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A year ago, Colorado ushered in a new era of oil gas regulation when Governor Jared Polis signed Senate Bill 19-181 (“SB-181”) into law.[1] For opponents of oil and gas development, SB-181 represented a significant victory—and a reversal of fortune. Over the course of the previous year, Colorado voters had soundly defeated Proposition 112, a statewide initiative that would have mandated aggressive setback rules for new wells,[2] and the Colorado Supreme Court issued its unanimous decision in Martinez v. Colorado Oil and Gas Conservation Commission, which upheld a decade’s worth of rulemaking by the Colorado Oil and Gas Conservation Commission (“COGCC”) under the state’s prior regulatory regime.[3]

In response to these developments, newly elected Governor Polis, with the support of a Democratic majority in both houses of the Colorado General Assembly, vowed to push for legislation to “reform” the COGCC and “make sure health and safety are prioritized.”[4] The result was SB-181, which was touted as a solution to the long-simmering “oil and gas wars” between environmental activists and industry groups in the state.[5]

A year has now passed since the signing of SB-181. In that time, the COGCC and other state regulators have begun the process of implementing the law. It has become clear, however, that the “oil and gas wars” are not over. Rulemaking at the COGCC remains contentious, and local governments continue to flex their muscles and threaten to significantly restrict oil and gas development within their borders. Meanwhile, legal challenges to these regulations are likely on the horizon, and voters may once again be asked to decide whether to impose new regulations on the industry when they head to the ballot box for this year’s election. While the current COVID-19 crisis and the related turmoil in global markets have recently dominated concerns about the future of oil and gas development in Colorado, determining the state’s long-term regulatory scheme remains a top priority for both the proponents and opponents of Colorado’s oil and gas industry.

A Recap of SB-181’s Major Changes

SB-181 made fundamental changes to Colorado’s regulatory structure for the oil and gas industry, in some cases reversing assumptions that had been a part of state law for decades.

First, SB-181 granted local governments power to regulate future oil and gas development within their jurisdictions, including the power to preempt less restrictive statewide regulations promulgated by the COGCC.[6] This decentralization of authority was a dramatic shift in Colorado’s regulatory approach. In the decades before SB-181, lawmakers had been hesitant to grant local governments significant control over the industry. Doing so, they feared, would lead to an impractical patchwork of regulations across the state.[7] SB-181 was an about-face: a local government may now impose oil and gas regulations that are stricter than those promulgated by the COGCC, and those stricter rules will govern oil and gas development within the local government’s jurisdiction.[8] SB-181’s only limitations on local regulatory powers are that these powers must be exercised in a “reasonable manner” and any regulations imposed on the industry must be “necessary and reasonable” to protect public health and the environment—limitations that are undefined and have yet to be tested by the courts.[9]

Second, SB-181 altered the overall mission of state regulators. Previously, the COGCC was charged with a statutory mandate to “foster” development of oil and gas resources to achieve the “maximum efficient rate of production.”[10] Protection of public health and the environment was a significant goal, but the COGCC pursued that goal in tandem with oil and gas development. Now, under SB-181, the COGCC is required to “regulate”—not “foster”—oil and gas development in Colorado, and it must do so “in a manner that protects” public health and the environment.[11] In effect, SB-181 required the COGCC to reevaluate its regulatory approach while deemphasizing full utilization of state oil and gas reserves. Consistent with this “mission change,” the COGCC is required to collaborate with the Colorado Department of Public Health and Environment (“CDPHE”) to address the “cumulative impact” of oil and gas development.

Third, SB-181 called for the restructuring and professionalization of the COGCC.[12] Previously, the COGCC was composed of nine members. Seven were unpaid volunteers, three of whom were required to have substantial experience in the oil and gas industry.[13] By July 1, 2020, however, membership will be reduced by two commissioners, and each of the seven will be paid, full-time government employees. Five will be newly appointed by the Governor, only one of which is required to have industry experience. The remaining two are the Executive Directors of the Colorado Department of Natural Resources and CDPHE, who will serve as ex officio non-voting members.[14] SB-181 mandates that the newly appointed commissioners be free from conflicts of interest, which are defined to include working as a registered lobbyist at the state or local levels, serving in the Colorado General Assembly within the past three years, or serving in an official capacity with an entity that advocates for or against oil and gas activity.[15] The COGCC began accepting applications for the full-time commissioner positions in January 2020, but Governor Polis has not yet announced his nominations.[16]

Delays in the Statewide Rulemaking Process

To implement its wide-reaching reforms, SB-181 required the COGCC to undertake major rulemaking initiatives on a range of subjects, including (1) updates to the COGCC’s hearing procedures (the so-called “500 Series” rules); (2) public disclosure of flowline locations; (3) criteria for the selection of drilling sites, including consideration of alternative locations; (4) wellbore integrity; (5) minimizing the cumulative impact of oil and gas development (in consultation with the CDPHE); and (6) the overall “mission change” of the COGCC.[17] In addition, SB-181 instructed CDPHE to establish rules to minimize air and water pollution generated from exploration and development activities.[18]

All of these rules were initially scheduled to be finalized by July 1, 2020, before the transition in the COGCC’s structure and membership.[19] But the rulemaking process has proved more contentious than expected and has been plagued by delays. As a result, the COGCC has acknowledged that meeting the July deadline is unlikely.[20]

The COGCC attempted to ease into the rulemaking process in June 2019, just after SB-181 went into effect, tackling a subject thought to be relatively uncontroversial—the so-called 500 Series, which would amend existing procedural rules.[21] Instead, public rulemaking hearings became a battleground, with environmental groups demanding a moratorium on new drilling permits until a full suite of updated health and safety regulations could be drafted, approved, and implemented.[22] The COGCC eventually adopted updated 500 Series rules in July 2019 and new flowline rules in November 2019,[23] but delays continue to affect the COGCC’s other rulemaking proceedings.

The COVID-19 crisis has exacerbated these delays. Rulemaking hearings to address the “mission change” of the COGCC, cumulative impacts of oil and gas development, and drilling site criteria were delayed by several months.[24] Hearings to consider rules governing wellbore integrity were rescheduled from February 2020 to April 2020[25] and were rescheduled again to June 2020.[26] While the COGCC recently began holding hearings via videoconference to continue the rulemaking process, it has recognized the inadequacy of these virtual meetings for public testimony and open discussion with respect to especially controversial rulemakings, such as the mission change rules.[27] As a result, the COGCC has opted to reschedule public hearings on the mission change rules until August 24 through September 24, when the COGCC hopes to be able to hold in-person hearings, though it currently plans to proceed with the June 2020 public hearings on wellbore integrity rules, likely by videoconference.[28] Accordingly, the COGCC will not meet its July 1st goal of completing all of the rulemaking required by SB-181. While the current commissioners may be able to complete the wellbore integrity regulations before July 1st, the ongoing rulemaking process will be completed by the newly constituted COGCC, not the current commissioners.[29] It remains to be seen whether shifting the balance of the rulemaking proceedings to the new COGCC commissioners will further delay adoption of final rules or affect their content.

Meanwhile, CDPHE has been engaged in separate rulemaking proceedings through two of its divisions, the Air Quality Control Commission (“AQCC”) and the Water Quality Control Commission (“WQCC”). In December 2019, the AQCC adopted rules imposing increased leak detection and repair requirements on producing wells, comprehensive annual emissions reports, and more stringent controls on emissions from storage tanks—all of which will increase operation costs substantially, particularly for small producers.[30] At the same time, AQCC also adopted regulations requiring oil and gas producers to obtain air-quality permits (in addition to the permit to drill required by the COGCC) before they can begin exploration and production activities, eliminating a 90-day grace period under previous rules.[31] In a future rulemaking, the AQCC will consider rules intended to reduce emissions of hydrofluorocarbons and rules requiring oil and gas producers to track and report greenhouse gases emissions.[32] Separately, the WQCC is finalizing tighter regulations governing surface and ground water, which will affect injection wells, waste disposal, and other oil and gas operations.

Local Regulation: Renewed Drilling Moratoriums and a Patchwork Approach

Soon after the passage of SB-181, a number of cities and counties in the Denver-Julesburg Basin enacted moratoriums on new applications for local drilling permits, including Adams and Boulder counties and the cities of Berthoud, Broomfield, Lafayette, Superior, and Timnath. The stated intent of these moratoriums was to pause oil and gas development while the COGCC and local governments updated their regulations.[33] Given the delays plaguing the rulemaking process at the COGCC, however, some of these moratoriums have effectively banned new oil and gas development for as much as a year.[34]

The legality of these moratoriums is unclear. Under the pre-SB-181 framework, a number of cities and counties in Colorado attempted to impose lengthy moratoriums on oil and gas activity. But the courts struck them down, and the Colorado Supreme Court confirmed that local governments did not have the power to halt oil and gas development within their borders.[35] SB-181, however, granted local governments new powers—including, perhaps, the power to ban oil and gas activities. In the coming months, this question may soon be decided by a trial court in Boulder County. A group of anti-industry activists has asked for a ruling that would confirm the legality of the city’s ban on hydraulic fracturing under SB-181.[36]

In the meantime, local governments have proceeded to consider and impose new regulations for the oil and gas industry. One of the industry’s primary criticisms of SB-181 was that it would enable and even encourage a patchwork of local regulations across the state, something that lawmakers in Colorado had long attempted to avoid through preemptive state rules. As the opponents of SB-181 explained, neighboring localities might adopt wildly different—and perhaps inconsistent—regulations.[37] Operating under this kind of jurisdiction-by-jurisdiction patchwork would be difficult and expensive, if not impossible, for producers.

These fears appear to be well-founded.[38] The neighboring counties of Boulder and Weld are taking diametrically opposed regulatory approaches. Boulder commissioners are seeking the “toughest regulations [they] can get” and will likely adopt some of the most restrictive rules in the state.[39] Its proposed rules would impose more stringent restrictions on oil and gas exploration and production, and will at the same time add additional restrictions on noise, vibration, odor, and seismic testing.[40] In stark contrast, Weld county—home to nearly half of Colorado’s active wells—rejected a permitting moratorium and has taken steps to facilitate, rather than restrict, new oil and gas development. For example, local officials designated unincorporated portions of the county as “mineral resource areas of state interest,” prompting an agreement with the COGCC to address the backlog of permits affecting oil and gas development in the county.[41]

While these two counties represent extreme approaches, they highlight the difficulties facing the industry. Mineral rights, leasehold interests, and wells may all span more than one jurisdiction, and producers will now have to grapple simultaneously with several sets of different local rules and regulations—not to mention new state-level rules—increasing the cost and complexity of their operations.

Statewide Permitting Slows and New Ballot Initiatives Loom

One of the primary effects of SB-181 has been a steep decline in the approval of new well locations and drilling permits, which were down nearly 57% and 58%, respectively, in the six months after SB-181 was enacted.[42] While some of this decline can be attributed to local government moratoriums, the COGCC has also indicated that the permitting slowdown is “a reflection of the new emphasis on health, safety and the protection of the environment” created by SB-181.[43] Indeed, shortly after SB-181 was passed, the COGCC adopted interim permitting criteria requiring additional analysis of some drilling permit applications “to ensure the protection of public health, safety, welfare, the environment, or wildlife resources.”[44] The recent decline in permitting has exacerbated an existing backlog, increasing operators’ uncertainty, interrupting drilling programs, and decreasing overall production.[45]

Critics of SB-181 have long predicted that the new law could contribute to a slowdown in Colorado’s oil and gas industry.[46] This prediction was echoed by the University of Colorado’s Leeds School of Business, which warned in December 2019 that “economic and regulatory uncertainties could very well slow development in 2020.”[47] The delayed and uncertain regulatory outlook, when coupled with the COVID-19 crisis and the turmoil in global oil markets, have forced the industry to take dramatic steps, such as slashing capital expenditures, reducing or eliminating dividends, and furloughing or laying off employees. Such measures directly impact adjacent industries, including oilfield services companies, investors, and employees. So far, no major lawsuits have been filed to challenge state or local regulations promulgated under SB-181. As the Leeds School of Business explained, however, “the possibility of legal challenges” is “persistently looming” given the high stakes.[48]

In the meantime, citizen initiatives seeking further changes to Colorado’s regulatory framework may reach the ballot for the upcoming 2020 presidential-year election. The proponent of Proposition 112, the setback initiative that was voted down in 2018, is pursuing six separate initiatives this year. Five of them would impose well setbacks similar to those found in Proposition 112; another would require oil and gas companies to post a far more expensive bond for new wells. If any of these initiatives make the ballot—which is anything but certain, given the difficulty of obtaining petition signatures during the COVID-19 pandemic—the industry could face another expensive campaign season. In 2018, industry groups spent nearly $40 million defeating Proposition 112.[49] A similar political fight in the midst of a presidential campaign may be even more expensive.

Conclusion

The implementation of SB-181 over the past year has been a difficult endeavor. The COGCC’s rulemaking process has been contentious, leading to repeated delays in the adoption of new regulations. Many local governments enacted moratoriums on new drilling applications, some of which have been extended due to the delays at the COGCC. These local governments have also taken different approaches to oil and gas regulation, creating a patchwork of rules across the state. With legal challenges to the implementation of SB-181 forthcoming and several new ballot initiatives on the horizon, SB-181 appears to have increased, not decreased, the clashes between proponents and opponents of oil and gas production in Colorado. Unfortunately for all involved, the end of the “oil and gas wars” in Colorado is a long way off.

______________________

[1] https://www.denverpost.com/2019/04/16/colorado-oil-gas-bill-signed-gov-jared-polis/.

[2] https://www.sos.state.co.us/pubs/elections/Initiatives/titleBoard/filings/2017-2018/97Final.pdf.

[3] Martinez v. Colo. Oil & Gas Conservation Comm’n, No. 17SC297 (available at http://blogs2.law.columbia.edu/climate-change-litigation/wp-content/uploads/sites/16/case-documents/2019/20190114_docket-17-SC-297_opinion.pdf).

[4] https://www.denverpost.com/2019/01/14/colorado-supreme-court-oil-gas-martinez-decision/.

[5] https://www.denverpost.com/2019/04/16/colorado-oil-gas-bill-signed-gov-jared-polis/.

[6] Senate Bill 19-181 §4.

[7] City of Longmont v. Colo. Oil & Gas Ass’n, 369 P.3d 573, 585 (Colo. 2016) (“The Oil and Gas Conservation Act and the Commission’s pervasive rules and regulations, which evince state control over numerous aspects of fracking, from the chemicals used to the location of waste pits, convince us that the state’s interest in the efficient and responsible development of oil and gas resources includes a strong interest in the uniform regulation of fracking.”).

[8] Senate Bill 19-181 §4; https://www.denverpost.com/2019/05/06/colorado-oil-and-gas-local-regulations-181/.

[9] Senate Bill 19-181 §4.

[10] C.R.S. 34-60-102 (2017).

[11] Senate Bill 19-181 §5.

[12] Senate Bill 19-181 §§8-9.

[13] C.R.S. 34-60-104 (2017).

[14] Senate Bill 19-181 §9.

[15] Senate Bill 19-181 §9(d).

[16] https://www.coloradopolitics.com/news/cogcc-solicits-application-for-full-time-commissioners/article_0c6e349a-42d3-11ea-b401-f3cbf6062c82.html.

[17] Senate Bill 19-181 §12.

[18] Senate Bill 19-181 §11.

[19] https://coloradosun.com/2020/04/24/zoom-colorado-oil-and-gas-rule-meeting/.

[20] Id.

[21] https://www.gjsentinel.com/breaking/cogcc-delays-action-on-first-sb-181-rules/article_7d09abd8-922c-11e9-b04d-6305eb780f5e.html.

[22] https://www.westword.com/news/colorado-oil-and-gas-environmental-groups-clash-in-first-round-of-sb-181-rulemaking-11384760.

[23] The 500 Series regulations and flowline regulations are available at 2 Code Colo. Regs. § 404-1-500 and 2 Code Colo. Regs § 404-1-1100, respectively. Both sets of regulations may be found online at: https://www.sos.state.co.us/CCR/GenerateRulePdf.do?ruleVersionId=8521&fileName=2%20CCR%20404-1.

[24] https://cogcc.state.co.us/documents/sb19181/Overview/SB_19_181_Rulemaking_Update_20190801.pdf; https://cogcc.state.co.us/sb19181_calendar.html#/rulemaking_mission_change.

[25] https://cogcc.state.co.us/documents/media/Press_Release_SB_19_181_Rulemaking_Updates_20200316.pdf.

[26] https://cogcc.state.co.us/sb19181_calendar.html#/rulemaking_wellbore_integrity.

[27] https://www.bizjournals.com/denver/news/2020/04/29/colorado-oil-and-gasregulator-puts-off-hearings.html
?ana=e_ae_prem&j=90506159&t=Afternoon&mkt_tok=eyJpIjoiTWpWbFlXSmxaR1JrTldZ
MyIsInQiOiI2bk9PeE1GN3JIbnZ5K1pUcE8yMlJHdGh1cGJ3dFozTW9TcjhBd3JMdzBJeldrbE11
WkJhZjNBYU5ZcVwvNFMwcGpkelpkMjVialhLclBMWDFabVUxQWpqelVUblZIV0ZhN3BEODF
sUmlONVRSQ1ZrVWQ4MG1YaTNuSmVkWFJrcTZmUnZnMDZcL1BxNjNcL0NQa3BhbUZ0SFE9PSJ9.

[28] https://cogcc.state.co.us/documents/media/Press_Release_RM_&_PC_Update_April_Hearing_20200429.pdf.

[29] https://coloradosun.com/2020/04/24/zoom-colorado-oil-and-gas-rule-meeting/.

[30] 5 Code Colo. Regs. § 1001-9; https://www.colorado.gov/pacific/cdphe/news/oil-and-gas-rulemaking.

[31] 5 Code Colo. Regs. § 1001-9; https://www.colorado.gov/pacific/cdphe/news/oil-and-gas-rulemaking;
https://www.denverpost.com/2019/12/17/colorado-oil-gas-regulations-air-quality/.

[32] https://www.colorado.gov/pacific/cdphe/news/climate-change-actions.

[33] https://www.coloradopolitics.com/news/boulder-county-commissioners-extend-oil-gas-moratorium/article_61dd130a-5d7d-11ea-995b-27efc3ba5399.html; https://www.denverpost.com/2019/06/28/boulder-county-oil-gas-moratorium/.

[34] https://www.bouldercounty.org/news/boulder-county-commissioners-extend-oil-and-gas-moratorium-to-july-31-2020/.

[35] City of Fort Collins v. Colo. Oil & Gas Ass’n, 369 P.3d 586 (Colo. 2016); City of Longmont v. Colo. Oil & Gas Ass’n, 369 P.3d 573 (Colo. 2016).

[36] Our Health, Our Future, Our Longmont v. Colorado, 2020cv30033 (Dist. Ct., Boulder Cty.).

[37] https://www.coga.org/uploads/1/2/2/4/122414962/sb19-181_summary_3-15-19.pdf.

[38] https://coloradosun.com/2019/08/05/colorado-oil-gas-rules-patchwork-sb181/.

[39] https://news.kgnu.org/2017/03/new-boulder-county-oil-gas-regulations-called-toughest-in-the-state/; https://www.denverpost.com/2017/03/24/new-boulder-county-oil-and-gas-rules/.

[40] https://assets.bouldercounty.org/wp-content/uploads/2020/03/dc-19-0002-summary-and-draft-text-amendments-20200306.pdf.

[41] https://www.cpr.org/2019/08/30/colorados-oil-and-gas-regulators-will-be-on-the-clock-to-review-weld-countys-permits/.

[42] https://www.bizjournals.com/denver/news/2019/11/08/colorado-oil-and-gas-well-permitting-post-reform.html.

[43] Id.

[44] https://cogcc.state.co.us/documents/sb19181/Guidance/SB_19_181_Guidance_20190529.pdf; https://www.ogj.com/general-interest/article/17279237/cogcc-issues-interim-guidelines-as-it-develops-new-regulations.

[45] Id.

[46] https://www.bizjournals.com/denver/news/2019/11/08/colorado-oil-and-gas-well-permitting-post-reform.html; https://www.bizjournals.com/denver/news/2019/04/12/big-changes-ahead-for-oil-but-a-slowdown-isnt-one.html.

[47] https://www.colorado.edu/business/sites/default/files/attached-files/2020_colo_business_econ_outlook.pdf.

[48] Id.

[49] https://www.cpr.org/2020/01/07/despite-prop-112s-loss-colorados-fracking-foes-are-back-with-6-new-ballot-measures/.

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

Beau Stark – Denver (+1 303-298-5922, [email protected])
Fred Yarger – Denver (+1 303-298-5706, [email protected])
Graham Valenta – Houston (+1 346-718-6645, [email protected])

Please also feel free to contact any of the following in the firm’s Oil and Gas group:

Michael P. Darden – Houston (+1 346-718-6789, [email protected])
Tull Florey – Houston (+1 346-718-6767, [email protected])
Hillary H. Holmes – Houston (+1 346-718-6602, [email protected])
Shalla Prichard – Houston (+1 346-718-6644, [email protected])
Doug Rayburn – Dallas (+1 214-698-3442, [email protected])
Gerry Spedale – Houston (+1 346-718-6888, [email protected])

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

Gibson Dunn’s lawyers regularly counsel clients on issues raised by the COVID-19 pandemic, and we are working with many of our clients on their response to COVID-19. The following is a round-up of today’s client alerts on this topic prepared by the Gibson Dunn team. Our lawyers are available to assist with any questions you may have regarding developments related to the outbreak. As always, for additional information, please feel free to contact the Gibson Dunn lawyer with whom you usually work, or any member of the firm’s Coronavirus (COVID-19) Response Team.

GLOBAL OVERVIEW

Criminal Bankruptcy Fraud: Will the COVID-19 Crisis Make It the New Prosecutorial Darling?

The COVID-19 crisis and the resulting disruption to business have adversely affected many corporate entities’ financial stability and outlook. Even rock-solid, liquid companies have been jolted into a new reality, and may be evaluating options for restructuring their business in accordance with Chapter 11 of the Bankruptcy Code. In rarer cases, a company may opt to liquidate under Chapter 7.

In such circumstances, counsel, directors, and executives of these corporate entities are well-served to understand the statutes criminalizing fraudulent actions related to bankruptcy, and the attendant risk of costly government investigations, litigation expenses, fines, and jail time. Although there has not been extensive historical application of these statutes to corporate entities, prosecutors and investigators invariably follow the money in their pursuit of alleged fraud, and bankruptcy is thus a natural area of focus in a financial crisis. Prosecutors looking to bring charges befitting the economic environment may be enticed by the many options bankruptcy fraud statutes offer to pursue what they perceive as financial wrongdoing.
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EU Merger Control and the Acquisition of Distressed Businesses in the Wake of COVID-19

As a result of the current pandemic and the work-from-home restrictions throughout much of the world, the European Commission has adjusted how it deals with merger reviews. The Commission continues to process already filed merger notifications (notwithstanding difficulties in getting feedback from third parties for the purpose of market testing). By contrast, for mergers that have yet to be filed, the Commission encourages parties to “delay [new] notifications, where possible”. Nevertheless, the Commission has confirmed that it stands ready to deal with cases where the parties can show “very compelling reasons” to proceed with a merger notification without delay.
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The coronavirus pandemic (“COVID-19”) has had far-reaching implications on virtually every aspect of the global economy, and the private equity industry has faced its share of challenges. As investment advisers and private equity fund managers navigate this uncertain terrain, many have identified alternative types of investments, including private investments in public equity (“PIPEs”) and various types of debt investments, as promising alternatives to their existing funds’ original investment strategies. With private equity firms holding an estimated $2 trillion of ‘dry powder’ and companies in dire need of capital, it should come as no surprise that, since late March, companies have raised approximately $8 billion from private equity funds in PIPE transactions, as sponsors eye dividends and an eventual equity stake in lieu of a more customary control investment approach. This client alert identifies a number of issues fund managers should consider as they evaluate opportunities outside of their existing funds’ primary investment focuses.
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COVID-19 United Kingdom Weekly Webinar (May 4, 2020)

The COVID-19 pandemic is undoubtedly the biggest public health crisis of our times. Like many other countries, the UK Government has exercised broad powers and passed new laws that impact how we do business and interact as a society. To address the pandemic, the Government announced several sweeping regulations and ushered through the Coronavirus Act 2020. These actions have a broad impact on law, public policy and daily life, impacting areas including health, social welfare, commerce, trade, competition, employment and the free movement of people.

Join our team of Gibson Dunn London lawyers, led by partner and former Lord Chancellor Charlie Falconer QC, for a discussion of these changes and to answer your questions on how they will affect British businesses and community, including the impact on new and ongoing business relationships. This webinar will cover governance – key issues for boards; HMRC’s response to tax residence and cross-border employment tax matters; and commercial real estate update – challenges or opportunities?
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I. Relevant Statutes

Bankruptcy fraud is most commonly prosecuted under Sections 152 and 157 of Title 18 of the United States Code.[1] Each imposes a maximum statutory sentence of five years.

18 U.S. Code § 152. Concealment of assets; false oaths and claims; bribery[2]: In nine subparts,[3] Section 152 broadly criminalizes various actions prior to[4] and during bankruptcy proceedings, including knowingly and fraudulently[5] concealing assets, making false statements, and withholding information from the bankruptcy trustee.[6] Paragraph 7 of Section 152 specifically covers transfers or concealment by an “agent or officer” of a corporation in or contemplating bankruptcy.

18 U.S. Code § 157. Bankruptcy fraud[7]: Section 157 criminalizes utilization of bankruptcy proceedings to further a broader fraudulent scheme.[8]

18 U.S. Code §§ 153 to 156[9]: Sections 153 through 156 criminalize other less commonly prosecuted offenses—including embezzlement of bankruptcy estate assets, agreements to fix fees or compensation, and knowing disregard of bankruptcy rules and procedures.

18 U.S. Code § 1519. Destruction, alteration, or falsification of records in Federal investigations and bankruptcy[10]: Section 1519 imposes higher penalties—up to twenty years’ imprisonment—for the destruction, alteration, or falsification of records to interfere with an investigation or bankruptcy proceeding.

18 U.S. Code § 3057. Bankruptcy investigations[11]: Section 3057 imposes mandatory reporting requirements on judges, receivers, and trustees who reasonably believe a legal violation has occurred, requiring that they report the possible violation to the U.S. Attorney’s office.

II. Sentencing Guidelines

The penalties applicable to bankruptcy fraud convictions can be as severe as any financial crime. Section 2B1.1 of the United States Sentencing Guidelines is used to determine the base offense level for the majority of bankruptcy fraud crimes.[12] The base offense level is six for violations under Sections 152 and 157—where the maximum term of imprisonment is five years.[13] However, the base offense level can be adjusted depending on certain characteristics of the offense.[14] Substantial financial loss, or intended loss, has the most significant increase in offense levels, up to 30 levels (resulting in a range of 108 to 405 months incarceration when combined with the base level) for losses over $550,000,000.[15]

The sentencing judge is also obligated to order restitution to any identifiable victim, most commonly creditors of the bankruptcy estate.[16] The amount of restitution will depend on the particular offense—for example, restitution for violations under Section 152(1) (relating to concealment of assets) may be measured by the value of the concealed assets.[17] The amount of restitution will always, however, be limited to the victims’ actual losses, not the intended losses relevant to sentencing.[18] A sentencing court is required to order full restitution “without consideration of the economic circumstances of the defendant.”[19]

III. The U.S. Trustee Program (USTP)

The USTP—commonly referred to as the “watchdog” of the bankruptcy system—is a civil, litigating component of the U.S. Department of Justice, designed to protect “the integrity and efficiency of the bankruptcy system for the benefit of all stakeholders—debtors, creditors, and the public.”[20] The USTP is headquartered in Washington, D.C. and has 92 field offices covering 21 regions.[21] The USTP has a statutory duty to refer matters to the U.S. Attorney for prosecution,[22] and has made over 2,000 such referrals annually since 2012.[23] Members of the public can submit reports of suspected bankruptcy fraud to the U.S. Department of Justice and USTP.[24] Of course, an increase in bankruptcy filings can be expected to correspond to a greater incidence of referred or reported suspicions of bankruptcy fraud.

IV. Trends in Criminal Bankruptcy Fraud Prosecution

Historically, the bankruptcy fraud statutes have been applied primarily to prosecute individual bankruptcy filers, rather than corporate entities. Nonetheless, corporate officers and agents, including board members, could face liability under the statute. Indeed, an article recently published in a DOJ bulletin suggests prosecutors should add charges of bankruptcy fraud to other criminal charges where applicable to strengthen their case and bolster admissibility of persuasive evidence, such as testimony from sympathetic creditor victims and the defendants’ testimony under oath and detailed financial history submitted in connection with the bankruptcy proceedings.[25] Misuse of bankruptcy proceedings by legal and other advisers to hide assets, as well as to defraud potential bankruptcy candidates, may well surface as an investigative focus in the aftermath of the COVID-19 financial crisis.[26]

Regardless of whether bankruptcy fraud charges are filed, the existence of a bankruptcy can be the thin edge through which problematic activity is pursued. As investigators follow the flow of money, they may mine bankruptcy filings for evidence to strengthen existing cases or to bring new charges. This is particularly so with respect to Ponzi schemes, the extent of which often surface once bankruptcy filings occur.[27]

Clients should also be cautioned that communications with and work product by attorneys may be discoverable if the court finds there is a “reasonable likelihood [the attorney] either knew or was willfully blind” to the facts forming the basis of a bankruptcy fraud allegation against the client. See in re Grand Jury Proceedings, G.S., F.S., 609 F.3d 909, 915 (8th Cir. 2010) (affirming that attorney work product and communications related to pre-bankruptcy asset transfer transactions were discoverable under the crime-fraud exception).

V. Examples of Relevant Prosecutions and Settlements of Individuals

Often, charges brought against executives related to misconduct concerning a company nearing or in bankruptcy proceedings involve other charges, such as wire fraud, bank fraud, and conspiracy. For example, in May 2017, a former CEO of the electronics and appliance retailer Vann’s Inc. was convicted of 170 counts, including bankruptcy fraud, and sentenced to over five years in prison, including a $2.4 million criminal forfeiture verdict. The defendant, in conjunction with Vann’s former CFO, was accused of establishing two shell companies as part of a real estate leaseback scheme. The jury found the defendant had committed bankruptcy fraud by making a claim for $2.4 million against Vann’s estate on behalf of the shell companies after Vann’s declared bankruptcy in 2012.[28] Similarly, in 2016, the former President and CEO of PureChoice, Inc. was sentenced to 22 years in prison for 11 counts, including three for bankruptcy fraud, arising out of an investment fraud scheme. As the scheme unraveled and victims began demanding payment, the defendant filed for personal bankruptcy, and was ultimately charged with bankruptcy fraud for falsifying statements and concealing property in connection with the bankruptcy proceeding. The defendant also was ordered to pay over $22 million in restitution and $7.6 million in a forfeiture judgment.[29]

In some cases of alleged embezzlement and concealment of bankruptcy assets, prosecutors have declined to include bankruptcy fraud as a charge altogether, instead relying on the broader counts of mail fraud, embezzlement, or money laundering.[30] Conversely, in other cases, bankruptcy is one of only one or two charges brought. For example, in 2018, the owner of a number of gas stations pled guilty to bankruptcy fraud and was sentenced to 45 months in prison for “scrambling” his finances and destroying records to defraud his creditors. In 2012, the Bankruptcy Court had denied the defendant’s request to discharge his debts because he had failed to retain business records that would enable the court to analyze his financial condition.[31] Also in 2018, a husband and wife who had previously served as partners in a business venture were each sentenced to 50 and 27 months prison time, respectively, for tax evasion and bankruptcy fraud.[32] The couple filed for bankruptcy after attempting to settle over $600,000 in taxes due with the IRS. However, at the same time, the couple caused their companies to pay substantial amounts of personal expenses, including vacation home rental payments and a country club membership. After a jury trial, the defendants were sentenced to jail time and ordered to pay $1.6 million in restitution to the IRS, and over $130,000 in a forfeiture money judgment.[33]

VI. Risk of Securities Fraud Liability for Corporate Insiders During Financial Distress

Corporate insiders who trade company stock prior to the company filing for bankruptcy may face civil and criminal liability, as well as costs associated with defending against an SEC investigation. Indeed, the SEC has previously brought enforcement actions against insiders who traded securities before news of the company’s financial difficulties or insolvency became public.[34]

In a recent press release, the SEC enforcement division acknowledged that due to the COVID-19 crisis, “a greater number of people may have access to material nonpublic information,” and admonished corporate insiders to be “mindful of their of their obligations to keep this information confidential and to comply with the prohibitions on illegal securities trading.”[35] Multiple public officials have faced scrutiny and resulting reports to the DOJ and SEC regarding their trading of stock prior to disclosure of the extent and seriousness of the COVID-19 crisis.[36] Similar public scrutiny is likely to result if corporate insiders engage in significant or uncharacteristic securities transactions during this crisis. This risk is particularly heightened due to the SEC permitting delayed disclosure filing in light of disruptions to business caused by COVID-19—thereby extending the duration of time in which information can be kept non-public.[37]

VII. Potential Liability for Collusive Bidding on Bankruptcy Assets

Companies seeking to acquire assets of a bankrupt entity also should be aware of the risk of liability under the Sherman Antitrust Act, 15 U.S.C. §§ 1 et seq., if they engage with competitors regarding the purchase of assets from the bankruptcy estate. Indeed, the Department of Justice has previously charged companies with violations of the Sherman Act for collusive bidding in a bankruptcy court auction.[38] The criminal penalties for a Sherman Act violation are severe—up to $100 million for a corporation and $1 million for an individual, along with up to 10 years in prison.[39]

Separately, the bankruptcy trustee can bring claims for civil liability against the purchaser under the Sherman Act during the bankruptcy court proceedings, in addition to claims under Section 363(n) of the Bankruptcy Code.[40] If a bankruptcy trustee fails to object to the sale during the bankruptcy proceedings, a later suit under the Sherman Act may be barred under res judicata, although a 363(n) claim will not.[41]

VIII. Recommendations

While investigators and prosecutors have rarely pursued criminal bankruptcy fraud allegations against companies and executives, the opportunities to do so are significant. The lack of prosecution could be a consequence of prosecutors’ unfamiliarity with the criminal bankruptcy fraud statutes and investigating agents’ preference for the traditionally more titillating fraud statutes to encompass the same conduct. These preferences can change quickly, including if the Department of Justice or FBI focus on bankruptcy in the aftermath of the COVID-19 financial crisis. These risks should be kept in mind when evaluating options for restructuring. Further, disgruntled former employees, such as those who may be laid off or furloughed due to COVID-19, increase the likelihood of a financially distressed company being reported to the USTP. Even baseless reports—if investigated—could result in significant costs in reputational harm and defense expenses. In light of the risk of criminal penalties and associated costs, counsel and directors of companies facing financial difficulties should seek competent guidance to navigate these concerns prior to initiating bankruptcy proceedings.

______________________

[1] While the commencement of a bankruptcy case imposes an “automatic stay” against most legal and administrative actions that could have been brought pre-bankruptcy against a debtor, the Bankruptcy Code expressly exempts from that automatic stay governmental criminal actions and claims. See 11 U.S.C. §§ 362(a), 362(b)(1).

[2] “A person who—

(1) knowingly and fraudulently conceals from a custodian, trustee, marshal, or other officer of the court charged with the control or custody of property, or, in connection with a case under title 11, from creditors or the United States Trustee, any property belonging to the estate of a debtor;

(2) knowingly and fraudulently makes a false oath or account in or in relation to any case under title 11;

(3) knowingly and fraudulently makes a false declaration, certificate, verification, or statement under penalty of perjury as permitted under section 1746 of title 28, in or in relation to any case under title 11;

(4) knowingly and fraudulently presents any false claim for proof against the estate of a debtor, or uses any such claim in any case under title 11, in a personal capacity or as or through an agent, proxy, or attorney;

(5) knowingly and fraudulently receives any material amount of property from a debtor after the filing of a case under title 11, with intent to defeat the provisions of title 11;

(6) knowingly and fraudulently gives, offers, receives, or attempts to obtain any money or property, remuneration, compensation, reward, advantage, or promise thereof for acting or forbearing to act in any case under title 11;

(7) in a personal capacity or as an agent or officer of any person or corporation, in contemplation of a case under title 11 by or against the person or any other person or corporation, or with intent to defeat the provisions of title 11, knowingly and fraudulently transfers or conceals any of his property or the property of such other person or corporation;

(8) after the filing of a case under title 11 or in contemplation thereof, knowingly and fraudulently conceals, destroys, mutilates, falsifies, or makes a false entry in any recorded information (including books, documents, records, and papers) relating to the property or financial affairs of a debtor; or

(9) after the filing of a case under title 11, knowingly and fraudulently withholds from a custodian, trustee, marshal, or other officer of the court or a United States Trustee entitled to its possession, any recorded information (including books, documents, records, and papers) relating to the property or financial affairs of a debtor,

shall be fined under this title, imprisoned not more than 5 years, or both.”

[3] The nine subparts can constitute multiple counts, provided they are not based on the same set of facts. See, e.g., United States v. Roberts, 783 F.2d 767, 769 (9th Cir. 1985); United States v. Ambrosiani, 610 F.2d 65, 70 (1st Cir. 1979), cert. denied, 445 U.S. 930 (1980).

[4] Acts prior to, but in contemplation of, a bankruptcy filing are sufficient to support a violation. United States v. Martin, 408 F.2d 949, 954 (7th Cir. 1969) (affirming convictions under prior version of Section 152 based on defendants’ transfer of corporate assets prior to filing bankruptcy).

[5] The term “fraudulently” means that the act was done with the intent to deceive. United States v. Diorio, 451 F.2d 21, 23 (2d Cir. 1971), cert. denied, 405 U.S. 955 (1972).

[6] See also Stegeman v. United States, 425 F.2d 984, 986 (9th Cir. 1970) (“[Section 152] attempts to cover all the possible methods by which a bankrupt or any other person may attempt to defeat the Bankruptcy Act through an effort to keep assets from being equitably distributed among creditors.”) (quoting 2 Collier on Bankruptcy 1151 (14th ed. 1968)).

[7] “A person who, having devised or intending to devise a scheme or artifice to defraud and for the purpose of executing or concealing such a scheme or artifice or attempting to do so—

(1) files a petition under title 11, including a fraudulent involuntary petition under section 303 of such title;

(2) files a document in a proceeding under title 11; or

(3) makes a false or fraudulent representation, claim, or promise concerning or in relation to a proceeding under title 11, at any time before or after the filing of the petition, or in relation to a proceeding falsely asserted to be pending under such title,

shall be fined under this title, imprisoned not more than 5 years, or both.” 18 U.S.C. § 157.

[8] See United States v. Milwitt, 475 F.3d 1150, 1155 (9th Cir. 2007) (“[T]he focus of § 157 is a fraudulent scheme outside the bankruptcy which uses the bankruptcy as a means of executing or concealing the artifice.”).

[9] “(a) Offense.—A person described in subsection (b) who knowingly and fraudulently appropriates to the person’s own use, embezzles, spends, or transfers any property or secretes or destroys any document belonging to the estate of a debtor shall be fined under this title, imprisoned not more than 5 years, or both.

(b) Person to Whom Section Applies.—

A person described in this subsection is one who has access to property or documents belonging to an estate by virtue of the person’s participation in the administration of the estate as a trustee, custodian, marshal, attorney, or other officer of the court or as an agent, employee, or other person engaged by such an officer to perform a service with respect to the estate.” 18 U.S.C. § 153 (“Embezzlement against estate”).

“A person who, being a custodian, trustee, marshal, or other officer of the court—

(1) knowingly purchases, directly or indirectly, any property of the estate of which the person is such an officer in a case under title 11;

(2) knowingly refuses to permit a reasonable opportunity for the inspection by parties in interest of the documents and accounts relating to the affairs of estates in the person’s charge by parties when directed by the court to do so; or

(3) knowingly refuses to permit a reasonable opportunity for the inspection by the United States Trustee of the documents and accounts relating to the affairs of an estate in the person’s charge,

shall be fined under this title and shall forfeit the person’s office, which shall thereupon become vacant.” 18 U.S.C. § 154 (“Adverse interest and conduct of officers”).

“Whoever, being a party in interest, whether as a debtor, creditor, receiver, trustee or representative of any of them, or attorney for any such party in interest, in any receivership or case under title 11 in any United States court or under its supervision, knowingly and fraudulently enters into any agreement, express or implied, with another such party in interest or attorney for another such party in interest, for the purpose of fixing the fees or other compensation to be paid to any party in interest or to any attorney for any party in interest for services rendered in connection therewith, from the assets of the estate, shall be fined under this title or imprisoned not more than one year, or both.” 18 U.S.C. § 155 (“Fee agreements in cases under title 11 and receiverships”).

“Offense.—If a bankruptcy case or related proceeding is dismissed because of a knowing attempt by a bankruptcy petition preparer in any manner to disregard the requirements of title 11, United States Code, or the Federal Rules of Bankruptcy Procedure, the bankruptcy petition preparer shall be fined under this title, imprisoned not more than 1 year, or both.” 18 U.S.C. § 156(b) (“Knowing disregard of bankruptcy law or rule”).

[10] “Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both.” 18 U.S.C. § 1519.

[11] “(a) Any judge, receiver, or trustee having reasonable grounds for believing that any violation under chapter 9 of this title or other laws of the United States relating to insolvent debtors, receiverships or reorganization plans has been committed, or that an investigation should be had in connection therewith, shall report to the appropriate United States attorney all the facts and circumstances of the case, the names of the witnesses and the offense or offenses believed to have been committed. Where one of such officers has made such report, the others need not do so.

(b) The United States attorney thereupon shall inquire into the facts and report thereon to the judge, and if it appears probable that any such offense has been committed, shall without delay, present the matter to the grand jury, unless upon inquiry and examination he decides that the ends of public justice do not require investigation or prosecution, in which case he shall report the facts to the Attorney General for his direction.” 18 U.S.C. § 3057.

[12] Section 2J1.2 provides a base offense level of fourteen for violations of Section 1519. U.S.S.G. § 2J1.2.

[13] U.S.S.G. § 2B1.1(a)(2).

[14] U.S.S.G. § 2B1.1(b); see also United States v. Messner, 107 F.3d 1448, 1457 (10th Cir. 1997) (holding bankruptcy fraud constitutes a violation of judicial process warranting the imposition of a two-level sentence enhancement under Section 2F1.1. of the Sentencing Guidelines).

[15] U.S.S.G. § 2B1.1(b)(1); see also id. at Application Note 3 (“[L]oss is the greater of actual loss or intended loss.”); https://www.ussc.gov/guidelines/2018-guidelines-manual/annotated-2018-chapter-5.

[16] 18 U.S.C. § 3663A(a)(1); see also U.S.S.G. § 5E1.1(a)(1).

[17] United States v. Maturin, 488 F.3d 657, 661–63 (5th Cir. 2007) (restitution should be based on the value of the concealed assets covered by the count of conviction, but should not include the value of other concealed assets).

[18] 18 U.S.C. §§ 3663A, 3664. A victim may receive more than its actual losses pursuant to a plea agreement. 18 U.S.C. § 3663(a)(3).

[19] 18 U.S.C. § 3664(f)(1)(A).

[20] https://www.justice.gov/ust; see also 28 U.S.C. § 586.

[21] https://www.justice.gov/ust.

[22] 28 U.S.C. § 586(a)(3)(F).

[23] See https://www.justice.gov/ust/bankruptcy-data-statistics/reports-studies (FY 2019 data not yet available).

[24] https://www.justice.gov/ust/report-suspected-bankruptcy-fraud.

[25] Charles R. Walsh, Why is a Bankruptcy Charge Valuable to Any Investigation, United States Attorneys’ Bulletin (Mar. 2018), https://www.justice.gov/usao/page/file/1046201/download at 131.

[26] See, e.g., Paul Kiel, How to Get Away With Bankruptcy Fraud, ProPublica (Dec. 22, 2017), https://www.propublica.org/article/how-to-get-away-with-bankruptcy-fraud (acknowledging a lack of resources available for bankruptcy-related prosecutions, but quoting DOJ as stating USTP activities and “collective efforts within the Justice Department and with the wider bankruptcy community may result not only in an increase in referrals and prosecutions, but also in greater deterrence of bankruptcy crimes at the outset”).

[27] See, e.g., https://www.justice.gov/usao-sdny/file/762811/download, https://www.justice.gov/usao-sdny/file/762821/download (sentencing Bernie Madoff to 150 years in prison and imposing a money judgment of $170 billion in connection with his Ponzi scheme, following appointment of a trustee to oversee liquidation of his corporation Bernard L. Madoff Investment Securities LLC pursuant to the Securities Investor Protection Act of 1970); https://www.justice.gov/archive/usao/nys/pressreleases/July09/dreiermarcsentencingpr.pdf (sentencing attorney Marc Dreier to 20 years in prison and ordering over $1 billion in restitution and forfeiture after he pleaded guilty to fraud related to his operation of a Ponzi scheme and following the bankruptcy of Dreier’s firm, Dreier LLP).

[28] https://www.justice.gov/usao-mt/pr/former-ceo-vann-s-inc-sentenced-5-years-prison-0.

[29] https://www.justice.gov/usao-mn/pr/purechoice-founder-sentenced-22-years-prison-28-million-dollar-investment-fraud-scheme.

[30] E.g., https://www.justice.gov/usao-mdla/pr/former-chief-financial-officer-restaurant-chain-indicted-wire-fraud-embezzlement.

[31] https://www.justice.gov/usao-wdmi/pr/2018_0423_Vernier.

[32] The husband was charged with three additional crimes.

[33] https://www.justice.gov/usao-co/pr/stapleton-couple-sentenced-income-tax-evasion-and-bankruptcy-fraud.

[34] See, e.g., https://www.sec.gov/news/press-release/2012-2012-198htm (charging former bank executive and his son with insider trading when the son bought and sold shares of the bank’s stock before and after information about the bank’s asset sale became public); https://www.sec.gov/news/digest/1993/dig102893.pdf at 3–4 (referencing charges brought against the chairman of the board of J. Baker, Inc. for selling 200,000 shares of stock prior to disclosure that the company planned to close a significant number of its retail outlets).

[35] https://www.sec.gov/news/public-statement/statement-enforcement-co-directors-market-integrity.

[36] E.g., https://www.commoncause.org/press-release/doj-sec-ethics-complaints-filed-against-senators-burr-feinstein-loeffler-inhofe-for-possible-insider-trading-stock-act-violations/.

[37] https://www.sec.gov/rules/other/2020/34-88318.pdf.

[38] https://www.justice.gov/archive/atr/public/press_releases/1993/211588.htm (bringing Sherman Act and bankruptcy fraud charges against a Spanish company for conspiring to rig bids for an aircraft at a bankruptcy auction); see also United States v. Seminole Fertilizer Corp., No. 97-1507-CIV-T-17E, 1997 WL 692953, at *6 (M.D. Fla. Sept. 19, 1997) (final judgment on Sherman Act charges related to its alleged agreement with another company to provide bid support to enable the defendant to defeat a rival bid during a bankruptcy auction).

[39] 15 U.S.C. § 1.

[40] See 11 U.S.C. § 363(n) (permitting the avoidance of a sale “if the sale price was controlled by an agreement among potential bidders,” along with the recovery of the difference in the value of the property and the price paid, along with costs, fees, and punitive damages); In re New York Trap Rock Corp., 160 B.R. 876, 881 (S.D.N.Y. 1993) (“§ 363(n) is in effect a supplementary antitrust law akin to § 1 of the Sherman Act (15 U.S.C. § 1) with its own separate jurisdictional groundwork and separate sanctions for violation).”), aff’d in part, vacated in part, 42 F.3d 747 (2d Cir. 1994).

[41] See In re International Nutronics, Inc., 28 F.3d 965 (9th Cir. 1994), cert. denied, 513 U.S. 1016 (1994).

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s White Collar Defense and Investigations or Business Restructuring and Reorganization practice groups, or the following authors:

Joel M. Cohen – New York (+1 212-351-2664, [email protected])
Mary Beth Maloney – New York (+1 212-351-2315, [email protected])
Zainab N. Ahmad – New York (+1 212-351-2609, [email protected])
Robert A. Klyman – Los Angeles (+1 213-229-7562, [email protected])
Scott J. Greenberg – New York (+1 212-351-5298, [email protected])
Emma Strong – Palo Alto (+1 650-849-5338, [email protected])

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

The Technology and Construction Court of England and Wales (“TCC”) has this month held that expert consultancy firms can owe a fiduciary duty of loyalty to a client. The relevant decision is A Company v (1) X (2) Y (3) Z, in which Mrs Justice O’Farrell has continued an injunction preventing the Defendant, an expert witness services firm, from acting for Claimant’s opponent in an ICC arbitration because, in short, that would be contrary to the firm wide fiduciary duty of loyalty that was created when Defendant’s Asian subsidiary was retained by the Claimant in another ICC arbitration that relates to the same project and overlaps on issues.[1] The court’s decision can be read here. The party names have been anonymised by the court because the litigation relates to two ongoing arbitrations. Below is our summary and initial reaction to the decision.

The background facts

Claimant is the developer of a petrochemical plant on which multiple construction related disputes have arisen. Claimant approached the First Defendant X (“X”) to provide expert services on 15 March 2019. A confidentiality agreement was signed on the same day and a letter of engagement concluded on 13 May 2019. Claimant’s formal letter of instruction, incorporating the confidentiality agreement by reference, followed on 26 May 2019. In short, as per the letter of engagement, X’s expert K and his team in Asia were to, in broad terms, undertake a delay analysis and prepare a report, give oral evidence at the arbitration hearing, and provide “ad-hoc support” to Claimant and its “professional team” (presumably lawyers and other experts) in connection with an arbitration commenced against Claimant in relation to Packages A and B of the project (the “Works Package Arbitration”). K and his team started work – evaluating delays on the construction subcontract for non-process buildings – around June 2019.

Later in the summer of 2019, an ICC arbitration was commenced against Claimant by a third-party entity seeking payment for sums due and owing under the project’s EPCM agreement (the “EPCM Arbitration”). In defence of those arbitration proceedings Claimant is advancing counterclaims for delay and disruption. Claimant is also alleging that the third-party caused Claimant loss by failing to manage and supervise the contractor. Materially, in the EPCM Arbitration, the delays in dispute are the same as those in the Works Package Arbitration. In October 2019, however, the Second and Third Defendants were approached to provide expert services – quantum and delay – for the Claimant’s opponent in the EPCM Arbitration.[2] K emailed Claimant noting the third party’s approach and setting out his firm’s position that there was no legal conflict because other experts and offices in the Defendant’s network would be involved in the EPCM Arbitration and not K and his team working on the Works Package Arbitration.

Between October and February there was no correspondence between Claimant and the Defendants in relation to the EPCM Arbitration, but later, in February 2020, Claimant learnt that its opponent on the EPCM Arbitration was in the process of instructing M – an expert working for the Defendant X firm – to act as quantum expert. The appointment of M was confirmed to Claimant by email dated 10 March 2020. Prior to this confirmation, on 5 March 2020, Claimant had written to K of X to expand his engagement to include expert services (delay) in respect of the EPCM Arbitration. On learning of M’s appointment in the EPCM Arbitration, Claimant’s counsel put on record its position, requested further information to consider the issues more thoroughly, and reserved all rights – including the right to challenge the appointment of the Defendants in the EPCM Arbitration. Counsel for Claimant’s opponent responded by rejecting Claimant’s position, resisting the information request, and countering that Claimant’s objections were simply an attempt to derail the EPCM Arbitration timetable.

By letter dated 12 March 2020, Claimant informed X that its engagement in the EPCM Arbitration created a conflict of interest contrary to its terms of engagement in respect of the Works Package Arbitration. In a letter of response seven days later, N of the Third Defendant (“Z”) rejected the suggestion of conflict and set out the measures taken to ensure X’s compliance with its confidentiality obligations to Claimant. As a result of this impasse, on 20 March 2020, Claimant applied (ex parte) to the TCC seeking an interim injunction preventing the Defenders from providing expert services to the third party in the EPCM Arbitration. The application was granted.

Continuation Hearing

At the continuation hearing, Claimant submitted that the interim injunction should be continued on the ground that Defendant’s provision of services to the third party in the EPCM Arbitration is a breach of the rule that a party owing a duty of loyalty to a client must not, absent informed consent, agree to act or actually act for a second client in a manner which is inconsistent with the interests of the first.

The Defendants opposed continuation on the grounds that the claimant’s application is misconceived. In short, they said, independent experts do not owe a fiduciary duty of loyalty to their clients and there is, in this case, no conflict of interest or risk that confidential information has been or will be disclosed to the third party.

The material issues before the court at the continuation hearing were:

i) whether independent experts, who are engaged by a client to provide advice and support in arbitration or legal proceedings, in addition to expert evidence, can owe a fiduciary duty of loyalty to their clients;

ii) whether, on the evidence before the Court, the claimant is entitled to a fiduciary obligation of loyalty from the first and/or second and /or third defendants;

iii) whether there has been, or may be, a breach of any duty of loyalty or confidence; and

iv) if so, whether the Court should exercise its discretion and grant the injunction.

Whether independent experts can owe a fiduciary duty of loyalty to clients

A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of a fiduciary is the obligation of loyalty; the principal is entitled to the single-minded loyalty of his fiduciary.[3] A number of legal authorities were cited by the parties in argument. In respect of expert witnesses, Mrs Justice O’Farrell distilled the authorities to the following general principles:

i) an expert can be compelled to give expert evidence in arbitration or legal proceedings by any party, even in circumstances where that expert has provided an opinion to another party;[4]

ii) when providing expert witness services, the expert has a paramount duty to the court or tribunal, which may require the expert to act in a way which does not advance the client’s case;[5] and

iii) where a fiduciary duty of loyalty arises, it is not limited to the individual concerned. It extends to the firm or company and may extend to the wider group[6].

iv) Where no fiduciary relationship arises, having regard to the nature and circumstances of the expert’s appointment, or where the expert’s appointment has been terminated, the Bolkiah test based on an ongoing obligation to preserve confidential and privileged information does not necessarily apply to preclude an expert from acting or giving evidence for another party.[7]

Accordingly, having regard to the above – and noting Defendants’ failure to cite any authority supporting its proposition that an independent expert does not owe a fiduciary obligation of loyalty to his or her client – Mrs. Justice O’Farrell found that experts can, in fact, owe such a fiduciary duty. Paragraph 53 of the judgment:

“[a]s a matter of principle, the circumstances in which an expert is retained to provide litigation or arbitration support services could give rise to a relationship of trust and confidence. In common with counsel and solicitors, an independent expert owes duties to the court that may not align with the interests of the client. However, as with counsel and solicitors, the paramount duty owed to the court is not inconsistent with an additional duty of loyalty to the client.”

Disposal

Having established that an expert can in principle owe a fiduciary duty to his or her client, Mrs Justice O’Farrell assessed whether a duty of loyalty was owed by the Defendants to Claimant as a result of expert K’s engagement in respect of the Works Package Arbitration.

Mrs. Justice O’Farrell found it was clear in the circumstances that there was a “clear relationship of trust and confidence” giving rise to a fiduciary duty of loyalty because, in addition to providing an expert report, the engagement was to “provide extensive advice and support for the [C]laimant throughout the arbitration proceedings”.

Given that a fiduciary duty of loyalty had arisen, it was held, applying Bolkiah, that the duty of loyalty extended – because of the global management, marketing and common financial interest of the Defendants – beyond subsidiary X to the entire group (including Y and Z).[8] On that basis, accepting instruction on the EPCM Arbitration for another client was “plainly a conflict of interest” in breach of the fiduciary duty.[9] The injunction was continued pending trial on the issue.

Observations

This decision will no doubt cause concern among expert consultancy firms. An initial and understandable reaction will be to update terms of engagement to expressly exclude the fiduciary duty of loyalty. It is however the substance – the contract as a whole, the scope of the engagement – that is examined when deciding whether a relationship is fiduciary. While an express exclusion will help, it is by no means the complete solution: to avoid the suggestion of a fiduciary relationship, experts must ensure that the terms and parameters of their engagement are clearly and comprehensively set out. Also, before accepting an appointment relating to a project on which the firm is already engaged, it’s essential to carefully consider the conflicts position. As this case illustrates, the position of the individual expert or his subsidiary is not all that matters: if another expert in the group owes a fiduciary duty then that may extend to the group as a whole, and where that is the case – absent express consent – the firm cannot act without breaching its duty of loyalty to the first client.

The authors are grateful to Trainee Solicitor Adam Ismail, London, for his assistance in preparing this alert.

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[1] A Company v (1) X (2) Y (3) Z [2020] EWHC 809 (TCC).

[2] The First, Second and Third Defendants are part of the same group.

[3] Bristol & West Building Society v Mothew [1998] Ch 1 (CA), per Millett LJ at p. 18 (as cited at para. 40 of the Judgment in the present case).

[4] Harmony Shipping Co SA v Saudi Europe Line Limited [1979] 1 WLR 1380.

[5] Jones v Kaney [2011] 2 AC 98 (SC).

[6] Prince Jefri Bolkiah v KPMG [1999] 2 AC 222 (HL) , per Lord Millett at p. 234; Marks and Spencer Group plc and Another v Freshfields Bruckhaus Deringer [2004] EWCA Civ 741; Georgian American Alloys, Inc & Or v White and Case LLP & Anor [2014] EWHC 94.

[7] Meat Corporation of Namibia Ltd v Dawn Meats (UK) Ltd [2011] EWHC 474 (Ch); A Lloyd’s Syndicate v X [2011] EWHC 2487 (Comm); Wimmera Industrial Minerals Pty Ltd v Iluka Midwest Ltd [2002] FCA 653.

[8] Prince Jefri Bolkiah v KPMG [1999] 2 AC 222 (HL).

[9] A Company v (1) X (2) Y (3) Z [2020] EWHC 809 (TCC), per O’Farrell J at p. 61.

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

Jeffrey Sullivan – London (+44 (0) 20 7071 4231, [email protected])
Ryan Whelan – London (+44 (0) 20 7071 4176, [email protected])

International Arbitration Group:
Cyrus Benson – London (+44 (0) 20 7071 4239, [email protected])
Penny Madden – London (+44 (0) 20 7071 4226, [email protected])
Graham Lovett (+971 (0) 4 318 4620, [email protected])
Jeffrey Sullivan – London (+44 (0) 20 7071 4231, [email protected])
Rahim Moloo – New York (+1 212-351-2413, [email protected])

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

I. Overview

The coronavirus pandemic (“COVID-19”) has had far-reaching implications on virtually every aspect of the global economy, and the private equity industry has faced its share of challenges. As investment advisers and private equity fund managers navigate this uncertain terrain, many have identified alternative types of investments, including private investments in public equity (“PIPEs”) and various types of debt investments, as promising alternatives to their existing funds’ original investment strategies. With private equity firms holding an estimated $2 trillion of ‘dry powder’ and companies in dire need of capital, it should come as no surprise that, since late March, companies have raised approximately $8 billion from private equity funds in PIPE transactions, as sponsors eye dividends and an eventual equity stake in lieu of a more customary control investment approach.[1] This client alert identifies a number of issues fund managers should consider as they evaluate opportunities outside of their existing funds’ primary investment focuses.

II. Investment Program

A. Investment Objective

Fund managers should first evaluate whether the relevant disclosure and partnership agreement language is flexible enough to permit alternative investment types. This evaluation should focus on whether the fund’s investment objective is sufficiently broad to accommodate the desired types of alternative investment strategies (such as a carve-out to allow the fund to invest in “other assets,” or similar language). Any fund manager that pursues alternative investments for a fund that fall outside of the fund’s primary investment strategy should consider whether the current disclosure documents adequately discuss the risks inherent in such types of investments, or whether such disclosure should be supplemented.

B. Investment Restrictions

Sponsors should also be mindful of applicable investment limitations, whether contained in the partnership agreement or in investor side letters. These provisions are often drafted to allow the fund’s limited partner advisory committee (“LPAC”) or limited partners to waive the restrictions on a case-by-case basis, and fund managers should consider whether to request such a waiver in light of other requests they may be making (e.g., waivers of the requirement to hold an annual meeting, extensions of fundraising and investment periods, etc.) and how they can make their requests more appealing by, for instance, including a time limitation that stresses the unique nature of the opportunity being pursued and assures the investors that the drift in investment objective will be temporary in nature.

Of particular concern to fund managers in this respect will be restrictions in investing in marketable securities, or otherwise investing in publicly traded securities in the open market. While these restrictions would typically apply to investments in publically traded debt, they generally would not apply to investments in PIPEs, as such transactions do not involve open market purchases.

Should the fund’s documentation permit the sponsor to pursue alternative investments, the sponsor may wish to consider whether any of its existing portfolio companies would benefit from a debt investment (including a bridge financing) as a means of providing working capital. Before pursuing such opportunities, however, sponsors should carefully review the fund’s governing documents to ensure that there are no relevant restrictions (e.g., a cap on follow-on investments or a requirement that they must be in the form of equity).

C. Alternative Vehicles and Supplemental Fundraises

The creation of annex or ancillary investment vehicles may provide relief to a fund manager that is not necessarily restricted from investing in PIPEs or other alternative investment strategies in an existing fund, but the existing fund is near the end of its investment period or has limited available capital (even taking into consideration recycling mechanisms and scope to complete follow-on investments).

1. Co-Investment Vehicles

To the extent that a fund lacks the flexibility to pursue a compelling opportunistic investment strategy (whether due to fund-level investment restrictions or a lack of sufficient capital) and is unable to (or otherwise does not wish to) seek relief from its LPAC or limited partners, the fund manager may wish to consider allocating the remainder of the targeted investment to a newly formed co-investment vehicle. This approach has the benefit of allowing the fund to take only as much of the targeted investment as the fund manager deems appropriate (due to capacity constraints, investment restrictions, or other factors). The approach has the additional advantage of allowing the fund manager to raise additional capital relatively quickly (particularly to the extent the manager has an established form of co-investment agreement and has completed co-investments with its existing limited partners in the past). Sponsors should of course first evaluate whether the fund documents (including investor side letters) permit the formation of a co-investment vehicle and whether they obligate the sponsor to offer co-investment opportunities to specific investors.

1. Annex Funds

To assist in raising additional capital, fund managers may also wish to consider forming an annex fund, which is a newly formed fund vehicle intended to supplement the existing fund’s investment program. Annex funds are typically first offered to the existing fund’s investors on a pro rata basis. Investors who already subscribed are then offered their pro rata share of any unclaimed capacity, and any remaining capacity can then be offered to outside investors. Management fees and carried interest are typically heavily reduced (or, in the case of management fees, eliminated entirely).

1. Independent Investment Vehicles

Even if the fund documentation permits the manager to pursue its desired type of alternative investments, the manager may wish to create a completely independent investment vehicle focused on such alternative investments. While this approach should allow the manager to achieve economics that are not obtainable in the co-investment or annex fund contexts, establishing a standalone investment vehicle has a longer time horizon than the alternatives discussed above. This approach also presents the most risk, particularly in the current uncertain fundraising climate where travel and the ability to conduct onsite due-diligence with prospective investors may be drastically curtailed.

1. Supplemental Fundraises

Finally, to the extent practicable, sponsors may wish to consider conducting a supplemental fundraise within the sponsor’s existing fund. Assuming that there is no outer limit on the period during which the sponsor may accept new investor commitments (or the limited partners or LPAC have agreed to an extension of such period), the sponsor may allow existing investors to increase their capital commitments (or, potentially, allow a select number of new investors to join the fund). While this may allow the sponsor to maintain the core economics of the existing fund and to raise new capital quickly, it involves a number of important questions that must be addressed, including whether the increasing (or new) investors will be able to dilute existing investors in existing investments.

Under any of these approaches, sponsors will likely want to raise capital in an accelerated timeframe in order to capitalize on the applicable opportunities. Accordingly, we recommend that interested managers immediately begin preparing highly tailored marketing presentations that provide detailed overviews of the relevant opportunities and schedule virtual conferences with lead investors in order to address any questions or concerns. Sponsors should also be mindful that an effective ancillary vehicle will not simply duplicate the primary fund’s terms, but rather adjust them in a manner that reflects the relevant facts in order to minimize investor negotiation and proceed quickly to closing. Additionally, even if a sponsor is not looking into alternative investments and is not preparing for a traditional fundraise, we encourage a careful review of the existing fund’s terms and structure in order to be prepared to quickly return to market as desirable opportunities arise, given the current uncertainty in the market.

The formation of annex or ancillary investment vehicles requires careful consideration of a number of potential hurdles, as discussed more fully in Part III below.

III. Time and Attention and Related Considerations

A. Time and Attention; Key Person

Before forming a new investment vehicle to pursue alternative investment strategies, a fund manager should analyze a number of provisions in its existing funds’ governing documents. Chief among these are the key persons’ time commitment covenants, which are often heavily negotiated and should be analyzed carefully if the fund’s key persons are expected to play significant roles in the new investment vehicle. For example, a key person essentially would be precluded from involvement in the new investment vehicle if an existing fund’s partnership agreement requires that the key person devote “substantially all” of his or her business time and attention to the fund’s affairs. However, a key person clause that only requires a “reasonably necessary” amount of time offers more latitude, particularly in a scenario where, for example, the existing fund only has enough dry powder to make one additional investment. Sponsors should also consider their fiduciary responsibilities when evaluating time and attention and key person obligations to a fund. Time commitment requirements typically are customized so these analyses tend to be highly fact-specific. We are very familiar with helping fund managers analyze the relevant considerations.

B. Successor Fund Restrictions

Sponsors should also consider whether and to what extent successor fund restrictions may limit flexibility to establish a new vehicle. Many partnership agreements restrict fund managers from forming new vehicles with investment strategies that are “substantially similar” to the current fund’s investment strategy, until the current fund deploys a specified amount of capital or reaches the end of its investment period. This of course requires careful consideration of how the documents describe each fund’s investment objective, as discussed in Part II above. Co-investment vehicles are often specifically carved out from the definition of “successor funds” (i.e. permitted), but annex funds typically are not. In many cases, a fund’s LPAC has the explicit ability to waive this restriction, which may be the most efficient option for managers interested in setting up an annex fund (or a co-investment vehicle, to the extent it is not already carved out).

C. Allocation of Investment Opportunities

Finally, fund managers should be mindful of potential conflicts of interest and restrictions that may arise when allocating investment opportunities among the manager’s various funds and clients. A fund’s partnership agreement may require that the fund manager allocate to the fund any investment opportunities that fall within its investment mandate (subject to exceptions), regardless of whether such opportunities were primarily envisioned when the fund was created. Managers should seek to articulate a clear rule that identifies investment opportunities that fall outside of an existing fund’s investment objective and that can be allocated to a new vehicle. Deal allocation provisions may create substantial hurdles for managers looking to create new fund vehicles to pursue alternative investment types. Managers must carefully analyze the existing fund’s deal allocation requirements, including a review of both the existing fund’s partnership agreement and disclosure documentation and the manager’s allocation policy. Similar issues may arise when allocating an investment between the existing fund and a co-investment or annex fund.

IV. Conclusion

COVID-19 has created a tremendous amount of uncertainty in the global economy, causing many private equity fund managers to pursue new, attractive opportunities outside of their traditional investment objectives. Such managers should carefully review their funds’ governing documents and disclosure materials to determine whether and to what extent it is possible to pursue such opportunities. Sponsors should also maintain an open dialogue with limited partners and clearly communicate the desired strategy in a concise, focused manner, including a consideration of the various tools at the sponsor’s disposal, as outlined above.

____________________

[1] Crystal Tse and Liana Baker, Buffett-Goldman Redux: Buyout Shops Fight for Lifeline Deals, Bloomberg (Apr. 27, 2020).

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding the issues and considerations discussed above. For further information, please contact the Gibson Dunn lawyer with whom you usually work, or the following authors:

Shukie Grossman – New York (+1 212-351-2369, [email protected])
Edward D. Sopher – New York (+1 212-351-3918, [email protected])
Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, [email protected])
William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, [email protected])
Robert Harrington – New York (+1 212-351-2608, [email protected])

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

On April 22, 2020, the U.S. Securities and Exchange Commission (the “Commission”) issued a settled order finding that a middle-market private equity fund adviser failed to adequately disclose that costs relating to an internal “Operations Group” would be charged to the portfolio companies of the adviser’s fund. In addition to finding a violation of Section 206(2) of the Investment Advisers Act of 1940, as amended (the “Advisers Act”), the negligence-based anti-fraud provision, the adviser agreed to pay disgorgement of $1.7 million and a civil penalty of $200,000.[1]

The order states that, although the applicable fund documents described certain fees that would be charged to portfolio companies, including “monitoring fees” and “consulting fees,” the documents failed to discuss any operations group costs or describe with any specificity any other relevant fees that would be charged by the adviser to the portfolio companies of the fund and not be subject to management fee offset. Furthermore, the Commission found to be inadequate language that was subsequently added to the adviser’s Form ADV disclosure brochure describing potential costs relating to adviser personnel that “may”[2] be charged to portfolio companies of the fund. The order is consistent with prior settlement orders where the Commission found disclosures inadequate for costs relating to in-house services[3] and captive consulting groups.[4]

Operating partner arrangements come in a variety of forms, and it is important to distinguish captive consulting groups from other arrangements. The recent order describes the operating partners as an “in-house ‘Operations Group’” and provides other facts that distinguish it from many third-party consultant arrangements, including that it was held out to investors as being in-house, that it serviced the adviser’s entire portfolio and that it charged fees designed to cover costs.[5] While the order does not address third-party consultant arrangements, by including such distinguishing facts in its order the Commission suggests that those facts are relevant to its evaluation of the adequacy of disclosure. While third-party consultant arrangements may receive somewhat less scrutiny, even those types of arrangements can present meaningful conflicts or other issues that merit specific disclosure.[6]

Given the Commission’s focus on operating partners and the variety of conflicts presented by operating partners, we encourage clients to discuss with counsel and consider the following general takeaways.

Determine if the operating partners will be viewed as third-party consultants or as an in-house, captive consulting group. Ensuring independence and limiting the use of operating partners may be appropriate depending on disclosure and other factors and may reduce regulatory risk.
Ensure that disclosure is adequate in view of the arrangement (specifically evaluating what costs are disclosed and can be fairly charged to funds and portfolio companies) and consider if periodic reporting of costs to investors is sufficiently comprehensive. Broad disclosures such as references to “monitoring fees” or “consulting fees” may be viewed as inadequate by the Commission. In particular, the more “captive” the operating partners arrangement is, the more extensive and specific the disclosure regarding the arrangement should be.
Consider what compliance controls are appropriate given the arrangement. Even if the operating partners are not “supervised persons” of the adviser under the Advisers Act, it may be appropriate to subject them to certain compliance controls consistent with an adviser’s responsibility to prevent the misuse of material, nonpublic information.
Evaluate broker-dealer registration issues, if the arrangement includes the potential for transaction-based compensation.
Generally consider other conflicts and issues presented by the arrangement and how they should be addressed (disclosure, consent, additional controls).
Where costs of internal operating partners are allocated among portfolio companies or between portfolio companies and the adviser, it is important to maintain contemporaneous documentation to support the allocations.

_____________________

[1] Monomoy Capital Management, L.P., Administrative Order No. 3-19764, the U.S. Securities and Exchange Commission (April 22, 2020) available at https://www.sec.gov/litigation/admin/2020/ia-5485.pdf.

[2] Notably, the Commission has expressed its dislike of the use of “may” in certain disclosures relating to conflicts of interest. See Commission Interpretation Regarding Standard of Conduct for Investment Advisers, the U.S. Securities and Exchange Commission (July 12, 2019), available at https://www.sec.gov/rules/interp/2019/ia-5248.pdf (“Similarly, disclosure that an adviser ‘may’ have a particular conflict, without more, is not adequate when the conflict actually exists.”).

[3] In 2015, the Commission found that an adviser violated Section 206(2) of the Advisers Act for failing to adequately disclose costs relating to legal and compliance services provided by in-house personnel charged by the adviser. See Cherokee Investment Partners, LLC and Cherokee Advisers, LLC, Administrative Order No. 3-16945, the U.S. Securities and Exchange Commission (November 5 2015) available at https://www.sec.gov/litigation/admin/2015/ia-4258.pdf.

[4] In 2018, the Commission announced settlement with an adviser concerning the way in which it allocated compensation-related expenses for employees of an internal operating partner group. See NB Alternatives Advisers LLC, Administrative Order No. 3-18935, the U.S. Securities and Exchange Commission (December 17, 2018) available at https://www.sec.gov/litigation/admin/2018/ia-5079.pdf.

[5] The order cites the following statements from the adviser’s advertising materials: “an extensive in-house operational and financial restructuring team that drives business improvement throughout the [adviser’s] portfolio.” “The operations team is led by two operating partners…. The operating partners currently supervise a team of five portfolio company employees and 12 contractors who lead business improvement and lean manufacturing programs throughout the [adviser’s] portfolio.”

[6] On December 13, 2018, the Commissioner announced a settlement with an adviser for its failure to disclose certain in-house employee costs and arrangements with third-party consultants that gave rise to actual or potential conflicts of interest. Notably, the arrangement with the third-party consultant included a personal loan between the consultant and a senior person at the adviser. See Yucaipa Master Manager, LLC, Administrative Order No. 3-18930, the U.S. Securities and Exchange Commission (December 113, 2018) available at https://www.sec.gov/litigation/admin/2018/ia-5074.pdf.

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

Mark K. Schonfeld – New York (+1 212-351-2433, [email protected])
Y. Shukie Grossman – New York (+1 212-351-2369, [email protected])
C. William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, [email protected])
Gregory Merz – Washington, D.C. (+1 202-887-3637, [email protected])
Chris Hamilton – New York (+1 212-351-2495, [email protected])
Dan Li – New York (+1 212-351-6310, [email protected])

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

One type of case where “very compelling reasons” are likely to be present is the acquisition of financially distressed assets for which the injection of resources and strategic control by new owners is urgent. In such cases, the Commission is likely to accept notifications, particularly if the competition analysis is both straightforward and clearly explained.

There are two other issues that potential acquirors may also need to consider in such cases: (i) the suspension of the ‘standstill’ obligation; and (ii) the possible use of “failing firm” arguments. The legal grounds for both of these issues are explained in this Alert.

It is also worth noting comments from Margrethe Vestager, Vice President of the European Commission in charge of Competition Law, who recently warned an online panel at the American Bar Association Antitrust Virtual Spring Meeting that: “[t]his crisis certainly shouldn’t be a shield to allow mergers that would hurt consumers and hold back the recovery”. While she acknowledged that the Commission has rarely accepted arguments about “failing firms”, she said that her staff would take such arguments into consideration, but that the long-standing test would remain the same. She added that: “The failing firm defence is a very well-known concept. It is also important that some things are stable in these very uncertain times”.

1) Derogation from the suspensory requirement

Despite the impact of the COVID-19 crisis on timelines and procedures, companies are still bound by the notification and standstill obligations laid down in the EU Merger Regulation (“EUMR”). Under these rules, and in the absence of a specific derogation from the Commission, firms cannot implement notifiable transactions prior to receiving clearance.

However, Article 7(3) EUMR provides that it is possible to obtain a derogation from the standstill obligation in exceptional cases where the negative effects of the suspension outweigh the threat to competition posed by the transaction. For this to happen, two conditions must be satisfied: (i) the suspension of the transaction must give rise to a risk of serious damage to the parties or third parties; and (ii) the transaction must not raise prima facie competition concerns.

As regards the first condition, the financial distress of the target company is the most commonly cited reason for seeking a derogation. During the 2008 financial crisis, the Commission granted derogations for the acquisition by Santander of Bradford & Bingley and the acquisition of Fortis by BNP Paribas. The Commission’s reasoning in these cases suggests that systemic risk threatening financial stability as a whole was a decisive factor in the assessment of the risks related to the suspension of the transaction (see Case No COMP/M.5384 – BNP Paribas/Fortis, Decision of 27.10.2018; Case No COMP/M.5363 Santander/ Bradford & Bingley Assets, Decision of 28.09.2008).

The second condition limits the application of the derogation to those transactions that do not pose a threat to competition, such as cases where there is a minimal overlap of the parties’ activities.

Where these conditions are satisfied, the Commission may allow the parties to proceed with the transaction before authorisation is received, potentially subject to conditions and obligations. Generally speaking the derogation will only allow the transfer of the minimum amount of control that is required to avoid the risk of serious economic damage (such as the transfer of funds and limited management control).

2) The failing firm/division defence

In the context of transactions involving distressed targets, the failing firm defence (“FFD”) is often raised but is rarely successful in practice. The Horizontal Merger Guidelines (at paragraph 89) explain that an otherwise problematic merger may nevertheless be authorised if one of the merging parties is a failing firm. The reasoning behind this important principle is that the deterioration of the competitive structure of the market that follows the merger is not caused by the transaction, but by the prevailing economic conditions affecting the target. In other words, the competitive structure of the market would deteriorate at least to the same extent in the absence of the merger.

There are three criteria which are relevant in the assessment of whether an FFD is likely to succeed: (i) the failing firm would in the near future be forced to exit the market due to financial difficulties if it is not taken over by another firm; (ii) there is no less anti-competitive alternative than the proposed merger; and (iii) in the absence of the proposed merger, the assets of the failing firm would inevitably exit the market. (See Joined Cases C-68/94 and C-30/95, Kali and Salz. See also Commission Decision 2002/365/EC in Case COMP/M.2314 – BASF/Pantochim/Eurodiol, at points 157-160). These conditions are cumulative.

The first condition requires sufficient evidence of the failing firm’s financial difficulties. While it is not required that the target is subject to a formal bankruptcy procedure, the notifying parties must demonstrate that the target would be forced to exit the market within a short period of time. The argument must be supported with data and evidence, particularly on various counterfactual scenarios. Internal documentation showing denied access to finance or failed attempts at restructuring constitutes particularly relevant evidence.

In 2013, the Commission cleared Aegean Airlines’ acquisition of Olympic Air, both Greek air carriers, after having previously blocked the same proposed transaction in 2011. The failing firm defence was invoked in both cases. In Aegean/Olympic II, the changed market conditions (prompted by the on-going economic crisis in Greece), the rapid decline in the target’s competitiveness and financial situation, and the parent company’s lack of ability and incentive to support Olympic, led the Commission to conclude that Olympic would soon exit the market in the absence of the transaction.

The second condition is fulfilled where it can be demonstrated that there are no credible alternative buyers for the target company, which would otherwise result in a more competitive outcome. In this regard, the Commission requires evidence of serious and credible efforts to seek alternative options. In Aegean/Olympic II, the Commission relied on past tender processes for the sale of Olympic and internal documents demonstrating the absence of alternative buyers.

The third condition requires the parties to demonstrate that, should the target company fail, its assets would inevitably exit the market absent the merger.

In Aegean/Olympic II, the Commission’s market investigation showed that there were no operators interested in acquiring Olympic’s assets in the event the firm would leave the market. Moreover, Olympic’s market shares on the relevant air routes would, in any event, accrue to Aegean since the parties were already in a quasi-duopoly situation, and entry by a third operator was considered to be unlikely in the foreseeable future.

The standard of proof that the parties must meet for a successful FFD is thus very high and the Commission’s economic analysis is necessarily complex. In fact, an FFD has only been accepted in three cases, namely: Cases C-68/94 and C-30/95, Kali and Salz; Case COMP/M.2314 – BASF/Pantochim/Eurodiol; and COMP/M.6796 – Aegean/Olympic II. Furthermore, the Commission has made it clear both in the context of the 2008 crisis and that of the present that it would continue to apply strict merger control standards in times of crisis. Thus, it is very unlikely that the Commission will lower its formal legal standards for the FFD in the context of the current pandemic.

However, even where an FFD argument is likely to fail, the decisional practice of the Commission suggests that clearance may nevertheless be available where the alternative counterfactual scenario clearly demonstrates that the exit of the target’s assets from the market would be more harmful to competition than allowing the transaction to go ahead. This might occur, for example, where only part of a firm is threatened with closure.

Thus, in BASF/Pantochim/Eurodiol, the Commission did not require that the market share of the failing firm must in any event accrue to the other merging party. Instead, the Commission applied an overall economic assessment and compared the effects the clearance would have on the market structure compared with the effects of a prohibition. The Commission concluded that a clearance in such circumstances would have fewer anti-competitive effects than a prohibition, particularly because the exit of the assets from the market would have led to capacity bottlenecks, thereby increasing prices even more and therefore operating more strongly against customer interests.

In Nynas/Shell/Harburg Refinery, the Commission allowed Nynas to acquire Shell’s refinery assets in Harburg, Germany, on the basis of the failing firm criteria despite the fact that the remainder of the firm was not financially challenged. It concluded that Shell would close the Harburg refinery, absent divestiture, and that the assets would in the near future be forced out of the market if not taken over by another undertaking, because of their poor financial performance and because of Shell’s strategic focus on other activities. (Case No COMP/M.6360 – Nynas/ Shell/ Harburg Refinery, Decision of 02.09.2013). The application by the Commission in its Decision of reasoning which facilitated the purchase of a single refinery without an explicit reference to the reasoning underpinning the FFD suggests that the case would not have met the formal FFD standards, especially regarding the satisfaction of the first condition. In fact, Shell’s decision to close the refinery was strategic in nature, because it could have chosen to maintain the business. By contrast, in Aegean/Olympic II, the parent company had neither the incentive nor the ability to continue to support Olympic.

In NewsCorp/Telepiù, the FFD was not accepted because the first and second criteria were not fulfilled. Notably, as regards the first condition, the Commission noted that the exit of the target from the market in the absence of the transaction was seen as a “management decision to abandon a business activity whose development has not lived up to the expectations of the firm’s managing board”. Even so, the Commission proceeded to employ a counterfactual analysis and concluded that the authorisation of the merger would be more beneficial than the disruption caused by a potential exit of the target from the market. (See Case No COMP/M.2876, NewsCorp/Telepiù, Decision of 02.04.2003).

Finally, in the T-Mobile/Tele2 NL and KLM/Martinair Decisions, the Commission cleared the mergers on the grounds that, in the absence of the mergers, the targets’ future competitive positions would inevitably deteriorate, which would be more detrimental to effective competition overall. (See Case M.8792 T-Mobile NL/Tele2 NL, 27.11.2018; Case No COMP/M.5141 KLM/ Martinair, 17.12.2008).

Hence, the precedents suggest that the Commission can be persuaded through an appropriate counterfactual analysis to take into consideration the financial difficulties of a target firm, whether by applying a formal FDD analysis or a more relaxed version of the FFD. The economic difficulties raised by the COVID-19 pandemic suggest that the time may be ripe for the more flexible use of that doctrine.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 outbreak. For additional information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Coronavirus (COVID-19) Response Team or its Antitrust and Competition Practice Group, or the following authors in 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])
David Wood (+32 2 554 7210, [email protected])

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

GLOBAL OVERVIEW

In the last week, as the U.S. Small Business Administration (“SBA”) prepared for additional Paycheck Protection Program (the “Program” or “PPP”) funding and began accepting—for the second time—applications from participating lenders, the SBA issued a series of new guidance materials related to Program eligibility, fund accessibility, and loan amount calculations.

This client alert, the sixth in a series of alerts regarding the Program, will address the SBA’s (1) Fourth Interim Rule, which speaks to, among other topics, the eligibility (or ineligibility) of private equity firms, hedge funds, and the gaming industry to participate in the Program; (2) certification that a PPP loan is needed in order to support ongoing operations; (3) Fifth Interim Final Rule acknowledging a disparity in treatment under the maximum loan calculation under the CARES Act for seasonal employers and Sixth Interim Final Rule on disbursements; (4) guidance on how to calculate maximum loan amounts and related payroll documentation requirements; and (5) guidance on how to calculate the number of employees under employee-based size standards for eligibility.
Read more

Economic and Trade Sanctions Developments in Response to COVID-19

Despite pressure from U.S. and non-U.S. officials to ease sanctions on Iran in response to COVID-19, the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) to date has not made substantial changes to the longstanding legal authorizations for humanitarian trade. Nonetheless, OFAC has in recent weeks published unprecedented guidance for those who may find themselves facing challenges to comply with OFAC’s reporting requirements in light of the pandemic, acknowledging that some businesses may be forced to reallocate sanctions compliance resources to other functions. While this is far from the substantial changes called for by some, it nonetheless indicates OFAC’s willingness to respond to the crisis with some measure of understanding for the new realities faced by many businesses affected by the pandemic.
Read more

COVID-19 United Kingdom Weekly Bulletin (April 29, 2020)

This weekly bulletin provides a summary and compendium of English law legal developments during the current COVID-19 pandemic in a variety of key areas.
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Analysis of Recent Economic and Trade Sanctions Developments in Response to COVID-19

The COVID-19 crisis has intensified longstanding controversy over the role of economic and trade sanctions in the context of international humanitarian efforts. OFAC has in recent weeks taken unprecedented actions in this area—including offering a unique position concerning the possible reallocation of compliance resources away from sanctions matters. We provide below a summary of recent actions and public statements by senior U.S. and non-U.S. officials related to sanctions in the context of the response to COVID-19 and our reflections on what to expect in the short term.

Both before and after the United States’ participation in the Iran Nuclear Deal, the scope of activities related to Iran undertaken by non-U.S. persons that could result in U.S. secondary sanctions was and remains broad. As a result, many foreign financial institutions, manufacturers, and others have simply decided to restrict business related to Iran, regardless of whether the business would otherwise be authorized under the U.S. Iran sanctions. This widespread over-compliance with OFAC’s rules both within and outside of the United States has placed a significant practical restrain on humanitarian trade with Iran.

In response to the COVID-19 pandemic, the United Nations High Commissioner for Human Rights and the High Representative of the European Union for Foreign Affairs intensified calls on the United States to ease sanctions on Iran in response to that country’s particularly severe outbreak of the novel coronavirus.

OFAC initially responded with the addition of a new Frequently Asked Question directing attention to existing authorizations and exemptions for humanitarian trade with Iran. The FAQ described the general scope of the existing authorizations for trade in agricultural commodities, medicine, and medical devices with Iran, subject to limitations related to restricted parties and payment mechanisms.

Political pressure continued to mount, as current and former senior U.S. officials and diplomats, including former Secretary of State Madeleine Albright and Vice President Joe Biden, issued public statements urging OFAC to expand existing authorizations. Proposals for action included expanding the list of items eligible for the general authorization for trade in medicine and medical devices with Iran; issuing “comfort letters” to non-U.S. banks asked to facilitate humanitarian trade; adding staffing and resources to OFAC to accelerate the licensing process for medical items subject to a licensing requirement; offering updates on the operationalization of the Swiss Humanitarian Trade Arrangement; and expressing support for humanitarian trade facilitated by Europe’s INSTEX arrangement.

In apparent response to these public requests, OFAC has taken several steps that, while novel in certain respects, fall short of the changes that others have called for.

First, on April 16, OFAC issued a “Fact Sheet” summarizing the existing authorizations and exemptions for humanitarian trade and other assistance provided in response to COVID-19 with respect to all of the comprehensively sanctioned jurisdictions, namely Iran, Venezuela, North Korea, Syria, Cuba, and the Crimea region of Ukraine. Although no new authorizations were included in this document, the Fact Sheet is a helpful resource for industry, as it is the most complete collection published by OFAC to date of the various legal provisions applicable to humanitarian trade.

On the other hand, the length and detail of the Fact Sheet itself demonstrate the significant complexity and compliance resources needed to effectively use the existing authorizations for humanitarian trade. Particularly with respect to Iran, the number of restricted parties, including Iranian financial institutions and medical facilities that may be connected to restricted entities such as the Islamic Revolutionary Guard Corp-Qods Force, can make sales or donations of medical supplies to Iran complicated and risky. In addition, U.S. banks are not permitted to maintain direct correspondent relationships with banks in Iran, requiring all payments even for authorized trade to be routed through third-country banks in order to reach the United States.

Further, the Fact Sheet does not cover licensing requirements that apply to some exports of medical supplies from the United States to comprehensively sanctioned jurisdictions administered by the U.S. Department of Commerce.

Second, on April 20, OFAC issued an unusual public statement in which it appeared to provide limited leniency for persons subject to reporting requirements or who have received requests for information under an administrative subpoena with respect to challenges arising from the COVID-19 emergency. OFAC acknowledged that the pandemic crisis has caused “technical and resource challenges” for organizations. OFAC stated:

Accordingly, if a business facing technical and resource challenges caused by the COVID-19 pandemic chooses, as part of its risk-based approach to sanctions compliance, to account for such challenges by temporarily reallocating sanctions compliance resources consistent with that approach, OFAC will evaluate this as a factor in determining the appropriate administrative response to an apparent violation that occurs during this period. OFAC will address these issues on a case-by-case basis.

OFAC has not previously made any similar statement appearing to accommodate the choice by a regulated organization to reassign resources away from sanctions compliance.

We note that this public statement by OFAC does not authorize any apparent violation of the existing sanctions rules. It merely refers to OFAC’s assessment of an organization’s risk-based compliance procedures in the context of an administrative enforcement action. Therefore, rather than indicate any departure by OFAC from the existing requirements with respect to sanctions compliance, this rather unprecedented statement may indicate the unusual amount of pressure that OFAC finds itself under to justify its maintenance of the status quo.

In the short term, we expect that OFAC will continue to resist calls to dramatically change the scope of existing authorizations for humanitarian trade. Press releases by the U.S. Department of State and the U.S. Department of the Treasury have offered public justification for OFAC’s position. OFAC has also indicated in recent calls and panel discussions that it does not anticipate issuing new general licenses. That said, we will continue to monitor this ongoing controversy as the unusual present circumstances may yet lead to unpredictable results.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 pandemic. For additional information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Coronavirus (COVID-19) Response Team or its International Trade Practice Group, or the authors:

Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [email protected])
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Samantha Sewall – Washington, D.C. (+1 202-887-3509, [email protected])

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

To Our Clients and Friends:

With an additional $349 billion in funding to PPP under the Paycheck Protection Program and Health Care Enhancement Act (the “PPP and Health Care Enhancement Act”), the Program, established by the Coronavirus, Aid, Relief, and Economic Security (“CARES”) Act, is set to provide a total of $659 billion to help small businesses impacted by COVID-19 with funds to pay eight weeks of payroll and other eligible costs. The PPP and Health Care Enhancement Act, which was enacted into law on April 24, 2020, and primarily designed to replenish funds for the Program, did not substantially change the overall structure of the Program. The new law did, however, set aside $60 billion in funding for “community financial institutions” to serve underserved small businesses and nonprofit organizations[1] and directed the SBA to allow agricultural enterprises[2] to apply for Economic Injury Disaster Loans. With the additional funds Congress provided in the PPP and Health Care Enhancement Act, the SBA started accepting PPP applications from lenders again on April 27, 2020.

This client alert, the sixth in a series of alerts regarding the Program,[3] will address the SBA’s (1) Fourth Interim Rule (the “Fourth IFR”), which speaks to, among other topics, the eligibility (or ineligibility) of private equity firms, hedge funds, and the gaming industry to participate in the Program; (2) certification that a PPP loan is needed in order to support ongoing operations; (3) Fifth Interim Final Rule (the “Fifth IFR”), acknowledging a disparity in treatment under the maximum loan calculation under the CARES Act for seasonal employers and Sixth Interim Final Rule (the “Sixth IFR”) on disbursements; (4) guidance on how to calculate maximum loan amounts and related payroll documentation requirements; and (5) guidance on how to calculate the number of employees under employee-based size standards for eligibility.

Thematically, much of the new guidance is cautionary in nature; warning public, private equity-held, and other businesses with access to liquidity that PPP loans are not for them. Adding teeth to those warnings the Treasury Department also announced that all PPP loans of more than $2 million will be audited.

The Fourth Interim Final Rule

Under the Fourth IFR, hedge funds and private equity firms are explicitly prohibited from receiving a PPP loan because they are “primarily engaged in investment or speculation.” This rule is consistent with prior restrictions on Section 7(a) loans identified in 13 CFR §120.110 and described in SBA’s Standard Operating Procedure (SOP) 50 10, which prohibited loans to “speculative businesses” for the “sole purpose of purchasing and holding an item until the market price increases” or “[e]ngaging in a risky business for the chance of an unusually large profit.” Prior to the Fourth IFR “speculative” businesses included those “[d]ealing in stocks, bonds, commodity futures, and other financial instruments.”[4]

The Fourth IFR acknowledges, however, that a portfolio company of a private equity fund may still be eligible for a PPP loan and concludes that “[t]he affiliation rules apply to private equity-owned businesses in the same manner as any other business subject to outside ownership or control.” The acknowledgment comes with a cautionary note: that borrowers should “carefully review” the PPP loan application certifications, including that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”

The Fourth IFR also contains the following additional clarifying provisions:

Government-Owned Hospitals. Hospitals otherwise eligible to receive a PPP loan are not determined ineligible because of ownership by state or local government if the hospital receives less than 50% of its funding from state or local government sources, exclusive of Medicaid.
Legal Gaming Activities. Businesses that receive legal gaming revenues are eligible for PPP loans. In a shift from the SBA’s Third Interim Rule, the Fourth IFR states that 13 CFR 120.110(g) (providing that businesses deriving more than one-third of gross annual revenue from legal gambling activities are ineligible for SBA loans) is inapplicable to PPP loans. Businesses that receive illegal gaming revenues remain ineligible.
Employee Stock Ownership Plans. Participation in an ESOP (as defined in 15 U.S.C. § 632(q)(6)) does not result in an affiliation between the business and the ESOP.
Bankruptcy Proceedings. An applicant is ineligible for PPP loans if it, or its owner, is the debtor in a bankruptcy proceeding at the time of the application or any time before the loan is disbursed.

Borrower Certification Safe Harbor

In the SBA’s FAQ, the SBA reiterates that “all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application.” Regardless of eligibility requirements, borrowers must certify in good faith that the PPP loan request is necessary even though the CARES Act suspended the ordinary requirement that borrowers must be unable to obtain credit elsewhere. Specifically, the guidance states that borrowers need to consider “their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business,” when certifying that the PPP loan request is necessary to ongoing operations.

The guidance concluded that it is “unlikely” a public company “with substantial market value and access to capital markets will be able to make the required certification in good faith, “ and cautioned that such companies should be prepared to demonstrate to the SBA, upon request, the basis for its certification. In addition, yesterday, Secretary of the Treasury Steven Mnuchin said that the government will audit any PPP loans above $2 million.

Notably, the Fourth IFR establishes a form of amnesty by allowing “borrowers [to] promptly repay PPP loan funds that the borrower obtained based on a misunderstanding or misapplication of the required certification standard.” Under the Fourth IFR, any borrower that applied prior to April 23, 2020 and repays the loan in full by May 7, 2020 “will be deemed by SBA to have made the required certification in good faith.”

The Fifth and Sixth Interim Final Rules

On April 27, 2020, the SBA issued the Fifth Interim Final Rule (available here) to provide seasonal employers with an alternative method to calculate their maximum loan amount. In doing so, the Fifth IFR stated that without the rule, “many summer seasonal businesses would be unable to obtain funding on terms commensurate with those available to winter and spring seasonal businesses.” Under Section 1102 of the CARES Act, a seasonal employer may determine its maximum loan amount by reference to the employer’s average total monthly payments for payroll during “the 12-week period beginning February 15, 2019, or at the election of the eligible [borrower], March 1, 2019, and ending June 30, 2019.” The Fifth IFR allows seasonal employers to calculate the maximum loan amount using any consecutive 12 week period between May 1, 2019 and September 15, 2019. The Rule also clarifies that if a seasonal business was not fully operating or dormant as of February 15, 2020, it is still eligible to receive a PPP loan.

The Sixth Interim Final Rule, posted on April 28, 2020 and available here, provides that lenders must make a one-time, full disbursement of the PPP loan within ten calendar days of loan approval (defined as when the loan is assigned an SBA loan number). Loan approvals will be cancelled for any loans that are not disbursed because of a borrower’s failure to provide required loan documentation, including a promissory note, within 20 calendar days of loan approval. The Sixth IFR provides for transition rules for those loans that have received an SBA loan number prior to the posting of the Sixth IFR but are not yet fully disbursed.

Maximum Loan Calculation and Payroll Documentation Requirements

In addition, on April 24, 2020, the SBA provided guidance (available here) to assist businesses in calculating their payroll costs for determining the maximum possible PPP loan amount. Under the guidance, the SBA outlines the methodology potential borrowers should use to calculate the maximum amount they can borrow, as well as the documentation the borrower should provide to substantiate the loan amount. A table summarizing the required documentation as articulated in the guidance is below.

The SBA guidance reminds borrowers that, under most circumstances, “PPP loan forgiveness amounts will depend, in part, on the total amount spent during the eight-week period following the first disbursement of the PPP loan.”

Records from a retirement administrator, or a health insurance company or third-party administrator for a self-insured plan can be used to demonstrate employers retirement and health insurance contributions.

Supporting Documentation Requirements

No.	Eligible Borrower	2019 Documentation	2020 Documentation
1.	Self-employed with no employees	IRS Form 1040 Schedule C. IRS Form 1099-MISC detailing nonemployee compensation received (box 7), invoice, bank statement, or book of record establishing you were self-employed in 2019.	Invoice, bank statement, or book of record establishing operation on February 15, 2020.
2.	Self-employed with employees	IRS Form 1040 Schedule C. IRS Form 941[1], or IRS Form W-2s, IRS Form W-3, or payroll processor reports, including quarterly and annual tax reports. State quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements). Documentation of any retirement or health insurance contributions.	Payroll statement or similar documentation from the pay period that covered February 15, 2020.
3.	Self-employed farmers	IRS Form 1040 Schedule 1 and Schedule F.
4.	Partnerships without employees	IRS Form 1065 (including K-1s).	Invoice, bank statement, or book of record establishing the partnership was in operation on February 15, 2020.
5.	Partnerships with employees	IRS Form 1065 (including K-1s). IRS Form 941, or IRS Form W-2s, IRS Form W-3, or payroll processor reports, including quarterly and annual tax reports. State quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements). Documentation of any retirement or health insurance contributions.	Payroll statement or similar documentation from the pay period that covered February 15, 2020.
6.	S Corporations or C Corporations	IRS Form 941, or IRS Form W-2s, IRS Form W-3, or payroll processor reports, including quarterly and annual tax reports. State quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements) Filed business tax return (IRS Form 1120 or IRS 1120-S) or other documentation of any retirement and health insurance contributions.	Payroll statement or similar documentation from the pay period that covered February 15, 2020.
7.	Eligible Non-Profit Organizations	IRS Form 941, or IRS Form W-2s, IRS Form W-3, or payroll processor reports, including quarterly and annual tax reports. State quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements) IRS Form 990 or other documentation of any retirement and health insurance contributions	Payroll statement or similar documentation from the pay period that covered February 15, 2020.

Employee-Based Size Standards and Definitions

In guidance issued on April 26, 2020 (available here), the SBA reiterated that under the 500-employee or other applicable employee-based threshold, the term “employee” under the CARES Act includes “individuals employed on a full-time, part-time, or other basis.” Although this is consistent with the original text of the CARES Act, the guidance confirms that a part-time employee working 10 hours per week should be counted the same as a full-time employee for purposes of loan eligibility. In contrast, the guidance acknowledges, to determine the extent of any reduction in the loan forgiveness amount in the event of a reduction in headcount, the CARES Act uses the standard of “full-time equivalent employees.”

Although the CARES Act and related guidance issued to date do not define the term in the context of the Program, Title II of the CARES Act defines “full-time employee” by referencing the Internal Revenue Code, 26 U.S.C. § 4980H, which defines the term as “an employee who is employed on average at least 30 hours of service per week.” In addition, the Internal Revenue Service defines “full-time equivalent employee” as “a combination of employees, each of whom individually is not a full-time employee, but who, in combination, are equivalent to a full-time employee.” Absent further guidance, these definitions may be instructive.

[1] A search tool for identifying all eligible lenders is available on the SBA website here.

[2] Existing law defines “agricultural enterprises” to mean “small business concerns engaged in the production of food and fiber, ranching, raising of livestock, aquaculture, and all other farming and agricultural-related industries.”

[3] For additional details about the PPP please refer to Gibson Dunn’s Frequently Asked Questions to Assist Small Businesses and Nonprofits in Navigating the COVID-19 Pandemic and prior Client Alerts about the Program: SBA “Paycheck Protection” Loan Program Under the CARES Act; Small Business Administration and Department of Treasury Publish Paycheck Protection Program Loan Application Form and Instructions to Help Businesses Keep Workforce Employed; Small Business Administration Issues Interim Final Rule and Final Application Form for Paycheck Protection Program; Small Business Administration Issues Interim Final Rule on Affiliation, Summary of Affiliation Tests, Lender Application Form and Agreement, and FAQs for Paycheck Protection Program, and Analysis of Small Business Administration Memorandum on Affiliation Rules and FAQs on Paycheck Protection Program.

[4] See SBA’s Standard Operating Procedure (SOP) 50 10.

[5] Very small businesses that file an annual IRS Form 944 instead of quarterly IRS Form 941 should provide IRS Form 944.

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

Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Roscoe Jones, Jr.* – Washington, D.C. (+1 202-887-3530, [email protected])
Alisa Babitz – Washington, D.C. (+1 202-887-3720, [email protected])
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, [email protected])
Alexander Orr – Washington, D.C. (+1 202-887-3565, [email protected])
William Lawrence – Washington, D.C. (+1 202-887-3654, [email protected])
Samantha Ostrom – Washington, D.C. (+1 202-955-8249, [email protected])

* Not admitted to practice in Washington, D.C.; currently practicing under the supervision of Gibson, Dunn & Crutcher LLP.

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

This bulletin provides a summary and compendium of English law legal developments during the current COVID-19 pandemic in the following key areas:

1. Competition and Consumers
2. Corporate Governance (including accounts, disclosure and reporting obligations)
3. Cybersecurity and Data Protection
4. Disputes
5. Employment
6. Energy
7. Finance
8. Financial Services Regulatory
9. Force Majeure
10. Government Support Schemes
11. Insolvency
12. International Trade Agreements (private and public)
13. Lockdown and Public Law issues
14. M&A and Private Equity
15. Real Estate
16. UK Tax

Links to various English law alerts prepared by Gibson Dunn during this period are also included in the relevant sections.

As always, for additional information, please feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the UK COVID-19 Taskforce (listed at the end of this bulletin), or one of the taskforce co-leads:

Charles Falconer – London (+44 (0)20 7071 4270, [email protected])
Anna Howell – London (+44 (0)20 7071 4241, [email protected])

1. COMPETITION AND CONSUMERS

Merger control

UK Competition and Markets Authority (CMA) guidelines on merger assessment during COVID-19 pandemic

On 22nd April 2020, the CMA issued guidance on its expected approach to merger control during the COVID-19 pandemic. We have summarised some of the key points below.

The CMA’s overall approach remains unchanged: The guidance suggests that the CMA’s overall approach remains unchanged i.e. the timescales under which the CMA is required to operate and its approach to assessment have not been altered. However, adjustments are being made to the usual process to accommodate remote working measures.

Timing of notifications: The CMA has acknowledged that the pre-notification process may take longer than usual, due to difficulties in obtaining information from both transacting parties and third parties. Further, it has highlighted that it may not be able to formally start the “clock” for a transaction’s review if third parties have been unable to “meaningfully engage” with the CMA’s investigation. The CMA is encouraging parties to discuss in advance the timing of a notification. However, it has not adopted a blanket approach encouraging delays to filings. Instead, it is encouraging added consideration as to whether some filings could be postponed, e.g. where a merger is “not particularly well-advanced and may not ultimately proceed”.

Substantive assessment: The CMA has stated that there will not be a relaxation of the normal standards during the COVID-19 pandemic. However, since the CMA’s merger assessment is forward-looking, the impacts of the COVID-19 pandemic will be factored into the CMA’s substantive assessment, where appropriate. Any conclusions will, however, need to be evidence led. Further, a merger control investigation typically takes into account long-lasting structural impacts of a merger on the relevant market(s). Short term, transient changes in market dynamics (e.g. industry wide economic shocks, even if “significant”) may not, in themselves, be sufficient to override competition concerns identified on this basis. This suggests that the CMA will need to make some calls about the likely extent and duration of certain impacts caused by the COVID-19 pandemic. The CMA has acknowledged that considerable uncertainty exists in some markets, which may raise challenges in this respect.

Failing firm defence: the CMA has issued a “refresher” document summarising how it is likely to approach “failing firm” defence claims (i.e. situations where firms are failing financially and claim that they would exit the market absent the merger in question). This is in anticipation of an increase in the frequency of such claims in the coming weeks/months. The CMA’s guidance flags that it does not intend to relax existing standards in the current climate, noting that the failing firm test has been applied “stringently” to date and that “relatively few cases” have met the relevant criteria so far. It also notes that a higher evidential bar exists during a Phase 1 review compared to Phase 2 review. Given the implications of a “failing firm” scenario (i.e. the clearance of a transaction that could otherwise raise significant competition concerns), it also highlights that such claims are only likely to be accepted where supported by a “material body of probative evidence, which the merging parties can expect the CMA to test thoroughly”. The guidance clearly states in this respect that unsupported assertions concerning the financial health of a business or the absence of alternative purchasers are highly unlikely to be sufficient. The CMA has recommended early engagement with the case team where parties anticipate making such claims, in particular to discuss what information is required to inform the CMA’s assessment. The publishing of the guidance follows the CMA’s previous announcement, discussed in our COVID-19 UK Bulletin – 22 April 2020, that it had provisionally cleared Amazon’s minority investment in Deliveroo. This announcement represented somewhat of a U-turn in the CMA’s treatment of the case, based on a successful failing firm claim.

Antitrust

Government Order – Exemption of certain health care agreements

The Government has granted a formal “exclusion order” (which exempts certain types of agreements in specific sectors from competition law), this time applying to certain agreements whose purpose is to assist the NHS in addressing the effects or likely effects of COVID-19 on the provision of health services to patients in Wales. The order applies to agreements between one or more NHS bodies and one or more independent providers or an association of independent providers or between two or more independent providers. Only certain activities are permitted, and conditions apply.

At the time of writing, four exclusion orders have been enacted. Other orders concern the groceries sector (grocery chain retailers, suppliers and logistics service providers), existing ferry transport operators in the Isle of Wight and agreements to assist the NHS in addressing the effects or likely effects of COVID-19on the provision of health services to patients in England. Again, only certain activities are excluded under these orders and conditions apply.

As mentioned previously, whilst some co-operation may be tolerated in the current environment, this is not without limits. Careful assessment is required as to whether a particular co-operation will be tolerated and safeguards must be put in place to ensure that the co-operation goes no further than strictly necessary to deal with critical issues. Companies facing issues with supply or distribution or considering co-operating with competitors should consult with counsel.

European Commission announces measures to assist agri-food sector

The European Commission has announced a number of measures to assist the agri-food sector, which it aims to adopt by the end of April. Prior to adoption, Member States will need to be consulted and vote on the measures. They are, therefore, subject to change.

The package is said to include: (i) measures for private storage aid in the dairy and meat sectors; (ii) flexibility in the implementation of certain market support programmes and the EU’s school scheme; and (iii) derogations from certain EU competition rules applicable to the milk, flowers and potatoes sectors. The latter will allow for certain self-organisation measures to be adopted to stabilise the market, and will be subject to conditions. The full detail of the proposals will be unveiled at the time of their final adoption.

For further details see here.

Consumer protection

CMA COVID 19 Taskforce – Update on complaints received and CMA response

An update was published by the CMA on 24 April 2020 regarding the CMA’s COVID-19 taskforce’s activities, briefly describing the nature and extent of complaints received and the CMA’s response to date.

As of 19 April 2020, the CMA had received just under 21,000 COVID-19 related complaints. The vast majority of complaints currently are said to relate to cancellations and refunds, relating to “large businesses”. Complaints related to cancellations and refunds are now said to account for 4 out of 5 of the complaints being received. The CMA has also written to 187 firms (which accounted for 2,500 complaints) about large price rises for personal hygiene products, such as hand sanitiser, and food products.

The CMA identified in the update its primary concerns currently in the areas of: (i) unfair practices in relation to cancellations and refunds (particularly when consumers are being obliged to cancel holiday, travel and other plans); and (ii) unjustifiable price increases (particularly for essential goods). On the former, the CMA is said to be particularly concerned about firms refusing refunds; introducing unnecessary complexity into the process for obtaining refunds; charging high administration or cancellation fees; and pressuring consumers into accepting vouchers instead of cash refunds.

The taskforce is said to be continuing to collect evidence, including allegations of unjustifiable price rises further up the supply chain. The CMA is due to announce shortly how it intends to tackle issues around cancellations and refunds.

What does this mean for you? Companies should be mindful of the need to continue to comply with competition and consumer laws throughout the crisis. If you receive an enquiry letter / information request from the CMA, or believe that a supplier is acting unfairly, our lawyers would be happy to assist you in responding and interacting with the authority on the issues identified. They would also be able to assist with advice on what can and cannot be done in the current circumstances.

2. CORPORATE GOVERNANCE (INCLUDING ACCOUNTS, DISCLOSURE AND REPORTING OBLIGATIONS)

Impact of COVID-19 on UK AGMs

Lexis Nexis has issued research looking at the impact of COVID-19 on AGMs in the UK. Data captured from 95 AGM notices issued by FTSE 350 and AIM 50 companies between 27 March 2020 and 15 April 2020 shows the following:

Changing the date of AGMs: The vast majority of the companies in the data set (92%) did not change the date of their AGM (although some of these may not have previously decided a specific date by the time the crisis accelerated).
Form of AGM: The majority of the companies in the data set (75%) opted to hold physical meetings, but restricted physical attendance to specific individuals only (usually senior officers or employees of the company to ensure the meeting was quorate). In terms of hybrid or virtual-only meetings, just 2% of the companies in the data set opted to hold meetings in this format. Virtual meetings raise potential legal issues.
Amending articles of association: A majority of companies in the data set (80%) have not announced amendments to their articles of association, with a few companies yet to announce their arrangements (9%) and a limited number of companies proposing amendments. So far, only FTSE 350 companies have proposed amendments to their articles, with the majority of those being FTSE 100 companies.
Adaptions to the procedure of meetings: All companies in the data set made changes to the way their AGM should be conducted (e.g. encouraging voting by proxy and adapting the way that shareholder questions are handled at the meeting).

Home Office guidance relating to modern slavery risks and reporting

The Home Office has issued guidance for businesses on how to address and report on modern slavery risks during the COVID-19 pandemic. It reminds businesses that during the pandemic it is essential that they continue to identify and address the risk of modern slavery in their operations and supply chains. The guidance also alerts businesses of the need to consider how fluctuations in demand and changes in their operating model may lead to new or increased risks of labour exploitation.

The guidance goes on to state that businesses may delay the publication of their modern slavery statement by up to 6 months if they are unable to publish their statement within the usual timeframe due to challenges presented by the pandemic. The reason for any such delay should be clearly identified in the modern slavery statement when issued.

The guidance also notes that work to address new or increased risks may take precedence over previously planned activities and may mean that businesses are not able to meet the goals set in earlier modern slavery statements, and that businesses should use their next statement to demonstrate how they monitored their risks during this period and adapted their activities and priorities in response.

The guidance notes that some workers may be more vulnerable to modern slavery during the pandemic and that issues to consider include the health and safety of workers (i.e. implementing Government policies throughout the supply chain, which may include adopting social distancing measures and paying statutory sick pay in order to prevent the spread of coronavirus), supporting suppliers (including paying for orders already in production where possible), grievance procedures (workers should still be able to access grievance procedures and new or adapted procedures should be made available where necessary), recruitment (ensuring that rigorous checks are maintained to ensure that vulnerable workers are not exploited) and emerging risks (businesses may need to undertake new risk assessments or reconsider the prioritisation of previously identified risks).

Guidance issued by the International Corporate Governance Network (ICGN)

The ICGN has issued a Statement of Shared Governance Responsibilities during the COVID-19 pandemic, which broadly speaking emphasises the need for members to:

prioritise employee safety and welfare while meeting short-term liquidity requirements to preserve financial health and solvency;
pursue a long-term view on social responsibility, fairness and sustainable value creation and publicly define a social purpose as we all adjust to a new reality;
take a holistic and equitable approach to capital allocation decisions, considering the workforce, stakeholders and providers of capital; and
communicate comprehensively with all stakeholders to instil confidence and trust in a company’s approach to build resilience into strategy and operations.

Further information can be found here.

FCA updates its Primary Markets Bulletin

The FCA has updated the Shareholder meetings and Corporate transactions and admission sections of its Primary Markets Bulletin No.27 to take account of its Statement of Policy of 8 April 2020 and accompanying Technical Supplements, in which the FCA announced a series of measures to assist London listed companies with raising new share capital during the COVID-19 crisis, whilst retaining an appropriate degree of investor protection. Please see our COVID-19 UK Bulletin – 16 April 2020 for a summary of the FCA Statement of Policy.

3. CYBERSECURITY AND DATA PROTECTION

Data protection

European Data Protection Board (EDPB) publishes guidelines on health data processing, location data and contact tracing in relation to COVID-19

On 22 April 2020, EDPB published two sets of guidelines. The first relates to the processing of health data for the purposes of COVID-19-related scientific research, the legal basis for such processing, adherence to data protection principles, data subject rights and international transfer of health data. The second covers requirements for the proportionate use of location data and contact tracing tools for the purposes of modelling the spread of COVID-19 and contact tracing. It emphasises a preference for anonymised data, but goes on to provide general legal analysis of the use of personal data in this context, as well as an analysis guide for app developers.

Organisations using health data, location data and/or contact tracing tools should have regard to these guidelines.

Information Commissioner’s Office’s (ICO) guidance on location data and contact tracing

Organisations using location data and/or contact tracing tools should also have regard to the ICO’s blog on compliance with data protection requirements under the GDPR. The ICO offers tools for organisations in the planning and development phase for projects adopting new technology and offers to performs audits of the measures and processes implemented once the project is operational.

Google and Apple’s contact-tracing initiative

Google and Apple have launched a joint initiative to use Bluetooth technology to help reduce the spread of COVID-19. The initiative is designed to help authorities create contact-tracing apps which exchange data between devices via Bluetooth and which individuals will be able to download via their app stores. Phase 1, in May 2020, involves Apple and Google releasing application programming interfaces to enable Android-iOS interoperability.

The ICO published an Opinion stating that Phase 1 aligns with data protection requirements, provided app developers take their own measures to comply therewith. It will continue to be involved in subsequent Phases.

Council of Europe’s analysis of ECHR rights

The Council of Europe published a toolkit for ECHR member states, which recognised that government measures may infringe on ECHR rights and freedoms. In particular, while it recognised the importance of personal data in containing the COVID-19 epidemic and accompanying exceptions to rights under data protection legislation, it emphasised that measures should be proportional and time-limited.

Cybersecurity

Video conferencing

The National Cyber Security Centre (NCSC) has published Video conferencing services: security guidance for organisations, in light of the increase in home working. The guidance encourages organisations to review their existing services before considering new services, and performing security risk assessments in either case. It includes guidance on configuring the service including access to remote meetings and conferences and helping staff access services securely. Links to existing guidance on various security considerations, beginning with Software as a Service security guidance for performing risk assessments, are included. The NCSC had already published guidance on preparing an organisation for home working.

4. DISPUTES

Operation of the courts and remote hearings

On 16 April 2020, the Senior Master of the Queen’s Bench Division issued the Court’s fifth coronavirus bulletin for court users, reviewing the impact of the pandemic on service of documents from foreign courts, requests for taking of evidence from foreign courts and registration of foreign judgments. It reports that service of judicial and extra-judicial documents that relate to proceedings outside of the UK is currently suspended, and that the processing of requests for service on parties out of the jurisdiction is likewise currently suspended, although parties are reminded that they can attempt service without the intervention of the Foreign Process Section provided that the manner of service complies with the Service Regulation, the Hague Service Convention or any other applicable bilateral treaty (in accordance with CPR 6.40).

Practice Direction 51Z: Stay of Possession Proceedings (first issued on 27 March 2020) was amended with effect from 18 April, in order to clarify that certain claims and applications are excluded from the 90-day stay.

Earlier in April, the Lord Chancellor approved a temporary Insolvency Practice Direction (IPD), with the stated purpose of providing workable solutions for court users during the current COVID-19 pandemic and avoiding, as far as possible, the need for parties to attend court in person. It supplements the July 2018 Practice Direction on Insolvency Proceedings and applies to all insolvency proceedings in the Business and Property Courts (BPC) (subject to variations outside London). Among other provisions, the temporary IPD directs that all applications, petitions and claim forms (with the exception of petitions for winding-up and bankruptcy before an ICC Judges sitting in the Rolls Building) currently listed for hearing before 21 April 2020 are adjourned, and are to be re-listed according to the order of priority set out therein. Where parties consider that the matter in question is urgent, they may apply to have it re-listed following the listing procedure set out in the temporary IPD. All insolvency hearings are to be conducted remotely unless ordered otherwise. The Chief London ICC Judge has issued a Guidance Note that sets out a list of hearings which will be deemed urgent in the BPC, being:

applications made pursuant to section 17 of the Company Directors’ Disqualification Act 1986;
applications made pursuant to section 216 (restriction on re-use of company names) of the Insolvency Act 1986;
public interest winding-up petitions;
applications to convene a meeting for members’ scheme of arrangement;
capital reduction claims; and
cross-border merger claims.

In a judgment dated 20 April 2020 (Muncipio De Mariana & Ors v BHP Group Plc [2020] EWHC 928 (TCC)), the Technology and Construction Court gave guidance on decisions regarding adjournment and remote hearings, identifying inter alia the following principles: that regard must be had to the importance of the continued administration of justice, as justice delayed is justice denied; that there should be rigorous examination of the possibility of a remote hearing before the court accepts that a just determination cannot be achieved in such a hearing; and that this question will inevitably be case-specific, with the need for live evidence and cross-examination being an important factor. Judge Eyre QC identified further principles relevant to the granting of time extensions, and granted the defendants an extension due to the impact of COVID-19 as he was satisfied that the defendants had shown it would take significantly longer to prepare their evidence via remote working. This justified a five to-six-week extension, despite the fact that this would mean vacating the scheduled hearing date.

On 23 March 2020 the Lord Chief Justice announced that all new jury trials would be postponed and they are yet to re-commence. On 24 April 2020, the Courts announced that a judicial working group has been established to consider ways to re-start some jury trials once it is safe to do so.

On 24 April 2020, the Judiciary of England and Wales issued guidance on the remote conduct of costs hearings for the period of the pandemic, specifically addressing detailed assessment hearings, oral review hearings of provisional assessments listed pursuant to a CPR 47.15(7) request, and application hearings in which the court is invited to certify an amount payable from a child or protected party’s damages pursuant to CPR 46.4(4).

Commercial disputes

The British Institute of International and Comparative Law (BIICL) has published a “Concept Note”, arising out of a meeting between senior judges and academics, on the effect of the pandemic on commercial contracts. The note warns of the risk of a deluge of litigation and arbitration as parties trigger default clauses and counterparties maintain that they are excused from performance, placing a strain on the system of international dispute resolution and increasing the prospect of uncertainty of outcome. It reflects on the challenge posed to the strict approach traditionally taken by the common law (widely used in international commerce) using doctrines such as force majeure, material adverse change, supervening illegality and frustration—given that there is no easy analogy for the present crisis in past case law—and on the fact that cases leaving one party a winner and the other a loser may not take full account of the market and social contextualisation of the crisis. In conclusion, the note calls for “breathing space” in the resolution of commercial contract disputes, citing procedural rules encouraging conciliation as well as various common law and civil law doctrines that may assist in producing fair outcomes between the parties while promoting the continuance of viable contracts.

Recently-issued guidance on arbitration hearings

The International Institute for Conflict Prevention and Resolution (CPR), a global non-profit organisation which aims to prevent and resolve legal conflict more effectively and efficiently (including through the convention of best practice and industry-oriented committees, training on dispute prevention, and resolution and publication of a monthly journal), has issued a new Annotated Modal Procedural Order for Remote Video Arbitration Proceedings, covering selection of videoconferencing platform, preparatory activities, requirements during the proceedings, documents and witness examinations, and enforceability.

5. EMPLOYMENT

No update to our COVID-19 UK Bulletin – 22 April 2020.

6. ENERGY

Oil price crash

Following a historic week for oil prices, where the West Texas Intermediate (WTI) futures contracts for May 2020 fell to almost negative US$40 a barrel, the Brent oil price continues to fluctuate between US$18 and US$21. As supply continues to outstrip demand, there are concerns that the OPEC+ deal (previously reported here and discussed along with the price crash more generally in our webinar of 27 April 2020) may not be sufficient to rebalance demand and supply in the short term. Although the OPEC+ deal kicks in from 1 May 2020, some countries such as Kuwait, Algeria, Nigeria and Saudi Arabia have already commenced production cuts. As global crude storage facilities near capacity, oil companies are looking for new storage facilities, including using fleets of parked trucks.

New Government measures

As reported in previous bulletins, UK Government bodies, including the Oil and Gas Authority (OGA) and Health and Safety Executive (HSE), have for the most part attempted to demonstrate flexibility in the face of the current crisis. The Government has now introduced new regulations (The Offshore Petroleum Production and Pipe-lines (Assessment of Environmental Effects) (Coronavirus) (Amendment) Regulations 2020), which came into force on 23 April 2020, to change requirements to make copies of certain documents available for collection in person. The measures disapply the requirement where there are restrictions on movement making this impractical, and provide an alternative of making documents available by post.

Impact of COVID-19 on workers and sites

A survey of oil industry executives by the consultancy Simon-Kucher reported that the focus of many companies is to cut capital expenditure by, on average, 35% due to the current crisis. It is therefore unsurprising that companies continue to scale back plans and production on-site, continuing a trend which was already visible before the current crises. In particular, recent news includes:

Maersk Drilling warns that it plans to cut 300 jobs, as business slows and demand collapses.
Shell has exited from a joint venture with Gazprom Neft to develop fields in Yamalo-Nenets, onshore Russian Federation.

However, not all projects are at a standstill, and some companies are expanding operations or, at least, continuing business as usual. There remains some activity in Australia and Africa in particular, and we expect to see activity pick up as some COVID-19 measures are loosened and companies that have capital to deploy in the current challenging market identify opportunities.

7. FINANCE

No update to our COVID-19 UK Bulletin – 22 April 2020.

8. FINANCIAL SERVICES REGULATORY

Financial services regulatory client alert

COVID-19: Further Developments on the UK Financial Conduct Authority’s Expectations of Solo-Regulated Firms.

9. FORCE MAJEURE

No update to our COVID-19 UK Bulletin – 22 April 2020.

10. GOVERNMENT SUPPORT SCHEMES

Bounce Back Loans Scheme

On 27 April 2020, the Government announced the launch of the Bounce Back Loans Scheme (the BBLS) for small and medium sized businesses (SMEs) from 4 May 2020. An SME will be able to borrow between £2,000 and £50,000 under the BBLS. The loans will be interest free for the first 12 months and the Government will guarantee the entirety of the loan. The Government will also be responsible for any lender-levied fees and no repayments of principal (or interest) will be due on the loans within the first 12 months. The loans will have maturity periods of up to six years and the Government has announced that it will work with lenders to keep interest rates as low as possible. The BBLS will be available to SMEs that are UK businesses that: (i) were not undertakings in financial difficulty as at 31 December 2019; and (ii) have been negatively impacted by the COVID-19 pandemic. Together with the 100% Government guarantee, this loosening of financial viability criteria is intended to allow more SMEs to access the BBLS, particularly those that were not eligible for loans under the Coronavirus Business Interruption Loans Scheme. Finally, any businesses that obtained loans under the Coronavirus Business Interruption Loans Scheme can apply to transfer their loans to the BBLS (thereby benefitting from the Government 100% guarantee) at any time until 4 November 2020 through their lenders.

New Government measures to further protect Tenants

The Government has announced that it will implement additional measures (over and above those previously announced imposing a moratorium on landlord evictions) to be included in the Corporate Insolvency and Governance Bill 2020. For more information, see the update in Real Estate below.

11. INSOLVENCY

No update to our COVID-19 UK Bulletin – 22 April 2020.

12. INTERNATIONAL TRADE AGREEMENTS (PRIVATE AND PUBLIC)

No update to our COVID-19 UK Bulletin – 22 April 2020.

13. LOCKDOWN AND PUBLIC LAW ISSUES

Virtual Parliament

Both Houses of Parliament returned from Easter recess on 21 April 2020 and both the House of Commons and the House of Lords passed measures to allow for virtual participation of its members in proceedings. Currently limited to statements and questions, the House of Commons approved a motion extending hybrid virtual proceedings to legislation, which would allow MPs to debate key legislative business such as the Finance Bill, and approved a further motion to introduce remote voting.

Restrictions Regulations Amendments

The Government introduced amendments to the existing lockdown regulations through The Health Protection (Coronavirus, Restrictions) (England) (Amendment) Regulations 2020. Coming into force on 22 April 2020, the regulations provide minor corrections and clarifications that, according to the Explanatory Memorandum “respond to concerns as to effective implementation raised by key stakeholders, such as Government departments, trade bodies, county councils, and the National Police Chief’s Counsel, following introduction of the measures.” For example, permitted reasons to be outside one’s home now include to access all types of money services businesses and to visit a cemetery to pay respects.

14. M&A AND PRIVATE EQUITY

No update to our COVID-19 UK Bulletin – 22 April 2020.

15. REAL ESTATE

New Government measures to further protect Tenants

In a major new blow to landlords/property owners, on 23 April 2020, the Government announced that it would implement additional measures (over and above those previously announced imposing a moratorium on landlord evictions) to be included in the Corporate Insolvency and Governance Bill 2020. The measures will protect tenants from winding-up proceedings and the making of winding-up orders if the debtor company is struggling to pay because of COVID-19, and will limit the issuance of statutory demands. They will also have the effect of temporarily voiding winding-up orders which are already in place and will last until 30 June 2020, subject to extension. There are also measures planned to limit use of commercial rent arrears recovery (CRAR). Details have not yet been released and the plans remain under discussion.

The new proposals have been badly received by landlords/property owners who have effectively had their “toolkit” of remedies for non-payment of rent removed until at least end June. Already reeling from historic low rent receipts for the March quarter, their problems will be further exacerbated on the June quarter and will make for difficult discussions with their lenders whose debt service is now severely compromised.

In a nod to landlords’ calls for assistance, the Government has encouraged tenants to pay if they are able to, and to enter into constructive conversation with their landlords. This has no legal teeth and provides little comfort to the industry.

Commercial outlook

Cass Business School has produced a report on Real Estate lending, predicting £8 to 10 billion in debt losses in the retail sector and £22 billion of development loans affected by problems regarding construction. They forecast that property prices and the overall transaction volume will decrease. The report also notes that lenders might, unlike in the Global Financial Crash, try to recover their losses by instituting higher capital costs, and that debt funds will suffer the effects too. However, the report does show that that loans originated in 2019 were 12% lower than in the previous year, which Cass has suggested follows from uncertainty regarding Brexit.

Travelodge (owned by Goldman Sachs, Avenue Capital and GoldenTree), which owns 150 UK hotels, was widely reported to have offered landlords a very low rent payment proposal for the March quarter, which was roundly rejected by landlords (the request involving reductions of up to 80% at its most exposed locations). Secure Income REIT, a major Travelodge landlord, announced that it would be seeking legal redress. It remains to be seen whether the new Government proposals (referenced above) will allow them any viable legal options in the short term.

Landlords have also commented that they have seen an increase in “section 27” notices which indicate tenants’ intention to terminate protected leases at expiry (rather than benefit from an automatic renewal on similar terms). Retailer Next has previously used this tactic and obtained significant rent reductions on its premises, leading to it opening up twice as much new space as it had expected on more beneficial terms.

Construction/Development

Persimmon has followed Taylor Wimpey and Vistry Group to announce that it will begin a phased re-opening of construction sites.

Building Regulations

The Government published guidance on Building Regulations on 21 April 2020, stating that they would not relax the Regulations but suggesting that building control bodies consider the exceptional circumstances. The guidance suggests that remote methods, although not to be used alone to check compliance normally, could be considered at this time.

16. UK TAX

Certificates of residence service

HMRC have provided an update on how requests for certificates of residence are being processed. In short, requests continue to be processed even where they are posted to HMRC. For details, see here.

Customs authorisations

HMRC have provided guidance on temporary changes to customs authorisations. For details, see here.

Employer compliance activity

HMRC has updated its internal Compliance and Operations Guidance manual to note the suspension of employer compliance activity until 30 April 2020. The guidance relates to the use of determinations under regulation 80 of the Income Tax (Pay As You Earn) Regulations 2003 (SI 2003/2682) in collecting tax due from employers under PAYE. For details, see here.

COVID-19 UK TASKFORCE LEADERS

Areas	Task Force Leaders
Competition and Consumers	Ali Nikpay – [email protected]
Corporate Governance	Selina Sagayam – [email protected]
Cybersecurity and Data Protection	James Cox – [email protected]
Disputes	Charlie Falconer – [email protected]
Employment	James Cox – [email protected]
Energy	Anna Howell – [email protected]
Finance	Greg Campbell – [email protected]
Financial Regulatory	Michelle Kirschner – [email protected]
Force Majeure	Patrick Doris – [email protected]
Government Support Schemes	Amar Madhani – [email protected]
Insolvency	Greg Campbell – [email protected]
International Trade Agreements	Patrick Doris – [email protected]
Lockdown and Public Law issues	Patrick Doris – [email protected]
M&A	Jeremy Kenley – [email protected]
Private Equity	James Howe – [email protected]
Real Estate	Alan Samson – [email protected]
UK Tax	Sandy Bhogal – [email protected]

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

GLOBAL OVERVIEW

European Perspective on Tracing Tools in the Context of COVID-19

As part of the fight against the spread of COVID-19 and desire to effectively lift the lockdown, governments and private companies around the world are considering the use of data driven digital tools, in particular digital tracing solutions. Such tracing technology may serve multiple purposes; among the main ones are: (i) collecting mobile location data in order to model the spread of the virus and measure the effectiveness of confinement measures; and (ii) contact tracing, in order to alert individuals that they have been in close proximity of someone who has tested positive for COVID-19.

Various initiatives to develop tracing solutions are currently being pursued, including both public and private initiatives, which praise the merits of tracing solutions that have been rolled out successfully in Asia-Pac. On April 21, 2020 the European Data Protection Board adopted its guidelines on the use of location data and contact tracing tools in the context of the COVID-19 outbreak. This Client Alert summarizes the key privacy implications of collecting personal data through tracing tools in Europe.
Read more

Institutions around the world continue to grapple with the intellectual property implications associated with their efforts to facilitate the prevention, diagnosis, and treatment of COVID-19. In a prior alert, we discussed recent initiatives promoting the donation of intellectual property rights in connection with businesses’ efforts to combat the pandemic, such as the Open COVID Pledge and the COVID-19 Technology Access Framework, as well as recent efforts to use trademark law to combat alleged price gouging for personal protective equipment (“PPE”). In this Alert, we provide a brief update on these and other initiatives.
Read more

Best Practices for Texas Lawyers Negotiating Over Email

With many companies and law firms implementing work-from-home policies to cope with and help contain COVID-19, the digital trend in the practice of law has only accelerated. Especially now, an increasing number of settlement and contract negotiations are occurring over email. Texas lawyers should be acutely aware of legal developments in our state applying the familiar themes of contract law—such as offer and acceptance—to this digital landscape. Originally published by Texas Lawyer on April 24, 2020.
Read more

Hong Kong partners Scott Jalowayski and Brian Schwarzwalder and associates Mary Kathryn Papaioannou and Rui Xie are the authors of “How Investors Can Manage Asia Data Center Acquisitions,” [PDF] published by Law360 on April 28, 2020.

New York partner Lee Dunst, Denver partner Jessica Brown and Los Angeles associate Daniel Weiss are the authors of “Preparing For A Surge In Virus-Related Whistleblower Claims,” [PDF] published by Law360 on April 23, 2020.

Institutions around the world continue to grapple with the intellectual property implications associated with their efforts to facilitate the prevention, diagnosis, and treatment of COVID-19. In a prior alert, we discussed recent initiatives promoting the donation of intellectual property rights in connection with businesses’ efforts to combat the pandemic, such as the Open COVID Pledge and the COVID-19 Technology Access Framework, as well as recent efforts to use trademark law to combat alleged price gouging for personal protective equipment (“PPE”). In this alert, we provide a brief update on these and other initiatives.

(1) Further Efforts to Facilitate the Donation of Patent Rights During the COVID-19 Pandemic

The Open COVID Pledge and the COVID-19 Technology Access Framework, which seek to facilitate the removal of intellectual property obstacles to the fight against the virus, are garnering further support. Signatories to the Open COVID-19 pledge grant a non-exclusive, royalty-free, worldwide license to use their patents and copyrights “for the sole purpose of ending” the COVID-19 pandemic. Companies such as Intel and Mozilla were among the first to subscribe. Since early last week, additional technology titans—Amazon, Facebook, HP, IBM, Microsoft, and Sandia National Laboratories—have also joined the pledge. The number of patents and patent applications within the scope of the license that signatories of the Open COVID Pledge grant the public is substantial. IBM, for example, in announcing its commitment to the Open COVID Pledge, asserted that it has over 80,000 existing patents and patent applications to which the pledge would apply, and that it would include new patent applications filed through 2023 as part of its pledge as well.

The COVID-19 Technology Access Framework (the “Framework”) encourages research institutions to implement technology transfer strategies to expedite the manufacture and distribution of products that help prevent, diagnose, and treat COVID-19 infections. Like the Open COVID Pledge, those who sign onto the Framework commit (among other things) to granting non-exclusive, royalty-free licenses to intellectual property rights for the purpose of promoting the development of products to fight the pandemic. In addition to the initial signatories (Stanford University, Harvard University, and Massachusetts Institute of Technology), and Yale University, which we previously noted joined on April 10, more institutions—including Georgetown University, Northeastern University, and RTI International, a non-profit research institute—have committed to the framework.

Finally, the World Intellectual Property Organization (“WIPO”) recently announced the launch of a new search functionality in its global patent database, “Patentscope,” which contains over 83 million patents and related documents. The new search functionality is directed towards returning documents that may be relevant to innovators focusing on developing new technologies to help prevent and treat the virus.

(2) Manufacturer 3M Obtains Temporary Restraining Order in its Effort to Stop Alleged Price Gouging

Last Friday, April 24, 2020, the manufacturing company 3M obtained a temporary restraining order in the Southern District of New York against Performance Supply, LLC enjoining it from, among other things, “using the ‘3M’ trademarks” in connection with “3M-brand N95 respirators” and other 3M goods; from “falsely representing that 3M has increased the price(s) of its 3M-brand N95 respirators”; and from otherwise “offering to sell any of 3M’s products at a price . . . that would constitute a violation of New York General Business Law § 369-[r],” that is, New York’s price gouging statute. In the lawsuit, 3M alleges that Defendant Performance Supply, LLC offered to sell New York City’s Office of Citywide Procurement millions of N95 respirators bearing the 3M logo and at inflated prices. 3M is asserting nine causes of action against Performance Supply, LLC for violations of federal and state trademark laws, as well as New York State laws addressing deceptive business practices and unfair competition. A telephonic preliminary injunction hearing has been scheduled for May 4. We are continuing to monitor for similar suits using trademark law to curb abusive practices relating to the manufacture, distribution, sale, or marketing of trademarked products used in responding to COVID-19.

Gibson Dunn lawyers regularly counsel clients on the issues raised by this pandemic, and we are working with many of our clients on their response to COVID-19. For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team. Please also feel free to contact the Gibson Dunn lawyer with whom you usually work, or the authors:

Joe Evall ([email protected]), Richard Mark ([email protected]), Doran Satanove ([email protected]), and Amanda First ([email protected])

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

Such tracing technology may serve multiple purposes; among the main ones are: (i) collecting mobile location data in order to model the spread of the virus and measure the effectiveness of confinement measures; and (ii) contact tracing, in order to alert individuals that they have been in close proximity of someone who has tested positive for COVID-19.

Various initiatives to develop tracing solutions are currently being pursued, including both public and private initiatives, which praise the merits of tracing solutions that have been rolled out successfully in Asia-Pac. The use of such tracing tools in the context of the pandemic requires the collection of personal data such as health data and potentially location data, which has prompted data protection authorities in Europe to alert on the need to comply with fundamental privacy rules set forth in the GDPR[1] and the ePrivacy Directive[2]. Debates have sparked in various European jurisdictions on how to conciliate the use of digital tracing solutions – which could be perceived as intrusive – and the need to guarantee individuals’ rights such as privacy and data security.

In order to help European countries navigate through these complex issues, on April 21, 2020 the European Data Protection Board (“EDPB”) adopted its guidelines on the use of location data and contact tracing tools in the context of the COVID-19 outbreak (“Guidelines”).[3]

This Client Alert summarizes the key privacy implications of collecting personal data through tracing tools in Europe.

1. Positions and Guidance of the EU Institutions regarding COVID-19 Tracing Applications

Since the beginning of the pandemic, the European Commission and its various institutions have been supportive of private and public initiatives for the creation of tracing applications capable of contributing to the containment of COVID-19. The European Commission has actually drafted an inventory of the initiatives carried out in Europe and worldwide to develop and offer digital tracing tools in response to the COVID-19 pandemic[4].

However, the use of data intensive technologies and applications, as well as the artificial intelligence underpinning such applications, have also raised concerns from a data privacy and cybersecurity perspective, which have led both the European Commission and the EDPB to adopt guidelines:

Taking the GDPR and the ePrivacy Directive as references, the European Commission and the EDPB have started to publish their opinions on the compliance of tracing applications with EU privacy and cybersecurity rules in mid-March and throughout April. The EDPB insisted first on the fact that the GDPR should not hinder the capacity of the EU Member States to fight the pandemic through the processing of mobile location data, provided that such data were anonymized and collected in an aggregated manner.[5] The European Commission published its guidance on applications[6] setting out the main requirements that applications shall meet to ensure compliance with data protection regulations (e.g., retention of control by users, applicable legal basis, data minimization principle). The European Commission further indicated in its guidance that app developers should aim to exploit the latest privacy-enhancing technological solutions, such as Bluetooth proximity technology, in order to provide contact tracing features without allowing applications to track individuals’ locations.
Based on the European Commission’s guidance, the EDPB finally adopted its Guidelines on April 21, 2020 on the use of location data and contact tracing tools in the context of the COVID-19 outbreak.[7]

The EDPB emphasized that preference should always be given to the processing of anonymized data rather than personal data of identified or identifiable persons. It also reminded that anonymization[8] processes have to comply with strict requirements and pass the “reasonableness test”, which considers the effectiveness of anonymization tools taking into account both objective aspects (e.g., technical means to re-identify individuals) and factual elements (e.g., nature and volume of data involved that would need to be process to re-identify individuals).

As to the use of tracing tools, the EDPB confirmed that the use of contact tracing applications should be voluntary. Accordingly, in order to ensure that individuals have a real choice, those who decide not to (or cannot) use such tracing applications should not suffer any negative consequence derived from that decision or situation. In the words of the EDPB, individuals must have full control over their personal data at all times, and should be able to choose freely to use any application.

The EDPB also recalled general data protection principles that should be complied with in this context, notably:

Accountability: The EDPB indicates that the controller of the contact tracing application should be clearly identified. In this respect, it considers that national health authorities could act as controllers for applications developed by public administrations, but other controllers may also be envisaged.

Purpose limitation: The Guidelines specify that the purposes aimed by tracing applications should exclude objectives or uses of data that are unrelated with the management of the COVID-19 crisis (for example, commercial purposes).

Data minimization and principles of privacy by design and by default: According to these GDPR principles, any personal data processed should be reduced to the strict minimum. Rather than collecting and sharing location data via the application, contact tracing applications should be based on proximity communication technologies that enable the broadcasting and receipt of data among users (e.g., proximity data based on Bluetooth Low Energy). The EDPB recommends that this data should be subject to regular pseudonymisation, and that measures should be implemented to prevent re-identification.

Lawfulness of processing: Different legal bases are considered by the EDPB depending on the data collected and the entity providing the application (e.g., consent, performance of a task for public interest). The choice of the most appropriate legal basis will largely depend on whether an application is developed and offered by private parties or by public administrations.

Storage limitation: The Guidelines recommend that personal data should be erased or anonymized immediately after the COVID-19 crisis.

Data security: The EDPB recommends to use pseudonymous identifiers and state-of-the-art cryptographic techniques to ensure data security.

Finally, the EDPB considers that a data protection impact assessment shall be carried out before implementing a tracing tool, as the data processes involved in the functioning of such an application are likely to result in a high risk to the rights and freedoms of individuals.

As an annex to these Guidelines, the EDPB provided practical guidance to app developers and users of contact tracing applications. For example, we note that the source code of the application and of its back-end should be open.

It is worth mentioning that the EDPB adopted two letters on April 24, 2020 in response to members of the European Parliament[9]. In its letters, the EDPB notably reminded that data protection law already enables to implement data processing necessary to fight an epidemic and that “there is no need to lift GDPR provisions but just to observe them”. The EDPB mainly referred to its recently adopted Guidelines and specified that it has taken into account concerns from the stakeholders involved as well as the general public when drafting such Guidelines.

2. Specific Positions of Member States regarding COVID-19 Tracing Applications

Certain EU Member States and other states from the European Economic Area have already implemented tracing tools in their respective territories (e.g., in Austria, Czech Republic, Iceland, Poland). While other EU Member States are currently still considering the development and roll-out of tracing applications, the conditions under which such applications would contribute to the fight against the COVID-19 have not been clearly established yet.

In this context, EU Member States’ Data Protection Authorities (“DPAs”) have also issued their own opinions in recent weeks, applicable to applications used in their respective territories. While these DPA opinions should follow and be based on the basic principles set at EU level, each DPA has taken a unique position on the various data privacy implications of tracing tools in its own EU Member State.

Belgium

In Belgium, the main initiative to develop a contact tracing application has come from the public administration. By mid-April, it was reported that the Belgian State was working on a public application that would enable the tracking of infected individuals and the issuing of warnings to other individuals who would have crossed infected persons within a period time. However, reporting to the press on April 23, 2020, the Belgian Minister of Digital Agenda indicated that Belgium no longer needed, for the time being, an application for automated contact tracing. Instead, the Minister expressed a preference for confinement rules and for manual tracing by health services. To support its position, the Minister also referred to the high utilization rate that a tracing application would require to ensure its effectiveness (60%), and the low download rates that had been recorded in other European countries where an application had already been launched (e.g., in Austria, where only 400,000 downloads had been registered in a country with a population of 8.9 million people – i.e., a 4.5% usage rate).

Notwithstanding the position adopted by the Belgian Government, on April 8, 2020 the Belgian Data Protection Authority (“Belgian DPA”) published a press release[10] emphasizing basic principles for the processing of personal data by contact tracing applications. First, the Belgian DPA recommends not processing any personal data if this is not required to offer the services to the users (e.g., name, e-mail address, mobile number). However, the provision of certain applications implies necessarily the processing of personal data in order to offer the service (e.g., IP addresses). In such situation, applications should only process personal data to ensure their appropriate functioning in light of the objective pursued. Any data inputted may continue to be processed by the app provider depending on whether the user intends the service to continue after it finishes using the application.

France

On April 24, 2020, the French DPA (“CNIL”) adopted a decision on the project of mobile application “StopCovid”[11] initiated by the French government, which is a contact tracing application based on Bluetooth technology (not using geolocation technology).

First, in accordance with the purpose limitation principle, the CNIL notes that the tracing tool may only be used to inform its users in the event of contact with an individual tested positive for COVID-19 but not for other purposes like monitoring the compliance of confinement measures. Besides, the CNIL welcomes the fact that the intended tool would be based on a voluntary approach. As recommended by the EDPB Guidelines, the CNIL reminds that individuals who decide not to download/use the “StopCovid” application should not suffer any negative consequences (such as a prohibition to take public transportation).

With respect to the lawfulness of the processing, again in line with the EDPB Guidelines, the CNIL estimates that the performance of a task of public interest would be the most appropriate legal basis when the processing is carried out by public authorities (Art. 6-1-e of the GDPR). For the specific processing of health data, the CNIL considers that the processing carried out in the context of the “StopCovid” application would be necessary for reasons of public interest in the area of public health (Art. 9-2-i of the GDPR). Having this in mind, the CNIL recommends that the use of a voluntary contact tracing application should be governed by a specific legal provision in French law.

In addition, the authority reminds the principles of data minimization and storage limitation according to which the data shall be kept only for the use of the application. Finally, the CNIL provided specifications on the application configuration. As to the accountability principle, the authority estimates that the controller should be the French Health Ministry or any other health authority involved in the health crisis management. It also reminds the necessity to carry out a data protection impact assessment, as recommended by the EDPB. The importance of data accuracy and data security as well as the respect of data subjects’ rights should also be taken into account.

The French Parliament will debate, in the upcoming weeks, on whether or not to implement this application. After the debate, if it is decided to deploy the application, the CNIL has requested to be consulted again in order to give its opinion on the final arrangements of the application “StopCovid”.

Germany

In Germany, one initiative emerged that initially garnered the strongest State support: the Pan-European Privacy-Preserving Proximity Tracing (“PEPP-PT”) initiative[12]. Composed of a consortium of over 130 members, including telecommunications operators, health service providers, scientists and other relevant actors and stakeholders, the PEPP-PT initiative was created on March 31, 2020 in order to develop and offer a tracing technology that would be compliant with EU privacy and data protection rules and would be effective in the contention efforts of States against COVID-19. However, the PEPP-PT initiative recently suffered strong criticism given its centralized structure, which requires users to upload contact logs to a central reporting server, thereby allegedly exposing users to direct State control.[13] The PEPP-PT protocol is allegedly supported by the UK, France[14] and, until recently, Germany.[15]

Another initiative, Decentralized Privacy-Preserving Proximity Tracing (“DP-3T”), has also garnered strong support in the EU. Backed by Switzerland, Austria and Estonia,[16] in cooperation with companies such as Apple and Google, DP-3T would reportedly abide more strictly by the guidance offered by EU authorities, in particular regarding the reliance on proximity data technology and the absence of tracking of location data. Its decentralized structure does not require users to upload contact logs (which remain in the users’ device), and the processing of data to inform users of contacts with infected individuals occurs locally. Further, under the decentralized DP-3T approach users may opt to voluntarily share their phone number and details of their symptoms with the authorities, but this would not automatically occur as opposed to the centralized structure of the PEPP-PT initiative.

Germany has been one of the main supporters of the PEPP-PT initiative until April 26, 2020, when it backed away from a centralized approach in favor of a decentralized system architecture.

The German data protection commissioner[17] indicated on his website that contact tracing tools should be implemented in a transparent manner and on a voluntary basis. According to the commissioner, an individual tracking or a later re-personalization should be excluded.

Spain

In Spain, regions like Madrid, Catalonia, Basque Country and Valencia, have offered publicly-sponsored applications to trace infected individuals. Based on the tracing application developed by the Madrid Region, the Spanish Government launched the nation-wide application, initially covering a limited number of regions. These applications aim at tracing users and their contacts in order to alert them of potential COVID-19 contagion and spread. However, the overlapping uses of the different applications and their limited success (not exceeding 10% of the population in the respective regions) have put their effectiveness into question. Recently, it was reported that Spain is participating in the PEPP-PT initiative, although it is unclear if this position will shift to the DP-3T initiative, backed by other Member States. As soon as the technology would become available, Spain would require the cooperation of both public administrations and private entities to launch the automated tracing application[18].

On March 26, 2020, the Spanish Data Protection Agency (“AEPD”) published a communication on self-evaluation and contact tracing applications to fight COVID-19[19]. While the AEPD acknowledged that the GDPR and Spanish data protection rules cannot serve as an obstacle to limit the effectiveness of any measure, it reminded that fundamental data protection and privacy rights still needed to be complied with. As regards the legal bases available to offer contact tracing applications, the AEPD indicates that data processing by national and regional health authorities may be carried out in the public interest and to protect the vital interests of the individuals. Applications developed and operated by private entities need to rely on another legal basis in order to process personal data (e.g., consent).

Any data collected may only be processed for purposes related to the control of the COVID-19 epidemic (e.g., to offer information on the use and control of the self-evaluation applications or to obtain statistics with aggregated geolocation data to offer maps that inform users on high/low risk areas). The AEPD also reminded app developers that parental authorization shall be required for users aged below 16.

United Kingdom

The United Kingdom DPA (“ICO”) published, on April 17, 2020, an opinion[20] on the Apple and Google joint initiative (called the Contact Tracing Framework) to enable the use of Bluetooth technology to help governments and public health authorities reduce the spread of the virus. The ICO indicates that the proposals for this initiative appear to be aligned with the principles of data protection by design and by default. It also specifies in its opinion that organizations designing contact tracing applications are responsible for ensuring that the application complies with data protection law and that such organizations are acting as controllers.

The ICO also published a series of questions[21] to be taken into account to ensure that privacy concerns are properly considered when using digital tracing tools.

Finally, it is worth noting that the ICO revealed[22] that it has been working with the National Health Service (“NHS”) in the context of the development of a contact tracing application in order to help them ensure a high level of transparency and governance. The NHS has emphasized its commitment to transparency, security and privacy and its collaboration with health data privacy stakeholders and advisers in developing the application[23]. However, the NHS’s proposed application is different from the Apple-Google model, in particular by using a structure centralized within the NHS, meaning that the matching process, which works out which phones to send alerts to, happens on a computer server rather than decentralized on handsets, to record infections and send out alerts. While it is hoped that this will make it easier for the NHS to notify people appropriately and adapt the system as knowledge improves, there may be a trade-off in terms of the central repository’s vulnerability to hackers.

***

As can be seen, the EU institutions, the EDPB and the EU Member State DPAs have published their guidelines and made clear the red lines that should be complied with in preparing and offering contact tracing tools. Regardless of whether they result from public or private initiatives, these rules and principles enshrined in the GDPR should drive the development and offering of contact tracing tools.

The effectiveness of contact tracing applications relies on its wide adoption by users in a territory, which largely depends on the strength of the State sponsorship received or the ability of companies to advertise its use.

From a technical standpoint, research projects and initiatives like PEPP-PT and DP-3T have emerged which aim at developing national applications based on a standardized approach. The infrastructure of the tools that are being developed under such protocols, centralized or decentralized, may come under scrutiny by the European Commission and the DPAs. However, given the importance of State sponsorship in the adoption of protocols for particular territories, and the apparent divergent approach followed by different EU Member States, it is likely that both protocols will co-exist within a non-harmonized EU approach.

We will continue to monitor privacy and cybersecurity developments related to COVID-19 in Europe and around the world, and will provide further communications as developments warrant. Gibson Dunn’s lawyers are also available to assist with any questions you may have regarding privacy implications of tracing tools in the United States.

____________________

[1] Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing Directive 95/46/EC.

[2] Directive 2002/58/EC of the European Parliament and of the Council of 12 July 2002 concerning the processing of personal data and the protection of privacy in the electronic communications sector.

[3] Guidelines 04/2020 on the use of location data and contact tracing tools in the context of the COVID-19 outbreak adopted on April 21, 2020.

[4] Commission’s Inventory Mobile Solutions against COVID-19.

[5] EDPB Statement on the processing of personal data in the context of the COVID-19 outbreak adopted on March 19, 2020.

[6] Commission Guidance of April 17, 2020 on Apps supporting the fight against COVID 19 pandemic in relation to data protection. Please note that considering the urgency of the current situation, these guidelines will not be subject to public consultation.

[7] Guidelines 04/2020 on the use of location data and contact tracing tools in the context of the COVID-19 outbreak adopted on April 21, 2020.

[8] The EDPB defined anonymization as “the use of a set of techniques in order to remove the ability to link the data with an identified or identifiable individual against any “reasonable” effort”.

[9] Letter of the EDPB to Sophie in’t Ved dated April 24, 2020; Letter of the EDPB to Mrs Ďuriš Nicholsonová and Mr Jurzyca’s dated April 24, 2020.

[10] Publication on the website of the Belgian DPA.

[11] Decision n° 2020-046 of April 24, 2020 adopting an opinion on the project of mobile application “Stop Covid”.

[12] Website of the PEPP-PT.

[13] Website of Ouest France.

[14] Reuters, Germany flips to Apple-Google approach on smartphone contact tracing, News Report dated April 26, 2020.

[15] Statement by Helge Braun, Minister of the Chancellery, and Jens Spahn, Federal Minister of Health, on the tracing app, Press Release dated April 26, 2020 (available in German).

[16] Supra note 13.

[17] Publication on the website of the Federal Commissioner for Data Protection and Freedom of Information dated April 22, 2020 (available in German).

[18] Publication on the website of El Pais dated April 14, 2020.

[19] Publication on the website of the Spanish Data Protection Agency dated March 26, 2020.

[20] ICO’s Opinion: Apple and Google joint initiative on COVID-19 contact tracing technology dated April 17, 2020.

[21] ICO’s Blog: Combatting COVID-19 through data: some considerations for privacy dated April 17, 2020.

[22] ICO’s Statement in response to details about an NHSX contact tracing app to help deal with the COVID-19 pandemic dated April 24, 2020.

[23] NHS Blog: NHSX: Digital contract tracing: protecting the NHS and saving lives dated April 24, 2020.

The following Gibson Dunn lawyers prepared this client update: Ahmed Baladi, Alexander Southwell, Patrick Doris, Michael Walther, Vera Lukic, Alejandro Guerrero, Clémence Pugnet, Selina Grün, Sarika Rabheru and Charlotte Fuscone. Gibson Dunn lawyers regularly counsel clients on the privacy and cybersecurity issues raised by this pandemic, and we are working with many of our clients on their response to COVID-19. Please also feel free to contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the Privacy, Cybersecurity and Consumer Protection Group:

United States
Alexander H. Southwell – Co-Chair, PCCP Practice, New York (+1 212-351-3981, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])
Matthew Benjamin – New York (+1 212-351-4079, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, [email protected])
Kristin A. Linsley – San Francisco (+1 415-393-8395, [email protected])
H. Mark Lyon – Palo Alto (+1 650-849-5307, [email protected])
Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Deborah L. Stein (+1 213-229-7164, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, [email protected])
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, [email protected])

Europe
Ahmed Baladi – Co-Chair, PCCP Practice, Paris (+33 (0)1 56 43 13 00, [email protected])
James A. Cox – London (+44 (0)20 7071 4250, [email protected])
Patrick Doris – London (+44 (0)20 7071 4276, [email protected])
Penny Madden – London (+44 (0)20 7071 4226, [email protected])
Michael Walther – Munich (+49 89 189 33-180, [email protected])
Kai Gesing – Munich (+49 89 189 33-180, [email protected])
Alejandro Guerrero – Brussels (+32 2 554 7218, [email protected])
Vera Lukic – Paris (+33 (0)1 56 43 13 00, [email protected])
Sarah Wazen – London (+44 (0)20 7071 4203, [email protected])

Asia
Kelly Austin – Hong Kong (+852 2214 3788, [email protected])
Jai S. Pathak – Singapore (+65 6507 3683, [email protected])

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

The Federal Financial Institutions Examination Council (“FFIEC”)[1] recently announced the publication of substantial revisions to the first section of its Bank Secrecy Act/Anti-Money Laundering Examination Manual (the “Manual”) regarding the BSA/AML examination process and the examination of a bank’s overall BSA/AML program. The revisions including the risk assessment and the required elements of the program (i.e., internal controls, BSA/AML compliance officer, independent testing, and training).[2] Other than the update in 2018 to reflect the changes resulting from the U.S. Department of the Treasury Financial Crime Enforcement Network’s (“FinCEN”) Customer Due Diligence Rule, the Manual had not been revised since 2014.[3]

With financial institutions and regulators focused on responding to the COVID-19 pandemic, these long-awaited revisions to the FFIEC Manual received scant attention. Although addressed to examiners, the Manual was and continues to be a window into how regulators understand BSA requirements and an expression of regulatory expectations.

The revisions to the Manual were the work of an interagency BSA/AML Working Group (the “Working Group”) composed of FinCEN and the federal depository institution regulators.[4] The Working Group is charged with promoting BSA/AML compliance efficiency and fostering better communication between federally regulated depositary institutions and their regulators. This group has issued several joint statements related to BSA/AML compliance on issues including the Customer Identification Program rules for premium finance lending,[5] the sharing of BSA/AML compliance resources,[6] the promotion of innovation in BSA/AML compliance,[7] the use of a risk-focused approach to BSA/AML compliance,[8] and the provision of services to hemp-related businesses.[9] Other joint statements from the Working Group are expected.

Initially, it was anticipated that the Working Group would put forward a revision of the entire Manual as early as 2018, but that did not occur. Last year, members of the Working Group indicated that the revisions to the Manual would be not be rolled out all at once, as with revisions to previous editions to the Manual. Instead, the revisions would begin with the first section—which was included in the recent revisions—and additional revised chapters would follow.

Importantly, Working Group members had indicated that they would try to ensure that the revised language would differentiate between what examiners should consider a regulatory or legal requirement as opposed to guidance. This approach can been seen in the newly revised chapters. For instance, the previous language on what independent testing should include has been revised to what testing may include in the newly issued guidance.[10]

Turning to the recent revisions, the overarching theme of these revisions is to reinforce and better describe the risk-based nature of BSA/AML compliance and the examination process. Consistent with its July 22, 2019 joint statement on using a risk-focused approach, “[m]any of the revisions [to the Manual] are designed to emphasize and enhance the Agencies’ risk-focused approach to BSA/AML supervision.”[11] Some of the key changes in the recent revisions include:

The core BSA/AML program elements must be examined in every examination cycle.[12]
Beyond the core elements and even in examining the core elements, the extent of an examination will depend on the risk profile and the quality of the risk management processes of the bank.[13] The scope of a BSA/AML examination “varies by bank and should be tailored primarily to the bank’s risk profile,” as well as the bank’s size, complexity, and organizational structure.[14]
Examiners may rely on the quality of the independent testing function as well as the risk assessment in scoping the examination.[15]
The prior version of the Manual stated that it is sound practice for banks to periodically reassess their BSA/AML risks at least every 12 to 18 months.[16] The Revised Manual, however, provides that there is no requirement to update a BSA/AML risk assessment “on a continuous or specified periodic basis.”[17]

The examples of specific products and services, customer and entity types, and geographic locations to consider in the risk assessment (pp. 18-22 of the 2014 Manual) have been eliminated. These may have been considered dated, incomplete, or too prescriptive.
There is a more expansive discussion given to examiners on the types of compliance testing to conduct on a risk basis.[18]
While always the practice, the Manual now explicitly states that the examiners should discuss the preliminary results of an examination with the bank before issuing a report.[19]
An OFAC review is not required during every examination cycle.[20]

The revisions are not intended to set forth any new requirements and none of the recent revisions should come as a surprise. Instead, the revisions reflect further clarification of BSA/AML requirements, regulatory expectations, and examination practices that have been communicated through the examination process and in public fora by the regulators for many years. The changes also reinforce that the examiners are encouraged to exercise discretion in the execution of the examinations based on the risk profile and compliance history of the institution.

__________________

[1] The member agencies of the FFIEC are the Federal Reserve Board (“FRB”), the Federal Deposit Insurance Corporation (“FDIC”), the Office of the Comptroller of the Currency (“OCC”), the National Credit Union Administration (“NCUA”), and the Consumer Financial Protection Bureau (“CFPB”).

[2] Federal Financial Institutions Examination Council, Interagency Statement on April 2020 Updates to the Bank Secrecy Act/Anti-Money Laundering Examination Manual (Apr. 15, 2020), https://www.ffiec.gov/press/PDF/Interagency%20Statement.pdf; Federal Financial Institutions Examination Council, Bank Secrecy Act/Anti-Money Laundering Examination Manual (Apr. 2020), https://www.ffiec.gov/press/PDF/FFIEC%20BSA-AML%20Exam%20Manual.pdf (the “Revised Manual”). While customer due diligence (“CDD”) is also a required element of a BSA/AML program, it is addressed in a later section of the Manual that was not revised at this time.

[3] See Federal Financial Institutions Examination Council, Customer Due Diligence — Overview (May 5, 2018), https://www.ffiec.gov/press/pdf/Customer%20Due%20Diligence%20-%20Overview%20and%20Exam%20Procedures-FINAL.pdf.

[4] Those regulators are the FRB, the FDIC, the NCUA, and the OCC.

[5] Working Group, Order (Sept. 27, 2018), https://www.fdic.gov/news/news/financial/2018/fil18052a.pdf.

[6] Working Group, Interagency Statement on Sharing Bank Secrecy Act Resources (Oct. 3, 2018), https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20181003a1.pdf.

[7] Working Group, Joint Statement on Innovative Efforts to Combat Money Laundering and Terrorist Financing (Dec. 3, 2018), https://www.occ.gov/news-issuances/news-releases/2018/nr-occ-2018-130a.pdf.

[8] Working Group, Joint Statement on Risk-Focused Bank Secrecy Act/Anti-Money Laundering Supervision (July 22, 2019), https://www.fdic.gov/news/news/press/2019/pr19065a.pdf.

[9] Working Group, Providing Financial Services to Customers Engaged in Hemp-Related Businesses (Dec. 3, 2019), https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20191203a1.pdf.

[10] Revised Manual at 24-26.

[11] Federal Financial Institutions Examination Council, Interagency Statement on April 2020 Updates to the Bank Secrecy Act/Anti-Money Laundering Examination Manual at 1 (Apr. 15, 2020), https://www.ffiec.gov/press/PDF/Interagency%20Statement.pdf

[12] Revised Manual at 10, 18.

[13] Id. at 1.

[14] Id.

[15] Id.

[16] Federal Financial Institutions Examination Council, Bank Secrecy Act/Anti-Money Laundering Examination Manual at 24 (2014), https://bsaaml.ffiec.gov/docs/manual/BSA_AML_Man_2014_v2_CDDBO.pdf.

[17] Revised Manual at 15.

[18] Id. at 24-28.

[19] Id. at 35.

[20] Id. at 2.

The following Gibson Dunn lawyers assisted in preparing this client alert: Matthew Biben, Stephanie Brooker, Joel Cohen, M. Kendall Day, Mylan Denerstein, Arthur Long, Joseph Warin, Linda Noonan, and Chris Jones.

Gibson Dunn has deep experience with issues relating to the defense of financial institutions. For assistance navigating white collar or regulatory enforcement issues involving financial institutions, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Financial Institutions Group, or the authors:

Matthew L. Biben – New York (+1 212-351-6300, [email protected])
Stephanie Brooker – Washington, D.C. (+1 202-887 3502, [email protected])
Joel M. Cohen – New York (+1 212-351-2664, [email protected])
Kendall Day– Washington, D.C. (+1 202-955-8220, [email protected])
Mylan L. Denerstein – New York (+1 212-351-3850, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Joseph Warin– Washington, D.C. (+1 202-8870-3609, [email protected])
Linda Noonan – Washington, D.C. (+1 202-887-3595, [email protected])
Chris Jones* – San Francisco (+1 415-393-8320, [email protected])

*Mr. Jones is admitted only in New York and Washington, D.C. He is practicing under the supervision of Principals of the Firm.

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

Decided April 27, 2020

Maine Community Health Options v. United States, Nos. 18-1023, 18-1028, 18-1038

Today, the Supreme Court held 8-1 that Congress failed to effectively repeal the government’s obligation to make more than $12 billion in payments to insurers under the Patient Protection And Affordable Care Act risk corridors program, and insurers may sue to recover the missed payments.

Background:
The Patient Protection And Affordable Care Act (“ACA”)—President Obama’s signature health care reform legislation—established “exchanges” on which previously uninsured individuals could purchase health insurance. To mitigate the risk to insurers and encourage them to participate in the new exchanges, the ACA created a three-year “risk corridors” program. Under the program, insurance companies that paid more in health care costs than they received in premiums would receive funds from the government to offset a fixed portion of their losses, while insurance companies that collected more in premiums than they paid in costs would pay back a fixed portion of their profit to the government.

After insurance companies had provided coverage and had set future premium rates, the Department of Health and Human Services announced that it would administer the program in a budget-neutral manner, using “payments in” from profitable insurers to make “payments out” to insurers who suffered losses. Congress later enacted language in an appropriations law limiting other sources of funding for payments out. Insurance companies who suffered losses on the exchanges sued the government in the Court of Federal Claims alleging that they were owed billions of dollars collectively in additional payments out. The Federal Circuit held that the insurers had received all payments due under the program because the appropriations law had “repealed or suspended” the government’s obligation to make additional payments.

Issue:
Did Congress limit the government’s obligation to make payments to insurers under the ACA’s risk corridors program by enacting an appropriations law restricting the sources of funds available to satisfy that obligation?

Court’s Holding:
No. Although Congress may enact legislation repealing its obligation to make future payments, Congress did not clearly repeal its obligation under the ACA to make risk corridor payments, and the health insurers properly brought suit for damages under the Tucker Act in the Court of Federal Claims.

“Th[e] holdings reflect a principle as old as the Nation itself: The Government should honor its obligations.”

Justice Sotomayor, writing for the Court

What It Means:

The ruling means that insurers can seek more than $12 billion in damages for missed payments under the risk corridors program, to be paid from the Judgment Fund—a standing appropriation by Congress of funds available to pay “final judgments, awards, compromise settlements, and interest and costs” awarded against the federal government. 31 U.S.C. § 1304(a)(1).
The decision recognizes that “Congress can create an obligation directly through statutory language” that is “neither contingent on nor limited by the availability of appropriations or other funds.” For the same reason, Congress’s decision to cut funding for an obligation does not necessarily repeal the obligation absent manifest evidence of intent to repeal.
The decision also clarifies the circumstances under which the government may be sued under the Tucker Act to enforce a statutory obligation. The Tucker Act waives the government’s immunity to monetary claims “founded . . . upon . . . any Act of Congress or . . . upon any express or implied contract with the United States,” 28 U.S.C. § 1491(a)(1), but does not create a cause of action. The Court endorsed longstanding Federal Circuit precedent holding that a statute’s use of the phrase “shall pay” “often reflects congressional intent ‘to create both a right and a remedy’ under the Tucker Act.”

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
[email protected]

Miguel A. Estrada
+1 202.955.8257
[email protected]

Thomas G. Hungar
+1 202.887.3784
[email protected]

Matthew D. McGill
+1 202.887.3680
[email protected]

Related Practice: Litigation

Richard J. Doren
+1 213.229.7038
[email protected]

Geoffrey Sigler
+1 202.887.3752
[email protected]

GLOBAL OVERVIEW

COVID-19: Fundraising Considerations for Private Investment Fund Sponsors

This briefing covers steps sponsors should consider taking when fundraising in the current environment. Investor interest in private investment funds is generally expected to remain subdued in the months ahead, based on recent industry surveys. These trends may become especially challenging for less established sponsors throughout 2020 and into 2021. Sponsors currently or soon to be fundraising should plan to be proactive in communicating with investors about the impact of the pandemic on their investments and operations.
Read more

COVID-19 Events: Key High-Level Considerations in Reviewing Project Agreements and Financing Documents

As you navigate through the implications of the pandemic on your business, the following is a high-level list of some of the key issues to consider with respect to one or more events or consequences caused by the COVID-19 pandemic (“COVID-19 Event”) in reviewing your project agreements and financing documents. These include the impact of a COVID-19 Event under project agreements and commercial contracts such as concession agreements, offtake agreements, construction contracts, supply contracts, O&M agreements, among other issues.
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Argued vs. Submitted Cases At 9th Circ. During Pandemic

The COVID-19 outbreak has placed significant pressure on courts and resulted in a surge of courts submitting cases on the briefs without oral argument. In response to COVID-19, the Ninth Circuit recently took the unusual step of canceling en banc oral arguments for the months of March, April and May. The court also announced that its panel hearings would be rescheduled, submitted on the briefs (without oral arguments), or argued remotely via teleconference or video. Since the Ninth Circuit’s March 2020 Notice, the percentage of cases submitted on the briefs without oral argument has increased from about 43% of the cases on the court’s calendar in January, February, and the first half of March 2020 to about 69% of cases in the second half of March and April. As illustrated below, this increase in the number of cases submitted on the briefs has affected all aspects of the court’s docket, but the effect on the court’s civil cases has been particularly notable. Originally published by Law360 on April 24, 2020.
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First, we hope you and your families are staying safe in the midst of this COVID-19 pandemic.

As you navigate through the implications of the pandemic on your business, below is a high level list of some of the key issues to consider with respect to one or more events or consequences caused by the COVID-19 pandemic (“COVID-19 Event”) in reviewing your project agreements and financing documents.

Impact of a COVID-19 Event under Project Agreements/Commercial Contracts (e.g., Concession Agreements, Offtake Agreements, Construction Contracts, Supply Contracts, O&M Agreements, etc.)
1. Relief Event/Compensation Event/Force Majeure Event – Determine whether the COVID-19 Event would qualify as a relief event, compensation event or force majeure event under the contract, what notices are required and the extent of relief available.Consider also if there are applicable “you snooze you lose” time frames that should be adhered to and if, in order to avoid missing any deadlines, a tolling agreement should be entered into. Discuss if there are strategic reasons to prefer entering into a tolling agreement versus filing relief event, compensation event and/or force majeure event notices with the counterparty (particularly with government entities/grantors). Finally, you should be familiar with, and proactively manage upfront, any contractual obligation to mitigate the impact of the COVID-19 Event in your (or your counterparty’s) business.

Here is a 4-step checklist and flow chart on force majeure relief under US law: https://www.gibsondunn.com/force-majeure-clauses-a-4-step-checklist-and-flowchart; and under English law: https://www.gibsondunn.com/english-law-force-majeure-clauses-a-4-step-checklist-flowchart. While the cases are primarily based on US and English law, respectively, a similar analysis would generally be undertaken under the governing law of the relevant contract.

We suggest reviewing whether and how relief events, compensation events and force majeure relief can be claimed both by your entities and your contract counterparties.

1. COVID-19 Event (whether or not it qualifies as a Relief Event, Compensation Event or Force Majeure Event) Implications on:
  1. Revenue – Analyse how the COVID-19 Event would impact your revenue stream under the contract and under any applicable business interruption or other insurance.
  2. Payment Obligation – Determine how the amount and timing of your payment obligations to counterparties would be affected by the COVID-19 Event.
  3. Schedule – Assess the impact of the COVID-19 Event on any milestone with a specific deadline or any other time-bound undertaking (e.g., completion date, commercial operations date, delivery date); review corresponding forecasts and expectations.
  4. Contract Enforceability – Assess the potential implications of the COVID-19 Event on enforceability and defences available under the applicable contract law principles (e.g., impossibility, frustration, impracticability).
  5. Ability to Perform Obligations – Analyse whether the relevant entity will continue to be able to meet its obligations. Considerations include having an appropriate business continuity plan (i.e., Does it take into account pandemics? Are there work-from-home arrangements, back-up plans if employees get sick, alternative sites for required back-office equipment? Are you experiencing supply chain disruptions that could impact construction or operation?).
  6. Non-Compliance Points / Liquidated Damages / Events of Default / Termination – Analyse whether the COVID-19 Event could potentially lead to a default and trigger a termination event under the contract or result in the assessment of non-compliance points or liquidated damages.
  7. Insurance – Determine whether insurance would cover any or all of your losses arising from the COVID-19 Event.
Financing Agreements
1. Representations & Warranties[1]
  1. “No Default” – Determine whether the COVID-19 Event would trigger actual or potential defaults by the borrower and/or the relevant contractcounterparties under the borrower’s material contracts. On occasion, this representation may also include defaults under the financing agreements.
  2. Insolvency/Bankruptcy/Inability to Pay Debts Generally When Due – Consider whether the COVID-19 Event would trigger a breach of this representation, which would also depend on the laws of the jurisdiction applicable to the subject entity/ies (including any recent pronouncements, relief measures, moratoria and the like by government entities in response to the pandemic).
  3. No Proceedings – Consider whether the relevant entity is or would be subject to litigation, disputes, claims, and the like, both actual or threatened, as a result of the COVID-19 Event, including any disputes relating to the availability of force majeure relief and labor-related disputes.
  4. MAC – Check whether the COVID-19 Event would lead to a “material adverse change” usually from the latest audited financials, or depending on the formulation, have/would/is reasonably likely to have a material adverse effect on the business, financials, operations, or prospects of the company or key contract counterparties. Note that this is a rapidly evolving area of the law in various jurisdictions and so it is prudent to check with counsel.
2. Covenants
  1. Information Covenants – Check what notice requirements will be triggered to the granting entity, lenders, trustees, bondholders and otherwise (e.g., force majeure claims, material litigation/disputes, potential or actual defaults under commercial contracts, potential delays in milestones, events that could have a material adverse effect, etc.). If the company has bonds that are publicly listed, are any reporting obligations triggered? Are voluntary disclosures recommended? In addition, certain deliverables such as financial statements (and any related audit review) may be delayed due the impact of the COVID-19 Event on both the company and the auditors.
  2. Financial Covenants and Ratio-based Distribution Tests – Review the calculation of the financial ratios both as maintenance covenants and dividend blocks (particularly for projected figures), and determine whether they are likely to be breached and how any such breach can be mitigated (e.g., equity cure, prepayments, tap into revolvers or additional facility). Note that previously contemplated dividend payments may now be delayed or prohibited.
  3. Other Covenants – Determine whether any of the other covenants would be triggered as result of the COVID-19 Event, including with respect to acts or omissions vis-à-vis counterparties under commercial contracts (e.g., enforcing rights and remedies under material contracts, not settling claims without lender consent), obligations to meet construction deadlines, meeting requirements, operating standards, etc.
  4. Reserve Accounts – To the extent that the relevant entity will experience liquidity issues, consider whether it will be able to meet any reserve account requirements. Determine also whether any failure to meet such reserve account requirements would result in a default and what mitigation measures are available.
  5. Distributions – In addition to determining the implications of the COVID 19 Event on the distribution test, consider if dividend policies should be revisited in terms of potential liquidity needs.
3. Drawstop Events

To the extent that the facility has not yet been fully drawn, a breach of representations and warranties or covenants (as described above), or the occurrence of an event of default or potential default (as described below), may prohibit subsequent draws. The implications of the COVID-19 Event on the borrower’s ability to make further borrowings and the consequences thereof on its business should be carefully reviewed.

1. Events of Default/Potential Default

The list of events of default should be reviewed to see whether any of them would be triggered by the COVID-19 Event, including by a prolonged occurrence thereof. Some examples include:

1. 1. Misrepresentation and Covenant-Related Defaults – Consider whether a breach of representations or failure to meet financial or other covenants as described above would result in a default.
  2. Failure to Meet Certain Milestones – If the borrower or a contract counterparty is required to achieve certain milestones by a date certain, e.g., commercial operations date or construction completion date, a delay resulting from a COVID-19 Event may trigger a default. Note that where such milestone in the financing agreement is not tied to the definition under the relevant commercial contract (e.g., concession agreement, construction contract, etc.), then the borrower would not be entitled to the same force majeure relief under the financing agreements as in the relevant commercial contract.
  3. MAC – In cases where the financing agreement includes a “Material Adverse Change/Effect” event of default (including through repeating representations), the formulation should be reviewed to see whether the COVID-19 Event would trigger such default.
  4. Audit Qualification – Determine whether the COVID-19 Event would lead to a qualification in the auditor’s report, and if so, whether such qualification would trigger a default.
  5. Payment-Related Defaults – Consider whether liquidity issues will result in difficulty meeting payment obligations, and whether waivers or extensions related to upcoming payments are required.

There may be other issues to consider given the specifics of your business and contractual arrangements. While this alert has been drafted to cover projects in a variety of jurisdictions globally and in all cases at a high level, we would be happy to help you on specific issues with respect to your projects in the respective geographies covered hereby. Should you have any questions please feel free to contact us.

[1] Under some loan agreements, representations and warranties are repeated periodically. If these representations and warranties have already been made and do not need to be repeated, it is likely that there would be a corresponding formulation in the Covenant or Event of Default section so the same analysis would apply.

Gibson Dunn regularly counsels clients on issues raised by this pandemic in the commercial context. For additional information, please contact the Gibson Dunn lawyer with whom you usually work or the authors:

Tomer Pinkusiewicz – New York (+1 212-351-2630, [email protected])

Patricia Tan Openshaw – Hong Kong (+852 2214-3868, [email protected])

Anita Girdhari – New York (+1 212-351-5362, [email protected])

Cristina Uy-Tioco – Hong Kong (+852 2214-3818, [email protected])

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

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