On March 17, 2020, Alex Azar, Secretary of the Department of Health and Human Services (HHS), issued a Declaration activating the Public Readiness and Emergency Preparedness Act (“PREP Act”), 42 U.S.C. § 247d-6d.  The Declaration extends immunity “from suit and liability under federal and state law with respect to all claims for loss caused by, arising out of, relating to, or resulting from” administration or use of qualifying products used to combat or reduce the spread of COVID-19 (the “PREP Declaration”).[1]  Along with other recent FDA guidance relaxing regulatory oversight for certain COVID-19-fighting products, the PREP Declaration protects manufacturers, suppliers, distributors, and others helping to mitigate supply shortages during the current crisis.  These protections are limited, however, and businesses should consider these limitations when evaluating whether the PREP Declaration protects their activities.  The applicability of the PREP Declaration to activities involving products created for use by the general public to minimize the spread of coronavirus, such as face masks and hand sanitizer, creates particularly challenging questions.

Who is covered by the PREP Declaration?

The PREP Declaration, issued under the PREP Act, grants immunity to manufacturers, suppliers, and distributors of, and healthcare providers authorized to use, qualifying products that treat COVID-19 or help prevent the spread of coronavirus.  The PREP Act defines “manufacturers” and “distributors” broadly to include suppliers and licensers, private label or own-label distributors, brokers, warehouses, wholesale drug traders, retail pharmacies, and carriers, among others.[2]  The PREP Declaration also extends immunity to “qualified persons,” such as licensed health care professionals or other individuals authorized to prescribe, administer, or dispense qualifying products.[3]

What activities and products come within PREP Act immunity?

The PREP Declaration makes immunity retroactive to February 4, 2020 and currently extends it to October 1, 2024.[4]  The PREP Act only creates immunity for activities involving a limited universe of authorized products.  Although the PREP Declaration extends immunity to activities directed to drugs, biologics, diagnostics, devices, and vaccines used to treat, diagnose, cure, prevent, or mitigate COVID-19, the product in question must meet two criteria in order for its manufacture, development, testing, distribution, use, or administration to be covered by the statutory immunity:

1) The product must be FDA approved, licensed for use under the Public Health Service Act, or cleared for use under a FDA emergency use authorization (“EUA”);[5] and

2) The party seeking immunity must be manufacturing, testing, developing, distributing, administering, or using the product pursuant to a federal contract or a federal, state, local or tribal virus response.[6]

These limitations require especially careful consideration by those involved in the production, distribution, or administration of protective products used by the general public, such as face masks and hand sanitizer.  Examination of these two groups of products illustrates some of the issues to be considered.

Example 1:  Face Masks for Use by the General Public.  Some face masks, including hospital grade surgical masks and certain N95 respirators, were FDA-approved before the PREP Declaration was issued.[7]  Other masks and respirators not intended for medical use, including respirators approved by the National Institute of Occupational Safety and Health (NIOSH) for use in manufacturing and similar workplaces, and certain imported respirators meeting NIOSH-like criteria in their home countries, were not previously FDA-approved.[8]  In further response “to this evolving public health emergency and continued filtering facepiece respirator . . . shortages,” FDA issued emergency use authorizations (EUA’s) in March and April 2020 allowing the medical use of both NIOSH-approved respirators and respirators approved under certain foreign standards, [9] and HHS brought them within the PREP Act’s definition of “Covered Countermeasures” by statute under the Families First Coronavirus Act.[10]  On April 3, FDA issued an EUA allowing medical use of imported disposable masks made in China, provided that the masks are approved by a Chinese regulatory authority and meet FDA-approved testing standards.[11]  In addition, FDA has authorized healthcare providers to reuse compatible, previously used N95 masks after decontaminating them pursuant to an approved system developed by the Battelle Memorial Institute.[12]

Activities directed to masks that are not approved by FDA or NIOSH (or otherwise authorized by FDA based on compliance with foreign agency standards), and that are not created pursuant to a federal contract or governmental response, such as fabric masks created for general use, are not likely to be afforded PREP Act immunity—potentially raising liability concerns for companies involved in the production, distribution, or administration of non-surgical cloth face masks, which the CDC has now recommended be worn by individuals when they go out in public.[13]

Another consideration that applies to face masks, in addition to whether the PREP Declaration provides immunity, is whether the manufacture and distribution of such masks could run afoul of FDA’s regulatory scheme for such products, potentially triggering an enforcement action.  On March 25, 2020, FDA issued guidance that it did not intend to initiate any enforcement action over non-surgical face masks that satisfy certain criteria, including that such masks: 1) have proper labeling that identifies the product as a face mask and includes a list of component materials, 2) have labeling that cautions against improper use, such as in surgical settings or other high-risk medical settings, or use in the presence of high heat or flammable gas; and 3) avoid labeling that misleadingly suggests that the mask will protect against viruses or allow for particulate filtration.[14]  FDA’s guidance also indicates that the agency will not enforce regulations governing surgical masks and face shields as long as they meet similar labeling and flammability criteria.[15]  Therefore, even if the manufacture or distribution of a nonmedical mask is not covered by PREP Act immunity, it is unlikely to be the target of a FDA enforcement action.

Example 2:  Hand Sanitizers.  Another product widely used by the public to block the spread of coronavirus, and also facing a critical supply shortage, is alcohol-based hand sanitizer.  As with other products used to fight COVID-19, any FDA-approved medical hand sanitizer or consumer hand sanitizer developed, supplied, or administered under a federal program or official virus response is likely to be covered by PREP Act immunity.

In contrast to respirators, however, FDA has not (as of this date) issued emergency use authorizations that would apply to hand sanitizers that were not previously FDA-approved.[16]  While unapproved hand sanitizers may not be subject to immunity under the PREP Declaration, FDA has encouraged increased production of hand sanitizer by compounding pharmacies and manufacturers, and has indicated that it will not enforce regulations against those entities provided certain qualifying conditions are present.  Specifically, the hand sanitizer must comprise only a list of approved ingredients, including 94% ethanol or isopropyl alcohol; be “de-natured” so that it is unsuitable for drinking; and be compounded according to a World Health Organization (WHO) formula.[17]

As these two examples illustrate, the availability of PREP Act protection for any manufacturer, supplier, distributor, or user of products designed to combat COVID-19 requires close analysis of the product; the relationship of the product and/or manufacturer to a federally contracted or governmental health program; and compliance with health and safety regulations that govern the product.  Notably, even in certain instances where there is no PREP Act protection, FDA has nevertheless indicated that it will not institute enforcement actions.

_____________________

[1] 85 Fed. Reg. 15198 (March 17, 2020).

[2] 85 Fed. Reg. 15198 § V (“Covered Persons”); 42 U.S.C. §247d-6d(i)(2).

[3] 85 Fed. Reg. 15198 § V (“Covered Persons”); 42 U.S.C. §247d-6d(i)(8).

[4] 85 Fed. Reg. 15198  § XII (“Effective Time Period”).

[5] 85 Fed. Reg. 15198 § VI (“Covered Countermeasures”) (“To be a Covered Countermeasure, qualified pandemic or epidemic products or security countermeasures also must be approved or cleared under the FD&C Act; licensed under the PHS Act, or authorized for emergency use under Sections 564, 564A, or 564B of the FD&C Act.”).

[6] 85 Fed. Reg. 15198 § VII (“Limitations on Distribution”).

[7] See 21 U.S.C.A. § 321(h); U.S. Food & Drug Administration, Enforcement Policy for Face Masks and Respirators During the Coronavirus Disease (COVID-19) Public Health Emergency (Revised) (April 2020), at 2-3.

[8] Letter from Denise M. Hinton, Chief Scientist, Food & Drug Administration, to Robert R. Redfield, MD, March 28, 2020 (“NIOSH EUA”); Letter from Denise M. Hinton to Stakeholders, March 28, 2020 (“non-NIOSH Imported Respirators EUA”).

[9] Id.

[10] Id.; see H.R. 6201 § 6005.

[11] Letter from Denise M. Hinton to Stakeholders, April 3, 2020 (“Chinese Masks EUA”).

[12] Letter from Denise M. Hinton to Jeff Rose, Battelle Memorial Institute, March 29, 2020 (“Battelle EUA”).

[13] Recommendation Regarding the Use of Cloth Face Coverings, Especially in Areas of Significant Community-Based Transmission, Centers for Disease Control and Prevention, https://www.cdc.gov/coronavirus/2019-ncov/prevent-getting-sick/cloth-face-cover.html (last visited April 5, 2020).

[14] U.S. Food & Drug Administration, Enforcement Policy for Face Masks and Respirators During the Coronavirus Disease (COVID-19) Public Health Emergency (Revised) (April 2020) at 4-5.

[15] Id. at 5-7.

[16] See Antiseptic FDA Letters, U.S. Food & Drug Administration, https://www.fda.gov/drugs/information-drug-class/antiseptic-fda-letters (last visited Apr. 3, 2020); see also 21 C.F.R. § 878.4040 (setting out approval criteria for topical hand sanitizer products).

[17] U.S. Food & Drug Administration, Temporary Policy for Preparation of Certain Alcohol-Based Hand Sanitizer Products During the Public Health Emergency (COVID-19): Guidance for Industry (updated March 27, 2020), at 3-5.

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For additional questions about  coronavirus-related product liability issues, please visit Gibson Dunn’s Coronavirus Mass Tort Litigation resource page or contact the Gibson Dunn lawyer with whom you usually work, or the authors:

Authors: Richard Mark, [email protected], Joe Evall, [email protected], and Amanda First, [email protected]

© 2020 Gibson, Dunn & Crutcher LLP

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

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In the current environment, many businesses have faced a precipitous drop in demand for their goods and services.  At the same time, economic and public health circumstances continue to change and legal frameworks continue to evolve in response.  In this rapidly changing environment, many employers are weighing employee furloughs as a means to conserve resources while remaining positioned for eventual recovery.  Employee furloughs can, however, implicate a variety of considerations and employment law obligations, many of which are changing in response to the current crisis and can vary by jurisdiction and employer specifics.  This Update highlights some of the common issues that employers must keep in mind when considering and implementing employee furloughs during the current health crisis.[1]

1. Is an Employee Furlough the Right Response for Your Business?

While the term “furlough” is not one that derives from any law or statute, it is generally recognized as a temporary cessation of employment, with the expectation that the employee will resume work for the employer at a later time.  A furloughed employee is usually, but not always, unpaid, although many employers will continue to provide benefits such as health and dental insurance to furloughed employees.

Given its temporary nature, the furlough has become a common response to the COVID-19 crisis, where many employers intend to restore employees to their full positions once the circumstances safely and legally permit.  Whether a furlough is right for a particular business in the face of this uncharted crisis, however, will depend on that business’s particular circumstances.

a. Employee Furlough Business Considerations

A starting point for assessing a potential furlough is a business’s likely near-term operational needs.  This will often turn on two factors:  (1) whether the business is legally and safely able to operate, and (2) whether there is demand for the business in light of the current crisis.   As to the first, whether the business can operate, except where employees can work from home, this factor will often turn on whether the business qualifies as “essential” or “critical” under the current patchwork quilt of state and local “stay at home” and shelter-in-place orders.  In general, many states have adopted in whole or in part the guidance regarding what businesses may qualify as critical infrastructure issued by the U.S. Department of Homeland Security’s Cybersecurity and Infrastructure Security Agency, although local orders vary and should be consulted.[2]  Notably, even where some of a company’s workforce may qualify as essential under the applicable orders, other employees may not.   Moreover, during the current health crisis, some employers have transitioned their activity to products and services that may more clearly qualify under controlling orders as essential.  And, under many (but not all) state and local orders, maintenance, information technology, or other activities necessary to preserve the operational viability of a non-essential business or to allow other employees to work from home during a shut-down may be considered essential.

As to the second factor, even where an employer can operate its business safely and legally under the applicable orders, demand may have fallen due to the physical limitations on the population, or even due to financial insecurity of consumers.  Thus, even businesses that qualify as “essential” under the applicable orders and can operate at this time may not find it profitable to do so due to lack of demand.  In such cases, employers may consider reducing cash expenditures through employee furloughs.

b. Potential Alternatives to Employee Furloughs

Of course, furloughs are not the only option for reducing the costs of payroll.  Employers should also carefully consider potential alternatives, including offsetting payroll costs with financial incentives available to businesses that continue to operate during this difficult time.  In particular, the federal CARES Act may offer financial incentives to such businesses, including tax credits, tax deferrals, and forgivable loans for small businesses that retain workers.  Several key provisions of the CARES Act warrant particular consideration.

First, the CARES Act authorized the Small Business Administration (“SBA”) to provide loan guarantees for up to $349 billion in loan commitments under the SBA’s 7(a) program, through a new “paycheck protection” program under which loans may be forgiven.  For further information on eligibility, loan terms, and loan forgiveness under the program, please see Gibson Dunn’s March 27, 2020 Client Alert, “SBA Paycheck Protection Loan Program under the CARES Act.”

Second, the CARES Act enacted the Coronavirus Economic Stabilization Act of 2020 (CESA), which authorizes up to $500 billion in loans, loan guarantees, and other investments by the Secretary of the U.S. Department of Treasury for businesses that do not qualify for other assistance under the CARES Act.  Approximately $46 billion in funds are allocated to passenger air carriers and certain allied businesses, cargo air carriers, and businesses critical to maintaining national security.  The remaining $454 billion may be used for loans, loan guarantees, and other investments for programs of facilities established by the Board of Governors of the Federal Reserve System for eligible businesses, States, and municipalities.  Also under CESA, the Secretary must implement a program to provide for direct, low interest loans to mid-sized businesses.  Additionally, $32 billion of financial assistance is available to air carriers and certain  related contractors under the CARES Act.  There are, however, certain restrictions under CESA and other provisions of the CARES Act to consider.  For example, a company that receives a federal loan or loan guarantee under CESA must maintain the company’s employment levels as of March 24, 2020 through September 2020 to the extent practicable, and if it must reduce such levels, it may not do so by more than 10%.  Similarly, mid-sized businesses who receive direct loans under the Secretary’s program must, among other requirements, retain 90% of their workforce at full compensation and benefits until September 30, 2020, restore 90% of their workforce as of February 1, 2020 (with full compensation and benefits) within four months following the end of the public health emergency, not outsource or offshore jobs, and remain neutral in any union organizing effort.  Additionally, air carriers and certain related contractors that receive financial assistance must refrain from conducting involuntary furloughs or reducing pay rates or benefits through September 30, 2020.

Third, the CARES Act provides for a number of temporary and permanent changes to the Internal Revenue Code of 1986.  These changes allow for certain tax relief including, but not limited to: modifications to the rules applicable to the use of business losses (including net operating losses); an increased limit of a taxpayer’s business interest expense deduction from 30% to 50%; the ability for certain employers to defer payment of the 6.2% employer share of Social Security payroll tax on wages paid from March 27, 2020 through December 31, 2020—with 50% of the deferred tax due December 31, 2021, and the remaining 50% due by December 31, 2022; a federal excise tax holiday applicable to aviation kerosene (including at refineries, terminals, and importation facilities) and alcohol and distilled spirits in the production of hand sanitizer; and SBA loan forgiveness income exclusion.  For further information on these changes, please see Gibson Dunn’s March 29, 2020 Client Alert, “Tax Relief in the CARES Act.”

Finally, states and cities have also announced economic aid packages for certain businesses and individuals.[3]

As a potential alternative to employee furloughs, both federal and state laws generally permit companies to make downward pay adjustments to employees, subject to certain wage and salary thresholds and certain state-specific notice requirements.  Where pay adjustments are made, non-exempt employees must continue to be paid hourly wages and overtime in compliance with applicable federal, state, and municipality minimum wage requirements, and wages must never drop below the applicable minimum wage.  Employees who are covered by the Fair Labor Standards Act (“FLSA”) and qualify as exempt from the FLSA’s minimum wage and overtime requirements must continue to be paid a salary of at least $35,568 per year, or $684 per week, or else be transitioned to hourly positions.  Businesses should confirm that salary adjustments also comply with any state-specific exemption requirements.  While some states rely on the FLSA requirements, or have lower requirements or none at all, others, including California and New York, have higher salary thresholds.  Employers must also take care to avoid impairing the exempt status of salaried employees by adjusting their weekly pay based on hours worked.  Generally, salaried employees are entitled to their agreed weekly salary in full for any weeks in which they perform compensable work for an employer, although there are certain provisions for pro rata adjustment of salary for long-term changes in schedule.[4]

Employers implementing pay reductions should also consider state-imposed notice requirements.  Some states, including California, Connecticut, Idaho, Illinois, Kansas, Kentucky, Michigan, New Jersey, Oregon, Tennessee, and Texas, require employers to provide advance notice to employees regarding pay adjustments, but do not specify a fixed statutory time period for issuing such notice.[5]  Other states like New York, North Carolina, and Missouri require advance notice ranging from 1 to 30 days.  Employers who fail to comply with these notice requirements may incur penalties.  Employers should also be cognizant of the form of notice provided; written notice is often required and may need to be posted at the workplace.  And employers are typically prohibited from imposing retroactive wage reductions for hours already worked.  As a result, employers should assume that any wage changes will only apply to hours worked after effective notice is provided.

Union employees, and those with individual employment agreements, may have additional rights.

2. Important Furlough Considerations

For those employers who choose to move forward with furloughs, there are several legal aspects of a furlough that employers should consider.

a. Is WARN Act Notice Required?

Employers considering furloughs in response to the current health crisis must assess whether advance notice to affected employees may be required.  Under the Federal Worker Adjustment and Retraining Notification (“WARN”) Act, employers who employ 100 or more full time workers must provide at least sixty days’ advance notice of a “plant closing” or “mass layoff.”[6]  A “mass layoff” occurs when a reduction in force “results in an employment loss at the single site of employment during any 30-day period for: (i) at least 33 percent of the active employees, excluding part-time employees, and (ii) at least 50 employees, excluding part-time employees.”[7]  “Where 500 or more employees (excluding part-time employees) are affected,” however, “the 33% requirement does not apply.”[8]  A covered “plant closing” means “the permanent or temporary shutdown of a ‘single site of employment’ or one or more ‘facilities or operating units’ within a single site of employment if the shutdown results in an ‘employment loss’ during any 30–day period at the single site of employment for 50 or more employees, excluding any part-time employees.”[9]  Both of these triggers turn on the number of employees who are expected to experience an “employment loss,” which is defined as “a layoff exceeding 6 months” or “a reduction in hours of work of individual employees of more than 50% during each month of any 6-month period.”[10]

This means that, under federal law, employers must provide advance notice if they employ at least 100 full time employees and are planning to furlough or reduce by at least 50% the hours of:

• More than 50 employees at a single site during any 30-day period;
• Comprising at least 33 percent of its active workforce (or 500 or more full-time employees) at the single site or compromising the complete shutdown of one or more facilities or operating units.

The Federal WARN Act includes an exception for layoffs or furloughs “caused by business circumstances that were not reasonably foreseeable as of the time that the notice would have been required.”[11]  Under these circumstances, which likely encompass many of the challenges employers are facing in the wake of the COVID-19 crisis, the employer is only required to provide “as much notice as is practicable.”[12]

Understandably, it may be difficult for employers to predict the duration of necessary layoffs or furloughs during this unprecedented crisis.  Thankfully, the law does not require employers to be omniscient.  Instead, it requires employers to issue notice only when it becomes “reasonably foreseeable” that one of the Federal WARN triggers will be met.[13]  Accordingly, “[a]n employer who has previously announced and carried out a short-term layoff (6 months or less) which is being extended beyond 6 months due to business circumstances (including unforeseeable changes in price or cost) not reasonably foreseeable at the time of the initial layoff is required to give notice when it becomes reasonably foreseeable that the extension is required.”[14]  In such circumstances, “[t]he employer must exercise such commercially reasonable business judgment as would a similarly situated employer in predicting the demands of its particular market.  The employer is not required, however, to accurately predict general economic conditions that also may affect demand for its products or services.”[15]

Where required, WARN notices must be provided to:

• The affected employees, defined as those who will suffer an employment loss;
• The dislocated worker unit (or Governor) in the State in which the furloughs will occur; and
• The chief elected official of the unit of local government in which the furloughs will occur.[16]

If the furloughed workers are represented by a union, notice must be provided to the chief elected officer of the affected employees’ bargaining agent or representative.[17]

Alongside the Federal WARN Act, many states have adopted so-called “Mini-WARN Acts” which reinforce and sometimes augment the federal scheme.  Importantly, some states require WARN notices to be sent in a broader set of circumstances than required under federal law.  As a result, it is important to consider state notice requirements as well.  To assist in this process, we have grouped the various state laws into three broad categories:  (1) states where the Mini-WARN Act imposes additional substantive obligations on employers beyond the Federal WARN Act; (2) states where the Mini-WARN Act expands coverage to smaller employers; and (3) states that currently either do not have a Mini-WARN Act or where the Mini-WARN Act currently does not impose significantly more stringent requirements than required under the Federal Act.

In particular, at least six states have enacted Mini-WARN Acts that impose greater obligations on employers than does the Federal WARN Act.[18]  Most notably, in California an employer has “a duty to provide statutory notice . . . even if the layoffs [a]re not permanent and [a]re for less than six months.”  Int’l Bhd. of Boilermakers v. NASSCO Holdings Inc., 17 Cal. App. 5th 1105, 1118 (2017).

Like the Federal WARN Act, several of those states have exceptions that may relax these notice requirements in the current crisis.  However, as under the Federal WARN Act, in most cases these exceptions continue to require an employer to provide as much notice as is feasible under the circumstances.  For example, New York’s Mini-WARN Act includes an exception for “business circumstances that were not reasonably foreseeable when the 90-day notice would have otherwise been required.”[19]  The regulations further explain that such circumstances include “an unanticipated and dramatic major economic downturn.”[20]  While New York has not issued a blanket declaration that the COVID-19 crisis qualifies for this exception,[21] other states, including Vermont, have made clear that the COVID-19 crisis qualifies for similar exceptions.[22]

Furthermore, states without these “business circumstances” exceptions are already taking steps to address the mass layoffs triggered by the COVID-19 crisis.  Most notably, Governor Gavin Newsom of California issued an Executive Order officially suspending the 60-day notice requirement under California’s Mini-WARN Act for mass layoffs “caused by COVID-19-related ‘business circumstances that were not reasonably foreseeable as of the time that notice would have been required.’”[23]  The Executive Order still requires California employers to provide “as much notice as is practicable,” as well as a “brief statement of the basis for reducing the notification period.”[24]

Beyond these states with substantively more demanding state Mini-WARN Acts, at least five states have adopted the Federal WARN Act’s framework but applied it to smaller employers or lower thresholds in their states.  For example, in Iowa, the Mini-WARN Act is similar to the Federal Act but applies to employers with more than 25 employees, essentially extending the Federal Act to employers with between 25 and 100 employees.[25]

Finally, at present, 39 states and the District of Columbia either do not have a Mini-WARN Act or have a Mini-WARN Act that does not impose significantly greater requirements on employers beyond those in the Federal Act.  In these states, employers should primarily follow the Federal WARN Act in assessing whether planned furloughs trigger WARN Act notice requirements.[26]  Even in these states, however, some statutes may require (or encourage) employers to provide supplemental information to the state in the employer’s WARN notice,[27] while others may require notice to the state following the initiation of layoffs.[28]  Employers should also remain aware that the current health crisis is spurring rapid change in this and related areas.[29]

b. Is Other Notice Required?

Employers implementing furloughs must also consider potential notice and other obligations under state unemployment insurance systems.  In particular, a number of states and the federal government have taken steps in response to the current health crisis to increase eligibility for unemployment benefits, including among employees who have been temporarily furloughed or who may continue to receive limited pay or benefits from their employers during a furlough.[30]

In conjunction with these increased opportunities for unemployment benefits, states have taken divergent approaches to enhanced employer obligations under state unemployment schemes in light of the crisis.  To date, approximately half of the states—including Illinois, New York, and Texas—have not addressed enhanced employer responsibilities as pertaining to furloughs or temporary layoffs in response to the current health crisis.  In contrast, some states—such as California, Kansas, and Michigan—have instituted notice requirements.  California, for example, requires employers who trigger the state’s WARN Act by furloughing employees due to COVID-19 to provide specific language in notices to those employees regarding eligibility for unemployment insurance.  In Kansas, employers must notify employees at the time of separation of the availability of unemployment benefits.  And in Michigan, employers are required to provide employees with a formal unemployment compensation notice and communicate to employees their eligibility for unemployment benefits.  Other states that have addressed employer responsibilities take different approaches to, for example, charging an employer’s account when an employee files for unemployment.  Some states have postponed employer tax increases until 2021, while others have indicated tax rates could rise sooner.

One area in which the states take a similar approach is in their recommendation that an employer considering furloughs or temporary layoffs work with state shared work (or similar) programs.  These programs generally provide an alternative to furloughs or layoffs by allowing an employer to reduce employees’ hours while allowing the employees to receive a limited unemployment benefit.  Many states have also recommended that employers implementing furloughs or temporary layoffs submit a “mass claim” on behalf of their employees to the state unemployment insurance division.

c. How Does a Furlough Impact Accrued Vacation, Paid Time Off (“PTO”) and Other Paid Leave Rights?

Employers considering furloughs should be aware that some states may view even temporary furloughs as a termination of employment, thereby triggering final pay obligations.  For example, the California Division of Labor Standards Enforcement (“DLSE”) issued two advisory letters in the 1990s, taking the position that a temporary lay-off will constitute a termination except where the lay-off does not exceed 10 days and there is a definite date given for return to work within the normal pay period.[31]  Because California law requires that all accrued vacation be paid at the time of “termination,”[32] these DLSE letters suggest that a temporary lay-off extending beyond the then-current pay period will trigger an obligation to pay final wages, including accrued vacation.  Such a rule could have significant implications for California businesses, as an employer’s willful failure to timely pay final wages can result in waiting time penalties under Labor Code Section 203, which are calculated as a day’s wage for every day final wages are not paid, up to 30 days.

Whether this DLSE guidance will apply in the time of COVID-19 is unknown.  The DLSE has provided no additional direction on whether final wages, including accrued vacation, must be paid out to employees furloughed in response to recent state and local orders.  Moreover, the two DLSE letters are not binding on courts, and are persuasive authority at best.[33]  Regardless, the DLSE’s guidance plainly did not contemplate a situation like the one employers face today, where employers are temporarily furloughing employees due to government-mandated closures and public health concerns, rather than solely business needs.  Notably, current furloughs share few of the markers of traditional temporary lay-offs, where the expectation is that the employees may seek and find other work during the lay-off (this may of course happen here—with employees obtaining other temporary or even permanent work—but this may be less likely).  By contrast, here, employers generally hope and expect to resume the employment relationship as soon as is legally and safely possible; many employers are providing assistance to employees such as partial pay or continued healthcare which would not typically accompany a temporary lay-off; and employees may want and expect to have their accrued vacation waiting for them when they return.  None of these circumstances indicate an intent to terminate the employer/employee relationship.  As a result, employers in California will want to carefully consider, in consultation with counsel, whether final wages including accrued vacation should be paid out to furloughed employees.

Employers outside California should similarly consider applicable state laws which may require the payment of final wages including accrued vacation when employees are furloughed.  For example, Colorado requires the pay-out of accrued vacation upon “interruption in the employer-employee relationship by volition of the employer.”[34]  A state- or locality-mandated shutdown would presumably not be “by the volition of the employer,” but employers should carefully consider this issue with counsel as well as whether the furlough of any employees who can work under the applicable orders (such as essential or work-from-home employees) prompted by reduced business demand for the employer’s goods or services would trigger final pay obligations.[35]

d. Other important employment considerations

Employee furloughs frequently raise a host of other issues employers must consider.  One frequent question is whether furloughed employees will continue to participate in employer-provided health benefit plans.  Typically, the ability to do so will turn on whether the plan’s terms and any underlying insurance policy (including any stop-loss policy associated with an otherwise employer funded plan) permit coverage of individuals who continue to be considered “employees” but who are performing no services and receiving no pay.  If workers will not continue to participate in employer health plans while on furloughed status, the furlough will likely trigger an employer’s obligation to provide timely notice of continuation coverage under COBRA.

Employers must also take care to avoid unintended wage and hour violations as a consequence of employee furloughs.  For example, because federal and state laws typically require an employer to compensate its employees for any work performed, employees should be clearly instructed not to perform any work for the benefit of the employer while on furlough, and the employer should be prepared to compensate employees for any job related activities by employees of which it becomes aware.  Employers who partially furlough their workforce should also be alert to unintended consequences the furloughs may have on those workers who remain on the job.  For example, in a small retail setting, staff reductions may result in formerly overtime-exempt managers supervising fewer workers or performing a larger share of operational (as opposed to managerial) tasks, either of which may impact their continuing status as overtime-exempt.[36]

Likewise in a partial furlough, the process by which employees are selected for furlough (or selected for recall if some but not all employees are called back) should be carefully considered to minimize potential claims of discrimination or retaliation.  Employers should ensure that the methodology for selecting employees for furlough can be clearly articulated and defended and is consistently followed.  Employers should also remain sensitive to potential adverse impact in the selection process on workers in legally protected groups, including employees who may have voiced concerns over workplace health and safety.  And employers should work to ensure that managers do not use the furlough selection process as an indirect means of addressing neglected employee performance or conduct issues (although performance, conduct, and skill set may, in appropriate cases, be relevant criteria for consideration).

Although temporary employee furloughs historically have not been coupled with employee releases of claims, during the current unsettled and rapidly changing environment employers may also want to consider whether, to the extent they are providing furloughed employees with voluntary compensation or benefits during the furlough period, to link such voluntary benefits to an employee release.  To the extent an employer does so—or should temporary furloughs evolve over time into permanent separations due to changed circumstances—an employer must keep in mind the requirements that may apply to such a release under the Federal Older Workers Benefit Protection Act and possible state laws as well as employee rights under any existing employer severance plans or agreements.

Apart from these and other employment law considerations, employers implementing a furlough should also consider how they will implement the change.  Where employees are not already required to remain home due to state or local “safer at home” or shelter-in-place orders, an employer should provide a safe, orderly, and humane plan to allow employees to gather necessary personal items and transition from work to furlough status.  As in all cases, such plans should give proper consideration to employee health and safety, including providing for appropriate hygiene and social distancing.

3. Post-Furlough Communications With Employees

Employers will be well-served to maintain open channels of communication with employees while on furlough.  At a minimum, an employer should have a clear and well-publicized point of contact for employee questions or issues that may arise during the furlough and maintain current contact information for furloughed employees.  Employers may also find it beneficial to provide employees with periodic updates on status and the business’s recovery planning.  Such updates may aid morale and help improve the employer’s opportunities to recall and quickly re-engage furloughed workers when the business is ready to resume operations.  Employers should remain sensitive, however, to the need to avoid employees engaging in uncompensated “work” while on furlough; accordingly, any updates should be brief and passive in nature, not requiring any action or follow-up on the part of employees.

Employers should also remain vigilant to changing circumstances that may impact the status of employees on furlough.  As noted earlier, if it appears that some or all furloughed employees may not be recalled due to evolving business conditions, the employer should immediately evaluate whether additional obligations, including potentially WARN Act notification, may be triggered.

Conclusion

Employers must weigh not only the legal implications of a potential furlough but also whether—in light of these and other considerations—a furlough is the best course under the circumstances to balance immediate staffing and financial needs against the longer term ability to retain a ready workforce and to be best positioned for a rapid recovery post-crisis.  The proper balance among those considerations will depend in part on the legal obligations and burdens triggered by a furlough under applicable federal and state law.  As events and governmental responses to them continue to rapidly evolve, employers should work closely with legal counsel in developing and implementing an appropriate plan for their particular circumstances and workforce.

_____________________

   [1]   These considerations assume a non-union workforce.  Where collective bargaining exists, additional considerations will come into play and must be included in any furlough planning.

   [2]   The Department of Homeland Security’s Cybersecurity and Infrastructure Security Agency’s revised guidance on “Essential Critical Infrastructure Workers” is available at https://www.cisa.gov/sites/default/files/publications/CISA_Guidance_on_the_Essential_Critical_Infrastructure_Workforce_Version_2.0_Updated.pdf, and our April 1, 2020 Client Alert “The Cybersecurity and Infrastructure Security Agency of the Department of Homeland Security Updates Essential Critical Infrastructure Workforce Guidance” is available here.

   [3]   E.g., Florida Small Business Emergency Bridge Loan Program; Maryland Small Business COVID-19 Emergency Grant Relief Fund; City of Los Angeles Small Business Emergency Microloan Program; New York City Small Business Continuity Loan Fund.

   [4]   According to the DOL, a prospective and “fixed reduction in salary effective during a period when a company operates a shortened workweek due to economic conditions would be a bona fide reduction not designed to circumvent the salary basis payment.  Therefore, the exemption would remain in effect as long as the employee receives the minimum salary required by the regulations and meets all the other requirements for the exemption.”  Wage and Hour Opinion Letter, FLSA2009-14 (January 15, 2009); Wage and Hour Opinion Letter, FLSA2009-18 (January 16, 2009).  By contrast, “deductions from salary due to day-to-day or week-to-week determinations of the operating requirements of the business are . . . preclude[d].”  Wage and Hour Opinion Letter, FLSA2009-14 (quoting § 541.602(a)(2)).

   [5]   In addition, some jurisdictions including the District of Columbia generally require employers to provide information regarding employee wage rates without specifying the timing of such notices.

   [6]   20 C.F.R. § 639.2.

   [7]   20 C.F.R. § 639.3(c)(1).

   [8]   20 C.F.R. § 639.3(c)(1)(ii).

   [9]   20 C.F.R. § 639.3(b).

[10]   20 C.F.R. § 639.3(f)(1).

[11]   29 U.S.C. § 2102 § 2102(b)(2)(A).

[12]   20 C.F.R. § 639.9(b).

[13]   20 C.F.R. § 639.4(b).

[14]   Id.

[15]   20 C.F.R. § 639.9(b)(2).

[16]   29 C.F.R. § 639.6.

[17]   Id.

[18]   Those states are:  California (requires notice of any “separation from a position for lack of funds or lack of work,” regardless of duration and expands WARN Act to cover employers with between 75 and 100 employees); Maine (requires 90 days’ notice); New Jersey (starting July 19, 2020, requires 90 days’ notice); New York (requires 90 days’ notice and expands WARN Act to cover employers with between 50 and 100 employees); Tennessee (requires notice when employer will “permanently or indefinitely” reduce the workforce by 50 or more employees for at least three months and expands coverage to employers with between 50 and 100 employees); and Vermont (requires notice of permanent employment loss for at least 50 employees during a 90-day period and expands coverage to employers with between 50 and 100 employees).

[19]   N.Y. Comp. Codes R. & Regs. tit. 12, § 921-6.3.

[20]   Id.

[21]   New York Department of Labor, Worker Adjustment and Retraining Notification, https://labor.ny.gov/workforcenypartners/warn/warnportal.shtm (“The WARN Act requirement to provide 90 days’ advanced notice has not been suspended because the WARN Act already recognizes that businesses cannot predict sudden and unexpected circumstances beyond an employer’s control, such as government-mandated closures, the loss of your workforce due to school closings, or other specific circumstances due to the coronavirus pandemic. If an unexpected event caused your business to close, please provide as much information as possible to the Department of Labor when you file your notice about the circumstances of your closure so we can determine if an exception to the WARN Act applies to your situation.”).

[22]   See Vermont Department of Labor, WARN Act and Notice of Potential Layoffs Act – COVID-19 Update, https://labor.vermont.gov/warn-act-and-notice-potential-layoffs-act (“[T]he Department of Labor does not intend to enforce the provisions of the Act against businesses who are forced to lay off employees due to the effects of the COVID-19 pandemic.”).

[23]   https://www.gov.ca.gov/wp-content/uploads/2020/03/3.17.20-EO-motor.pdf.

[24]   Id.  See also https://www.edd.ca.gov/About_EDD/coronavirus-2019/faqs/Warn.htm.

[25]   These states include:  Delaware (expands the definition of how part-time employees are counted for meeting the 100-employee threshold); Illinois (covers employers with 75 or more employees); Iowa (covers employers with 25 or more employees); New Hampshire expands definition of how part-time employees are counted for meeting the 100-employee threshold); and Wisconsin (covers employers with 50 or more employees).

[26]   At the time of writing, these states include:  Alabama, Alaska, Arizona, Arkansas, Colorado, Connecticut, Florida, Georgia, Hawaii, Idaho, Indiana, Kansas, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Texas, Utah, Virginia, Washington, Washington, D.C., West Virginia, and Wyoming.

[27]   For example, Michigan and Minnesota.

[28]   For example, Georgia, Maryland, and North Dakota.

[29]   State WARN Act requirements, as well as other valuable state-level developments, are tracked and regularly updated in our separate 50-State Survey of COVID-19 Responses.  To subscribe to that update, contact any member of the Gibson Dunn COVID-19 Response Team identified at the end of this Update.

[30]   Expanded opportunities for unemployment benefits under the federal CARES Act are summarized in our March 26, 2020 Client Alert, “Senate Advances the CARES Act, the Largest Stimulus Package in History, to Stabilize the Economic Sector During the Coronavirus Pandemic.”

[31]   DLSE Op. Ltr. (May 4, 1993); DLSE Op. Ltr. (May 30, 1996).

[32]   Cal. Lab. Code, § 201.

[33]   See Brinker Restaurant Corp. v. Sup. Ct. (2012) 53 Cal.4th 1004, 1029 (noting that DLSE opinion letters are not controlling upon the courts); see also Alvarado v. Dart Container Corp. of California (2018) 4 Cal.5th 542; Tidewater Marine Western, Inc. v. Bradshaw (1996) 14 Cal.4th 557.

[34]   Co. Rev. Stat. § 8–4-109.

[35]   Similarly, other states such as Illinois, Louisiana, Massachussetts, Montana, and Nebraska require payout of accrued vacation upon termination.  See, e.g., Mass. Gen. Laws ch. 149, § 148; Mont. Att’y Gen. Op. 56, vol. 23; Nebraska Stat. 48-1229(4), 48-1230(4)(a).  While none of these states offer specific guidance on whether a furlough or temporary lay-off would require payout of accrued vacation, employers should consider whether their particular employment decisions trigger such obligations.

[36]   Federal and state wage laws may provide some allowance for the performance of non-exempt work by managers during an emergency.  See 29 C.F.R. § 541.706.  The extent to which this would apply will of course depend on the facts of your situation.

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 outbreak. For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team.

Gibson Dunn attorneys regularly counsel clients on the array of employment 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 attorney with whom you work in the Labor and Employment Group, or the following authors:

Catherine A. Conway – Co-Chair, Labor & Employment Practice Group, Los Angeles

Jesse Cripps – Los Angeles

Gabrielle Levin – New York

Amanda C. Machin – Washington, D.C.

Jesenka Mrdjenovic – Washington, D.C.

Karl G. Nelson – Dallas

Katherine Smith – Los Angeles

Jason C. Schwartz – Co-Chair, Labor & Employment Practice Group, Washington, D.C.

© 2020 Gibson, Dunn & Crutcher LLP

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

NOTE: This Client Alert, which focuses on Delaware law, does not purport to provide an exhaustive guide to the issues directors should consider in times of financial stress.

The rapid spread of COVID-19, increasingly stringent government orders in response, and the profound effects on the global economy have raised concerns among corporate directors about how to adequately discharge their fiduciary duties.

First and foremost, directors can rest assured that the flexibility and protections afforded to them by the business judgment rule remain as vital today as they did before the COVID-19 pandemic. The COVID-19 pandemic does not alter the business judgment deference afforded to decisions made by a well-informed and non-conflicted board that acts in good faith towards what is best for the corporation and its stockholders.

However, directors do need to recognize that as a result of the COVID-19 pandemic, economic, regulatory, and public health related events are unfolding faster than ever.  Directors must make decisions on tight timetables and with limited resources.  This note is a tool for directors to help them identify some of the issues they should consider to ensure that their decisions are protected by the business judgment rule as they guide their companies during these challenging times.

Ensure Information and Reporting Systems Are Adequate.  Directors generally must attempt to assure a reasonable information and reporting system exists as part of their oversight obligations.  This is an area that had already become the focus of boards and their advisors over the last 18 months, as recent Delaware cases have criticized boards for failing to properly discharge their oversight obligations.[1]

Most companies already have in place systems for typically encountered business issues, including regularly scheduled management updates.  Those systems should be adapted as needed to respond to the current pandemic and its impact on your business.  At a minimum, evaluate whether your system involves:

• Regular Management Updates. To satisfy their duties, directors are expected to require management to deliver updates about the business to the board on a consistent basis—and to document those requirements where possible.  Management is likely gathering information related to COVID-19 and tracking the effects of the pandemic on the organization.  Directors should ensure they receive updates with the benefit of that information.
• Board Review and Adoption of Relevant Policies. Directors are often expected to play a role in reviewing policies that a company develops in response to applicable regulations and should oversee policies, among other things, relating to the regulatory response to COVID-19, when appropriate.
• Written Materials. It is not always possible to prepare written materials ahead of a board meeting; however, it is a good practice to provide written materials whenever practicable.  While the addition of written materials to update the directors places an additional burden on management, should a board decision later be subjected to judicial review, courts may consider whether directors reviewed written materials in making significant corporate decisions.  Note that written materials that reflect legal advice should be marked “privileged and confidential.”

Maintain Complete and Accurate Board Minutes.  Contemporaneously recorded board minutes are generally entitled to a presumption that they accurately reflect the substance of the board’s discussions. Whenever practicable, clients should continue to record board minutes contemporaneously with any meeting to ensure that if needed, the board has a written record of its actions.  And boards should evaluate how much detail is required under the circumstances:  for example, merely referring to a discussion of COVID-19 as an “operational update” is unlikely to provide a sufficient basis to determine whether the directors adequately discharged their fiduciary duties, unless the record reflects that additional written materials were provided to directors that reflect in a more fulsome manner the relevant “operational update.”  

Be Aware of Privilege Issues.  Directors should be especially vigilant about protecting privilege given the range of third-party non-legal advisors that may be assisting  clients in responding to the COVID-19 pandemic.  While board communications with in-house and outside counsel are generally privileged, the mere presence of an attorney at a board meeting will not cloak a communication in privilege because privilege only attaches to legal advice, including requests for legal advice, and attorney-client communications.  Additionally, the presence of third parties at board meetings where legal advice is being provided likely will constitute a waiver of privilege if the third parties (including observers and financial advisors) are not necessary for legal advice discussed.  Therefore, directors should evaluate regularly whether third parties should be excused from any portion of a meeting.  Directors should also exercise caution when forwarding or disseminating company materials to third parties, because doing so could constitute a waiver of privilege.  In addition, communications among the directors that do not involve communications with lawyers are likely not privileged.

Regularly Evaluate Solvency.  Businesses that were previously on strong financial ground are now facing financial challenges of a size and speed that was not contemplated prior to the COVID-19 pandemic.  Businesses already facing financial stress will likely face even greater financial stress, potentially pushing them closer to insolvency at a faster rate.  Directors should evaluate how often they need to receive reports on the financial condition of their business.

• Fiduciary Duties Expand to Cover Creditors. The board of directors owes fiduciary duties to the corporation.  Generally, when a corporation is solvent, the beneficiaries of those fiduciary duties are the stockholders; creditors do not benefit from fiduciary duties and instead are instead afforded protection through contracts and other sources of creditor rights.  But when a corporation becomes insolvent, under Delaware law, creditors become the primary beneficiaries of those fiduciary duties, and this shift will require that boards take into account the interests of creditors as well as stockholders when making strategic decisions.  Even when fiduciary remedies extend to creditors, they are still be subject to the default business judgment rule if the underlying actions were taken by non-conflicted directors.  Note that under Delaware law, LLC operating agreements can include broad waivers of fiduciary duties, so boards of those entities may want to confirm whether applicable waivers are in such operating agreements.
• Insolvency May Prohibit Scheduled Actions. Certain board decisions made before the COVID-19 pandemic may require re-evaluation to account for the company’s post-COVID-19 financial status.  For example, the board may have approved an extraordinary capital expenditure prior before to the COVID-19 pandemic (g., opening a new factory), which it is prudent to revisit given the current climate.  Or the board may have declared a dividend prior to the pandemic, but before paying a dividend, certain state statutes require that the corporation have sufficient assets such that the payment would not leave the corporation insolvent.  Should the board determine the company is sufficiently stressed that it cannot issue a dividend, that may create legal peril if the dividend was previously declared.  The prior declaration of a dividend may have created an irrevocable debtor-creditor relationship between the corporation and its stockholders, and the only lawful option might be to postpone the record date (if it has not yet passed) and payment date until a future date when adequate funds become lawfully available for distribution to stockholders.  This is just one of the many previously approved board actions that boards may need to reassess after being fully informed about the company’s financial condition. 

Check Your D&O Insurance.  Evaluate whether you have sufficient coverage.  Confirm whether your insurance policy has, or whether you need, Side A coverage (direct coverage for directors and officers who the company is unable or unwilling to indemnify) or Side B coverage (reimbursement to the company for indemnity payments made on behalf of directors and officers).  Evaluate whether your policy has exclusions that would vitiate coverage in the event the company files for bankruptcy.

Key Employee Retention Plan.  Evaluate whether steps should be taken to retain key management.  Particularly in cases where the company is in distress, typical equity grants may be insufficient as a retention tool.  Further, key employees may consider a future promise of retention payments to be too speculative or risky in light of the company’s financial stress.  One strategy that may mitigate the risk is to make an upfront cash retention payment to key employees, with a written agreement that the employee will keep the payment if by a designated milestone the employee has not been fired for cause or did not resign without cause.

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   [1]   See Gibson, Dunn & Crutcher LLP, Delaware Supreme Court Revisits Oversight Liability (July 29, 2019), https://www.gibsondunn.com/delaware-supreme-court-revisits-oversight-liability/.

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

Authors: Shireen Barday, Mary Beth Maloney, Dennis Friedman, Eduardo Gallardo, Robert Klyman, Jonathan Fortney and Patrick Hayden

The COVID-19 pandemic has caused unprecedented global economic turmoil and disruption.  There are daily reports of massive employee layoffs across all segments of the economy, and millions of people are suddenly out of work.  Federal and state governments have stepped in with numerous new, patchwork and ill-defined programs, rules and regulations to address the unemployment crisis and related effects.  This is all reminiscent of the days after 9/11 and the 2008 Great Recession.  And if what’s past is prologue, companies should expect that current and former employees will unleash an onslaught of allegations about company misconduct, both COVID-19-related and otherwise.  Indeed, government regulators and the plaintiffs’ bar are already publicizing various reporting mechanisms for disgruntled employees seeking to raise such claims.

In this context, increased whistleblower complaints are inevitable.  While most companies already have policies and processes in place to address those complaints, it is no longer business as usual.  Existing programs likely do not account for a displaced and remote workforce, rapid and substantial employee layoffs and furloughs, ongoing work in an environment where health and safety are at the forefront, or any of the countless other disruptions that COVID-19 has caused to a company’s operations.  Yet with so many immediate and pressing issues to address during these challenging and unprecedented times, it is understandable that evaluating and updating a company’s whistleblower action plan may not be seen as a mission-critical task.  Inaction, however, could have detrimental effects that last long after the pandemic has been contained and the economy has begun to recover.

As before COVID-19, and even more so now, it is important that companies have a robust action plan for addressing employee complaints, as well as related governmental investigations and civil litigation.  There are tried and true methods for addressing whistleblower complaints.  For companies that have not yet implemented them, now is the time to do so.

But even for companies that have established a whistleblower action plan, COVID-19 may cause material changes at the company that render the plan ineffective or incomplete.  For instance, a company’s anonymous complaint hotline may no longer be operational because the third-party vendor has shuttered, or a company’s investigative process may not apply because positions referenced in the policy have been eliminated.  And the fact that compliance professionals likely are working remotely could result in delays or failures in addressing employee complaints while more pressing business issues are addressed.  Notwithstanding that the written policies and established practices do not reflect a company’s current working environment (especially in these unprecedented times), a company could still be criticized by a whistleblower, government regulator or plaintiffs’ attorney for not following its written policies or established processes to a tee.  They will no doubt argue that the COVID-19 pandemic does not justify departures from the standard protocol for handling employee complaints.  So it is important that a company’s current whistleblower action plan accurately reflect the company’s current operations.

What’s Past Is Prologue:  COVID-19-Related Unemployment Inevitably Will Spawn Whistleblower Claims

It may take years to know the full economic and societal impact of COVID-19, but it is already clear that in the near-term the pandemic will result in unimaginable layoffs and reductions in force.  During the two weeks ending April 2, 2020, some 10 million American workers filed unemployment claims, smashing previous records.[1]  And it appears we are just at the beginning, with experts estimating unemployment rates may reach as high as 20%, far exceeding unemployment at the height of the Great Recession.[2]  And unlike past economic downturns, which impacted certain industries more than others, this pandemic affects every segment of the U.S. economy.[3]

With such rapid and unprecedented economic dislocation across the global economy, it is reasonable to assume that there will be a commensurate increase in whistleblower claims.  In part, these claims may stem from actions taken by workers under economic stress or other pressures that could give rise to reportable conduct, or because the usually effective precautions and controls fail during this challenging time.  They might also stem from newly passed laws or policies promulgated to address COVID-19-related misconduct, as happened during the Great Recession with respect to the finance industry.  And they might result from the fact that workers, confronted with the prospect of being let go and resulting economic instability, will have greater incentive than ever to report any suspicious activity, or to claim that they had done so after the fact, especially given the substantial monetary rewards that can be obtained.[4]

Cracking Down:  Regulators Are Encouraging Whistleblowers to Report COVID-19-Related Violations

In addition to the increase in potential personal incentives to come forward, federal and state regulators have signaled that they will prioritize enforcement investigations and actions against COVID-19-related misconduct.  This too will encourage an increase in whistleblowing.  Before the COVID-19 pandemic, various agencies already included highly lucrative whistleblower incentives as part of their enforcement mechanisms.  The False Claims Act, for example, allows individuals to sue corporations on behalf of the United States, and to retain a percentage of any penalty awarded.[5]  At the same time, such reporters are obliged to provide all of their evidence to the U.S. Department of Justice (DOJ), making enforcement yet more potent.  Given that the False Claims Act extends to Medicaid and Medicare programs, it is logical to expect that many forms of healthcare-related misconduct in the current crisis may be reported through this channel.[6]

Similarly, the Sarbanes-Oxley Act of 2002 created mandatory reporting requirements for fraud and other illegal activity, and provides protections for whistleblowers who come forward.[7]  And under the Dodd-Frank Act, passed in 2010 in part as a reaction to the 2008 financial crisis, whistleblowers who report financial misconduct to the U.S. Securities and Exchange Commission (SEC) are entitled to receive substantial financial awards, provided that they (1) voluntarily (2) provide original information (3) to the SEC (4) that leads to a successful enforcement action.[8]  Dodd-Frank also strengthened anti-retaliation protections against whistleblowers.  Awards typically range from 10% to 30% of the monetary sanction the SEC collects, meaning this incentive can be extremely powerful.[9]  And the SEC, through its Office of the Whistleblower, makes it easy for employees to report tips via an interactive website that prominently highlights the fact that whistleblowers have received awards of over $300 million in recent years.[10]  Whistleblower protections exist under scores of other federal laws (such as the Occupational Safety and Health Act) and state laws as well.[11]

During the current pandemic, regulators will turn to these and other channels to crack down on corporate misconduct, particularly if it is in any way related to the COVID-19 pandemic.  The DOJ, for example, has urged citizens to report COVID-19-related fraud schemes by calling or emailing the National Center for Disaster Fraud (NCDF) and, in turn, information reported to the NCDF is disseminated to relevant federal law enforcement agencies and U.S. Attorney’s Offices across the country.[12]  This program reflects a larger shift in priorities, as announced by Attorney General William Barr last month, in which “detecting, deterring, and punishing wrongdoing” seen as connected to the COVID-19 pandemic has taken center stage.[13]  The DOJ has even launched its own website (https://www.justice.gov/coronavirus) as a central repository for the general public to report anonymously any concerns about COVID-19 fraud.

State and local regulators are also focusing on investigating and punishing COVID-19-related misconduct.  For example, New York State has launched the “COVID-19 ‘New York on PAUSE’ Enforcement Task Force,” which will receive and investigate claims via an online complaint intake form.[14]  And the New York Attorney General has been outspoken about investigating whistleblower claims raised by employees concerning COVID-19 health concerns in the workplace.  California’s Attorney General has made price gouging linked to shortages caused by the outbreak a top enforcement priority, encouraging citizens in his state to come forward with any information on such misconduct.[15]  Likewise, the Washington Attorney General has undertaken enforcement actions against local businesses engaged in illegally overpricing products like masks and hand sanitizers.[16]

As the pandemic has rolled across the U.S. in recent weeks, whistleblowers have already started to come forward publicly.  For instance, an anonymous bus operator for Atlanta’s MARTA transit system made news for alleging that MARTA’s buses were not properly sanitized to address the virus.[17]  Likewise, a nurse in Illinois has filed a lawsuit alleging that she was fired in retaliation for raising concerns regarding inadequate provision of masks for healthcare workers.[18]  And in New Jersey, counsel for a labor union has filed charges alleging that warehouse workers and others were fired in retaliation for speaking out about poor coronavirus safety practices.[19]  As the virus spreads, these trends will surely continue.

Additionally, legislation such as the federal Coronavirus Aid, Relief, and Economic Security (CARES) Act,[20] a $2.2 trillion stimulus that provides for substantial loans and subsidies to businesses, creates the potential for misuse or perceived misuse of funds.  Because of the potential for abuse, the CARES Act contains several oversight provisions, including providing additional funding to create oversight bodies that will investigate how companies use funds made available under CARES.  Specifically, the CARES Act provides funding to existing inspector general offices in several government agencies and creates a Special Inspector General for Pandemic Recovery in the Treasury Department, a Congressional Oversight Commission, and a Pandemic Response Accountability Committee.  In addition, Speaker Nancy Pelosi has announced a bipartisan House Committee to oversee the distribution of funds under the CARES Act, stating that “[t]he panel will root out waste, fraud, and abuse and will protect against price gouging, profiteering, and political favoritism.”[21]  The additional monitoring and scrutiny that accompany CARES funding will create even more opportunities for whistleblowers to emerge.

Finally, in the current 24/7 media climate, with the country appropriately focused on the crisis, COVID-19-related fraud will likely gain substantial coverage, as well as the focus of government regulators (and plaintiffs’ attorneys) looking to publicize available whistleblower mechanisms.

Being Prepared:  Employers Will Need Robust Action Plans in Place to Handle Increased Whistleblower Claims

The most effective way to prepare for the expected increase in whistleblower claims in the current environment is to ensure that a company has an appropriate and robust action plan in place, and sticks to that plan as whistleblower scenarios arise.[22]  While a comprehensive whistleblower action plan is complex and multi-faceted (and not “one size fits all” for every business), below are some key issues to consider when reevaluating an action plan.

• Knowing the Law: This is a rapidly changing environment.  Companies should take stock of the various whistleblower laws and regulations that may apply within their given industry, and whether any new guidance is being issued with regard to those laws related to the COVID-19 pandemic.  In particular, be aware of whether whistleblower complaints may trigger mandatory reporting to federal or state governments under various government programs.
• Communications and Reporting Channels: Companies should ensure that they have clear and operational internal communication and reporting channels for whistleblower complaints.  This includes ensuring that existing processes have not been compromised as a result of work-from-home protocols or layoffs.  For instance, companies should update their compliance plans to ensure that they permit telephone calls or emails to human resources, legal and compliance departments—and provide current contact information for doing so—as opposed to scheduling an in-person meeting or simply assuming that pre-pandemic systems will continue to operate normally.  Similarly, companies with compliance hotlines should make sure those hotlines remain operational.  Companies should then re-emphasize the continued availability of these reporting mechanisms to employees, particularly if they are updated to reflect remote work environments.  As always, this messaging should drive home the company’s non-retaliation policy.
• Robust Response and Investigative Protocols: Companies should consider whether existing investigation protocols need to be updated to reflect the current atmosphere.  Most obviously, remote work may make it more difficult to follow existing guidelines with regard to confidentiality or in-person interviews.  Moreover, individuals tasked with conducting investigations may have been furloughed or otherwise affected by COVID-19.  While these processes should be updated and documented, every effort should be made to maintain confidentiality and existing protocols.  The same is true with responding to the whistleblower and determining whether existing processes for that communication need to be revised to reflect work-from-home protocols.  With the expected uptick in whistleblower claims and the disruption to a company’s internal investigative structure caused by the COVID-19 pandemic, it is possible that a company’s ability to address employee complaints could be delayed.  While some delay may be understandable, it is imperative that companies not allow whistleblower complaints to fall through the cracks or go unanswered.
• Document Retention: Companies should evaluate their document retention policies to ensure that key paper and electronic documents are retained.  This applies both to potentially relevant business documents as well as documents related to the company’s investigation and resolution of any complaints.  For instance, to the extent employees are using personal devices to engage in company functions, consider whether there is a sufficient mechanism for key documents to be captured on the company’s systems.  Similarly, if there is a reduction in force following a complaint, make sure there are steps taken to obtain and retain information from the employees who had their employment terminated and prevent them from taking confidential corporate documents in violation of company policy (while respecting protected whistleblowing activity, including by having appropriate confidentiality carveouts—e.g., under the Defend Trade Secrets Act whistleblower provision—in any separation agreements).
• Communications with Government Regulators: In light of the heightened government scrutiny, companies should review their existing policies to ensure proper communication with government regulators.  Where the whistleblower has already approached regulators, protocols should ensure effective and prompt communication back to the government throughout the internal investigation.  Where the complaint is entirely internal, a decision-framework should exist to assist in evaluating the potential costs and benefits of self-disclosure to government regulators.
• Use of Outside Counsel: As always, companies should consider when it may be necessary to consult with outside counsel in response to a whistleblower claim.  With an anticipated uptick in whistleblower activity, it will be more important than ever to assess at the outset which complaints are significant enough to engage outside counsel—for example, those in which regulators or plaintiffs’ attorneys are already involved or those involving novel laws and programs relating to COVID-19—and those that can appropriately be handled internally.

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[1]              Rebecca Rainey and Nolan D. McCaskill, “‘No words for this’: 10 million workers file jobless claims in just two weeks,” Politico (Apr. 2, 2020), available at https://www.politico.com/news/2020/04/02/unemployment-claims-coronavirus-pandemic-16108.

[2]              See, e.g., Ben Winck, “Nobel-winning economist Paul Krugman sees unemployment soaring to 20% in a matter of weeks,” Business Insider (Apr. 3, 2020), available at https://www.businessinsider.com/paul-krugman-says-unemployment-spikes-soar-forecast-weeks-coronavirus-layoffs-2020-4; Tommy Reggiori and Sujata Rao, “U.S. Economy to Shrink at Fastest Rate Since 1946, Unemployment to Top 15%: Morgan Stanley,” U.S. News and World Report (Apr. 3, 2020), available at https://money.usnews.com/investing/news/articles/2020-04-03/us-economy-to-shrink-at-fastest-rate-since-1946-unemployment-to-top-15-morgan-stanley.

[3]              Liz Hoffman and Marcelo Prince, “The Month Coronavirus Felled American Business,” Wall Street Journal (Apr. 4, 2020), available at https://www.wsj.com/graphics/march-changed-everything/.

[4]              For example, on April 3, 2020, the SEC announced an award of approximately $2 million to a whistleblower who provided information and assistance that substantially contributed to an ongoing investigation.  See Securities and Exchange Commission, “SEC Awards Approximately $2 Million to Whistleblower,” (Apr. 3, 2020), available at https://www.sec.gov/news/press-release/2020-80.

[5]              31 U.S.C. §§ 3729-3733.

[6]              Gibson Dunn, “Implications of COVID-19 Crisis for False Claims Act Compliance,” (Mar. 31, 2020), available at https://www.gibsondunn.com/implications-of-covid-19-crisis-for-false-claims-act-compliance/.

[7]              Pub. L. No. 107-204, 107th Cong. (2002).

[8]              Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 111th Cong. (2010).

[9]              See, e.g., Securities and Exchange Commission, “SEC Announces Largest-Ever Whistleblower Award,” (Sep. 22, 2014), available at https://www.sec.gov/news/press-release/2014-206 (noting SEC whistleblower award of more than $30 million).  This activity does not show any signs of slowing, notwithstanding the current COVID-19 pandemic.  See supra note 4.

[10]             https://www.sec.gov/whistleblower.

[11]             See, e.g., N.J. Stat. Ann. §§ 2A:32C-1 et seq. (New Jersey False Claims Act); Cal. Gov’t Code §§ 12650 et seq. (California False Claims Act).

[12]             Department of Justice, “Attorney General William P. Barr Urges American Public to Report COVID-19 Fraud,” Mar. 20, 2020, available at https://www.justice.gov/opa/pr/attorney-general-william-p-barr-urges-american-public-report-covid-19-fraud.

[13]             William Barr, “Memorandum on COVID-19 – Department of Justice Priorities,” Department of Justice (Mar. 16, 2020), available at https://www.justice.gov/ag/page/file/1258676/download.

[14]             See New York State COVID-19 “New York on PAUSE” Enforcement Task Force Violation Complaint Form, available at https://mylicense.custhelp.com/app/ask; Complaint Forms Available to Report Violations of Coronavirus Mandates, available at https://www.wktv.com/content/news/Complaint-forms-available-to-report-violations-of-NY-state-mandates-569290041.html.

[15]             California Department of Justice, “Attorney General Becerra Issues Consumer Alert on Price Gouging Following Statewide Declaration of Emergency for Novel Coronavirus Cases in California Communities,” (Mar. 4, 2020), available at https://oag.ca.gov/news/press-releases/attorney-general-becerra-issues-consumer-alert-price-gouging-following-statewide.

[16]             Jim Brunner, “Washington state attorney general warns 5 businesses to stop coronavirus price-gouging of sanitizer, masks on Amazon,” Seattle Times (Mar. 31, 2020), available at https://www.seattletimes.com/seattle-news/health/state-attorney-general-warns-5-businesses-to-stop-coronavirus-price-gouging-of-sanitizer-masks-on-amazon/.

[17]             WAOK Radio, “Exclusive: MARTA Whistleblower Says Company Not Protecting Riders From COVID-19,” (Mar. 31, 2020), available at https://waok.radio.com/articles/radiocom/rashad-richey-marta-not-protecting-riders-from-covid-19.

[18]             Sophie Sherry, “Nurse says she was fired by Northwestern Memorial Hospital after warning co-workers that face masks being used were not the safest,” Chicago Tribune (Mar. 25, 2020), available at https://www.chicagotribune.com/news/breaking/ct-nurse-northwestern-memorial-hospital-coronavirus-20200324-6smjuxbn6fgnxpaiyzzkjymorq-story.html.

[19]             Federal Charges Filed By Teamsters Against Warren Buffett-Owned Furniture Firm For Mass Firing Of Coronavirus Whistleblowers, Union Supporters, Yahoo! Finance (Apr. 2, 2020), available at https://finance.yahoo.com/news/federal-charges-filed-teamsters-against-201900772.html.

[20]             H.R. 748, 116th Cong. (2020).

[21]             Heather Caygle, Kyle Cheny and Melanie Zanona, “Pelosi Forms New Select Committee to Oversee $2 trillion Coronavirus Relief Package,” Politico (April 2, 2020), available at https://www.politico.com/news/2020/04/02/pelosi-forms-new-select-committee-to-oversee-2-trillion-coronavirus-relief-package-161436.

[22]             Jason C. Schwartz and Lisa J. Banks, “Whistleblower Law: A Practitioner’s Guide,” American Lawyer Media/Law Journal Press.

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

Authors: Lee Dunst, Jessica Brown, Daniel Weiss, Daniel Rauch and Peter Baumann.

© 2020 Gibson, Dunn & Crutcher LLP

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

On April 2, 2020, the California Supreme Court issued an important opinion regarding the right of parties to agree to waive the mandatory provisions for service of process abroad under the Convention on the Service Abroad of Judicial and Extrajudicial Documents in Civil or Commercial Matters (hereinafter the “Hague Service Convention”).

Gibson Dunn drafted the leading amicus brief that set forth the legal argument that supported the right of private parties to agree to waive the provisions of the Hague Service Convention in the context of proceedings to enforce an award resulting from an international commercial arbitration.

I.  The California Supreme Court’s Decision

In Rockefeller Technology Investments (Asia) VII v. Changzhou Sinotype Technology Co., Ltd., No. S249923, ___ Cal.5th ___, 2020 WL1608906 (Cal. Apr. 2, 2020), the California Supreme Court reversed a court of appeal decision that had ruled that the failure to comply with the Hague Service Convention rendered a judgment confirming an arbitration award void because the plaintiff’s service of the petition to confirm the arbitration award did not conform with the requirements of the Hague Service Convention.  Instead, the Court, in a unanimous opinion authored by Justice Corrigan, ruled that the parties could agree to provide for notice and service of process through other means, as permitted under California law, because the Hague Service Convention “applies only when the law of the forum state requires formal service of process to be sent abroad” and alternatively, “because the parties’ agreement constituted waiver of formal service of process under California law in favor of an alternative form of notification.”  (Id. at *1.)

In Rockefeller, Rockefeller Technology and Changzhou SinoType had contracted to arbitrate their disputes in Los Angeles, to submit to the jurisdiction of the federal and state courts in California, and to consent to service of process by notice via Federal Express or similar courier, with copies via facsimile or email.  (Id.)  After a dispute arose and despite notice as provided in the contract, SinoType did not appear at the arbitration, and a default award for $414.6 million was issued against it.  (Id. at *2.)  Thereafter, Rockefeller petitioned to confirm the award and served the petition and summons pursuant to the notice provisions in the contract.  (Id.)  SinoType did not appear, and the award was confirmed.  (Id.)  Only when Rockefeller sought assignment of various royalty payments owed to SinoType did SinoType assert that Rockefeller’s failure to comply with the Hague Service Convention rendered the judgment confirming the award void.  (Id.)

The California Court of Appeal agreed and held that, notwithstanding the parties’ agreement, service had to comply with the Hague Service Convention.  (Id.)

In reversing the Court of Appeal, the California Supreme Court “conclude[d] that the parties’ agreement constituted a waiver of formal service of process under California law” and thus the Hague Service Convention did not apply.  (Id. at *5.)  First, the high court observed that the Code of Civil Procedure provides that a petition to confirm, correct, or vacate an arbitral award provides that it shall be served “in the manner provided in the arbitration agreement for service of such petition and notice.”  (Id. at *7, quoting Code Civ. Proc., § 1290.4, subd. (a).)  It then ruled that when the parties agree to waive formal service of process under California law in favor of informal notification, the case does not present the need to transmit a judicial document for formal service abroad under the Hague Service Convention.  (Id.)  And it concluded that “because the parties’ agreement constituted a waiver of formal service of process under California law in favor of an alternative form of notification, the Convention does not apply.”  (Id. at *1.)  It explained that “[r]equiring formal service abroad under California law where sophisticated business entities have agreed to arbitration and a specified method of notification and document delivery would undermine the benefits arbitration provides” and that uncertainty with respect to service “appears contrary to the Legislature’s attempts to position California as a center for international commercial arbitration.”  (Id. at *10.)

II.  Conclusions

Gibson Dunn has played a leading role in supporting the legal foundation for international commercial arbitration in California.  Its partner, Daniel M. Kolkey, co-authored California’s International Arbitration statute (Code Civ. Proc., § 1297.11 et seq.), chaired a working group formed by the California Supreme Court in 2017 that led to the enactment of legislation authorizing foreign and out-of-state attorneys to represent their clients in international commercial arbitrations in California, and was the author of the lead amicus brief in the Rockefeller case.

Gibson Dunn’s amicus brief helped secure the stable future of those choosing California law for their contracts calling for arbitral resolution in their dealings abroad, ensuring California will remain a sought-after market for legal expertise in this increasingly important arena.

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For more information, please feel free to contact the Gibson Dunn lawyer with whom you usually work or the leaders of Gibson Dunn’s California Appellate Practice Group and its International Arbitration Practice Group set forth below.

California Appellate Practice Group:
Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, [email protected])
Daniel M. Kolkey – San Francisco (+1 415-393-8420, [email protected])
Julian W. Poon – Los Angeles (+1 213-229-7758, [email protected])
Theane Evangelis – Los Angeles (+1 213-229-7726, [email protected])

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

© 2020 Gibson, Dunn & Crutcher LLP

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

The UK Government has announced a series of measures to support public services, people and businesses through this period of severe – but temporary – disruption caused by COVID-19.  The Government’s measures are a mixture of tax relief, financing and support towards the cost of employees. Further clarity on the Government’s plans and practical processes for taking advantage of the support is expected to be provided as the days progress.

In this client alert we give a brief overview of the financial packages that have been made available to UK businesses. This is a very fluid situation where UK Government policy announcements are being made on an almost daily basis. The brief overview provided below presents the measures available as at 3 April 2020.

See also the Gibson Dunn Coronavirus (COVID-19) Resource Centre for more details on these UK Government schemes, including our prior client alerts on:

• The Covid Corporate Finance Facility and Coronavirus Business Interruption Loans: https://www.gibsondunn.com/covid-19-uk-financial-support-for-businesses-through-purchases-of-commercial-paper-and-lending-to-smes/
• The Coronavirus Job Retention Scheme and other UK employment related-matters: https://www.gibsondunn.com/uk-employment-law-considerations-for-companies-responding-to-covid-19-update/ ; https://www.gibsondunn.com/uk-employment-law-updated-considerations-for-companies-responding-to-covid-19/ ; https://www.gibsondunn.com/uk-employment-law-considerations-for-companies-responding-to-covid-19/

Scheme	Details
Financial Support Measures
1.     COVID-19 Corporate Financing Facility (CCFF)	Under the CCFF scheme, the Bank of England (BoE) will buy commercial paper from larger companies. The CCFF scheme will support companies that are fundamentally strong but which have been affected by a short-term funding squeeze. Small and medium-sized enterprises are unlikely to be able to access the CCFF scheme. The scheme will operate for at least 12 months and will purchase sterling-denominated commercial paper, with the following characteristics: Maturity of one week to twelve months. Where available, a credit rating of A-3 / P-3 / F-3 / R3 from at least one of Standard & Poor’s, Moody’s, Fitch and DBRS Morningstar as at 1 March 2020. Issued directly into Euroclear and/or Clearstream. The CCFF scheme is available to companies, and their finance subsidiaries, that “make a material contribution to the UK economy.” The BoE states that, in practice, firms that meet this requirement would typically be: UK incorporated companies (including those with foreign-incorporated parents and with a genuine business in the UK); companies with significant employment in the UK; firms with their headquarters in the UK. The BoE notes that it will also consider whether the company generates significant revenues in the UK, serves a large number of customers in the UK or has a number of operating sites in the UK. The CCFF is open to firms that can demonstrate that they were in “sound financial health” prior to the impact of COVID-19. This means companies that had a short or long-term rating of investment grade, as at 1 March 2020, or equivalent.  If firms have different ratings from different agencies, and one of those is below investment grade then the commercial paper will not be eligible.  The CCFF is open to all firms and sectors, providing that the eligibility criteria as set out above are satisfied.  If a firm does not have a credit rating it should speak to its existing lenders and if the firm was considered to be in “sound financial health” at 1 March 2020, a submission can be made to the BoE on that basis. Alternatively, the BoE notes that companies can contact one of the major credit rating agencies to seek an assessment of credit quality in a form that can be shared with the BoE and HM Treasury. More information on eligibility and application documents can be found on the Bank of England Website.
2.     Coronavirus Business Interruption Loan Scheme	This temporary scheme supports small and medium-sized businesses with an annual turnover of up to £45 million with access to £5 million of finance in the form of term loans, overdrafts, invoice finance and asset finance facilities for up to six years. The Scheme has also been extended to enable banks to make loans of up to £25 million to firms with an annual turnover of between £45 million and £500 million. The scheme will be delivered through commercial lenders (including all major banks), backed by the UK Government-owned British Business Bank. As part of the scheme, the UK Government will provide lenders with a guarantee of 80% on each loan (subject to a per-lender cap on claims). The UK Government will also make a business interruption payment to cover the first 12 months of interest payments and any lender-levied fees. However, clients should note that the borrower remains 100% liable for the debt. Clients should also note that there is no obligation on a lender to offer a loan within the Scheme. If a lender can offer finance on normal commercial terms without making use of the Scheme, it will do so.  Security is not required to secure lending below £250,000. For any borrowing above £250,000, it is open to lenders to ask for security including personal guarantees from directors and security over their assets in support of such guarantees, however, there is a prohibition on taking security over a director’s primary residential property. Taking into consideration the UK Government’s guarantee, any personal guarantees for borrowing in excess of £250,000 are capped at 20% of the outstanding value of the loan. To be eligible to participate in the Scheme the business must meet the following key tests: the applicant must be UK-based in its business activity; the applicant must have an annual turnover of no more than £500 million the applicant must have a borrowing proposal which the lender would consider viable, were it not for the current pandemic; and the applicant must self-certify that it has been adversely impacted by the coronavirus (COVID-19). The full rules of the Scheme (including further eligibility criteria and the application process) is available on the British Business Bank website.
3.     Insurance Claims for Notifiable Diseases	Most commercial insurance policies are unlikely to cover pandemics or unspecified notifiable diseases, such as COVID-19. However, those businesses which have an insurance policy that covers government ordered closure and pandemics or government ordered closure and unspecified notifiable disease should be able to make a claim (subject to the terms and conditions of their policy). Businesses are encouraged to check the terms and conditions of their specific policy and contact their providers. Notifiable diseases are certain infectious diseases that registered medical practitioners have a statutory duty to notify the ‘proper officer’ at their local council or local health protection team about when they come across a suspected case. The Government keeps an updated list of notifiable diseases. On 5 March 2020, the government added COVID-19 to its list of notifiable diseases. Many insurers use diseases on notifiable diseases list as triggers for the activation or exclusion of insurance cover. For example, insurers’ policies that cover notifiable diseases will typically only cover a specific subset of notifiable diseases (such as Cholera or Anthrax) that the insurer will reference in the policy documentation. These policies will exclude any notifiable disease not on the insurers list, as well as future/unknown diseases (such as COVID-19). The price that the insurer charges for the policy is modelled against the risk posed by this set list of diseases. Some businesses will have purchased add-ons for their insurance that cover for ‘unspecified notifiable diseases’. These policies effectively cover any disease listed as a notifiable disease, enabling the business to claim for losses for all notifiable diseases as well as from diseases that are unknown at the point the policy is written. The effect of the Government adding COVID-19 to its list of notifiable diseases is to ensure that businesses with unspecified notifiable disease cover are able to make a claim – subject to the terms and conditions in their policy. For example, someone infected with COVID-19 may need to have been on the premises. The Government also asked a number of different businesses and venues to remain closed from 21 March 2020 onwards. Insurers have agreed that this advice is sufficient for businesses covered for COVID-19 losses to make a claim (if the only barrier to them making a claim was a lack of clarity on whether the government had ordered businesses to close). As such, intervention by the police or any other statutory body is no longer required to trigger cover in the current circumstances. However, most businesses’ commercial insurance policies (including for denial of access) are unlikely to offer cover for COVID-19. Insurance policies differ significantly, so businesses are encouraged to check the terms and conditions of their specific policy and contact their providers.
4.     State Aid	EU State aid rules apply in the UK during the Brexit transition period which expires on 31 December 2020. On 19 March 2020, the European Commission (Commission) adopted a Temporary Framework for State aid measures to support the economy in the current COVID-19 outbreak. Under the Temporary Framework, the Commission can authorize member states and the UK to adopt aid schemes in the form of tax advantages or direct grants, State guarantees or loans on an expedited basis (within 24-48 hours). On 25 March, the Commission approved two UK aid schemes. The guarantees scheme covers 80% of loan facilities for SMEs with a turnover of up to GBP 45 million to cover their working and investment capital needs and will be implemented through the British Business Bank. Under the direct grants scheme, SMEs are eligible for an up to GBP 734,000 support in the form of a direct grant. The schemes will be in place until 30 September 2020, and can be extended by the UK until 31 December 2020. In addition to the Temporary Framework, which provides for the possibility of adopting aid schemes, the UK can grant State aid under the existing (non-COVID-19) State aid rules, which permit member states and the UK, under certain conditions, to: (i) provide rescue aid without first notifying the Commission;  and (ii) provide State aid to make good the damage caused by natural disasters or exceptional occurrences. On 12 March, the EC declared that Covid-19 is an exceptional occurrence. Whether larger companies that cannot benefit from the COVID-19 aid schemes, both because of their size and their funding needs, can receive UK Government support will need to be assessed on a case-by-case basis.
Employment Support Measures
5.     Coronavirus Job Retention Scheme	All UK employers with a PAYE (“pay as you earn”) scheme in operation on 28 February 2020 will be able to access support to continue paying part of their employees’ salary for those that would otherwise have been laid off during this crisis. The scheme applies to all employees that have been asked to stop working, but who are being kept on the pay roll (described as “furloughed workers”).  To claim, employees must be designated as furloughed workers and notified of this change. The UK tax authority (HMRC) will reimburse 80% of furloughed workers’ wages, up to £2,500 per month, plus the associated Employer’s National Insurance contributions and minimum automatic enrolment employer pension contributions on that wage. Employers can choose to “top up” the pay of a furloughed employee to 100% of their contractual pay, but are not obliged to under the scheme. The scheme will cover the cost of wages backdated to 1 March 2020.  It is initially open for three months, but “will be extended if necessary”. HMRC expects the first grants to be paid by the end of April.  In the meantime, if a business needs short term cash flow support, it may be eligible for a Coronavirus Business Interruption Loan (see below). More information here.
6.     Self-employment income support scheme	The UK government has outlined details of new Self-Employment Income Support Scheme. The scheme will provide a taxable grant to self-employed individuals (including members of partnerships) worth 80% of average monthly income taken over the last three tax years, capped at £2,500 per month. The scheme is only open to anyone with trading profits less than £50,000 and to those who earn the majority of their income from self-employment. The scheme is unlikely to be up and running before the start of June 2020, so it will not help self-employed individuals with immediate cash flow issues. Unlike the Coronavirus Job Retention Scheme, an eligible self-employed person can continue to work while claiming the grant.
7.     Statutory Sick Pay Rebate	Small-and medium-sized enterprises (SME) and employers will be able reclaim Statutory Sick Pay (SSP) paid for sickness absence due to COVID-19. A company is considered an SME if it meets two out of three of the following criteria: (i) Turnover of less than £25 million; (ii) Fewer than 250 employees, and/or (iii) Gross assets of less than £12.5 million. The eligibility criteria for the scheme will be as follows: (i) 2 weeks’ SSP per eligible employee who has been off work because of COVID-19; (ii) SMEs only; (iii) employers can reclaim expenditure for any employee who has claimed SSP (according to the new eligibility criteria) as a result of COVID-19; (iv) employers should maintain records of staff absences and payments of SSP, but employees will not need to provide a GP fit note. If evidence is required by an employer, those with symptoms of coronavirus can get an isolation note from NHS 111 online and those who live with someone that has symptoms can get a note from the NHS website; and (v) the eligible period for the scheme will commence the day after the regulations on the extension of SSP to those staying at home comes into force. The process for claiming a rebate has not yet been developed and further detail is expected in due course. More information here.
Tax Support Measures
8.     Time to Pay	All businesses and self-employed people in financial distress, and with outstanding tax liabilities, may be eligible to receive support with their tax affairs through HMRC’s Time To Pay service. The service previously did not cover corporation tax, PAYE and Valued Added Tax (VAT), however, the UK Government’s measures have now extended to apply to VAT and HMRC will consider deferral of PAYE and corporation taxes on a case by case basis. All arrangements are agreed on a case-by-case basis and are tailored to individual circumstances and liabilities. More information here.
9.     VAT Deferral	The UK Government has deferred Valued Added Tax (VAT) payments for three months (from 20 March 2020 until 30 June 2020). All VAT-registered UK businesses are automatically eligible without application required. However, quarterly returns should still be filed as normal and HMRC will pay VAT refunds and reclaims as normal (providing cash flow for some businesses). The payment of VAT that has been deferred under the scheme should be paid at the end of the next tax year, in April 2021. More information here.
10.  Deferral of Self-Assessment payment	The Self- Assessment payment on account, that is ordinarily due to be paid to HMRC by 31 July 2020 may now be deferred until January 2021. The deferment is automatic but optional. No penalties or interest for late payment will be charged if the July 2020 payment on account is deferred until January 2021. More information here.
11.  Business Rates Holiday for Retail, Hospitality and Leisure	Businesses in the retail, hospitality and leisure sectors in England[1] will not have to pay business rates (municipality taxes) for the 2020-21 tax year. There is no action to take. Local authorities will automatically apply the business rates holiday to business rates bills for the 2020/2021 tax year. More information here.
12.  Cash Grant for Retail, Hospitality and Leisure	Businesses in England in the retail, hospitality or leisure sector with a rateable value between £15,001 and £51,000 will receive a cash grant of up to £25,000 per property. There is no action to take. Local authorities will write to businesses that are eligible for this grant. More information here.
13.  Small Business Grant Funding	This scheme supports small businesses in England that already pay little or no business rates because of small business rate relief, rural rate relief and tapered relief.  The scheme will provide a one-off grant of £10,000 to businesses with a rateable value of up to £15,000 to help meet their ongoing business costs. Local Authorities will write to all eligible businesses with information on how to claim this grant. More information here.
14.  Business Rates Holiday for Nurseries	Nurseries in England that provide Early Years Foundation Stage do not have to pay business rates for the 2020-21 tax year. Local authorities will automatically apply the business rate holiday to relevant business rates bills for the 2020-21 tax year. More information here.

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   [1]   Some aspects of business support are devolved.  Separate schemes may apply in Scotland, Wales and Northern Ireland.

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This client update was prepared by Michelle Kirschner, Mark Sperotto, Attila Borsos, Anne MacPherson, Amar Madhani, and Martin Coombes.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 outbreak. For additional information, please contact your usual contacts or any member of the Firm’s Coronavirus (COVID-19) Response Team. In the UK, the contact details of the authors and other key practice group lawyers are as follows:

The Authors:

Michelle M. Kirschner – London, Financial Institutions (+44 (0)20 7071 4212, [email protected])
Mark Sperotto – London, Private Equity (+44 (0)20 7071 4291, [email protected])
Attila Borsos – Brussels, Antitrust (+32 2 554 72 11, [email protected])
Anne MacPherson – London, Senior Transactional PSL (+44 (0)20 7071 4134, [email protected])
Martin Coombes – London, Financial Institutions (+44 (0)20 7071 4258, [email protected])
Amar Madhani – London, Private Equity and Real Estate (+44 (0)20 7071 4229, [email protected])

London Key Contacts:

Sandy Bhogal – London, Tax (+44 (0)20 7071 4266, [email protected])
Thomas M. Budd – London, Finance (+44 (0)20 7071 4234, [email protected])
Gregory A. Campbell – London, Restructuring and Finance (+44 (0)20 7071 4236, [email protected])
James A. Cox – London, Employment (+44 (0)20 7071 4250, [email protected])
Patrick Doris – London, Litigation & Data Protection (+44 (0)20 7071 4276, [email protected])
Christopher Haynes – London, Corporate (+44 (0)20 7071 4238, [email protected])
James R. Howe – London, Private Equity (+44 (0)20 7071 4214, [email protected])
Anna Howell – London, Energy, Oil & Gas (+44 (0)20 7070 4241, [email protected])
Charles Falconer, QC – London, Litigation (+44 (0)20 7071 4270, [email protected])
Jeremy Kenley – London, M&A, Private Equity & Real Estate (+44 (0)20 7071 4255, [email protected])
Penny Madden, QC – London, Arbitration (+44 (0)20 7071 4226, [email protected])
Ali Nikpay – London, Antitrust (+44 (0)20 7071 4273, [email protected])
Philip Rocher – London, Litigation (+44 (0)20 7071 4202, [email protected])
Selina S. Sagayam – London, Corporate (+44 (0)20 7071 4264, [email protected])
Alan A. Samson – London, Real Estate & Real Estate Finance (+44 (0)20 7071 4222, [email protected])
Jeffrey M. Trinklein – London, Tax (+44 (0)20 7071 4264, [email protected])

© 2020 Gibson, Dunn & Crutcher LLP

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

Washington, D.C. partner Joshua Lipshutz and Los Angeles partner Michael Holecek are the authors of “Gig-Worker Classification in the Age of COVID-19,” [PDF] published in The Recorder on April 3, 2020.

On 3 April 2020, the UK Financial Conduct Authority (“FCA”) published a statement setting out its expectations of FCA solo-regulated firms under the Senior Managers and Certification Regime (“SMCR”) during the COVID-19 outbreak. This client alert provides FCA solo-regulated firms with an overview of the FCA’s SMCR-related expectations.

What are the responsibilities of senior management during the current outbreak?

The FCA has previously stated that it does not require firms to have a single senior manager responsible for their coronavirus response. Rather, firms should allocate these responsibilities in the way which best enables them to manage the risks they face. The FCA’s latest statement notes that senior managers are responsible for risks in their areas of responsibility and should be considering:

• where the current situation might lead to emerging risks, and
• how it affects existing risks, along with the controls used to manage them.

Does my firm need to make changes to statements of responsibilities?

The FCA recognises that some firms may need to make temporary arrangements to cover absences or change senior manager responsibilities in light of the COVID-19 outbreak. However, the FCA has stated that it wants to minimise the burden to firms at this time and does not intend to enforce the requirement on firms to submit updated statements of responsibilities provided that the change is:

• is made to cover multiple sicknesses, or other temporary changes in responsibilities in direct response to the pandemic, and
• is temporary and expected to revert to the firm’s previous arrangements.

However, the FCA does expect allocations (even if temporary) to be clearly documented internally to ensure that those within the firm understand who is responsible for what. This must be made available to the FCA on request. Furthermore, firms’ internal records should aim to keep a “running commentary” of their senior manager population and their responsibilities during this period. The FCA has stated that this includes keeping statements of responsibilities, role profiles and, if applicable, responsibilities maps up-to-date. The FCA does not expect firms to notify it of such temporary arrangements using Form D.

Firms that are classified as “fixed portfolio” firms should supply the FCA with timely detail of the changes they would normally include in updated statements of responsibilities. Firms should also update their FCA supervisors of any furloughing of one or more senior managers.

What if my firm needs to make temporary arrangements for senior management functions?

The FCA intends to issue a Modification by Consent to the “12 week rule” to support firms using temporary arrangements during the crisis. The 12 week rule permits an individual to cover for a senior manager without FCA approval where the absence is temporary or reasonably unforeseen and the appointment is for less than 12 consecutive weeks. If temporary arrangements last longer than 12 weeks as a result of the COVID-19 outbreak, firms can notify the FCA that they consent to a modification of the 12 week rule. In these cases, temporary arrangements can be extended up to 36 weeks.

Under the modification, firms will also be able to allocate the prescribed responsibilities of the absent senior manager to the individual who is standing in for the absent Senior Manager. Usually, prescribed responsibilities can only be allocated to another FCA approved senior manager under this rule. However, if possible, the FCA still expects firms to do this. Firms should still allocate to the most senior person responsible for that activity or area, who has sufficient authority and an appropriate level of knowledge and competence to carry out the responsibility properly. The “temporary” manager will require access to the governance forums they need to exercise their responsibilities.

The FCA expects firms to clearly document these responsibilities, however temporary, including on relevant statements of responsibilities and, if applicable, responsibilities maps.

What notifications does my firm need to make?

The FCA does not expect firms to submit the updated statement of responsibilities of the absent senior manager or of senior managers who take on the responsibilities of the absent manager. However, the FCA does expect allocations to be clearly documented internally. Although, the FCA has stated that, if applicable, the firm’s responsibilities map should reflect the responsibilities of those non-senior managers with temporary responsibilities taken on under the 12 week rule.

What is the position regarding furloughed senior managers?

The FCA has previously noted that senior managers may be considered key workers. However, there may be circumstances where a senior manager has been furloughed. Unless such a senior manager is permanently leaving their position, the senior manager will retain their FCA approval and will not be required to re-apply for approval on their return to work.

To the extent that a firm is subject to the “Overall Responsibility” rule, the responsibilities of the furloughed senior manager must be allocated to another senior manager. If the firm is relying on the 12 week rule, the replacement does not need not be a senior manager.

Does my firm need to re-allocate prescribed responsibilities?

If a firm has furloughed a senior manager, that senior manager’s prescribed responsibilities should be re-allocated to another senior manager. However, if a temporary replacement has been appointed under the 12 week rule, the proposed modification by consent allows the firm to re-allocate prescribed responsibilities to the temporary replacement, even if the replacement is not a senior manager.

The FCA has stated that individual performing “required function” (for example, Compliance Oversight and MLRO) should only be furloughed as a last resort. Where an individual holding a required function is furloughed, the firm should replace that individual until their return. If the replacement is temporary, firms can use the 12 week rule to arrange cover.  The FCA’s rules regarding who can hold certain functions still apply. For example, executives should not be allocated an oversight role.

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

Authors: Michelle Kirschner and Martin Coombes

© 2020 Gibson, Dunn & Crutcher LLP

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

Yesterday, the U.S. Small Business Administration (“SBA”) published an interim final rule on affiliation (the “Affiliation IFR”) (available here), a summary of affiliation tests (available here) (the “Summary”), a lender application form and agreement (available here and here, respectively), and FAQs (available here), with respect to, the Paycheck Protection Program (the “Program” or “PPP” and such rule, the “Rule”).  As described in greater detail in our previous client alerts, 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, and Small Business Administration Issues Interim Final Rule and Final Application Form for Paycheck Protection Program, the Program provides $349 billion to help small businesses impacted by COVID-19 keep their employees on the payroll and their businesses solvent.

The Affiliation IFR is effective immediately and confirms the general principle that a borrower will be considered together with its affiliates for purposes of determining eligibility for the PPP.  The only waivers to this general rule for purposes of the Program are a new exemption for faith-based organizations established by the Affiliation IFR and the three affiliation rule waivers established by the CARES Act for any business concern: (1) with not more than 500 employees and that is assigned a North American Industry Classification System code beginning with 72; (2) operating as a franchise that is assigned a franchise identifier code by the SBA; and (3) that receive financial assistance from a small business investment company (i.e., a company licensed under section 301 of the Small Business Investment Act of 1958).  The CARES Act also makes eligible a business concern that “employs not more than 500 employees per physical location of the business concern and that is assigned a North American Industry Classification System code beginning with 72 at the time of disbursal.”

The Affiliation IFR also clarifies that the 500 employee eligibility standard applies to only “employees whose principal place of residence is in the United States.”  The CARES Act itself does not state a clear rule as to the locus of employees for purposes of determining whether a business concern meets the eligibility standard; it simply sets the eligibility standard at “500 employees.”  The SBA size standards regulations at 13 CFR 121.106 clearly state that the employee eligibility calculation includes domestic and foreign employees.  The Affiliation IFR, on the other hand, states the different standard noted above.  Our view is that clients should know what the Affiliation IFR states and that this interpretation is neither compelled by nor inconsistent with the CARES Act.  If a business concern chooses to apply for a PPP loan, we recommend that it state clearly in an addendum to the application form how it is interpreting the employee eligibility requirements and note its foreign employees.  We recommend further that the applicant state in an addendum that it would use the portion of the funds allocated to payroll costs exclusively to benefit its employees in the U.S., and not its non-U.S. employees.

The Summary is almost identical to the language of the first four bases for affiliation described in the existing SBA affiliation rules.[1]  The Summary provides that affiliation under four different circumstances is sufficient to establish affiliation under the Program:

1. Ownership. Affiliation exists as a result of ownership or the power to control more than 50% of voting equity.

• If no individual, concern, or entity owns or controls more than 50% of a concern’s voting equity, the Board of Directors or President or CEO (or other officers, managing members, or partners who control the concern’s management) are deemed to control the concern.
• A minority shareholder is deemed to control the concern if the shareholder has the right under the concern’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board or shareholders.

2. Stock options, convertible securities, and merger agreements. The rights granted under stock options, convertible securities, and agreements to merge (including agreements in principle, but not agreements to negotiate) are deemed to have been exercised. For example, if a 20% stockholder has an option to acquire another 30% of the concern’s voting stock, that stockholder is deemed an affiliate of the concern.

• SBA will not deem exercise of the following to have occurred: options, convertible securities, and agreements that are subject to conditions precedent which are incapable of fulfillment, speculative, conjectural, or unenforceable, or where the probability of the transaction (or exercise of the rights) occurring is extremely remote.
• A shareholder that agrees to divest its ownership interest in a concern is still deemed to own such interest.

3. Management. If the CEO, President, other officers, managing members, or partners who control the management of a concern also control the management of another concern, the concerns are affiliates. If a single individual, concern, or entity that controls the Board of Directors or management of a concern also control the Board of Directors or management of another concern, the concerns are affiliates.

• Affiliation also arises where a single individual, concern or entity controls the management of a concern through a management agreement.

4. Identity of interest. If an individual and his or her spouse, parent, child, sibling or spouse of such any such person have identical or substantially identical business or economic interests (such as where they operate concerns in the same or similar industry in the same geographic area), they are affiliates.

• Affiliation based on identity of interest may be rebutted with evidence showing that the interests deemed to be one are in fact separate.

Unlike the SBA’s existing rules (available here), the Summary does not provide that affiliation may arise between individuals or firms with common investments, or firms that are economically dependent through contractual or other relationships).  Also unlike the existing SBA rules, the Summary does not establish affiliation based on: the “newly organized concern rule” applicable to concerns actively operating for two years or less; the totality of the circumstances; or franchise agreements.

While the Affiliation Rule is effective immediately, the SBA will solicit public comments and consider the need to make revisions in light of such comments.

The FAQ states that the SBA, in consultation with the Department of Treasury, intends to provide timely additional guidance to address borrower and lender questions concerning the Program.  Such guidance may be relied upon as the SBA’s interpretation of the CARES Act and the Paycheck Protection Program Interim Final Rule.  The FAQ states it will be updated on a regular basis.  The initial FAQ provided clarifies that Program lenders are not required to replicate every borrower calculation.  Instead, “lenders are expected to perform a good faith review, in a reasonable time, of the borrower’s calculations and supporting documents concerning average monthly payroll cost.”  The SBA also issued a separate set of FAQs for faith-based organizations.

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   [1]   The Affiliation Rule states that the detailed affiliation standards contained in 13 CFR 121.103 do not apply to PPP borrowers.  This is consistent with SBA regulations in effect prior to the enactment of the CARES Act.  Applicants for Section 7(a) loans, including PPP loans, are subject to the affiliation rule contained in 13 CFR 121.301 pursuant to 13 CFR 103(a)(8) and 13 CFR 301(f).

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

Authors: Michael D. Bopp, Roscoe Jones, Jr.*, Alisa Babitz, Courtney Brown, Alexander Orr, William Lawrence and Samantha Ostrom

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

© 2020 Gibson, Dunn & Crutcher LLP

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

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.

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UNITED STATES

Small Business Administration Issues Interim Final Rule and Final Application Form for Paycheck Protection Program

Yesterday, the U.S. Small Business Administration (“SBA”) published (a) an interim final rule (available here) regarding, and (b) a “final” form application (the “revised application”, available here) with respect to, the Paycheck Protection Program (the “Program” or “PPP” and such rule, the “Rule”). As described in greater detail in our previous client alerts, SBA “Paycheck Protection” Loan Program Under the CARES Act and Small Business Administration and Department of Treasury Publish Paycheck Protection Program Loan Application Form and Instructions to Help Businesses Keep Workforce Employed, the Program provides $349 billion to help small businesses impacted by COVID-19 keep their employees on the payroll and their businesses solvent.
Read more

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UNITED KINGDOM / EUROPE

Gibson Dunn’s Highlights on the Latest COVID-19 Related Changes to the Law and Government Policy

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.
Read more

European and German Programs Counteracting Liquidity Shortfalls and Relaxations in German Insolvency Law

The significant decline in sales or even temporary close downs of businesses in the last couple of weeks already led to a massive shortfall in liquidity available to entrepreneurs while the cost level remains largely the same. In a joint effort to back the economy, the European Central Bank as well as the German Federal Government (Bundesregierung) and the State Governments (Landesregierungen) implemented several programs to counteract a break-down of companies from large multinationals to sole entrepreneurs.
Read more

 

Yesterday, the U.S. Small Business Administration (“SBA”) published (a) an interim final rule (available here) regarding, and (b) a “final” form application (the “revised application”, available here) with respect to, the Paycheck Protection Program (the “Program” or “PPP” and such rule, the “Rule”). As described in greater detail in our previous client alerts, SBA “Paycheck Protection” Loan Program Under the CARES Act and Small Business Administration and Department of Treasury Publish Paycheck Protection Program Loan Application Form and Instructions to Help Businesses Keep Workforce Employed, the Program provides $349 billion to help small businesses impacted by COVID-19 keep their employees on the payroll and their businesses solvent.

To read more, click here.

Spring 2020 effectively brought us two Budgets. There was the “core” Budget delivered on 11 March, setting out medium-term tax and spending plans, and then there has, in effect, been an emergency Budget aimed at dealing with the immediate potential consequences of the COVID-19 coronavirus.

All of the economic forecasts on which the core Budget was based were put together before any significant effects of the COVID-19 coronavirus were fully accounted for, and were therefore essentially out of date at the moment of publication. With recent developments, it is now apparent that the short-term disruption first envisaged will not be short-term at all. The significant longer-term effects will almost certainly be felt in a period of deep economic recession, with many predictions of a considerable shrinking of the UK economy in the second quarter of this year at least, and will likely mean the tax and spending plans set out on 11 March 2020 will lead to an even bigger deficit in the first few years of this decade (at least). It is, however, too early to meaningfully comment on the full long-term effects of the COVID-19 coronavirus.

This alert, therefore, aims to update clients on various key tax-related announcements and developments in Q1 2020 that we consider will be of most interest, mainly unrelated to the COVID-19 coronavirus (including the key proposals in the “core” 2020 Budget).

For our client alert on tax measures in respect of the COVID-19 coronavirus, please see EU Economic and Fiscal Measures.

We hope that you find this alert useful. Please do not hesitate to contact us with any questions or requests for further information.

Table of Contents

A.  UK Budget 2020

1. Review of UK funds regime, including consultation on the tax treatment of asset holding companies in alternative investment fund structures
2. VAT treatment of financial services
3. Changes to Entrepreneurs’ Relief lifetime limit for capital gains tax
4. Consultation on hybrid mismatch rules
5. Notification of uncertain tax treatments for large businesses
6. Tax consequences of IBOR-discontinuation
7. Real estate-specific updates
8. Digital Services Tax

B.  Other Significant Developments

1. International Tax Enforcement (Disclosable Arrangements) Regulations 2020 (DAC6) update
2. COVID-19 coronavirus and internationally mobile workers
3. Cayman Islands added to EU list of “non-cooperative jurisdictions”

C.  Recent Notable Cases

1. Melford Capital General Partner v Revenue and Customs Commissions
2. Blackrock Investment Management (UK) Limited v United Kingdom
3. Assem Allam v HMRC
4. Walewski v HMRC
   

A.  UK Budget 2020

I. Review of the UK funds regime, including consultation on the tax treatment of asset holding companies in alternative investment fund structures

In the course of 2020, the UK government has committed to undertake a review of the UK’s funds regime. In addition to regulatory matters, the direct and indirect taxes to which funds are subject will be considered, “with a view to considering the case for policy changes”. This will include a review of the VAT treatment of fund management fees (as to which, see below), and a consultation regarding the tax treatment of intermediate fund entities (rather than fund vehicles themselves).

The aim of the consultation on intermediate fund entities is to “gather evidence and explore the attractiveness of the UK as a location for intermediate entities through which alternative funds hold assets”. “Alternative funds”, for this purpose, means funds that are “not subject to investor protection regulation” – generally being “closed-end funds that raise capital from sophisticated investors [typically pension funds, insurance companies and sovereign wealth funds]…and invest in…higher risk assets”.

According to the government, the consultation (which will run until 20 May 2020) is a response to representations from the fund industry that there are “barriers to the establishment of these intermediate fund entities in the UK”. Some of the issues cited are specific to particular kinds of funds, while others are more general in nature:

• Credit funds:
  • Distribution treatment for results-dependent interest (including issues in structuring back to back lending arrangements, where returns are intended to track underlying instruments); and
  • The relative narrowness of the UK’s securitisation regime;
• Real estate funds:
  • The trading condition to the UK’s capital gains participation exemption (the so-called “substantial shareholding exemption”); and
  • Relatively stringent conditions to accessing the UK REIT regime;
• Private equity:
  • Income treatment on the distribution by intermediate holding companies to funds of disposal proceeds from the sale of underlying assets (in particular in the context of share buybacks); and
• General:
  • Administrative burdens in qualifying for exemption from interest withholding tax; and
  • The application of hybrid-mismatch rules to exempt fund investors, and difficulties arising from investors being treated as “acting together” for the purposes of the rules.

The government has confirmed that it is prepared to make legislative changes in response to the consultation, and expressly notes that while it is open to adopting isolated changes, it would also consider a more comprehensive overhaul of the regime. However, there are limits on how far it is willing to go. The consultation stresses (a) that the government is not willing to make changes which would take income or gains outside the scope of UK  tax in a manner which is “inconsistent with the overall principles of the UK tax system” and (b) that any such changes must be compatible with the UK’s international obligations under the OECD BEPS project and the UK’s obligations in respect of state aid.

In particular, it is worth noting that the government has called for evidence of how the UK’s regime compares to other jurisdictions, and whether/how the problems identified in the UK are addressed elsewhere. This may perhaps indicate that the UK government’s inclination is to match, but go no further than, its competitors. Although not expressly mentioned, an example which will surely inform their thinking is Luxembourg, which has a mature and generous regime for intermediate holding companies (featuring no withholding tax on interest, and a broad participation exemption for dividends and capital gains) and a well-functioning supporting infrastructure. Following the wide-spread adoption of the OECD’s Multilateral Instrument (with its principle purpose test and ever more stringent substance requirements), the trend within the funds industry has been to accumulate holding vehicles in a single jurisdiction, in order to achieve a critical mass. If the UK wishes to compete with, and lure funds away from, Luxembourg and other investment hubs, it is hoped that the government will be ambitious in its thinking.

II. VAT treatment of financial services

Wider exemption for SIF management

The UK government has published legislation providing for a wider VAT exemption for the management of so-called “Special Investment Funds” (“SIFs”). Conditions for close-ended collective investment undertakings (“CECIVs”) will be relaxed, and an existing concession for defined contribution pension funds will be codified.

Currently, the exemption for SIFs applies to the management of open ended investment companies, authorised unit trusts and any similar collective investment undertakings competing in the UK retail market (including CECIVs) . However, the management of CECIVs is currently exempt only if its sole object is “the investment of capital, raised from the public, wholly or mainly in securities”.

The new legislation, which takes effect from 1 April 2020, broadens the fund management exemption on two fronts:

• A concession applying to the management of “qualifying pension funds”, which has been in place since 2014, will now be put on legislative footing. The exemption will now apply to the management of funds meeting the following conditions:
  • The pension fund must be established in the UK or an EU member state, and funded solely (either directly or indirectly) by the pooled contributions of those entitled to benefit from distributions from the pension fund (so-called “members”); and
  • The members must bear investment risk, which must be spread over a range of investments. Accordingly, the exemption would not apply to the management of defined benefit, as opposed to defined contribution, pension schemes.
• To qualify for the exemption, CECIVs will no longer need to invest “wholly or mainly in securities”. This change is timely, in light of the recent AG opinion in Blackrock Investment Management (UK) Limited v. United Kingdom C-231/19 (discussed below). If apportionment of consideration between exempt and non-exempt supplies proves not to be possible, the UK’s move to widen what constitutes a SIF may increase the likelihood of mixed supplies being characterised as predominantly exempt. Whether that is good news, or bad, will depend on the circumstances of the particular taxpayer.

Review of VAT treatment of fund management fees and financial services

As part of a broader review of the UK funds regime, the UK government intends to “consider the VAT treatment of fund management fees”. In addition, an industry working group “to consider the VAT treatment of financial services” more generally will be created.

No detailed information has yet been published regarding the precise issues to be considered as part of this review.

EU laws already give member states relatively broad latitude regarding the scope of the VAT exemption for fund management, by granting discretion in determining what constitutes a “SIF”  (as to which, see further above). However, the above could suggest that the UK intends to implement a more wide-ranging overhaul. It remains to be seen whether, in a bid to maintain its attractiveness as a location for fund management and financial services, the UK will (at the end of the Brexit transitional period) exercise its new freedom to depart from EU VAT rules. Whatever route is chosen, it is hoped that the government will be mindful of the potential compliance burden for pan-European businesses in navigating different regimes, and that any changes will be either easy to administer, or sufficiently material to outweigh such hindrance.

III. Changes to Entrepreneurs’ Relief Lifetime Limit for Capital Gains Tax

After much speculation in the run up to the Budget, Entrepreneurs’ Relief (“ER”) escaped abolition. However, its utility has been much reduced, via an immediate reduction in the lifetime limit from £10 million to £1 million. As changes to the scope of the relief were widely expected, special measures have been introduced to defeat planning done in anticipation.

In practical terms, the changes will result in a reduction of the maximum relief available from £1 million to £100,000 for individuals who realise gains that qualify for ER (i.e. in view of the 10% rate of capital gains tax that applies in respect of the lifetime limit when the conditions are met).

Perhaps the most interesting aspect of the measure is the timing of its introduction. The changes will affect disposals taking place on or after 11 March 2020, allowing no time for planning. Generally, those who completed sales to unconnected buyers before 11 March 2020 should be able to benefit from the higher lifetime limit. However, this is subject to an important qualification: those who entered into uncompleted sale contracts or certain share exchanges pre-Budget in an attempts to circumvent expected changes to the relief may fall foul of anti-forestalling provisions, and be denied the benefit of the higher lifetime limit.

As a general rule, the time of disposal for capital gains purposes is the time when the contract for sale becomes unconditional (rather than the time of completion). Parties to an uncompleted pre-11 March 2020 sale contract will be subject to the £1 million lifetime limit unless they can demonstrate (a) that no purpose of entering into the contract was to take advantage of this timing rule (in order to circumvent the widely reported narrowing of ER) and, (b) in the case of connected parties, that the contract was also entered into for wholly commercial reasons.

In addition, where shares have been exchanged for those in another company in the period from 6 April 2019 to (and including) 10 March 2020, and an election to crystallise the gain on the exchange (rather than adopt rollover treatment) is made on or after 11 March 2020, the new lifetime limit will apply if, broadly, either:

• the companies whose shares are exchanged are under common control; or
• the consequence of the exchange is that the exchanging shareholders’ proportionate shareholding is increased, and qualifies for ER.

In many ways, it is unsurprising that the Chancellor has opted to reduce the significant cost of the relief, which was £2.3 billion in 2017/18. ER has been a politically unpopular measure among certain sectors of the general electorate, with its benefit concentrated amongst the relatively small pool of persons making material gains. The surprise is perhaps that its scope was limited only after, and not before, the election.

Historically, a significant element of acquisition structuring in the private equity sphere has involved ensuring that target management can benefit from ER on exit. Now that the value of such structuring has been materially diluted, it will be for buyers to decide whether the time and energy such planning requires is still justified. This will likely be a question to be answered on a case by case basis.

As an aside, it’s also worth noting that it has been proposed that ER in its new form will be known as “business asset disposal relief” – a move that has drawn criticism from some quarters on the basis that it does not accurately describe the nature of the relief and may lead to taxpayer confusion.

IV. Consultation on UK hybrid mismatch rules

The UK was an early adopter of the OECD’s proposals on countering hybrid mismatch arrangements, introducing a “gold-plated” domestic regime in 2017 (which in some instances went beyond the BEPS proposals). The mechanical operation of these rules has, however, resulted in unexpected material disallowances for some taxpayers. This is particularly true in the context of US multinationals with UK “check the box” entities – even where there is no UK tax advantage being obtained. A consultation on certain technical aspects of the hybrid rules has been launched,  providing a welcome opportunity for taxpayers to engage with the government to ensure that the rules work proportionately and as intended.  However, it should be noted that the consultation only addresses certain issues with the rules, and other problems and uncertainties remain unresolved for now (including, for example, the interaction of the rules with other parts of the UK tax code dealing with the deductibility of payments, and how the rules might be applied to entities with special tax status, such as UK securitisation companies).

The consultation on the UK hybrid mismatch rules focuses on three areas, as set out below.

Double deduction mismatches

Expenses deducted twice (either in two jurisdictions or by more than one taxpayer) in relation to arrangements where a hybrid entity is involved – for example, where expenses are both deductible for a US parent company and a subsidiary company in the UK treated as a disregarded entity for US federal income tax purposes – may trigger a counteraction under the UK hybrid mismatch rules, such that a UK tax deduction would be denied to a relevant UK entity within scope of the rules. However, no counteraction is required to the extent that the expenses are deducted from so-called “dual inclusion income”. This is broadly intended to refer to the same amounts of income brought into the charge to tax  for different taxpayers. However, there are strict limits as to when amounts so brought into account would qualify. Despite changes made in 2018 (specifically, the introduction of section 259ID Taxation (International and Other Provisions) Act 2010), it is generally recognised that the double deduction rules can often apply more widely than they should, targeting genuinely commercial arrangements where there is no economic mismatch. This is largely due to their formulaic nature, which cannot comprehensively contemplate the nuances of particular non-UK laws. In contrast, the equivalent rules in other jurisdictions (notably Ireland) adopt a more substance-based approach, and seek to filter out arrangements where there is no egregious mismatch.

In addition, HMRC has acknowledged that the “fix” intended to be introduced by section 259ID Taxation (International and Other Provisions) Act 2010 – which broadly can treat amounts paid to an investor in a UK hybrid entity which are then paid on to the UK hybrid entity as dual inclusion income – is narrow in its application.

In the absence of amendments to the UK rules, many affected taxpayers would have no choice but to take laborious steps to restructure their operations only to preserve the same net economic outcome – something which may adversely impact long-term inbound investment into the UK. It seems that HMRC may have come to recognise this – although questions in the consultation regarding the barriers to such restructurings suggest that there may be limits on how far they are willing to go.

The following example illustrates one scenario we have encountered that poses problems in connection with the double deduction rules (where section 259ID TIOPA 2010 does not obviously apply on the particular facts): Potential issues: UK Subsidiary always – in economic terms – has an accounting profit of £5. By denying a deduction for third party expenses, UK Subsidiary would be required to pay UK corporation tax on profits it does not economically have. Even if UK Subsidiary was a regarded entity for US federal income tax purposes, it would still have £5 of accounting profit in the UK. The fact that UK Subsidiary is treated as a disregarded entity for US federal income tax purposes means that US Parent is not permitted to recognise its true economic outlay of £105 in calculating its profit for US federal income tax purposes (rather it is restricted to the £100 of expense incurred by UK Subsidiary).  Conversely, were UK Subsidiary to be a regarded entity for US federal income tax purposes, US Parent would theoretically be entitled to deduct its full economic outlay of £105 in calculating its taxable profit for US federal income tax purposes. Therefore, the hybridity of UK Subsidiary produces no economic mismatch or undesirable “double dipping” of tax deductions in the UK and the United States.

Acting together

Broadly, in the absence of “structured arrangements”, the hybrid rules will only apply where parties to the arrangements are connected. In applying this test, parties who are “acting together” will be deemed to be connected. The purpose is to prevent otherwise unconnected parties from working together or being used to circumvent the effect of the rules. Nevertheless, the consultation acknowledges that the test can throw up practical difficulties (e.g. as a result of difficulties in obtaining sufficient information about counterparties’ structures to assess whether the deeming provisions apply). HMRC has therefore called for evidence of circumstances where taxpayers feel the impact of the deeming provisions should be modified. Fund structures may well provide ample raw material, with the risk of limited partners being considered to act together constituting a frequent cause of concern.

The consultation states that if the rules were tweaked to narrow the scope of the “acting together” provisions, the targeted anti-avoidance rules would apply to non-commercial arrangements put in place to benefit from the changes. Additionally, it would still be necessary for taxpayers to consider whether they may be party to “structured arrangements” (and hence still subject to the application of the rules).

Exempt investors in hybrid entities

An expense in a UK company would not typically be disallowed if the payment is made directly to an exempt investor (e.g. a pension fund or sovereign wealth fund). However, where the payment is indirectly made to such exempt investors (e.g. where the payment is made to a fund in which exempt investors are members) there is no equivalent general dispensation. This goes against the overarching intention of the UK tax system to achieve tax neutrality for collective investment, and unduly penalises exempt investors in fund structures featuring entities which are transparent in the UK and opaque in the investors’ jurisdiction. HMRC is consulting on options to improve the operation of the rules, e.g. a “white list” of entities which would not give rise to a counteraction.

V. Notification of uncertain tax treatments for large businesses

From April 2021 large businesses will be required to notify HMRC when they take a tax position which HMRC is likely to challenge.

The proposal is designed to improve HMRC’s ability to identify issues where businesses have adopted a different “legal interpretation” to HMRC’s view. This includes the interpretation of legislation, case-law and guidance. Taxes covered by the proposal include corporation tax, income tax (including PAYE), VAT, excise and customs duties, insurance premium tax, stamp duty land tax, stamp duty reserve tax, bank levy and petroleum revenue tax. Interestingly, one example given by HMRC of a scenario in focus is a disagreement regarding the accounting treatment of a transaction (which is of course different to “legal interpretation”).

The intention is to catch all such “uncertain tax positions”, irrespective of whether they derive from  genuine uncertainty or “with the deliberate intention of pushing the boundaries of the law to their advantage”. There are, however, exceptions.  Only “large” businesses (broadly expected to be those with a turnover above £200million and/or a balance sheet total above £2billion) will be within scope. Notification will not be necessary where (a) a transaction is disclosed under the Disclosure of Tax Avoidance Schemes rules or under DAC6 or (b) the uncertainty is the subject of formal discussion with HMRC or HMRC confirms that it already has sufficient information regarding the uncertainty. Similarly, (although not a formal exemption) HMRC would (unsurprisingly) not consider the rules to bite where they have previously provided clearance and there is no change in facts or circumstances.  It is also proposed that uncertain tax treatments which, individually or combined, amount to a maximum of less than £1million in the tax outcome, will not be notifiable. In terms of practicalities, the administrative and penalty features of the regime will be similar to that of the Senior Accounting Office (“SAO”) regime. In particular, one individual within affected organisations will need to take personal responsibility for ensuring compliance (or potentially face personal penalties).

HMRC draws an analogy between the proposal and similar assessments which must be made for accounting purposes (namely in accordance with IFRIC23). It is notable, however, that (in contrast with the accounting-based obligations) uncertainty is defined by reference to the likelihood of HMRC, and not the courts, disagreeing. Comparisons are also made to existing notification obligations in the US and Australia. Those regimes, however, are more closely aligned with accounting judgments (as well as being narrower in scope and subject to higher thresholds regarding the tax at stake). Justification is, at least, offered for HMRC’s approach: the measure is, apparently, not intended to promote any assumption that HMRC’s interpretation is always correct, nor that HMRC is a final arbiter of disputes relating to tax law. HMRC’s intention is instead to identify areas of disagreement and accelerate discussions with taxpayers. It may, however, equally be construed as a wielding of soft power, and an addition to HMRC’s already substantial information gathering powers. It remains to be seen whether HMRC is leaning in its thinking towards more formal regulation of tax advisers, potentially raising interesting parallels with financial services regulation.

VI. Tax consequences of IBOR discontinuation

It is expected that, from the end of 2021, London interbank offered rates (“LIBORs”), which are used as reference rates in the loan, bond and derivatives markets, will cease to be published. Instead, these rates are to be replaced with ‘nearly risk free’ benchmark rates (“RFRs”). Similar processes are occurring with other benchmark rates e.g. EONIA. The UK government has launched a consultation calling for information from taxpayers regarding “tax issues that arise from the reform of LIBOR and other benchmark rates”.

The most significant tax concerns in respect of this transition relate to so-called “legacy contracts” – existing contracts with a term beyond the end of 2021 which will need to be amended to reflect the switch-over. It is generally accepted that, despite efforts to minimise resultant value transfers, they cannot be completely avoided. At the same time as the consultation document was released, HMRC published draft guidance addressing some of the resultant issues:

1. Parties to legacy contracts that are subject to corporation tax are generally taxed in accordance with their accounts. The transition may result in amounts being recognised in the profit or loss statement for accounting purposes, either as a result of a “modification” to the instrument, or because the conditions to hedge accounting are no longer met. In addition, although not expressly mentioned by HMRC, increased hedge ineffectiveness going forward may also result in profit and loss recognition. Accounting relief may be available in respect of some of these impacts. However, if not, the draft guidance notes that “where amounts are recognised in the income statement, these will typically be brought into account for tax purposes”.
2. For certain tax purposes, it is necessary to consider whether interest constitutes more than a reasonable commercial return (e.g. distribution provisions, grouping provisions, the stamp duty/SDRT loan capital exemption) or an arm’s length provision (e.g. transfer pricing). If this question had to be assessed by reference to prevailing rates at the time of amendment, the revised interest rate could fall foul of the relevant provisions. Helpfully, it seems that HMRC generally considers that these questions can be answered by reference to the position when the legacy contracts were first entered into.
3. If sufficiently material, amendments could be treated as giving rise to the end of the legacy contract, and the creation of a new contract. This could jeopardise any grandfathering the taxpayer relies on, and require clearances obtained in respect of the legacy contract to be refreshed. The draft guidance indicates that generally, amendments won’t be treated as giving rise to new contracts.

However, for (b) and (c), the guidance indicates that favourable treatment will, to varying degrees, depend on the extent to which the amendments change the economics between the parties. This is particularly unhelpful in two regards: first, it introduces an element of value judgment and uncertainty and second, the degree of value transfer which HMRC considers acceptable seems to vary depending on the context (exacerbating the problem).

Although the guidance will go some way in easing taxpayer concerns regarding tax issues arising from benchmark transition, there are notable concerns on which the draft guidance is silent.  Most significantly, the draft guidance (which is noted as applying only to businesses) does not confirm whether (for individuals, for example) amendments to contracts could give rise to a disposal for capital gains tax purposes. This will make it particularly difficult for those who have issued notes referencing LIBOR into retail markets to pursue consent-solicitation processes (to amend the notes). Moreover, timing remains an issue. Regulators have indicated that, generally, the COVID-19 coronavirus pandemic will not impact the transition timetable, and financial institutions in particular are coming under increasing pressure from government bodies to amend legacy contracts. In the absence of final guidance from HMRC, taxpayers may be forced to do so without certainty of tax treatment.

The consultation document, the draft guidance and potential issues which are yet to be resolved will be discussed in further detail in an upcoming Gibson Dunn client alert.

VII. Real estate-specific updates

For real estate, this year’s Budget is neither as hostile nor dramatic as previous years. Rather, with Budget 2020, HMRC seem (for the most part) to be content to tinker with existing measures. That has, in general, produced something of a mixed bag – with both good news, and bad, to be found.

Structures and Buildings Allowance

Businesses that incur qualifying expenditure on the construction, renovation or conversion of non-residential structures and buildings on or after 29 October 2018 may claim Structures and Buildings Allowances (“SBA”). The annual rate of SBA will increase from 2% to 3% from 1 April 2020 for corporation tax purposes, and 6 April 2020 for income tax purposes. While the change is certainly modest, it is nevertheless welcome.

Corporation tax on non-UK resident companies with UK property income

Non-UK resident companies with UK property income have traditionally been liable to income tax – not corporation tax – on net rental profits. However, as previously announced, from 6 April 2020, these profits will instead become liable to corporation tax – with resulting differences in the applicable rates, computational rules, and payment and filing requirements.

Broadly, going forward:

• corporation tax will be levied at 19% (instead of the 20% rate of income tax);
• expenses of management should be deductible (which was not possible under the income tax rules);
• surrenders of losses between such non-residents and UK resident group members will now be possible;
• financing arrangements will be subject to the loan relationship rules, with net debits and credits being calculated separately before being set-off against rental profits.

There are, however, downsides, including potential restrictions on:

• the deduction of interest and other finance costs under the hybrid mismatch rules (if applicable) or the corporate interest restriction (which broadly limits deductions in excess of £2 million per group to 30% of EBITDA as a default position, subject to available exemptions and elections);
• the use of carried forward income and capital losses (which, cannot be set-off against more than 50% of profits exceeding £5 million in any year). However, pre-6 April 2020 property rental losses can still be carried forward for use against future profits without restriction.

More practically, existing income tax withholding provisions under the non-resident landlord scheme (the “NRLS”) will continue to apply, unless the non-UK resident company has permission to be paid gross (notwithstanding that amounts withheld will be within the corporation tax regime).

To facilitate a smooth transition to the new regime, changes announced in the Budget include  a number of technical changes to the legislation facilitating the above changes. These include a new ability to obtain relief for financing costs incurred in the seven years prior to its carrying on a UK property business.

New Stamp Duty Land Tax surcharge for non-UK residents

From 1 April 2021, a 2% Stamp Duty Land Tax surcharge will apply where non-UK residents purchase residential property in England and Northern Ireland. The changes will impact non-UK resident trusts and companies, as well as individuals, and it is expected that commercial purchases of residential developments will be within scope. The change follows a consultation last year. More details about the proposed scope of the new measures will likely be available when the responses to the consultation are published later this year.

The rate increase is the most recent in a series of reactive moves by HMRC against non-residents investing in the UK property market. While it appears that the UK government is interested in seeking inward investment (as to which, see the forthcoming review of the funds regime mentioned above), the welcome will not, it seems, be extended to all equally. It remains to be seen whether the economic impact of the COVID-19 coronavirus, and the impending need to jump-start the economy thereafter, will result in a softening of HMRC’s stance. However, a U-turn seems unlikely.

Construction Industry Scheme domestic reverse charge

The construction industry scheme (“CIS”) requires contractors (including “deemed contractors”) to withhold tax from payments to their sub-contractors, and account for the money to HMRC. The amount withheld may then be applied against certain of the sub-contractors’ tax and national insurance contribution liabilities (potentially resulting in refund payments). The government is introducing measures which will tighten the evidentiary requirements sub-contractors will need to meet before deductions can be so applied against their tax and national insurance liabilities. Specifically, HMRC will reduce or deny the credit claimed by the sub-contractor against employment tax liabilities if the sub-contractor is unable to evidence the deductions. New measures will also simplify the rules covering those who are deemed to be contractors, clarify the rules on allowable deductions for expenditure on materials, and expand the scope of the penalty for supplying false information when registering for CIS. In addition, the government has  published a consultation regarding the promotion of supply chain due diligence, including proposals for tackling fraud in supply chains.

HMRC clearly has abuse within the construction industry (whether real or perceived) within its sights. It has already consulted on measures for tackling fraud in the industry, resulting in the proposed VAT domestic reverse charge for building and construction services, although it is to be noted that the implementation of the reverse charge has been delayed until 1 October 2020 (and it remains to be seen whether it will be deferred again). It is to be hoped that any further measures taken are proportionate, and will not result in an excessive administrative burden for a sector which will likely suffer a significant downturn during the COVID-19 coronavirus pandemic.

VIII. Digital Services Tax

The Finance Bill 2020 includes draft legislation in respect of the new 2% tax on revenues of large businesses that provide a social media service, search engine, or online marketplace to UK-based users. The UK digital services tax will apply from 1 April 2020.

The UK’s digital services tax will be discussed in detail in an upcoming Gibson Dunn client alert.

B.   Other Significant Developments

I. International Tax Enforcement (Disclosable Arrangements) Regulations 2020 (DAC6) update

Final regulations implementing DAC6 in the UK were published on 13 January 2020. DAC6, is the most recent EU reporting regime and requires promoters and “service provider” intermediaries to report details of certain cross-border tax arrangements that feature one or more “hallmarks”. Such arrangements are captured where the first implementation step was made on or after 25 June 2018, although first reporting will be due in August 2020. It is not clear whether the reporting timetable will be delayed because of the COVID-19 coronavirus pandemic.

In January 2020, UK regulations implementing Directive (EU) 2018/822 (the “Directive”) were published. Even though the UK has officially left the EU, it is still legally obliged to implement the EU Directive properly and, therefore, the scope of the UK rules closely follows that of the EU Directive. Any deviation from this would mean the UK would not meet its international obligations and could also lead to potential differences in the approaches of the UK and other countries.

The government has acknowledged that the Directive is wide and HMRC has, in some instances, indicated a willingness to take helpful positions (where the wording of the Directive allows). This is reflected in some interpretations adopted by HMRC in draft guidance (most recently published in March) . However, such guidance does not carry the force of law and is not binding on HMRC. It will only – at best – outline HMRC’s (current) interpretation of the rules and provide insight into HMRC’s (current) practical approach to the regulations. While it can, of course, be useful, it should be treated with caution.

As there is no legislative framework for taxpayers to exercise any control over the information which is reported by intermediaries, taxpayers may wish to consider whether it is necessary to put contractual arrangements in place to maintain some oversight over the process.

The first DAC6 reports are due to be made by taxpayers in August this year. In light of the recent COVID-19 coronavirus pandemic, requests have been made to HMRC from numerous trade bodies for this reporting timetable to be delayed. However, such matters would need to be decided at an EU level, and Brexit negotiations may limit the government’s willingness to make requests of the EU at this time. Another difficulty for the UK government with delaying the timetable is its stated public policy and the risk of appearing lenient on perceived tax avoidance (however misunderstood) whilst upholding pledges to further reduce the tax gap through additional compliance activity.  Nevertheless, calls for a delay to the reporting timetable are being made from all corners of the EU and Gibson Dunn is following any and all developments closely.

II. Impact of COVID-19 coronavirus measures on internationally mobile workers

Travel restrictions implemented in response to the COVID-19 coronavirus outbreak raise concerns regarding the tax implications of persons being stranded in unintended places. For businesses, there may be possible consequences for corporate residency, permanent and VAT establishments, transfer pricing apportionment, controlled foreign company attributions and employment taxes. Individuals may also have concerns about residency and their own employment tax liabilities.

With lockdowns announced around the world due to the COVID-19 coronavirus pandemic (including in the UK on 23 March 2020) travel has been severely curtailed and business practices are having to change accordingly. The physical location of people – of course – is a critical factor in determining where tax should be paid for cross-border businesses. These restrictions may therefore have implications across a wide range of potential taxes (particularly if maintained for material periods):

• Corporate tax residency: Broadly, a company will be UK tax resident if it is either (a) incorporated in the UK or (b) centrally managed and controlled in the UK (which is typically determined by reference to where the board of directors, or others involved in high-level strategy setting, make decisions). If directors of non-UK companies take decisions from the UK, there is a risk that they may render the relevant companies UK tax resident. Conversely, where entities are not incorporated in the UK and maintenance of UK tax residence is dependent on board meetings being held in the UK, the inability of non-UK resident directors to travel may jeopardise UK tax residence. Companies that either acquire or lose their usual corporate tax residency status are also at risk of suffering exit charges. Companies should also take care to check their articles of association which may include protocols to preserve tax residency e.g. restrictions on directors holding board meetings or participating by telephone or other electronic means from certain locations.
• Permanent establishments and VAT establishments: The requirement for employees to switch to remote working due to mandatory office closures may inadvertently create a permanent establishment (for corporation tax purposes), or a VAT fixed establishment, if employees are forced to work from jurisdictions in which their employer does not already have a place of business.
• Substance requirements: There is a risk that substance requirements may not be met where, as a result of lockdowns, employees (and in particular key employees) are unable to work from the jurisdiction in which their usual workplace is located.
• Transfer pricing allocations and controlled foreign company rules: The application of both sets of rules depends on significant people functions being located in particular jurisdictions. As with substance, this is not necessarily a question of quantity, and the absence / presence of certain critical persons for a sustained period could have an impact.
• Employment tax: Rules governing (a) the income tax and national insurance contributions payable by employees, (b) employer liabilities for national insurance contributions and (c) employer obligations to operate PAYE withholding, depend, to varying degrees, on:
  
  
  
  • the tax residence of the individual, which is itself generally determined by reference to the number of days spent in a particular jurisdiction in a given year; and
  
  
  • the location in which the employee’s duties are carried out and whether such duties are “incidental”.
  
  
  
  

  Both employees and their employers will therefore be concerned about the risk of employees exceeding relevant thresholds.

  
  

Certain jurisdictions, such as Ireland and Australia, have issued guidance allaying taxpayer concerns about most (if not all) of the above issues. To address residency concerns, the Luxembourg authorities have enacted legislation enabling Luxembourg resident companies to hold virtual board meetings, which will be deemed to have been held at the company’s registered office. Meanwhile, authorities in Jersey and Guernsey have published guidance confirming that economic substance will not be jeopardised by changes in operating practices arising from coronavirus restrictions.

In contrast, HMRC has, thus far, remained silent on most of the above issues. Its only (minimal) concession to date has been to allow (subject to certain conditions) a maximum grace period of 60 days’ physical presence in the UK in applying statutory residence tests where individuals are stranded here due to COVID-19 coronavirus-related travel restrictions. It is hoped that more expansive guidance will be forthcoming.

Gibson Dunn is seeking HMRC’s confirmation on certain issues raised in this section. If there are specific concerns you would like us to address, please contact a member of the Gibson Dunn tax team.

III. Cayman Islands added to EU list of “non-cooperative jurisdictions”

On 18 February 2020, it was announced that the EU’s Economic and Financial Affairs Counsel (“ECOFIN”) had added the Cayman Islands to its list of “non-cooperative jurisdictions” (countries which the EU considers to have sub-par tax governance standards). The move stems from the Cayman Islands’ late implementation of “economic substance” requirements for collective investment vehicles.

Many jurisdictions have their own list of “non-cooperative” jurisdictions which mirrors or closely models the EU’s. Addition to such local lists can have significant consequences for those transacting with counterparties in blacklisted jurisdictions. For example, in France, payments to persons resident in non-cooperative jurisdictions may be subject to 75% withholding tax. Moreover, the EU Council has invited member states which haven’t yet implemented defensive measures (such as withholding tax, and denial of deductions, on payments made to blacklisted jurisdictions) to do so by 1 January 2021. On March 25, the Luxembourg government heeded the call, announcing its intention to restrict deductions on payments of interest and royalties to residents in non-cooperative jurisdictions. This suggests that others may well follow.

No such defensive measures have been adopted in the UK and the UK government has not given any indication whether it intends to do so. Accordingly, (for the moment at least) the addition of the Cayman Islands to the blacklist should not have any substantive UK tax implications. However, the addition of the Cayman Islands to the list is relevant to UK (and EU) reporting consequences. Broadly, under DAC6 (see section B.I.) certain cross border arrangements which take place after 25 June 2018 and feature specific “hallmarks” will need to be reported to the tax authorities of the UK and EU member states. One such “hallmark” is the making of deductible payments to associated persons in EU/OECD non-cooperative jurisdictions. It is not necessary for the parties to have a main benefit of obtaining a tax advantage.  However, it is likely that such arrangements involving the Cayman Islands would be reportable in any event under DAC6, based on the “hallmark” that looks at deductible payments to associated persons in jurisdictions which do not impose tax on the receipt of such payments.

It is expected that ECOFIN will next update the blacklist in October 2020, and that the Cayman Islands will, at such time, be removed (although it is unclear whether the ECOFIN timetable may be impacted by the COVID-19 coronavirus pandemic).

C.   Recent Notable Cases

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

In Melford, the UK First Tier Tribunal (FTT) revisited the often controversial subject of holding company VAT recovery – this time, in the context of a private equity fund investment structure. In a victory for the industry, good sense prevailed, and the VAT recovery position of the structure in question was affirmed.

Melford involved the following private equity fund investment structure comprised of two VAT groups:

• The appellant (the “GP”) was the general partner of a private equity fund vehicle (an English limited partnership). For VAT purposes, the activities of a limited partnership are treated as the activities of its general partner. The GP was a member of a VAT group (the “Group”) with the fund’s investment advisor (the “Investment Manager”).
• The fund’s investment holding vehicle held shares in various SPVs which themselves held properties. These entities (“the Portfolio”) formed a second VAT group.

The Investment Manager provided investment management services to the fund (which were disregarded due to the existence of the Group) and the Portfolio (which were standard rated). The fund also provided interest free loans to the SPVs. The GP incurred costs in setting up the fund and providing management services to the SPVs, and applied for full recovery of the associated input VAT.

To obtain full recovery either (a) the relevant costs must be directly related to the provision of taxable supplies or (b) if part of general overheads, the taxpayer must only provide (non-exempt) supplies in the course of an economic activity. The Group’s claim was challenged by HMRC, who contended that (a) the setting up costs were directly related to the fund’s non-economic investment activity and (b) the ongoing management costs were general overheads which should, in light of such non-economic activity, only be partially recoverable.

In particular, HMRC considered that the ECJ judgement in Larentia + Minerva (C-108/14) (which concluded that corporate holding companies’ costs in acquiring subsidiaries are fully recoverable if the holding company provides, or intends to provide, management services to the subsidiaries) should not apply to funds. The FTT disagreed, and found that (a) the setting up costs were directly related to the Group’s economic activity of managing the subsidiaries and (b) the Group was not carrying on a separate non-economic investment activity. Indeed, the FTT appears to have gone further: in noting that the “setting up costs [were] incurred for the purpose of subscribing for shares in or providing loans to [the Portfolio] with the intention of providing the advisory services to them”, the tribunal appears to characterise the loans as part of the Group’s economic activities in managing the Portfolio.

It is not yet known whether HMRC has appealed the FTT’s decision. However, for the moment at least, Melford confirms that the VAT structuring used by the taxpayer (which is widely replicated within the private equity industry) works. Although sometimes considered a “post-completion” issue, for costs incurred in formation/acquisition to be recovered, it must be clear that management services are being (or are intended to be) provided. Best practice is therefore to ensure that a management agreement is in place, and that services are provided thereunder, from the outset.

Looking forward, HMRC’s choice to challenge the Group’s claim may perhaps have given rise to a concern that, after the Brexit transitional period comes to an end, the UK would utilise its new legislative freedom to reverse the effect of Minerva for UK investment structures. However, the almost two year gap between the Melford hearing and delivery of the judgment may perhaps have given HMRC pause for thought; the implication from the Budget documents (see further above) is that the UK wishes to revisit the VAT treatment of financial services in a manner which is competitive, and helpful to taxpayers. It is hoped that, as regards the VAT treatment of the fund management industry, this may indicate an intention on HMRC’s part to play the role of friend, rather than foe.

II. Blackrock Investment Management (UK) Limited v. United Kingdom C-231/19

The Advocate General (“AG”) opinion in Blackrock will be of interest to fund managers providing investors with a mix of exempt and VAT-able supplies (or receiving such mixed supplies from counterparties) – as the AG advised that apportionment of consideration between the two should not generally be possible.

The management of so-called special investment funds (“SIFs”) is exempt for VAT purposes (as to which, see above). The taxpayer (“Blackrock”) predominantly managed SIFs, but it also provided some VAT-able investment advisory services to non-SIFs. A related US entity (“Blackrock US”) provided investment management services to Blackrock in the form of an AI platform known as “Aladdin”. Blackrock applied for a refund of the portion of the VAT thereon attributable to Aladdin’s use in the management of non-SIFs. HMRC denied the claim, arguing that, as Blackrock US had provided a single supply, its characterisation as exempt or taxable could not be bifurcated, and must be determined by reference to its predominantuse.

At HMRC’s request, the UK’s Upper Tribunal (a chamber of the High Court) sought confirmation from the ECJ as to whether the VAT exemption for the management of SIFs justified a departure from general rules preventing bifurcation of single supplies. As is customary, the ECJ’s judgment (which has not yet been delivered) has been preceded by an advisory opinion of the AG. The AG considered that the supply by Blackrock US could not be apportioned, because it was a single indivisible supply, which must be treated uniformly. The conclusion was influenced by the need to interpret exemptions from VAT strictly, but practical considerations also appear to have been a factor: the nature of the supplies provided by Blackrock US did not vary depending on whether they were used in the management of SIFs or non-SIFs. If (as Blackrock suggested) the supply was apportioned by reference to the value of SIF and non-SIF funds under its management (a) the applicable rate of VAT would be subject to constant variation and (b) the management of non-SIFs could be rendered (albeit partially and proportionately) exempt.

If the opinion is followed by the ECJ, the consequences for taxpayers would vary depending on their VAT position. For example, those providing a limited number of taxable services who wish to reduce the cost to their investors may welcome such an approach. In contrast, if fund managers would prefer to improve their VAT recovery position, it is likely to be unhelpful.

However, the opinion does offer a route to a sensible result if care is taken. The AG considered that apportionment would be possible where detailed evidence could be provided that services were provided specifically and solely for SIFs. If followed, the practical (if unintended) impact may well be to offer taxpayers flexibility regarding the characterisation of supplies, by serving to highlight the importance of clear contractual arrangements. Where a mix of exempt and taxable supplies are to be made/received, if it is obvious that they are exclusively or predominantly exempt (or alternatively, taxable) then a single contract should suffice – and may perhaps be preferable, depending on the circumstances. However, if not, (while supplies should not be artificially split) it may be advisable to contract for the supplies separately.

III. Assem Allam v HMRC

In Assem Allam, the FTT (a) rejected the application of a strict numerical threshold when assessing whether non-trading activity was “substantial” for the purposes of Entrepreneurs’ Relief and (b) concluded that the transactions in securities (“TiS”) rules (which re-characterise capital receipts as income in certain circumstances) did not apply, as the transaction was undertaken for commercial reasons – notwithstanding that it could have been structured in a manner which attracted more tax.

Dr Allam transferred his shares in a property holding company (which undertook some development activities) to another entity he owned. He claimed Entrepreneurs’ Relief (“ER”) (which reduces the rate of capital gains tax to 10%) in respect of the transfer. HMRC denied the relief, arguing that the company transferred was not a trading company (as is required for ER) and that the TiS rules applied to re-characterise the disposal proceeds as income.

Entrepreneurs’ Relief

To claim ER on the disposal of shares, the company being transferred must not undertake “substantial” non-trading activities. HMRC guidance considers that “substantial” means more than 20% by reference to certain measures (e.g. income, asset-base, expenses incurred, time spent by employees). In finding that the condition was not met, the FTT looked to neither HMRC’s 20% threshold, nor Dr Allam’s suggested 50% threshold, noting “that there is no sanction in the legislation for the application of a strict numerical threshold”. Instead, the tribunal considered the question on first principles, concluding that words must be given “their ordinary and natural meaning in their statutory context” and that substantial should mean “of material or real importance in the context of the activities of the company as a whole”.

HMRC’s guidance had not offered a true safe harbour (in that a subjective weighing of the above-mentioned factors was required). However, by denying taxpayers the comfort of an objective threshold, the judgment will increase uncertainty (particularly where a company’s non-trading activities would fall below the 20% threshold on all measures). It remains to be seen whether the same approach will be applied in other legislative contexts where “substantial non-trading activities” are relevant (e.g. the UK’s capital gains participation exemption / “SSE”). More generally, the judgment serves as a reminder that HMRC guidance should be treated with some caution. In the event of conflict, it will be the terms of the relevant legislation, and not necessarily HMRC’s interpretation of it, which will be determinative.

Transactions in securities rules

For the TiS rules to apply, the taxpayer must have a tax avoidance motive. In this respect, Mr Assam relied on his commercial purposes for the transfer (e.g. the desire to group the two companies for corporation tax purposes and extract cash for his retirement). HMRC argued that Mr Assam would nevertheless have a tax avoidance motive if the transaction was deliberately structured in a manner which resulted in a smaller tax liability (as against alternative structures).

HMRC’s stance was aggressive, in light of existing case law which confirms that taxpayers are not obliged to structure their affairs so as to incur the maximum amount of tax. Although the FTT rejected HMRC’s argument, it was less than robust in defending this principle. The tribunal concluded that “the mere fact that there exists an alternative means of undertaking a transaction which has a different tax result is not conclusive of the question as to whether an inference can be drawn that the obtaining of an income tax advantage was a main purpose of the transaction” (emphasis our own) and that “in a particular case, the fact that [such] an alternative transaction existed and was perhaps considered but rejected, may be a factor in deciding whether or not [such] an inference can be drawn”. The judgement could be interpreted as an unfortunate watering down of the meaning of tax avoidance.

The decision to bring the case may well be a worrying indication that HMRC’s stance towards tax planning is growing ever-less tolerant. More concerning, however, is the suggestion that taxpayers may no longer be able to rely on established case law to protect them from HMRC’s most severe positions; regrettably, it appears that outcomes will turn on the particular facts, rather than long-held principles.

IV. Nicolas Walewski v HMRC [2019] UKFTT 0058

The mixed partnership rules are anti-avoidance measures which prevent individuals from diverting their partnership profit share to the corporate partners they control (so that income may be taxed at the lower corporation tax rate). These rules were examined for the first time by the FTT in Walewski.  The FTT found in HMRC’s favour, concluding that the rules applied to reallocate profits from a company the taxpayer was director of, to the taxpayer himself.

In Walewski, the taxpayer was an investment advisor. He provided his services to clients through two LLPs, of which he was an individual member and employee. A UK company (“UKCo”), of which the taxpayer was an employee and director, was a second member of the LLPs. UKCo was indirectly owned by an offshore trust established for the benefit of the taxpayer’s children, but from which he could not benefit. As provided for by the partnership deeds of the LLPs, c. 99% of the profits were (directly or indirectly) distributed to UKCo, which in turn distributed them to the offshore trust.

Reallocation under the mixed partnership rules occurs, broadly, when (a) the profits allocated to a corporate partner exceed the notional return attributable to services or capital the corporate partner provides to the partnership and (b) it is reasonable to suppose that the excess allocation is attributable to an individual partner, via their power to enjoy the corporate partner’s profits. HMRC argued that both these tests were met, such that the profits allocated to UKCo should be reallocated to the taxpayer in his capacity as an individual member of the LLPs. The FTT agreed with HMRC.

The FTT considered that it was not possible to attribute UKCo’s allocation to its capital contribution (which was not significant) or the services provided by UKCo (via the taxpayer) to the LLPs. There was “no commercial, physical or temporal separation of the [taxpayer’s] activities”, so they could not be characterised merely as services provided to the LLPs in his capacity as employee of UKCo. As there was no commercial justification for the excessive allocation to UKCo, it was reasonable to suppose that it was attributable to the taxpayer’s power to enjoy the profits (and hence, to the services provided by the taxpayer to the LLPs directly). The FTT was unconvinced by the taxpayer’s argument that he did not have power to enjoy UKCo’s profits as he was a mere employee; his indirect power to enjoy them via the overseas trust to which his children were entitled was sufficient.

The case emphasises the importance of clear contractual arrangements supporting the provision of services in mixed fund structures. The capacity in which persons are acting when they provide services to the fund must be apparent – both as a matter of contract, and in practice. In this respect, where possible, simplicity should be favoured. Tiers of service providers may well result in boundaries being blurred in practice, running the risk that contractual arrangements may not be respected if tested before the courts. Moreover, where profit allocations exceed the amount attributable to capital or services, a clear commercial justification must be evidenced. This should be considered at the outset, and should not merely follow enquiries from HMRC. That being said, existing mixed fund structures should test their arrangements, and ensure that they are comfortable that allocations are justifiable, and not liable to fall foul of the mixed partnership rules.

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

Sandy Bhogal – London (+44 (0) 20 7071 4266, [email protected])
Ben Fryer – London (+44 (0)20 7071 4232, [email protected])
Panayiota Burquier – London (+44 (0)20 7071 4259, [email protected])
Bridget English – London (+44 (0)20 7071 4228, [email protected])
Fareed Muhammed – London (+44(0)20 7071 4230, [email protected])

© 2020 Gibson, Dunn & Crutcher LLP

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

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.

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UNITED STATES

Department of Labor Issues Temporary Regulations for Families First Coronavirus Response Act

On April 1, 2020, the Wage and Hour Division (the “Division”) of the U.S. Department of Labor posted a temporary rule relating to the paid leave provisions of the Families First Coronavirus Response Act (the “FFCRA”), which was enacted to provide additional paid leave to employees in light of the novel coronavirus (“COVID-19”) pandemic. These temporary regulations expand on the additional guidance provided by the Division over the weekend, which took the form of additional questions and answers on the Division’s FFCRA Q&A website. Below, we provide an overview of the Division’s temporary regulations and additional guidance. For a summary of the Division’s prior guidance on the FFCRA paid leave provisions—the Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Expansion Act (the “Emergency FMLA Expansion Act”)—see Gibson Dunn’s March 26, 2020 update here.
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What Is an “Essential Business”? New York and California Take Different Approaches

As the coronavirus (COVID-19) pandemic continues, state and local jurisdictions across the country have issued unprecedented directives restricting in-person business operations in order to minimize the spread of the virus. New York and California illustrate two differing approaches to this novel issue. In this rapidly changing environment, businesses with operations in multiple jurisdictions must look carefully—and continuously—at the orders applicable to each jurisdiction to determine whether and to what extent their business operations and obligations may be affected.
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© 2020 Gibson, Dunn & Crutcher LLP

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

As the coronavirus (COVID-19) pandemic continues, state and local jurisdictions across the country have issued unprecedented directives restricting in-person business operations in order to minimize the spread of the virus.  New York and California illustrate two differing approaches to this novel issue.  In this rapidly changing environment, businesses with operations in multiple jurisdictions must look carefully—and continuously—at the orders applicable to each jurisdiction to determine whether and to what extent their business operations and obligations may be affected.

As discussed in more detail in our March 20, 2020 Client Alert, “New York Governor Andrew Cuomo Introduces New Executive Order Restricting Non-Essential Business Activity,” New York Governor Andrew Cuomo issued an executive order, effective March 22 at 8:00 p.m. through April 19, requiring businesses to keep 100 percent of their workforce at home.  “Essential businesses” are exempted from this order.  The New York State Department of Economic Development (“ESD”) has provided guidance outlining twelve categories of essential businesses, most of which relate to health, safety, and transportation.  The in-person restriction for non-essential businesses is subject to extension by future executive orders.

In contrast, California’s approach to restricting non-essential business activity has been directed at the local level, with counties and cities issuing their own orders and guidance first in the absence of, and now in addition to, orders at the state level.  Santa Clara, San Francisco, San Diego, and Orange counties lead the way by declaring local states of emergency as early as February 10, 2020, and Governor Gavin Newsom followed with a statewide declaration of emergency on March 4, 2020.  On March 16, 2020, the Health Officers of San Francisco, Santa Clara, San Mateo, Marin, Alameda, Santa Cruz, and Contra Costa counties and the City of Berkeley issued first-in-the-state orders directing residents to shelter in place except to engage in certain essential activities and to work for essential business and government services.  On March 31, 2020, the Bay Area counties issued new Orders, strengthening and clarifying the restrictions initially imposed, and extending them through May 3, 2020.  The Bay Area orders, which closely mirror one another, define approximately twenty categories of essential businesses that may continue to operate at this time (see San Francisco’s Order here).  Per the County Orders, essential businesses include, among other things, healthcare operations, grocery stores and other suppliers of food and consumer goods, media services, financial institutions, laundromats, and transportation services necessary for essential activities.  While essential businesses are “strongly encouraged” to remain open, they must scale down operations to their essential components only, maximize the number of employees who work from home, and implement a “Social Distancing Protocol.”

On March 19, 2020, Governor Gavin Newsom issued Executive Order N-33-20, which required all Californians to “stay home or at their place of residence except as needed to maintain continuity of operations of the federal critical infrastructure sectors” as outlined by the U.S. Department of Homeland Security Cybersecurity and Infrastructure Security Agency (CISA).  CISA’s guidance, which the Governor’s order incorporates, broadly lists sixteen critical infrastructure sectors considered vital to the population’s health and well-being.  (See our April 1, 2020 Client Alert, “The Cybersecurity and Infrastructure Security Agency of the Department of Homeland Security Updates Essential Critical Infrastructure Workforce Guidance” for details of how this guidance has been revised).  On March 22, 2020, the California State Public Health Officer issued its own list of “Essential Critical Infrastructure Workers,” which is almost identical to CISA’s guidance in its descriptions of essential personnel.  Cities and counties throughout the state continue to issue their own orders and guidance to local businesses, including through lists of Frequently Asked Questions posted on their websites.

The New York ESD guidance and California Public Health Officer guidance, like that adopted by states nationwide, broadly overlap in which businesses are deemed essential.  For example, both states consider the food and agriculture sector essential, including most services in the food supply chain.  Restaurants are restricted to take-out or delivery only, but are not required to close entirely.  Likewise, the health care and public health sector, including services and products in the supply chain, is broadly exempt from work from home restrictions.  In addition, essential services, infrastructure, and manufacturing are considered essential, as are certain financial institutions such as banks.  Both states permit individuals to leave their homes for fresh air or exercise—as long as people practice social distancing, but fitness centers and gyms are closed.

Despite broad overlap between New York and California, businesses are advised to decide for themselves if their operations qualify (in full or in part) under each applicable state and local order as “essential” and whether they are obliged to close.  The orders and guidance are rife with nuances that merit consideration.  For example, construction is one ambiguous area where the New York and California approaches may depart.  Although originally wholly exempted in New York, revised ESD guidance now exempts only non-essential emergency construction and essential construction, which includes “roads, bridges, transit facilities, utilities, hospitals or health care facilities, affordable housing, and homeless shelters.”  However, even non-essential emergency construction and essential construction must cease if these operations cannot maintain social distancing and safety best practices.   In California, the State Public Health Officer’s March 20, 2020 directive views “[w]orkers who support . . . construction of critical or strategic infrastructure”; “construction material suppliers”; and “Construction Workers who support the construction, operation, inspection, and maintenance of construction sites and construction projects (including housing construction)” to be essential.  Many of the Counties’ Orders take a narrower view.  For example, the Bay Area counties’ March 31 orders further restricted construction beyond what was originally permitted, in response to perceived abuse and a lack of compliance by residential and commercial developers.  Now, the Bay Area counties permit only projects immediately necessary with respect to Essential Infrastructure, projects associated with healthcare operations, construction of affordable housing or shelters, and construction necessary to ensure that existing residences and essential businesses are safe.  General commercial construction is not allowed.

Notably, the states’ directives differ in the degree to which they govern the employees of essential businesses, with New York businesses granted greater discretion in determining which employees are essential.  California’s state-wide order and Public Health Department guidance are oriented toward workers’ roles, not business functions, and the latter provides detailed guidance on who constitutes the “essential workforce.”  In contrast, New York focuses on business functions.  For business that operate essential and non-essential services, only those operations, and therefore employees, that are necessary to support the essential services are exempt from the New York order.  This latter approach gives businesses greater latitude in defining the essential workforce that may continue to work in-office.

The states also take different approaches to exemptions from and potential punishments for violations of the applicable orders.  In New York, businesses that do not fit within those categories may apply for “essential” status through ESD.  Businesses in violation of the order are subject to civil penalties under section 12 of the Public Health Law.  While this order, and further orders and guidance that will likely follow, was issued on the state-level, businesses should expect that certain New York counties may enforce the order more vigorously than others.  In contrast to New York, California does not provide a procedure for non-“essential” businesses to obtain an exemption from the public health orders and continue operating.  Although the state and local orders provides for potential civil and criminal penalties for noncompliance, according to public statements by the Governor and local public officials, the primary goal of the orders is to achieve voluntary cooperation rather than punitive enforcement.  In sum, California’s approach is driven at the local level, with issues such as defining “essential businesses” and enforcement being decided by cities and counties based on community priorities but within the overarching rules set forth by the Governor.  In contrast, the Governor of New York has provided more specific guidance, resulting in less variability among counties.

Additional client alerts focusing on New York State’s executive orders regarding in-person workforce restrictions and guidance on essential businesses exempt from those orders may be accessed here and here.  Gibson Dunn is continuing to monitor developments relating to the restriction of non-essential business activity in various states.  Further developments can be expected to follow in the coming days and weeks.

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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, any member of the firm’s Public Policy Group, or the authors:

Mylan L. Denerstein – Co-Chair, Public Policy Practice, New York

Lauren J. Elliot – New York

Dione Garlick – Los Angeles

Victoria Weatherford – San Francisco

Stella Cernak – New York

Julianne Duran – New York

Emily Black – New York

Alisha Siqueira – New York

© 2020 Gibson, Dunn & Crutcher LLP

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

On April 1, 2020, the Wage and Hour Division (the “Division”) of the U.S. Department of Labor posted a temporary rule relating to the paid leave provisions of the Families First Coronavirus Response Act (the “FFCRA”), which was enacted to provide additional paid leave to employees in light of the novel coronavirus (“COVID-19”) pandemic.[1]  These temporary regulations expand on the additional guidance provided by the Division over the weekend, which took the form of additional questions and answers on the Division’s FFCRA Q&A website.[2]  Below, we provide an overview of the Division’s temporary regulations and additional guidance.  For a summary of the Division’s prior guidance on the FFCRA paid leave provisions—the Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Expansion Act (the “Emergency FMLA Expansion Act”)—see Gibson Dunn’s March 26, 2020 update here.

Application of FFCRA Paid Leave to Furloughed Employees and Closed Worksites

As we noted in our March 26 update, the Division’s initial March 24 guidance left open the question of whether employers who are covered under the paid leave provisions of the FFCRA—those with fewer than 500 employees—were required to provide paid leave under the FFCRA to employees on furlough or lay off status who had not been terminated.  The Division has now clarified that employers are not required to provide paid sick leave or expanded family and medical leave to furloughed employees or employees whose worksites have closed, even if the employees were furloughed or the worksites were closed after the FFCRA’s April 1, 2020 effective date.[3]  If an employer closes a worksite while an employee is on paid sick leave or expanded family and medical leave, the employer must pay for any such leave that the employee used before the worksite closed, but the employer is not required to provide any further paid sick leave or expanded family and medical leave as of the date of the worksite closure.  Further, if the employer closes a worksite but later reopens it, the employer is not required to provide paid sick leave and expanded family and medical leave to employees for the period that the worksite was closed.  The Division’s further guidance notes that employees who are furloughed or subject to worksite closures may be eligible for unemployment insurance benefits and refers employees to https://www.careeronestop.org/LocalHelp/service-locator.aspx for further information.[4]

The Division also clarified that employees who have been laid off or furloughed and have not subsequently been reemployed do not count toward the 500-employee threshold for determining employer eligibility under the FFCRA.[5]

Qualifying Reasons Under the Emergency Paid Sick Leave Act

The temporary regulations provide additional detail as to what constitutes a qualifying reason to take paid sick leave under the Emergency Paid Sick Leave Act.

First, employees may take paid sick leave under the Emergency Paid Sick Leave Act if the employee “is subject to a Federal, State, or local quarantine or isolation order related to COVID-19.”[6]  The temporary regulations clarify that a “quarantine or isolation order” can include a broad range of governmental orders, including “quarantine, isolation, containment, shelter-in-place, or stay-at-home orders issued by any Federal, State, or local government authority that cause the Employee to be unable to work.”[7]

Second, employees can take paid sick leave under the Emergency Paid Sick Leave Act if they have been advised by a health care provider to self-quarantine due to concerns related to COVID-19.  The advice to self-quarantine must be based on the health care provider’s belief that the employee has COVID-19, may have COVID-19, or is particularly vulnerable to COVID-19.  Further, the self-quarantine must prevent the employee from working—that is, if employees can telework during the self-quarantine, they are not eligible for paid sick leave.  An employee is able to telework if (a) the employer has work for the employee to perform; (b) the employer permits the employee to perform that work from home; and (c) there are no extenuating circumstances, such as serious COVID-19 symptoms, that prevent the employee from performing that work.[8]

Third, paid sick leave is available to employees who are experiencing symptoms of COVID-19 and who are seeking a medical diagnosis.  The temporary regulations explain that qualifying symptoms are fever, dry cough, shortness of breath, or other COVID-19 symptoms identified by the U.S. Centers for Disease Control and Prevention.  Additionally, the paid sick leave taken for this reason must be limited to the time the employee is unable to work because he or she is taking affirmative steps to obtain a medical diagnosis, such as making, waiting for, or attending an appointment for a test for COVID-19.  An employee waiting for the results of a test who is able to telework may not take paid sick leave under this provision unless there are extenuating circumstances, such as serious COVID-19 symptoms, that prevent the employee from teleworking.  An employee who is not able to telework while awaiting a test result may continue to take paid sick leave under this provision.[9]

Fourth, an employee can take paid sick leave where the employee is unable to work because he or she needs to care for an individual who is either subject to a quarantine or isolation order or who has been advised by a health care provider to self-quarantine.  To qualify under this provision, the “individual” must be the employee’s immediate family member, a person who regularly resides in the employee’s home, or a similar person with whom the employee has a relationship that creates an expectation that the employee would care for the person if he or she were quarantined or self-quarantined.[10]

Fifth, paid sick leave is available to an employee who is caring for his child if the child’s school or place of care has been closed, or the child care provider is unavailable, due to COVID-19 precautions.  Employees are eligible for paid sick leave under this provision only if no other suitable person is available to care for the child.[11]

Finally, an employee is eligible for paid sick leave if the employee is unable to work because the employee is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services in consultation with the Secretary of Treasury and the Secretary of Labor.[12]  Neither the temporary regulations nor the updated Q&As provide additional detail about what constitutes a “substantially similar condition” under this provision.

Interaction with FMLA Leave

An employee’s eligibility for expanded family and medical leave under the Emergency FMLA Expansion Act depends on how much FMLA leave the employee has already taken during the 12-month period used by the employer for FMLA leave.

Under the FMLA, eligible employees are entitled to 12 workweeks of unpaid leave during a 12-month period due to (1) the birth of a child or placement of a child with the employee for adoption or foster care; (2) the need to care for a spouse, son, daughter, or parent who has a serious health condition; (3) a serious health condition that makes the employee unable to perform the essential functions of his or her job; or (4) any qualifying exigency arising out of the fact that a spouse, son, daughter, or parent is a military member on covered active duty.[13]

Under the Emergency FMLA Expansion Act, eligible employees—those who are unable to work due to the need to care for children because the children’s school or place of care has been closed or child care provider is unavailable—are entitled to a total of 12 workweeks of expanded family and medical leave between April 1, 2020 and December 31, 2020.[14]  The first two weeks of leave under the Emergency FMLA Expansion Act are unpaid, while the remainder of the 12 weeks of leave must be paid at a rate of two-thirds of the employee’s regular rate of pay for 40 hours per week for full-time employees, or, for part-time employees, the number of hours the employee is normally scheduled to work over that period.[15]

The Division has clarified that the Emergency FMLA Expansion Act provisions do not change the overall amount of FMLA leave employees can take during an applicable FMLA 12‑month period.  For example, if an employee took four weeks of FMLA leave in February 2020 to recover from a surgical procedure, the employee would be entitled to take up to eight weeks of expanded family and medical leave under the Emergency FMLA Expansion Act, rather than the full 12 weeks.  Conversely, if an employee has not taken any FMLA leave in the 12-month period used by the employer for FMLA leave and elects to take all 12 weeks of expanded family and medical leave to care for his children who are out of school due to COVID-19, that employee would not be entitled to any additional FMLA leave for the remainder of the 12-month period.[16]  In addition, employees are limited to a total of 12 weeks of expanded family and medical leave under the Emergency FMLA Expansion Act even if the applicable time period (April 1 to December 31, 2020) spans two 12-month leave periods under the FMLA.  For example, if an employer’s 12-month period begins on July 1 and an eligible employee took seven weeks of expanded family and medical leave in May and June 2020, the employee could only take up to five additional weeks of expanded family and medical leave between July 1 and December 31, 2020, even though the first seven weeks of expanded family and medical leave fell in the prior 12-month period.[17]

Unlike with expanded family and medical leave, eligible employees under the Emergency Paid Sick Leave Act—for example, employees who are subject to a Federal, State, or local quarantine or isolation order related to COVID-19 or who have been advised by a health care provider to self-quarantine due to concerns related to COVID-19—are entitled to paid sick leave regardless of how much leave they have taken under the FMLA.  However, if an employee takes paid sick leave concurrently with the first two weeks of expanded family and medical leave (which would otherwise be unpaid), then those two weeks do count toward the 12 workweeks to which eligible employees are entitled under the FMLA.

Telework and the FFCRA

In response to the COVID-19 pandemic, many employees are now working from home, or “teleworking.”  The temporary regulations clarify that telework is work for which normal wages must be paid and is not compensated under the paid leave provisions of the FFCRA.  In addition, under federal law as interpreted by these rules, employees who are teleworking must be compensated for all hours actually worked and which the employer knew or should have known were worked.[18]

The temporary regulations also clarify that the FLSA’s continuous workday rule does not apply to teleworking under the FFCRA.  The continuous workday rule generally provides that all time between performance of the first and last principal activities is compensable worktime.[19]  However, the Department of Labor has determined that an employer allowing employees to telework during the COVID-19 pandemic will not be required to count as hours worked all time between the first and last principal activity the employee performed while teleworking.  This means that if an employee teleworks from 9:00 am to 12:00 pm and then again from 3:00 pm to 5:00 pm, the employer must compensate the employee for the hours actually worked (five hours) but not for all eight hours between the employee’s first principal activity at 9:00 am and her last principal activity at 5:00 pm.[20]

The Division further clarified that if an employer permits teleworking but an employee is unable to telework for a qualifying reason under the FFCRA (if, for example, the employee who is teleworking is caring for a child whose school or place of care is closed), then the employee is entitled to take leave under the FFCRA.  However, if the employee is able to telework while caring for a child, paid sick leave and expanded family and medical leave are not available.[21]

Intermittent Work

While an employee is teleworking, the employer and employee may agree to allow the employee to take intermittent paid sick leave or expanded family and medical leave.  Employees may take intermittent leave in any increment agreed upon by the employer and employee.[22]

However, to discourage conditions that may exacerbate the spread of COVID-19, the Division notes that the ability of an employee to take intermittent leave while working at the employee’s usual worksite is more limited.  Once the employee begins taking paid sick leave for any qualifying reason other than caring for a child whose school or place of care is closed, the employee must continue taking paid sick leave each day until (1) the employee uses the full amount of paid sick leave, or (2) the employee no longer has a qualifying reason for taking paid sick leave.  But if an employee is taking paid sick leave to care for a child whose school or place of care is closed, the employee and employer may agree that the employee can take paid sick leave intermittently, in any increment.  The Division provides the following example:  if any employee’s child is at home because his place of care is closed or his child care provider is unavailable, the employee may take paid sick leave on Mondays, Wednesdays, and Fridays, but work at the employee’s normal worksite on Tuesdays and Thursdays.[23]

The Division encourages employers and employees to memorialize in writing any agreement relating to intermittent leave arrangements, but notes that this is not a requirement and that “a clear and mutual understanding between the parties is sufficient.”[24]

Recordkeeping

The temporary regulations provide that employees taking paid sick leave under the Emergency Paid Sick Leave Act must provide their employers with documentation in support of their sick leave.  Employees must provide written requests for paid leave under the FFCRA that include (1) the employee’s name; (2) the date or dates for which leave is requested; (3) a statement of the COVID-19 related reason for which the employee is requesting leave; and (4) a statement that the employee is unable to work (or telework) for that reason.[25]  In the case of a leave request based on a quarantine order or self-quarantine advice, the employee must include the name of the governmental entity ordering quarantine or the name of the health care professional advising self-quarantine.[26]

If an employee takes paid sick leave or expanded family and medical leave to care for a child whose school or place of care is closed, the statement from the employee should include the name of the child to be cared for, the name of the school that has closed or place of care that is unavailable, and a representation that no other person will be providing care for the child during the period for which the employee is receiving leave.[27]  The employer may request that an employee provide additional material as needed for the employer to support a request for tax credits pursuant to the FFCRA.[28]

An employer may require an employee to follow reasonable notice procedures to inform the employer of the employee’s need to take paid sick leave or expanded family and medical leave.  The employer may require notice after the first workday or portion thereof for which an employee takes such leave, but may not require notice in advance.  Whether a notice procedure is reasonable is determined under the facts and circumstances of each particular case.  If an employee fails to give proper notice, the employer should provide notice of the failure to the employee and an opportunity to provide required documentation prior to denying the request for leave.[29]

Employers must retain all documentation provided by employees for four years, regardless of whether leave was granted or denied.  Employers also must document any oral statements provided by an employee to support his or her request for leave.  If an employer denies an employee’s request for leave pursuant to the small business exemption, the employer must document its authorized officer’s determination that the prerequisite criteria for the exemption are satisfied and retain such documentation for four years.[30]

Private employers providing paid leave under the FFCRA are eligible for reimbursement of the costs of that leave through refundable tax credits, and should retain appropriate documentation in order to claim those tax credits.  Additional information about these requirements can be found on the Department of Treasury website here.

All existing certification requirements under the FMLA remain in effect if an employee is taking leave for one of the existing qualifying reasons under the FMLA.

Returning to Work After FFCRA Leave

The temporary regulations clarify that the FFCRA requires that employers provide the same or equivalent job to an employee who returns to work following paid sick leave or expanded family and medical leave under the FFCRA.  However, employees are not protected from employment actions that would have affected them regardless of whether they took leave.  For example, an employee who is on leave under the FFCRA can be laid off for legitimate business reasons, such as closure of a worksite.  The employer must be able to demonstrate that the employee would have been laid off even if the employee had not taken leave.[31]

An employer may also refuse to return an employee who took leave under the FFCRA to work in his or her same position under the following circumstances:

(1)       the employer has fewer than 25 employees;

(2)       the employee took leave to care for his or her child whose school or place of care was closed; and

(3)       all of the following hardship conditions exist:

(a)        the employee’s position no longer exists due to economic or operating conditions that affect employment and that are caused by the COVID-19 emergency;

(b)        the employer made “reasonable efforts” to restore the employee to the same or an equivalent position;

(c)        the employer makes “reasonable efforts” to contact the employee if an equivalent position becomes available; and

(d)       the employer continues to make “reasonable efforts” to contact the employee for one year beginning either on the date the leave related to COVID-19 reasons concludes or the date 12 weeks after the employee’s leave began, whichever is earlier.[32]

In addition, an employer may refuse to return an employee who took leave under the FFCRA to work in his or her same position if the employee is a highly compensated “key” employee as defined in the FMLA (which requires, among other things, specific advance notice to that employee) and if such denial is necessary to prevent “substantial and grievous economic injury to the operations” of the employer.[33]

Supplementing Paid Leave Provided by the FFCRA

As discussed previously, the first two weeks of expanded family and medical leave are unpaid, but employees may choose to take paid sick leave under the Emergency Paid Sick Leave Act during those two weeks.  The Division’s initial guidance did not address whether employees may simultaneously take paid sick leave under the Emergency Paid Sick Leave Act concurrently with any paid leave he or she might have under the employer’s paid leave policy, such as personal leave or paid time off.  The temporary regulations now clarify that, during the first two weeks of unpaid expanded family and medical leave, an employee may not simultaneously take paid sick leave under the Emergency Paid Sick Leave Act and other paid leave to which the employee is entitled under the employer’s policies, unless the employer allows the employee to supplement the amount received from paid sick leave with the employee’s preexisting leave, up to the employee’s normal earnings.[34]

After the first two weeks of expanded family and medical leave, however, employees may elect to take—or employers may require the employee to take—the remaining expanded family and medical leave at the same time as any existing paid leave that would be available to the employee under the employer’s preexisting policies.  If any employer requires an employee to take existing leave concurrently with the expanded family and medical leave, the employer must pay the employee the full amount to which the employee is entitled under the employer’s existing paid leave policy for the period of leave taken, and the employer is not entitled to a tax credit for payment of any leave that exceeds the limits set forth in the Emergency FMLA Expansion Act.[35]

Exclusions

Both the Emergency Paid Sick Leave Act and the Emergency FMLA Expansion Act contain exclusions for certain health care providers and emergency responders, as well as for employees of small businesses (defined as businesses with fewer than 50 employees).[36]  The temporary regulations contain some additional parameters detailing when small businesses and employers of health care providers and emergency responders may avail themselves of these exclusions.

Health Care Providers and Emergency Responders

Employers who employ “health care providers” or “emergency responders” may exclude such employees from being able to take paid leave under the Emergency Paid Sick Leave Act or the Emergency FMLA Expansion Act.  The temporary regulations clarify who qualifies as a “health care provider” and an “emergency responder.”

For purposes of this exclusion, a “health care provider” is “anyone employed at any doctor’s office, hospital, health care center, clinic, post-secondary educational institution offering health care instruction, medical school, local health department or agency, nursing facility, retirement facility, nursing home, home health care provider, any facility that performs laboratory or medical testing, pharmacy, or any similar institution, employer, or entity.”[37]  This includes any permanent or temporary institution, facility, location, or site where medical services are provided that are similar to such institutions.  This definition also includes any individual employed by an entity that contracts with any of the above institutions, employers, or entities to provide services or to maintain the operation of the facility.  Further, the definition includes anyone employed by any entity that provides medical services, produces medical products, or is otherwise involved in the making of COVID-19-related medical equipment, tests, drugs, vaccines, diagnostic vehicles, or treatments.  Finally, the highest official of a state or territory may determine that additional individuals fall within the definition of “health care provider” if those individuals are necessary for that state’s or territory’s response to COVID-19.[38]

An “emergency responder” is an employee who is necessary for the provision of transport, care, health care, comfort, and nutrition of patients, or whose services are otherwise needed to limit the spread of COVID-19.  This includes but is not limited to military or national guard, law enforcement officers, correctional institution personnel, fire fighters, emergency medical services personnel, physicians, nurses, public health personnel, emergency medical technicians, paramedics, emergency management personnel, 911 operators, public works personnel, and persons with skills or training in operating specialized equipment or other skills needed to provide aid in a declared emergency as well as individuals who work for such facilities employing these individuals and whose work is necessary to maintain the operation of the facility.  Again, the highest official of a state or territory may determine that additional individuals fall within the definition of “emergency responder” if those individuals are necessary for that state’s or territory’s response to COVID-19.[39]

The Division encourages employers to be “judicious” when using these definitions to exempt health care providers and emergency responders from the provisions of the FFCRA.

Small Businesses

The FFCRA authorized the Department of Labor to outline an exemption to the paid leave requirements for employers with fewer than 50 employees when providing leave would jeopardize the viability of the small business as a going concern.[40]  In outlining the requirements for this exemption, the Department of Labor guidance states that it may apply only if the employee seeks to use such leave to care for a child whose school or place of care is closed and doing so would jeopardize the viability of the small business as a going concern.  If an employee of a small business seeks to use paid sick leave under the Emergency Paid Sick Leave Act for one of the other qualifying reasons (such as if the employee is subject to a Federal, State, or local quarantine or isolation order related to COVID-19), the employer is not exempt from providing such leave.  Furthermore, a small business may only claim the exemption if an authorized officer of the business makes certain determinations (outlined in the regulations) about the effect of the leave on the business.[41]

Other Guidance

Health Insurance Coverage

If an employer provides group health coverage, employees are entitled to continue such coverage during FFCRA leave.  Employees must continue to make any normal contributions to the cost of their health coverage during this time.[42]

Employment for 30 Calendar Days

Employees are eligible for expanded family and medical leave under the Emergency FMLA Expansion Act only if they have worked for the employer for at least 30 calendar days.  The Division has clarified that employees are considered to have been employed for at least 30 calendar days if the employer has had the employee on its payroll for the 30 calendar days immediately prior to the day the employee’s leave would begin.[43]  As an example, an employee who wants to take leave on April 1, 2020 would need to have been on the employer’s payroll as of March 2, 2020.  If an employee has been working for an employer as a temporary employee and is subsequently hired on a full-time basis, the employee may count any days he or she previously worked as a temporary employee toward this 30-day eligibility period.[44]  Further, an employee who is laid off or otherwise terminated by an employer on or after March 1, 2020, is nevertheless also considered to have been employed for at least 30 calendar days, and therefore eligible for expanded family and medical leave, provided (1) the employer rehires or otherwise reemploys the employee on or before December 31, 2020, and (2) the employee had been on the employer’s payroll for 30 or more of the 60 calendar days prior to the date the employee was terminated.[45]

Definition of “Son or Daughter”

Under the FFCRA, a “son or daughter” is the employee’s own child, which includes biological, adopted, or foster children, stepchildren, legal wards, or children for whom the employee is standing in loco parentis (someone with day-to-day responsibilities to care for or financially support the child).  The Division has clarified that a “son or daughter” is also an adult son or daughter (i.e., one who is 18 years of age or older) who has a mental or physical disability and who is incapable of self-care because of that disability.[46]

Maximum Amount of Paid Sick Leave

Each individual is entitled to a maximum of 80 hours of paid sick leave regardless of whether he or she changes employers during the time in which the Emergency Paid Sick Leave Act is in effect.[47]  In other words, if an employee takes 80 hours of paid sick leave while working for Employer A and then resigns and begins working for Employer B, the employee is not entitled to any paid sick leave from Employer B under the Emergency Paid Sick Leave Act.

FLSA Exemption Status

The temporary regulations clarify that an employee’s use of paid sick leave or expanded family and medical leave will not impact the employee’s status or eligibility for any exemption from the requirements of sections 6 or 7 of the FLSA.[48]  For example, an employee’s use of intermittent leave combined with paid sick leave should not be construed as undermining the employee’s salary basis for purposes of the FLSA.

Multiemployer Collective Bargaining Agreements

Employers that are part of a multiemployer collective bargaining agreement may satisfy their obligations through the Emergency Paid Sick Leave Act and the Emergency FMLA Expansion Act by making contributions to a multiemployer fund, plan, or other program in accordance with the employer’s existing collective bargaining obligations.  These contributions must be based on the amount of leave to which each of the employer’s employees is entitled based on each employee’s work under the multiemployer collective bargaining agreement.  Such a fund, plan, or other program must allow employees to secure or obtain their pay for the related leave they take under the Emergency Paid Sick Leave Act or the Emergency FMLA Expansion Act.  Alternatively, employers may also choose to satisfy their obligations under the Act by other means, provided they are consistent with the bargaining obligations and collective bargaining agreement.[49]

Redress for Refusal to Provide Leave

An administrative complaint alleging any violation of the Emergency Paid Sick Leave Act or the Emergency FMLA Expansion Act may be filed in person, by mail, or by telephone with the Division or any local office of the Division.[50]  The Secretary of Labor has the investigative authority and subpoena authority set forth in the FLSA and FMLA with respect to enforcing these laws.[51]  The temporary regulations provide that employees may file a private action to enforce the Emergency FMLA Expansion Act only if the employer is otherwise subject to the FMLA.[52]

In its updated guidance, the Division also provided a phone number and website for employees who believe their employers are improperly refusing to provide paid leave under the FFCRA.  Employees contacting the Division will be directed to the nearest Division office for assistance with answering questions or filing a complaint.  If the employer employs 50 or more employees, the Division notes that an employee may also file a lawsuit against the employer directly without contacting the Division.[53]

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   [1]   See Department of Labor, U.S. Department of Labor Announces New Paid Sick Leave and Expanded Family and Medical Leave Implementation, https://www.dol.gov/newsroom/releases/whd/whd20200401.

   [2]   See Department of Labor, Families First Coronavirus Response Act: Questions and Answers, https://www.dol.gov/agencies/whd/pandemic/ffcra-questions.

   [3]   29 C.F.R. § 826.40(a)(1)(iii); Department of Labor, Families First Coronavirus Response Act: Questions and Answers, https://www.dol.gov/agencies/whd/pandemic/ffcra-questions, at Questions 23-27.

   [4]   See Department of Labor, Families First Coronavirus Response Act: Questions and Answers, https://www.dol.gov/agencies/whd/pandemic/ffcra-questions, at Questions 23-27.

   [5]   29 C.F.R. § 826.40(a)(1)(iii).  For more information about which employees count toward the 500-employee threshold, see Gibson Dunn’s March 26 update.

   [6]   H.R. 6201, Division E, § 5102(a)(1).

   [7]   29 C.F.R. § 826.10(a).

   [8]   29 C.F.R. § 826.20(a)(3).  For purposes of this provision, the Division has adopted the definition of “health care provider” contained in the FMLA, which includes medical professionals who are capable of diagnosing serious health conditions.  This definition is narrower than the definition of “health care provider” used in sections 3105 and 5102(a) of the FFCRA, which are the provisions that allow employers to exempt health care providers and emergency responders from paid leave under the Act.

   [9]   29 C.F.R. § 826.20(a)(4).

[10]   29 C.F.R. § 826.20(a)(5).

[11]   29 C.F.R. § 826.20(a)(6).

[12]   29 C.F.R. § 826.20(a)(1)(vi).

[13]   29 U.S.C. § 2612(a)(1).  Additionally, an eligible employee who is the spouse, son, daughter, parent, or next of kin of a covered servicemember with a serious injury or illness is entitled to 26 workweeks of leave during a single 12-month period to care for the servicemember.  29 U.S.C. § 2612(a)(3).

[14]   H.R. 6201, Division C, § 3102; 29 C.F.R. § 826.23.

[15]   Id.  For both full-time and part-time employees, the amount of pay to which employees are entitled under the Emergency FMLA Expansion Act is capped at $200 per day and $10,000 in the aggregate.  29 C.F.R. § 826.24(a).

[16]   Expanded family and medical leave under the Emergency FMLA Expansion Act is only available until December 31, 2020.  After that date, employees may only take FMLA leave.

[17]   29 C.F.R. § 826.70(e).

[18]   29 C.F.R § 826.10(a).

[19]   See 29 C.F.R. § 790.6(a).

[20]   29 C.F.R § 826.10(a).

[21]   29 C.F.R § 826.20.  In separate guidance relating to the notice requirements under the FFCRA, the Division clarified that employers may satisfy the notice-posting requirement for employees who are teleworking by emailing or direct mailing the notice to employees, or posting it on an employee information internal or external website.  See Department of Labor, Families First Coronavirus Response Act Notice – Frequently Asked Questions, https://www.dol.gov/agencies/whd/pandemic/ffcra-poster-questions.

[22]   29 C.F.R. § 826.50.

[23]   See Department of Labor, Families First Coronavirus Response Act: Questions and Answers, https://www.dol.gov/agencies/whd/pandemic/ffcra-questions, at Question 21.

[24]   29 C.F.R. § 826.50(a).

[25]   29 C.F.R. § 826.100(a).

[26]   29 C.F.R. § 826.100(b)-(c).

[27]   29 C.F.R. § 826.100(e).

[28]   29 C.F.R. § 826.100(f).

[29]   29 C.F.R. § 826.90.

[30]   29 C.F.R. § 826.140.

[31]   29 C.F.R. § 826.130.

[32]   The regulations do not elaborate on what constitutes the “reasonable efforts” employers need to undertake to restore an employee to the same or similar position or to contact the employee if an equivalent position becomes available.

[33]   29 C.F.R. § 826.130(2).

[34]   29 C.F.R. § 826.70(f).

[35]   29 C.F.R. § 826.160(c).

[36]   H.R. 6201, Division C, §§ 3102, 3105, Division E, §§ 5102, 5111.

[37]   29 C.F.R. § 826.30(c)(1).

[38]   Id.

[39]   29 C.F.R. § 826.30(c)(2).

[40]   See 29 C.F.R. § 826.40(b) for a more detailed discussion of how this determination should be made.

[41]   Id.

[42]   29 C.F.R. § 826.110.  For additional information about employee health insurance coverage under the FMLA, see Department of Labor, Fact Sheet #28A: Employee Protections under the Family and Medical Leave Act, https://www.dol.gov/agencies/whd/fact-sheets/28a-fmla-employee-protections.

[43]   29 C.F.R § 826.30(b).

[44]   Id.

[45]   29 C.F.R. § 826.30(b)(1)(ii).

[46]   29 C.F.R § 826.10(a).

[47]   29 C.F.R. § 826.160(f).

[48]   29 C.F.R. § 826.20(c).

[49]   29 C.F.R. § 826.120.

[50]   29 C.F.R. § 826.152.

[51]   29 C.F.R. § 826.153.

[52]   29 C.F.R. § 826.151.

[53]   See Department of Labor, Families First Coronavirus Response Act: Questions and Answers, https://www.dol.gov/agencies/whd/pandemic/ffcra-questions, at Question 41-42.

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding legal developments related to the COVID-19 outbreak. For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team.

Gibson Dunn attorneys regularly counsel clients on the compliance 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 attorney with whom you work in the Labor and Employment Group, or the following authors:

Catherine A. Conway – Co-Chair, Labor & Employment Practice Group

Amanda C. Machin – Washington, D.C.

Karl G. Nelson – Dallas

Jason C. Schwartz – Co-Chair, Labor & Employment Practice Group

Zoë A. Klein – Washington, D.C.

Greta B. Williams – Washington, D.C.

Charlotte A. Lawson – Washington, D.C.

© 2020 Gibson, Dunn & Crutcher LLP

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

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.

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UNITED STATES

Small Business Administration and Department of Treasury Publish Paycheck Protection Program Loan Application Form and Instructions to Help Businesses Keep Workforce Employed

Yesterday, the Small Business Administration (“SBA”) and U.S. Department of the Treasury published guidance (available here and here) on the Paycheck Protection Program (the “Program” or “PPP”), including an application form and related instructions.  As described in greater detail in our previous client alert, SBA “Paycheck Protection” Loan Program Under the CARES Act, the Program―implemented by the SBA with support from the Department of Treasury―provides $349 billion to help small businesses impacted by the coronavirus keep their employees on the payroll.
Read more

COVID-19 & International Trade – Nation-State Responses to a Global Pandemic

The COVID-19 pandemic has already had a catastrophic impact on international markets, with far reaching impacts on international trade that will be felt for years to come.  In the short term, government authorities responsible for the regulation of global trade have been hobbled by the rapidly spreading pandemic and its resulting restrictions on their ability to work.  Nevertheless, several early initiatives may serve as a harbinger of things to come, as regulators around the globe act to mitigate the impact of the pandemic on global supply chains and national security.  This client alert provides information on the first visible impacts on and changes to export controls, tariffs, foreign direct investment regulations, and sanctions and respective enforcement.
Read more

The Cybersecurity and Infrastructure Security Agency of the Department of Homeland Security Updates Essential Critical Infrastructure Workforce Guidance

On Saturday, March 28, 2020, the Department of Homeland Security’s Cybersecurity and Infrastructure Security Agency (“CISA”) revised its list of “Essential Critical Infrastructure Workers,” which provides expressly non-binding guidance to state and local authorities on identifying their essential workforce during the COVID-19 pandemic. As explained by CISA Director, Christopher C. Krebs, in his memorandum accompanying the agency’s initial March 19 guidance, the list of essential workers was intended to “inform critical infrastructure community decision-making to determine the sectors, sub-sectors, segments, or critical functions that should continue normal operations[.]” CISA’s revised guidance further emphasizes its advisory nature, modifying references to the document as “guidance” in the initial March 19 list to “advisory guidance” in the new version throughout. It is therefore critical that businesses do not rely solely on the guidance in making any determinations about continuing operations, and that they first consult any orders and guidance issued by the states and localities in which they operate.
Read more

Gibson Dunn Pro Bono Newsletter: Coronavirus Response Efforts

During this uncertain time, we are all facing unpredictable and unprecedented challenges. Recent events have impacted every aspect of our daily life, and are already reverberating through the world economy, healthcare system, and much more. Each of us faces individual challenges, as we take care of our children, parents, and loved ones, all while working and trying to take care of ourselves too. During this time, the Gibson Dunn community has been stronger than ever and has been a source of support.

Amidst all this, we have not only looked inward, but we have also looked out into our broader communities and tried to find ways to help those in need. Our pro bono clients are among the most at risk, as they face myriad issues, including the very scary potential health and economic problems applicable to all. As always and perhaps more than ever, Gibson Dunn is committed to providing top-notch legal services to those clients and to our broader communities. We are proud to be helping, among others, immigrants, the elderly, small businesses, and nonprofit organizations that serve these clients.
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UNITED KINGDOM

COVID 19: ESMA Suggests Regulatory Forbearance in Relation to Best Execution Reporting Deadlines

On 31 March 2020, the European Securities and Markets Authority (“ESMA”) issued a public statement to clarify issues regarding the publication by execution venues and firms of best execution reports required by RTS 27 and RTS 28 of MiFID II. This client alert provides an overview of ESMA’s public statement and its consequences for execution venues and firms.
Read more

COVID-19: UK Financial Conduct Authority’s Short Selling Notification Thresholds Amended

The UK Financial Conduct Authority (“FCA”) has made clarifications to its previous announcement on 16 March regarding the European Securities and Markets Authority’s decision concerning temporary amendments to short selling notification thresholds under the Short Selling Regulation. The FCA will now be ready to receive notifications at the lower threshold from 6 April 2020. This client alert provides firms holding net short positions with an overview of the FCA’s new notification thresholds in light of the coronavirus outbreak.
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English Law Force Majeure Clauses: A 4-Step Checklist & Flowchart

Following the publication of Gibson Dunn’s 4-Step Checklist and Flowchart to review and assess force majeure clauses in the context of the COVID-19 pandemic, Gibson Dunn’s London office has prepared a companion 4-Step Checklist & Flowchart to assist with the analysis of force majeure clauses under English law.
Read more

 

On Saturday, March 28, 2020, the Department of Homeland Security’s Cybersecurity and Infrastructure Security Agency (“CISA”) revised its list of “Essential Critical Infrastructure Workers,” which provides expressly non-binding guidance to state and local authorities on identifying their essential workforce during the COVID-19 pandemic.  As explained by CISA Director, Christopher C. Krebs, in his memorandum accompanying the agency’s initial March 19 guidance, the list of essential workers was intended to “inform critical infrastructure community decision-making to determine the sectors, sub-sectors, segments, or critical functions that should continue normal operations[.]”  CISA’s revised guidance further emphasizes its advisory nature, modifying references to the document as “guidance” in the initial March 19 list to “advisory guidance” in the new version throughout.  It is therefore critical that businesses do not rely solely on the guidance in making any determinations about continuing operations, and that they first consult any orders and guidance issued by the states and localities in which they operate.

The original March 19 list identified essential workers in 14 industry sectors: (1) Chemical; (2) Communications and Information Technology; (3) Critical Manufacturing; (4) Public Works; (5) Defense Industrial Base; (6) Law Enforcement, Public Safety, First Responders; (7) Energy; (8) Financial Services; (9) Food and Agriculture; (10) Other Community-Based Government Operations and Essential Functions; (11) Healthcare/Public Health; (12) Hazardous Materials; (13) Transportation and Logistics; and (14) Water and Wastewater.

Since CISA released the initial guidance, state and local governments have relied upon it to varying degrees in implementing shelter-in-place and business closure directives.  Many states, including Hawaii, Indiana, Minnesota, North Carolina, and California, have expressly incorporated CISA’s guidance into their orders, often defining the types of workers and businesses that may continue physical operations based at least in part on the CISA list.  Other states, such as Washington, have not expressly incorporated CISA’s list into any definitions in their orders, but have mimicked language from the CISA list, or, in the case of Pennsylvania, represented on the state’s website that its governing business closure orders conform with CISA’s guidance.  On the other hand, states such as Virginia and New Jersey do not appear to have made any explicit references to the CISA guidance in implementing their stay-at-home orders.

The revised guidance adds three news sectors to the list: (1) “Commercial Facilities,” encompassing workers supporting the supply chain of various commercial appliances relating to plumbing, ventilation, and refrigeration, among other things; (2) “Residential/Shelter Facilities and Services,” encompassing workers responsible for leasing residential properties, handling property management, and providing animal shelter and elderly care services, among others; and (3)  “Hygiene Products and Services,” encompassing workers who provide laundry and dry cleaning services, produce hygiene products, and install, maintain, and manufacture water heating equipment, among other things.  The revised list also expands the types of workers enumerated in the original 14 sectors.  For example, the “Public Works” sector has been revised to the “Public Works and Infrastructure Support Services” sector, newly encompassing HVAC technicians, landscapers, and “any temporary construction required to support COVID-19 response.”  And the “Energy” sector has been broadened to specify workers supporting the energy sector through renewable energy infrastructure and nuclear re-fueling operations, as well as workers involved in manufacturing and distributing equipment necessary for production at energy sector facilities.  Accordingly, we anticipate that states relying more heavily on CISA’s guidance may update their own orders and guidance to reflect the broader scope of the March 28 list of “Essential Critical Infrastructure Workers.”

Businesses in states that rely more heavily on CISA’s guidance should consult the revised list and any subsequent adjustments to their state and local orders in making assessments about their physical operations, and in applying for any waivers from such orders to the extent applicable.

Prior client alerts focusing on New York State’s executive orders regarding in-person workforce restrictions and guidance on essential businesses exempt from those orders may be accessed here, here, and here. Gibson Dunn is continuing to monitor developments relating to the restriction of non-essential business activity in various states.  Additional developments can be expected to follow in the coming days and weeks.

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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, any member of the firm’s Public Policy Group, or the authors:

Mylan L. Denerstein – Co-Chair, Public Policy Practice, New York (+1 212-351-3850, [email protected])
Lauren J. Elliot – New York (+1 212-351-3848, [email protected])
Lee R. Crain – New York (+1 212-351-2454, [email protected])
Stella Cernak – New York (+1 212-351-3898, [email protected])
Doran Satanove – New York (+1 212-351-4098, [email protected])

© 2020 Gibson, Dunn & Crutcher LLP

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

The COVID-19 pandemic has already had a catastrophic impact on international markets, with far reaching impacts on international trade that will be felt for years to come.  In the short term, government authorities responsible for the regulation of global trade have been hobbled by the rapidly spreading pandemic and its resulting restrictions on their ability to work.  Nevertheless, several early initiatives may serve as a harbinger of things to come, as regulators around the globe act to mitigate the impact of the pandemic on global supply chains and national security.  This client alert provides information on the first visible impacts on and changes to export controls, tariffs, foreign direct investment regulations, and sanctions and respective enforcement.

1.      The Immediate Impact: Export Restrictions on Medicine, Medical Devices and Personal Protective Equipment

On March 26, the G-20 Leaders issued a statement promising to work together to “facilitate international trade and coordinate responses in ways that avoid unnecessary interference with international traffic and trade,” although many countries around the world have already taken steps to protect their supply of medicines and personal protective equipment (“PPE”).  In the first week of March, France, Germany, Russia and the Ukraine prohibited the export of certain PPE.  By mid-March, the French and German restrictions were replaced by broader European Union regulations prohibiting the export of PPE—regardless of origin—outside of the EU for six weeks.  By late March, India—a nation that is central to the global production of hydroxychloroquine (a medicine under study as a potential COVID-19 treatment)—had prohibited exports of hydroxychloroquine as well as the export of ventilators, sanitizers and surgical masks due to domestic shortages.

The COVID-19 pandemic is the first major crisis to sweep the world since the United Kingdom announced its withdrawal from the European Union on January 31, 2020.  While EU law is still in application in the UK during the transition period, late last year regulators in the United Kingdom limited the export of critical drugs to prevent shortages in the event of a no-deal Brexit.  The UK prohibited the parallel export—here, the practice of buying medicines already on the market in the UK in order to sell them in the European Economic Area (“EEA”)—of certain critical medicines currently being tested for efficacy in treating COVID-19.[1]  On March 20, 2020, over 80 additional medicines used to treat patients in intensive care units were banned from parallel export from the UK in order to seek to ensure uninterrupted supply to NHS hospitals treating coronavirus patients.  Included in this latest list of restrictions are medicines such as insulin, paracetamol, and morphine.  The full list of medicines that cannot be parallel exported from the UK can be found here.  The UK has guidance in place on parallel export and hoarding of restricted medicines.  Parallel export of a restricted medicine risks violation of regulation 43(2) of the Human Medicines Regulations 2012 and potential enforcement action by the Medicines and Healthcare products Regulatory Agency (“MHRA”).

China—which faced an early and devastating outbreak of COVID-19 and is also the primary source of most surgical masks globally—has not prohibited the export of PPE.  Instead, in mid-March China exported medical supplies to assist Italy and Thailand, and in late March sent the first shipment of such supplies to the United States.  Beijing has also been sending teams of medical experts to hotspots around the world to help combat the disease.

The United States has not imposed any immediate restrictions on the export of PPE, medicine or medical devices used to treat COVID-19, despite its own severe shortages nationwide and reports of large quantities of PPE being purchased by foreign buyers.  Indeed, the United States has long depended upon imports of such materials, and efforts to obtain emergency supplies of face masks and other PPE from manufacturers in China were hobbled by the U.S. administration’s efforts to label COVID-19 as the “Chinese” or “Wuhan” virus.  Moving forward, the U.S. Department of Commerce’s Bureau of Industry and Security (“BIS”) has the authority to use the Export Administration Regulation (“EAR”) Short Supply Controls (15 C.F.R. Part 754) to curtail the export of items that may become scarce as the COVID-19 crisis continues.  For example, certain PPE controlled under ECCN 2B352 could be subjected to short supply controls that impose more stringent licensing requirements, prohibit the use of license exceptions that would otherwise apply, or restrict the availability of export licenses.  BIS even has the flexibility to apply the short supply controls to certain PPE or other items that may be designated EAR99 and therefore currently subject to the least restrictive export controls.  BIS can list those EAR99 items on which it wants to impose short supply controls, along with their Harmonized System-based Schedule B commodity numbers, as BIS has done for certain crude oil and petroleum products.  These controls currently only apply to a handful of items unrelated to COVID-19—petroleum products, unprocessed western red cedar, and horses exported by sea for slaughter—but BIS could expand the category of short supply items relatively quickly.

2.      International Trade Regulator Responses

United States

In the United States, most federal agencies with export control or sanctions enforcement authority are continuing to operate, albeit under an expectation of delay in light of widespread teleworking arrangements in force throughout the U.S. federal government.

The U.S. Trade Representative (“USTR”) plays a key role in the trade regulatory process, having already exempted Chinese PPE from duties, including tariffs recently imposed on Chinese imports under Section 301 of the Trade Act of 1974.  Additionally, USTR announced on March 20, 2020 that it would open a new comment period for the public to suggest additional items that should be exempt from the Section 301 tariffs on Chinese imports due to the spread of the coronavirus.  Last week a bipartisan group of senators on the Senate Finance Committee warned the Trump administration against trying to implement a new trade deal with Canada and Mexico too quickly in light of the novel coronavirus outbreak’s impact on U.S. business.  The senators issued a letter to U.S. Trade Representative Robert Lighthizer to back off the White House’s apparent plan to bring the U.S.-Mexico-Canada Agreement into force by June 1, 2020.

BIS is also active with respect to the export controls that apply to vaccine development.  BIS currently controls the export of certain pathogens, viruses, vaccines, medical products, diagnostic kits, personal protective equipment, and equipment for handling biological materials under Categories 1 and 2 of the Commerce Control List (“CCL”).  Notably, certain viruses (including the SARS-related coronavirus associated with the 2002-2003 SARS outbreak) typically are classified as bio-agents and toxins on the CCL, imposing certain restrictions on the manner in which samples and vaccines may be exported as well as certain types of foreign direct investment.  However, BIS has issued guidance clarifying that SARS-CoV-2, the virus that causes COVID-19, is not currently subject to the controls of these categories, removing a potential impediment to international collaboration on the development of a vaccine and treatments.  To further facilitate the provision of important medical equipment to countries or end-users facing shortages during the pandemic, BIS could relax the broad licensing requirements for items classified under Categories 1 and 2 or implement additional favorable licensing policies.  Alternatively, BIS could impose new, more strict licensing requirements on exports of these items or impose less favorable licensing policies—helping to ensure those items remain available for domestic use.

Additionally, BIS can use the 0Y521 series Export Control Classification Numbers (“ECCNs”) to quickly impose unilateral export controls on previously uncontrolled items (e.g., SARS-CoV-2) if BIS determines the item a “significant military or intelligence advantage” or determined there are “foreign policy reasons” supporting restrictions on its export.  A license would be required to export items controlled under the 0Y521 series to any destination, except Canada, and exporters would be prohibited from relying on exceptions to this license requirement that might otherwise be available.  Although these controls would only last one year—which may be sufficient to manage response to COVID-19—they could be moved to a more permanent ECCN before their expiration.  Interestingly, this rarely used export controls tool may be top-of-mind for U.S. regulators.  The Trump administration recently used the 0Y521 series to control AI-enabled geospatial imagery analysis software in response to an imminent national security concern.

The U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”), which administers United States sanctions programs, provided new guidance clarifying the scope of general licenses (regulatory exemptions) which authorize the supply of medicine, medical devices, and other humanitarian goods to assist Iran in coping with its severe outbreak of COVID-19.  OFAC also maintains relatively broad general licenses permitting the export of medicine and medical devices to other sanctioned jurisdictions, including the Crimea Region of Ukraine and Venezuela, as well as general licenses permitting nongovernmental organizations to provide medical aid to North Korea and Syria and to allow certain humanitarian aid and medical research collaborations with Cuba.  These licenses and licensing policies may be relied upon to provide medicine and medical devices as the pandemic spreads.  We are also aware that OFAC is currently reviewing on an expedited basis several COVID-19 related Specific License requests for shipment of goods and services that are not otherwise covered by the general exemptions.  Senior OFAC leadership have indicated that the agency continues to operate at full pace.  Despite broad work-at-home mandates, certain OFAC personnel responsible for enforcing sanctions must operate from secure office locations, limiting their ability to function remotely for the duration of the crisis.   This may explain the agency’s recent spate of designations since the coronavirus crisis began, suggesting that at least the targeting unit at the agency—charged with identifying sanctions targets and compiling dossiers to designate them—has continued its mission at a similar intensity as before the crisis hit.  In fact, on March 31, against the backdrop of both recently increased sanctions and legal pressure against the Maduro regime and a likely significant expansion of COVID-19 cases in Venezuela, the Trump Administration offered the Maduro regime a significant reduction in sanctions in exchange for moving towards a transition government with the opposition.

On March 26, the U.S. Customs and Border Protection (“CBP”) revoked a proposal to allow companies more time to pay import duties during the coronavirus outbreak.  Less than a week after CBP told importers that it would consider delaying tariff payments on a case-by-case basis, the agency issued a new bulletin indicating that no further requests for delayed payment would be accepted.  The CBP’s earlier announcement regarding potential tariff payment delays drew criticism from the U.S. steel industry, which has been among the most forceful advocates for aggressive enforcement of U.S. trade laws.   President Donald Trump has publicly dismissed the idea of tariff reduction as part of his coronavirus strategy, while White House trade adviser Peter Navarro has floated an executive order that will strengthen “Buy American” government procurement rules for drugs and medical devices as a means of reducing the government’s reliance on imports.

Europe

In the EU, at the EU Commission level, offices are broadly closed and all employees in non-critical functions have been ordered to work from home as of March 16, 2020.  So far, this has not had a substantial impact on pending license applications, as EU sanctions and specifically EU (member state) export controls are administered and enforced on a member state level.

At the member state level, the impact of the virus on operations has differed from country to country as—despite alignment efforts—each member state has been impacted by COVID-19 in different ways (with the devastation in Italy and Spain at the extreme end) and states have been reacting to the pandemic on their own schedules and pursuing their own policies (ranging from severe lock-downs in some countries to more limited approaches taken by others, such as Sweden and the Netherlands).  Generally, working from home is not common in many EU member states and thus a certain adjustment period, including related delays on any types of license applications, should be expected.

United Kingdom

On March 20, 2020, the UK Joint Export Control Unit issued a Notice regarding export license handling during the pandemic.  The British government will continue to process export control licenses, but applications for strategic export licenses have been identified as business-critical operations for the Department for International Trade.  The compliance/inspection program will continue, but site audits will be now conducted remotely.

3.      Foreign Direct Investment Regulations:  Protecting National Security in a Pandemic

Numerous countries have strengthened their foreign direct investment (“FDI”) controls in an effort to better protect against national security risks—most recently with respect to the use and development of sensitive technologies and data.  In the coming weeks and months—especially if depressed asset prices spur increased interest in cross-border transactions—we expect regulators around the globe to turn to these restrictions in an effort to protect domestic companies necessary to combat the spread of the virus.  Foreign direct investment regulations—already robust in many major recipients of foreign direct investments, and nascent in many other states—may be used to fend off acquisitions from foreign firms.  Critically, as much of the western world imposes strict lockdown measures, China has made moves to restart economic activity, raising concerns that distressed foreign assets could be acquired by Chinese companies without appropriate checks and balances.  For example, the Australian government indicated last week that all proposed foreign investments into Australia will be reviewed as the government seeks to protect distressed Australian assets from the economic aftermath of the pandemic.

United States

The national security risks associated with the coronavirus pandemic may implicate the U.S. Committee on Foreign Investment in the United States (“CFIUS” or the “Committee”), an interagency group that is empowered to block or condition foreign acquisitions of U.S. companies involved in manufacturing necessary treatments or supplies.  Proposed foreign acquisitions of U.S. drug manufacturers may require CFIUS review, and CFIUS review requirements may impact bankruptcy proceedings with respect to the sale of distressed U.S. assets.  Furthermore, CFIUS is authorized to review national security risks associated with the foreign acquisition of U.S. companies involved in the production of high-priority goods.  Depending on the extent and duration of the pandemic in the United States, CFIUS may use its authority to prevent the sale of key U.S. suppliers to foreign buyers.

The United States recently expanded the scope of transactions subject to CFIUS review, imposing mandatory filing requirements in certain narrow circumstances.  As we described here, in February 2020 the Committee implemented new regulations formally expanding its authority pursuant to the 2018 Foreign Investment Risk Review and Modernization Act (“FIRRMA”).   Notably, the expanded CFIUS regulations impose a mandatory filing requirement for certain non-controlling investments in life sciences companies that produce, design, test, manufacture, fabricate or develop “critical technologies” used in connection with the biotechnology industry.  Critical technologies include items on the CCL that are controlled agents and toxins covered by 7 CFR part 331, 9 CFR part 121, or 42 CFR part 73, including the earlier strain of SARS-CoV.  As such, foreign investments in U.S. companies working with the novel coronavirus may trigger a mandatory CFIUS filing requirement if the U.S. company manufactures, tests, develops or produces other bio agents classified on the CCL.  CFIUS has taken action against several life sciences and biotechnology firms in recent years, including a proposed transfer of the U.S. operations of a German pharmaceutical company as a part of the German parent company’s sale to a Chinese investor in 2018.  As a result of the Committee’s refusal to clear the originally proposed transaction, the German parent company divested its U.S. operations to an undisclosed U.S. buyer in order to continue with the acquisition.

EU Foreign Investment Screening Process

The president of the EU Commission, Ursula von der Leyen, noted that if Europe is to be as strong after the crisis as it was before, it “must take preventive measures now … to protect [its] security and…economic sovereignty.”  She appealed to EU member states to “make full use of the necessary instruments.”

So far only half of EU member states have comprehensive screening processes for takeovers of strategically important companies.  The EU Commission has called on the remaining EU member states to establish similar regulations as permitted by the Regulation on Establishing a Framework for Screening of Foreign Direct Investments  into the European Union—which we have discussed in detail here.

Below, we elaborate on recent developments in Germany, the EU’s leading exporter and likely bellwether for bloc-wide developments with respect to such restrictions and controls—which we assess will likely be catalyzed by the COVID-19 crisis.

3.1.   German Foreign Investment Control

Like many other companies around the world, the German-based biopharmaceutical company CureVac is currently in the process of researching and developing a vaccine against the novel coronavirus.  In mid-March, it was reported that U.S. President Trump attempted to secure the exclusive rights to CureVac’s work and use the possible vaccine only for the United States.  The company immediately rejected allegations about offers of an acquisition or an exclusive contract with the United States.  However, the fact that the company’s CEO Daniel Menichella was replaced on March 11, 2020 shortly after he had met with Trump and other members of the U.S. administration’s coronavirus taskforce at the White House fueled speculation that an acquisition could in fact be imminent.

This incident sparked a heated debate in Germany, leading CureVac’s majority shareholder Dietmar Hopp (the co-founder of software firm SAP) to state: “Once we … succeed in developing an effective vaccine against the coronavirus, it should reach, protect and help people not only regionally but in the spirit of solidarity around the world.”

Germany’s Federal Secretary of Economic Affairs, Peter Altmaier, praised CureVac’s decision and emphasized, “Germany is not for sale.”  In this context, various German politicians have referred to Germany’s foreign trade law, under which the federal government can examine takeover bids from non-EU “third countries” if national or European security interests are deemed to be at stake.  After company valuations in Europe’s largest economy have been markedly reduced by the coronavirus pandemic, political leaders have made clear that Germany will protect domestic firms from foreign takeovers.  As the state premier of Bavaria, Markus Söder, put it: “If most of Bavaria’s and Germany’s economy ends up in foreign hands once this crisis is over … then it’s not only a health crisis but a profound alteration of the global economic order.”

Judging from the strong reactions by political leadership, COVID-19 will certainly have a profound impact on Germany’s rules on foreign direct investment which the German government was already in the process of tightening.

3.1.1.      Status Quo of the German Foreign Investment Control Process

Under the German rules governing the foreign investment control process[2], the German Federal Ministry for Economic Affairs and Energy (“BMWi” or the “Ministry”) may, among other things, review, restrict or prohibit the acquisition of a direct or indirect interest of 25 percent or more of the voting rights of a domestic company by a foreign investor if the transaction poses a threat to the public order or security in the Federal Republic of Germany.  The law expressly identifies domestic companies such as operators of critical infrastructures (including energy, IT, telecommunications, transport, health, water, food, finance and insurance sectors to the extent they are critical to  the proper functioning of the community), operators of telecommunication systems and providers of surveillance technology and equipment, cloud computing services, providers of telematics services and components as well as media companies as businesses the acquisition of which may be deemed a threat to the public order or security.

The German foreign investment control process provides for even stricter rules if the domestic company develops and modifies software that is sector-specifically used for operating any of the above-mentioned critical infrastructures.[3]  In those cases, the acquisition is already subject to the German foreign investment control process if the foreign investor acquires ownership of 10 percent or more of the voting rights of such German company and the transaction must be reported to the Ministry.

3.1.2.      Current Proposals to Further Tighten the Rules on German Foreign Investment Control

Even before the COVID-19 crisis arose, similar to initiatives underway in the United States, Japan, UK, France and other European states, Germany had been contemplating enhanced scrutiny on foreign investors targeting domestic companies.  On January 30, 2020, the BMWi published a draft bill to reform and tighten the rules governing the German foreign investment control process.  This marks the third major reform of the German FDI rules in less than three years.  Below are the most relevant amendments currently contemplated, and we expect that those amendments will be enacted quickly and potentially sharpened in light of COVID-19:

First, as noted above, the current test is whether the contemplated acquisition constitutes an actual threat to the public order or security of the Federal Republic of Germany.  The draft bill proposes to enhance such scrutiny by lowering the requirements for the test and broadening the Ministry’s scope of discretion by only asking whether the acquisition is likely to affect the public order or security of Germany.

Second, in accordance with Regulation (EU) 2019/452, which we have discussed in detail here, the draft bill also extends the scope of screening to include the public order or security of another EU Member State or of projects or programs of EU interest.

Third, so far the validity of most acquisitions subject to the current German FDI rules (except for acquisitions in the military or IT security sectors, for which stricter rules already apply) is subject only to the condition subsequent that the acquisition will not be prohibited by the Ministry.  Under the newly proposed rules, any acquisition of voting rights in a domestic company that is required to be reported to the Ministry will be rendered invalid as long as it has not received written approval by the Ministry or the review deadline following the proper reporting of the transaction has not expired.  This change will have a major impact on both the certainty of deals and the timing of transactions going forward.

Fourth, the Ministry is planning to define a catalog of critical technologies, for which the reporting requirement as well as the lower 10 percent threshold will apply. Those critical technologies are reported to include artificial intelligence, robotics, semiconductors, biotechnology and quantum technology.  This is part of the German government’s attempt to retain Germany’s technological preeminence.

4.      Conclusion

Despite calls by some in the United Nations—specifically the UN High Commissioner for Human Rights, Michelle Bachelet—to re-evaluate trade restrictions in force against countries dealing with the COVID-19 pandemic, states have by and large not heeded these calls.  Instead, they have responded to the crisis by not only closing their borders to visitors, but also by restricting exports of pharmaceuticals and medical equipment, and in some cases even expanding upon sanctions and other restrictions in place against states dealing with COVID-19.  Further, measures have been undertaken or announced to support and protect their respective economies from damage due to COVID-19 or from foreign takeovers.

Heartening examples of German hospitals accepting COVID-19 patients from France appear to be the exceptions to what threatens to become the rule—unilateralism at all costs, every country for itself.  Once the initial panic regarding the virus fades, we hope to see a return of cooperation, multilateral approaches, and solidarity to fight COVID-19 and its already devastating economic effects.  For the time being, companies, specifically in the health care sector, should expect severe—and likely mounting—challenges to their international trade operations.

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[1]              This restriction has been applied to chloroquine phosphate and lopinavir + ritonavir in all dosages, as well as to hydroxychloroquine in all dosages—medicines that are among the many which are currently under review as potential treatments for COVID-19.  There are exceptions regarding the export of restricted medicines by UK distributors and drug companies if they were initially manufactured to be exported to non-domestic markets.

[2]             For English translations of the German Foreign Trade and Payments Act and Foreign Trade and Payments Ordinance see: https://www.gesetze-im-internet.de/englisch_awg/ and http://www.gesetze-im-internet.de/englisch_awv/.

[3]             For an English convenience translation of the Act on the Federal Office for Information Security defining the “critical infrastructures” see: https://www.bsi.bund.de/SharedDocs/Downloads/EN/BSI/BSI/BSI_Act_BSIG.pdf

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Gibson Dunn, its International Trade Practice Group and its dedicated COVID-19 support team, stand ready to support you in dealing with such challenges.

Authors: Ron Kirk, Judith Alison Lee, Adam M. Smith, Jose Fernandez, Stephanie Connor, Chris Timura, Samantha Sewall and R.L. Pratt (United States); Fang Xue (China); Michael Walther, Markus Nauheim, Richard Roeder (Germany); Patrick Doris and Steve Melrose (United Kingdom); and Nicolas Autet (France); with contributions from Anna Helmer, Karthik Ashwin Thiagarajan, and Prachi Jhunjhunwala (India, Russia, and the Ukraine).

© 2020 Gibson, Dunn & Crutcher LLP

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

 

Yesterday, the Small Business Administration (“SBA”) and U.S. Department of the Treasury published guidance (available here and here) on the Paycheck Protection Program (the “Program” or “PPP”), including an application form and related instructions.  As described in greater detail in our previous client alert, SBA “Paycheck Protection” Loan Program Under the CARES Act, the Program―implemented by the SBA with support from the Department of Treasury―provides $349 billion to help small businesses impacted by the coronavirus keep their employees on the payroll.

At four-pages in length (including instructions), the application form and its related guidance provide new information for small businesses and potential lenders, including that PPP loans will have maturities of two years and an interest rate of 0.5 percent (the CARES Act established only a maximum maturity and interest of 10 years and 4.0 percent, respectively).  Small businesses and sole proprietorships may apply as soon as April 3, 2020, and we strongly advise clients to submit their applications to an approved lender on that day.  Independent contractors and self-employed individuals can apply starting April 10, 2020.  Although the program is open until June 30, 2020, the Treasury Department encouraged businesses to apply quickly “because there is a funding cap.”[1]  Additional assistance may be available through the SBA’s Economic Injury Disaster Loan and Debt Relief Programs; the COVID-19 Economic Injury Disaster Loan Application may be submitted online.

Additional Guidance for Lenders

As the new guidance emphasizes, existing SBA-certified lenders will be given delegated authority to process PPP loans.  Potential new lenders may submit applications to [email protected] and may begin processing loans as soon as they are approved. However, only “regulated lenders” will be “approved and enrolled in the program.”

Once approved and enrolled in the Program, lenders are responsible for verifying that: (1) a borrower was in operation on February 15, 2020; (2) a borrower had employees for whom the borrower paid salaries and payroll taxes; and (3) the dollar amount of average monthly payroll costs.  The guidance notes that the lender must comply with Bank Secrecy Act requirements.  Lenders may not collect any fees from the applicant but will receive a processing fee from the SBA based on the loan balance at final disbursement, ranging from 1.0 percent for loans greater than $2 million to 5.0 percent for loans $350,000 and under.  Agent fees will be paid out of lender fees.  Lenders may also sell loans in the secondary market and the SBA will not collect any fees for any guarantees sold into the secondary market.

Guidance Regarding Loan Forgiveness

The new guidance makes clear that lenders must make decisions on loan forgiveness within 60 days.  The new guidance states that “due to likely high subscription, at least 75 percent of the forgiven amount must have been used for payroll,” which is a limitation that does not appear in the CARES Act.  Accordingly, under this guidance, to be eligible for loan forgiveness, no more than 25 percent of loan proceeds may be used for interest on mortgage obligations, rent, or utility expenses incurred or otherwise obligated before February 15, 2020.  The guidance states that “SBA will forgive loans if all employees are kept on the payroll for eight weeks” beginning on the date of the loan origination, so long as employee and compensation levels are maintained.  As described in our client alert SBA “Paycheck Protection” Loan Program Under the CARES Act, such loan forgiveness may be reduced if employee or salary levels during the eight-week period are not maintained as compared to certain prior periods.  For changes made between February 15, 2020 and April 26, 2020, businesses have until June 30, 2020 to restore full-time employment and salary levels to avoid a loan forgiveness reduction.

Application Form Summary

The application form requires, in addition to certain identifying information, the following preliminary information:

• Business type (non-profit, veteran organization, tribal business, independent contractor, or self-employed).
• Average monthly payroll. The form notes that most applicants will use the average monthly payroll for 2019, excluding costs over $100,000 on an annualized basis for each employee.
• Number of jobs as of the application date.
• Name, Taxpayer Identification Number (“TIN”), and address of all owners with greater than 20% percent ownership stakes.

Applicants are required to select the purpose of the loan including payroll, rent/mortgage interest, utilities and, with explanation, “other.”  All businesses and each 20 percent or greater owner must certify, among other representations, that: (1) the loan is necessary to support ongoing operations (although typical SBA requirements that potential borrowers try to obtain some or all of the loan funds from other sources are waived); and (2) the applicant will not receive another PPP loan during the period beginning February 15, 2020 and ending on December 31, 2020.  All applicants and each 20 percent or greater owner must further certify that they understand that the federal government may pursue criminal fraud charges if funds are used for purposes other than to retain workers and maintain payroll or make mortgage, lease, and utility payments, although we note that these categories are narrower than the permissible uses for loan proceeds under the CARES Act, and that this narrower list aligns more closely with the list of uses with respect to which portions of the loans may be forgiven under the CARES Act.  The Treasury Department emphasizes the point by warning that although there are no personal guarantee requirements, “if the proceeds are used for fraudulent purposes, the U.S. government will pursue criminal charges” (emphasis added).  The signatory of the application, as well as each 20 percent or greater owner, might be subject to criminal penalties for false statements made to obtain a loan under the Program.[2]

In addition, by signing the application form, applicants make certain additional representations, including:

• A commitment to purchasing, “[t]o the extent feasible . . . only American-made equipment and products.”
• Compliance with Occupational Safety and Health Administration (OSHA) requirements both as of the application date and during the life of the loan.
• Compliance with nondiscrimination requirements in any business practice, including employment practices and services to the public on the basis of protected categories. All borrowers must display the “Equal Employment Opportunity Poster” prescribed by SBA.
• That the applicant is not engaged in any activity illegal under federal, state, or local law, and neither borrower nor any of its Associates[3] have within the past three years been (a) debarred, suspended, declared ineligible or voluntarily excluded from participation in a transaction by any Federal Agency; (b) formally proposed for debarment, with a final determination still pending; (c) indicted, convicted, or had a civil judgment rendered against it for any of the offenses listed in the regulations; or (d) delinquent on any amounts owed to the U.S. Government or its instrumentalities as of the date of execution of this certification.

The Application Form makes clear that applicants will be disqualified if:

• Suspension and Debarment. The business, or any of its owners, are presently suspended, debarred, proposed for debarment, declared ineligible, voluntarily excluded from participation in this transaction by any Federal department or agency.  (Question 1.)
• Bankruptcy. The business or any of its owners are presently involved in any bankruptcy.  (Question 1.)
• Loan Loss to the Government. The business or any of its owners (or any business owned or controlled by any of them) caused a loss to the government through a direct or guaranteed loan from SBA or any other Federal agency that is (1) currently delinquent or (2) has defaulted in the last 7 years.  (Question 2.)
• Criminal Proceedings. Any individual or owner with 20 percent or greater ownership in the business is subject to criminal proceedings, such as indictment, criminal information, arraignment, incarceration, probation, or parole.  The application authorizes the SBA to request criminal record information about the applicant (if an individual or an Associate) from criminal justice agencies for the purposes of determining eligibility.  (Question 5.)
• Crimes Against a Minor. Any individual or owner with 20 percent or greater ownership in the business, has within the last seven years, for any felony or misdemeanor for a crime against a minor who have: (1) been convicted; (2) pleaded guilty; (3) pleaded nolo contendere; (4) been placed on pretrial diversion; or (5) been placed on any form of parole or probation (including probation before judgment).  (Question 6.)
• U.S. Citizenship or Residency. Any individual or owner with 20% or greater ownership in the business is not a U.S. citizen or does not have lawful permanent resident status.  (Question 7.)

* * * * *

   [1]   U.S. Department of Treasure, Small Business Paycheck Protection Program Top-Line Overview, available here.

   [2]   Specifically, the Application Form requires applicants and each 20 percent or greater acknowledge that “knowingly making a false statement to obtain a guaranteed loan from SBA is punishable under 18 USC 1001 and 3571 by imprisonment of not more than five years and/or a fine of up to $250,000; under 15 USC 645 by imprisonment of not more than two years and/or a fine of not more than $5,000; and, if submitted to a Federally insured institution, under 18 USC 1014 by imprisonment of not more than thirty years and/or a fine of not more than $1,000,000.”

   [3]   An “Associate” of a small business, although not defined in the instructions, is defined in 13 C.F.R. § 120.10 as (i) An officer, director, owner of more than 20 percent of the equity, or key employee, of the small business; (ii) any entity in which one or more individuals referred to in paragraph (2)(i) of this definition owns or controls at least 20 percent; and (iii) any individual or entity in control of or controlled by the small business (except a Small Business Investment Company (‘‘SBIC’’) licensed by SBA).  For purposes of this definition, the time during which an Associate relationship exists commences six months before the following dates and continues as long as the certification, participation agreement, or loan is outstanding: . .  (iii) For a small business, the date of the loan application to SBA, the CDC, the Intermediary, or the Lender.

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

Authors: Michael D. Bopp, Roscoe Jones, Jr.*, Alisa Babitz, Courtney Brown, Alexander Orr, William Lawrence and Samantha Ostrom

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

© 2020 Gibson, Dunn & Crutcher LLP

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

Dallas parter Krista Hanvey interviewed Haley Taylor Schlitz, a 16 year-old first-year law student, the youngest student to attend Southern Methodist University Dedman School of Law, about her incredible journey thus far. Haley is an author, public speaker and advocate for education equity. Click here to access the interview [16 minutes].