in internal corporate investigations and DOJ, SEC, and other government agency enforcement actions involving, for example, matters involving BSA/AML; sanctions; anti-corruption; securities, tax, and wire fraud; whistleblower complaints; and “me-too” issues. Her practice also includes BSA/AML compliance counseling and due diligence and significant criminal and civil asset forfeiture matters. Ms. Brooker has been named a Global Investigations Review “Top 100 Women in Investigations” and National Law Journal White Collar Trailblazer.

Kendall Day is a litigation partner in Washington, D.C. and was a white collar prosecutor for 15 years, eventually rising to become an Acting Deputy Assistant Attorney General, the highest level of career official in the Criminal Division at DOJ. He represents financial institutions, multi-national companies, and individuals in connection with criminal, regulatory, and civil enforcement actions involving anti-money laundering (AML)/Bank Secrecy Act (BSA), sanctions, FCPA and other anti-corruption, securities, tax, wire and mail fraud, unlicensed money transmitter, false claims act, and sensitive employee matters. Mr. Day’s practice also includes BSA/AML compliance counseling and due diligence, and the defense of forfeiture matters.

Adam M. Smith is a partner in Washington, D.C. and was the Senior Advisor to the Director of the U.S. Treasury Department’s OFAC and the Director for Multilateral Affairs on the National Security Council. His practice focuses on international trade compliance and white collar investigations, including with respect to federal and state economic sanctions enforcement, the FCPA, embargoes, and export controls. He routinely advises multi-national corporations regarding regulatory aspects of international business. Mr. Smith is ranked by Chambers and Partners and was named by Global Investigations Review as a leading sanctions practitioner.

Ella Alves Capone is a senior associate in the Washington, D.C. office. Her practice focuses primarily in the areas of white collar criminal defense, corporate compliance, and securities litigation. Ms. Capone regularly conducts internal investigations and advises multinational corporations and financial institutions, including major banks and casinos, on compliance with anti-corruption and anti-money laundering laws and regulations.

Our webcast provides a preview of what Congress is likely to investigate in the coming Congress. We look at the investigative committees, including who is likely to lead them and on what topics they are likely to focus. We discuss the impact of the Presidential election on congressional investigative and oversight priorities. We examine how recent rules changes and court cases impact the ability of congressional committees to enforce compliance with document, information and deposition requests. And we discuss strategies for responding to congressional requests. This is a fast-paced, practical look at the landscape of the 117th Congress, which promises an active slate of investigations focused on the private sector.

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PANELISTS:

Michael Bopp is a partner in the Washington, D.C. office. He spent more than a decade on Capitol Hill running congressional investigations in both the House and Senate and brings his extensive government and private-sector experience to help clients navigate through the most difficult crises, often involving investigations as well as public policy and media challenges.

Thomas Hungar is a partner in the Washington, D.C. office. Mr. Hungar served as General Counsel to the U.S. House of Representatives from July 2016 until January 2019, when he rejoined the firm. He has presented oral argument before the Supreme Court of the United States in 26 cases, including some of the Court’s most important patent, antitrust, securities, and environmental law decisions, and he has also appeared before numerous lower federal and state courts.

Roscoe Jones is counsel in the Washington, D.C. office, and a member of the firm’s Public Policy, Congressional Investigations, and Crisis Management groups. Mr. Jones formerly served as Chief of Staff to U.S. Representative Abigail Spanberger, Legislative Director to U.S. Senator Dianne Feinstein, and Senior Counsel to U.S. Senator Cory Booker, among other high-level roles on Capitol Hill.

Megan Kiernan is an associate in the Washington, D.C. office. She practices in the firm’s Litigation Department and is a member of its White Collar Defense, Congressional Investigations, and Crisis Management Practice Groups. She defends clients in Executive and Congressional Branch investigations as well as in civil litigation at the trial and appellate level.

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

The Company’s Form 8-Ks

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

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

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

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

What the Company Did Not Disclose

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

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

The SEC’s Findings

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

Observations and Takeaways

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

Two observations:

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

Some takeaways:

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

_______________________

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

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

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

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

Please also feel free to contact the practice group leaders:

Securities Enforcement Practice Group Leaders:
Barry R. Goldsmith – New York (+1 212-351-2440, [email protected])
Richard W. Grime – Washington, D.C. (+1 202-955-8219, [email protected])
Mark K. Schonfeld – New York (+1 212-351-2433, [email protected])

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
James J. Moloney – Orange County, CA (+ 949-451-4343, [email protected])
Lori Zyskowski – New York, NY (+1 212-351-2309, [email protected])

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

This year presented unique challenges for the Court, as New York was situated at the national epicenter of the COVID-19 pandemic. When the virus’s effects took hold in March, the Court responded by limiting access to its courthouse. By the end of the month, the Governor issued an Executive Order suspending various litigation deadlines and issued a statewide work-from-home order. New York courts—led by Chief Judge Janet DiFiore—took measures to restrict the virus’s spread. The Court closed its courthouse and elected not to hear oral argument during its remaining March, April, and May sessions. In late May, however, the Court began reopening, and it is now accepting in-person filings and hearing oral arguments with appropriate safety protocols.

Both the pace of decisions and new additions to the docket appear to have been reduced by approximately 20%. Nevertheless, the Court has continued resolving cases of exceptional importance, on a broad array of issues spanning from due process, freedom of speech, and arbitration, to class actions, statutes of limitations, consumer protection, administrative law, and employment law.

This year continued the Court’s recent lack of unanimity, with judges issuing a large number of concurring and dissenting opinions. Moreover, Judge Leslie Stein announced that she will retire in June 2021, and Judge Eugene Fahey will reach his mandatory retirement age next year. Their replacement marks a potential shift for the Court, which has been perceived by some as ideologically moderate and growing increasingly conservative on certain issues in recent years, including law enforcement and business regulation.

The New York Court of Appeals Round-Up & Preview summarizes key opinions in civil cases issued by the Court over the past year and highlights a number of cases of potentially broad significance that the Court will hear during the coming year. The cases are organized by subject.

To view the Round-Up, click here.

Gibson Dunn’s New York office is home to a team of top appellate specialists and litigators who regularly represent clients in appellate matters involving an array of constitutional, statutory, regulatory, and common-law issues, including securities, antitrust, commercial, intellectual property, insurance, unfair trade practice, First Amendment, class action, and complex contract disputes. In addition to our expertise in New York’s appellate courts, we regularly brief and argue some of the firm’s most important appeals, file amicus briefs, participate in motion practice, develop policy arguments, and preserve critical arguments for appeal. That is nowhere more critical than in New York—the epicenter of domestic and global commerce—where appellate procedure is complex, the state political system is arcane, and interlocutory appeals are permitted from the vast majority of trial-court rulings.

Our lawyers are available to assist in addressing any questions you may have regarding developments at the New York Court of Appeals, or any other state or federal appellate courts in New York. Please feel free to contact any member of the firm’s Appellate and Constitutional Law practice group, or the following lawyers in New York:

Mylan L. Denerstein (+1 212-351-3850, [email protected])
Akiva Shapiro (+1 212-351-3830, [email protected])
Seth M. Rokosky (+1 212-351-6389, [email protected])
Genevieve B. Quinn (+1 212-351-5339, [email protected])

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

Allyson N. Ho – Dallas (+1 214.698.3233, [email protected])
Mark A. Perry – Washington, D.C. (+1 202.887.3667, [email protected])

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

A. International and UK developments

I. BEPS 2.0 – OECD Blueprints

II. OECD consultation on dispute resolution mechanics

III. Updates to the Directive on Administrative Cooperation (DAC)

(i) DAC 6 update

(ii) DAC 7 update

(iii) DAC 8: proposal for the automatic exchange of information relating to crypto-assets

IV. UK developments

(ii) Finance Bill 2021 – updates following consultation responses

V. UK and EU VAT updates

(i) UK VAT grouping – Establishment, Eligibility and Registration Call for Evidence

B. Notable Cases

I. Blackrock HoldCo 5 LLC v HMRC [2020] UKFTT 443 (TC)

II. Dunsby v HMRC [2020] UKFTT 0271 (TC) and Bostan Khan v HMRC [2020] UKUT 168 (TCC) (2 June)

III. Bluejay Mining plc [2020] UKFTT 473 (TC)

1. The Competition Ordinance in a Nutshell

2. Cartels

3. Other Nonmerger Enforcement Actions taken by the Commission

4. Private Litigation

5. Mergers

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

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

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

I. Deciding Who Decides: Should Employers Mandate Vaccination?

II. Playbook For Employer Vaccine Policies

I. Background

II. Judgment of the Court of Justice

III. Implications of the Case

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