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June 20, 2018 |
Acting Associate AG Panuccio Highlights DOJ’s False Claims Act Enforcement Reform Efforts

Click for PDF On June 14, 2018, Acting Associate Attorney General Jesse Panuccio gave remarks highlighting recent enforcement activity and policy initiatives by the Department of Justice (“DOJ”).  The remarks, delivered at the American Bar Association’s 12th National Institute on the Civil False Claims Act and Qui Tam Enforcement, included extensive commentary about DOJ’s ongoing efforts to introduce reforms to promote a more fair and consistent application of the False Claims Act (“FCA”).  While the impact of these policy initiatives remains to be seen, DOJ’s continued focus on these efforts, led by officials at the highest levels within DOJ, suggests that FCA enforcement reform is a priority for the Department. After giving an overview of several FCA settlements from the last eighteen months—apparently designed to demonstrate that this DOJ recognizes the importance of the FCA in a breadth of traditional enforcement areas—Mr. Panuccio discussed two particular priorities: the opioid epidemic and the nation’s elderly population.  He emphasized that DOJ would “actively employ” the FCA against any entity in the opioid distribution chain that engages in fraudulent conduct.  He then highlighted the crucial role of the FCA in protecting the nation’s elderly from fraud and abuse, citing examples of enforcement against a nursing home management company, hospices, and skilled rehabilitation facilities. The majority of Mr. Panuccio’s remarks focused, however, on policy initiatives DOJ is undertaking to ensure that enforcement “is fair and consistent with the rule of law.”  Mr. Panuccio alluded to general reform initiatives by the department, such as the ban on certain third-party payments in settlement agreements, before expanding on reforms specific to the FCA.  Mr. Panuccio highlighted that the recent FCA reform efforts have been spearheaded by Deputy Associate Attorney General Stephen Cox; Mr. Cox had delivered remarks at the Federal Bar Association Qui Tam Conference in February of this year that had provided insight into the positions articulated in the Brand and Granston memoranda.  In his speech, Mr. Panuccio described five policy initiatives being undertaken by DOJ to reform FCA enforcement: (i) qui tam dismissal criteria; (ii) the use of guidance in FCA cases; (iii) cooperation credit; (iv) compliance program credit; and (v) preventing “piling on.” Qui tam dismissals Mr. Panuccio acknowledged the tremendous increase in the number qui tam cases that are filed each year, which includes cases that are not in the public interest.  Recognizing that DOJ expends significant resources to monitor cases even when it declines to intervene, Mr. Panuccio noted that DOJ attorneys have been instructed to consider whether moving to dismiss the action would be an appropriate use of prosecutorial discretion under the FCA.  While DOJ previously exercised this authority only rarely, consistent with the Granston memo, Mr. Panuccio suggested that, going forward, DOJ may use that authority more frequently in order to free up DOJ’s resources for matters in the public interest. Although defendants generally may not yet be experiencing significant differences regarding the possibility of dismissal at the DOJ line level, the continued public discussion of the potential use of DOJ’s dismissal authority by high-level officials suggests that DOJ appreciates the problems caused by frivolous qui tams and may ultimately be more receptive to dismissal of actions lacking merit. Guidance As stated in the Brand Memorandum, DOJ will no longer use noncompliance with agency guidance that expands upon statutory or regulatory requirements as the basis for an FCA violation.  Mr. Panuccio explained that, in an FCA case, evidence that a party received a guidance document would be relevant in proving that the party had knowledge of the law explained in that guidance.  However, DOJ attorneys have been instructed “not to use [DOJ’s] enforcement authority to convert sub-regulatory guidance into rules that have the force or effect of law.” Cooperation With respect to cooperation credit, Mr. Panuccio indicated that DOJ is working on formalizing its practices and that modifications to prior practices should be expected.  That notwithstanding, Mr. Panuccio provided assurances that DOJ will continue to “expect and recognize genuine cooperation” in both civil and criminal matters.  He also noted that the extent of the discount provided when negotiating a settlement would depend on the nature of the cooperation, how helpful it was, and whether it helped identify individual wrongdoers. Though DOJ’s new policies on cooperation credit are still forthcoming, Mr. Panuccio’s remarks suggest that formal cooperation credit might be expanded to cover situations outside of those in which the defendant makes a self-disclosure. Compliance In recognition of the challenges of running large organizations, DOJ will “reward companies that invest in strong compliance measures.”  How this may differ, if at all, from current ad hoc considerations remains to be seen. Piling On Mr. Panuccio acknowledged that, when multiple regulatory bodies pursue a defendant for the same or substantially the same conduct, “unwarranted and disproportionate penalties” can result. In order to avoid this “piling on,” DOJ attorneys will promote coordination within the agency and other regulatory bodies to ensure that defendants are subject to fair punishment and receive the benefit of finality that should accompany a settlement.  Moreover, Mr. Panuccio remarked that DOJ attorneys should not “invoke the threat of criminal prosecution solely to persuade a company to pay a larger settlement in a civil case,” which really is simply a restatement of every attorney’s existing ethical duty.  Whether DOJ leadership’s interest here will result in significant practical developments is uncertain.  Such developments, though perhaps unlikely, could include eliminating the cross-designation of Assistant U.S. Attorneys as both Civil and Criminal; limiting the ability of Civil Division attorneys to invite Criminal Division lawyers to participate in meetings without the request or consent of defendants; or perhaps even somehow inhibiting the Civil Division from using the FCA, with its mandatory treble damages and per-claim penalties, following criminal fines and restitution. We will continue to monitor and report on these important developments. The following Gibson Dunn lawyers assisted in preparing this client update: Stephen Payne, Jonathan Phillips and Claudia Kraft. Gibson Dunn’s lawyers have handled hundreds of FCA investigations and have a long track record of litigation success.  Among other significant victories, Gibson Dunn successfully argued the landmark Allison Engine case in the Supreme Court, a unanimous decision that prompted Congressional action.  See Allison Engine Co. v. United States ex rel. Sanders, 128 S. Ct. 2123 (2008).  Our win rate and immersion in FCA issues gives us the ability to frame strategies to quickly dispose of FCA cases.  The firm has more than 30 attorneys with substantive FCA expertise and more than 30 former Assistant U.S. Attorneys and DOJ attorneys.  For more information, please feel free to contact the Gibson Dunn attorney with whom you work or the following attorneys. Washington, D.C. F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com) Stuart F. Delery (+1 202-887-3650, sdelery@gibsondunn.com) Joseph D. West (+1 202-955-8658, jwest@gibsondunn.com) Andrew S. Tulumello (+1 202-955-8657, atulumello@gibsondunn.com) Karen L. Manos (+1 202-955-8536, kmanos@gibsondunn.com) Stephen C. Payne (+1 202-887-3693, spayne@gibsondunn.com) Jonathan M. Phillips (+1 202-887-3546, jphillips@gibsondunn.com) New York Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com) John D.W. Partridge (+1 303-298-5931, jpartridge@gibsondunn.com) Ryan T. Bergsieker (+1 303-298-5774, rbergsieker@gibsondunn.com) Dallas Robert C. Walters (+1 214-698-3114, rwalters@gibsondunn.com) Los Angeles Timothy J. Hatch (+1 213-229-7368, thatch@gibsondunn.com) James L. Zelenay Jr. (+1 213-229-7449, jzelenay@gibsondunn.com) Palo Alto Benjamin Wagner (+1 650-849-5395, bwagner@gibsondunn.com) San Francisco Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com)Winston Y. Chan (+1 415-393-8362, wchan@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 14, 2018 |
Revisions to the FFIEC BSA/AML Manual to Include the New CDD Regulation

Click for PDF On May 11, 2018, the federal bank regulators and the Financial Crimes Enforcement Network (“FinCEN”) published two new chapters of the Federal Financial Institution Examination Council Bank Secrecy Act/Anti-Money Laundering Examination Manual (“BSA/AML Manual”) to reflect changes made by FinCEN to the CDD regulation.[1]  One of the chapters replaces the current chapter “Customer Due Diligence – Overview and Examination Procedures” (“CDD Chapter”), and the other chapter is entirely new and contains an overview of and examination procedures for “Beneficial Ownership for Legal Entity Customers” to reflect the beneficial ownership requirements of the CDD regulation (“Beneficial Ownership Chapter”).[2] The new CDD Chapter builds upon the previous chapter, adds the requirements of the CDD regulation, and otherwise updates the chapter, which had not been revised since 2007.  The Beneficial Ownership Chapter largely repeats what is in the CDD Rule.  Both new chapters reference the regulatory guidance and clarifications from the Frequently Asked Questions issued by FinCEN on April 3, 2018 (the “FAQs”).[3]   Other Refinements to the CDD Regulation May Impact the BSA/AML Manual Implementation of the CDD regulation is a dynamic process and may require further refinement of these chapters as FinCEN issues further guidance.  For instance, in response to concerns of the banking industry, on May 16, 2018, FinCEN issued an administrative ruling imposing a 90-day moratorium on the requirement to recertify CDD information when certificates of deposit (“CDs”) are rolled over or loans renewed (if the CDs or loans were opened before May 11, 2018).  FinCEN will have further discussions with the banking industry and will make a decision whether to make this temporary exception permanent within this 90-day period (before August 9, 2018).[4] In his May 16, 2018, testimony at a House Financial Services Committee hearing on “Implementation of FinCEN’s Customer Due Diligence Rule,” FinCEN Director Kenneth Blanco suggested that FinCEN may be receptive to refinements as compliance experience is gained with the regulation.  Director Blanco also indicated that there will be a period of adjustment for compliance with the regulation and that FinCEN and the regulators will not engage in “gotcha” enforcement, but are seeking “good faith compliance.” Highlights from the New Chapters Periodic Reviews:  The BSA/AML Manual no longer expressly requires periodic CDD reviews, but suggests that regulators may still expect periodic reviews for higher risk customers.  The language in the previous CDD Chapter requiring periodic CDD refresh reviews has been eliminated.[5]Consistent with FAQ 14, the new CDD Chapter states that updating CDD information will be event driven and provides a list of possible event triggers, such as red flags identified through suspicious activity monitoring or receipt of a criminal subpoena.  Nevertheless, the CDD Chapter does not completely eliminate the expectation of periodic reviews for higher risk clients, stating:  “Information provided by higher profile customers and their transactions should be reviewed . . . more frequently throughout the term of the relationship with the bank.”Although this appears to be a relaxation of the expectation to conduct periodic reviews, we expect many banks will not change their current practices.  For a number of years, in addition to event driven reviews, many banks have conducted periodic CDD reviews at risk based intervals because they have understood periodic reviews to be a regulatory expectation. Lower Beneficial Ownership Thresholds:  Somewhat surprisingly, there is no expression in the new chapters that consideration should be given to obtaining beneficial ownership at a lower threshold than 25% for certain high risk business lines or customer types.  The new Beneficial Ownership Chapter simply repeats the regulatory requirement stating that:  “The beneficial ownership rule requires banks to collect beneficial ownership information at the 25 percent ownership threshold regardless of the customer’s risk profile.”  The FAQs (FAQ 6 and 7) refer to the fact that a financial institution may “choose” to apply a lower threshold and “there may be circumstances where a financial institution may determine a lower threshold may be warranted.”  We understand that specifying an expectation that there should be lower beneficial thresholds for certain higher risk customers was an issue that was debated among FinCEN and the bank regulators.For a number of years, many banks have obtained beneficial ownership at lower than 25% thresholds for high risk business lines and customers (e.g., private banking for non-resident aliens).  Banks that have previously applied a lower threshold, however, should carefully evaluate any decision to raise thresholds to the 25% level in the regulation.  If a bank currently applies a lower threshold, raising the threshold may attract regulatory scrutiny about whether the move was justified from a risk standpoint.  Moreover, a risk-based program should address not only regulatory risk, but also money laundering risk.  Therefore, banks should consider reviewing beneficial ownership at lower thresholds for certain customers and business lines and when a legal entity customer has an unusually complex or opaque ownership structure for the type of customer regardless of the business line or risk rating of the customer. New Accounts:  The new chapters do not discuss one of the most controversial and challenging requirements of the CDD rule, the requirement to verify CDD information when a customer previously subject to CDD opens a new account, including when CDs are rolled over or loans renewed.  This most likely may be because application of the requirement to CD rollovers and loan renewals is still under consideration by FinCEN, as discussed above. Enhanced Due Diligence:  The requirement to maintain enhanced due diligence (“EDD”) policies, procedures, and processes for higher risk customers remains with no new suggested categories of customers that should be subject to EDD. Risk Rating:  The new CDD Chapter seems to articulate an expectation to risk rate customers:  “The bank should have an understanding of the money laundering and terrorist financing risk of its customers, referred to in the rule as the customer risk profile.  This concept is also commonly referred to as the customer risk rating.”  The CDD Chapter, therefore, could be read as expressing for banks an expectation that goes beyond FinCEN’s expectation for all covered financial institutions in FAQ 35, which states that a customer profile “may, but need not, include a system of risk ratings or categories of customers.”  It appears that banks that do not currently risk rate customers should consider doing so.  Since the CDD section was first drafted in 2006 and amended in 2007, customer risk rating based on an established method with weighted risk factors has become a best and almost universal practice for banks to facilitate the AML risk assessment, CDD/EDD, and the identification of suspicious activity. Enterprise-Wide CDD:  The new CDD Chapter recognizes the CDD approach of many complex organizations that have CDD requirements and functions that cross financial institution legal entities and the general enterprise-wide approach to BSA/AML long referenced in the BSA/AML Manual.  See BSA/AML Manual, BSA/AML Compliance Program Structures Overview, at p. 155.  The CDD Chapter states that a bank “may choose to implement CDD policies, procedures and processes on an enterprise-wide basis to the extent permitted by law sharing across business lines, legal entities, and with affiliate support units.” Conclusion Despite the CDD regulation, at its core CDD compliance is still risk based and regulatory risk remains a concern.  Every bank must carefully and continually review its CDD program against the regulatory requirements and expectations articulated in the BSA/AML Manual, as well as recent regulatory enforcement actions, the institution’s past examination and independent and compliance testing issues, and best practices of peer institutions.  This review will help anticipate whether there are aspects of its CDD/EDD program that could be subject to criticism in the examination process.  As the U.S. Court of Appeals for the Ninth Circuit recently recognized, detailed manuals issued by agencies with enforcement authority like the BSA/AML Manual “can put regulated banks on notice of expected conduct.”  California Pacific Bank v. Federal Deposit Insurance Corporation, 885 F.3d 560, 572 (9th Cir. 2018).  The BSA/AML Manual is an important and welcome roadmap although not always as up to date, clear or detailed as banks would like it to be. These were the first revisions to the BSA/AML Manual since 2014.  We understand that additional revisions to other chapters are under consideration.    [1]   May 11, 2018 also was the compliance date for the CDD regulations.  The Notice of Final Rulemaking for the CDD regulation, which was published on May 11, 2016, provided a two-year implementation period.  81 Fed. Reg. 29,398 (May 11, 2016).  https://www.gpo.gov/fdsys/pkg/FR-2016-05-11/pdf/2016-10567.pdf. For banks, the new regulation is set forth in the BSA regulations at 31 C.F.R. § 1010.230 (beneficial ownership requirements) and 31 C.F.R. § 1020.210(a)(5).    [2]   The new chapters can be found at: https://www.ffiec.gov/press/pdf/Customer%20Due%20Diligence%20-%20Overview%20and%20Exam%20Procedures-FINAL.pdfw  (CDD Chapter) and https://www.ffiec.gov/press/pdf/Beneficial%20Ownership%20Requirements%20for %20Legal%20Entity%20CustomersOverview-FINAL.pdf (Beneficial Ownership Chapter).    [3]   Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions, FIN-2018-G001.  https://www.fincen.gov/resources/statutes-regulations/guidance/frequently-asked-questions-regarding-customer-due-0.  On April 23, 2018, Gibson Dunn published a client alert on these FAQs.  FinCEN Issues FAQs on Customer Due Diligence Regulation.  https://www.gibsondunn.com/fincen-issues-faqs-on-customer-due-diligence-regulation/. FinCEN also issued FAQs on the regulation on September 29, 2017. https://www.fincen.gov/sites/default/files/2016-09/FAQs_for_CDD_Final_Rule_%287_15_16%29.pdf.    [4]   Beneficial Ownership Requirements for Legal Entity Customers of Certain Financial Products and Services with Automatic Rollovers or Renewals, FIN-2018-R002.  https://www.fincen.gov/sites/default/files/2018-05/FinCEN%20Ruling%20CD%20and%20Loan%20Rollover%20Relief_FINAL%20508-revised.pdf    [5]   The BSA/AML Manual previously stated at p. 57:  “CDD processes should include periodic risk-based monitoring of the customer relationship to determine if there are substantive changes to the original CDD information. . . .” Gibson Dunn’s lawyers  are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or the authors: Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Linda Noonan – Washington, D.C. (+1 202-887-3595, lnoonan@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 4, 2018 |
Efforts to Strengthen U.S. Public Capital Markets Continue – New SIFMA Report Provides Recommendations to Help More Companies Go and Stay Public

Click for PDF On April 27, 2018, the Securities Industry and Financial Markets Association (“SIFMA”), the leading industry group representing broker-dealers, banks and asset managers, along with other securities industry related groups, released a report called “Expanding the On-Ramp: Recommendations to Help More Companies Go and Stay Public” (the “Report”).[1]  In response to the decline in the number of IPOs and the number of public companies generally in the United States over the last twenty years, the Report provides recommendations aimed at reducing perceived impediments to becoming and remaining a public company. As the Report notes, the United States is now home to only about half the number of public companies that existed 20 years ago.  This decline is believed to have had adverse repercussions for the American economy generally, and the jobs market specifically.  For example, the Report cites a 2010 study by IHS Global Insight suggesting that, generally speaking, 92% of a company’s job growth occurs after it completes an IPO.[2]  In addition, the growth of private capital markets at the expense of public capital markets has raised concerns that individual investors are being marginalized.  More specifically, as many of the most innovative companies in the U.S. stay private longer and raise significant amounts of capital privately, the returns generated by such companies appear to accrue disproportionally to institutional, high net worth and other similar investors.  As Securities and Exchange Commission (the “SEC”) Chairman Jay Clayton noted in a July 2017 speech, “the reduction in the number of U.S.-listed public companies is a serious issue for our markets and the country more generally.  To the extent companies are eschewing our public markets, the vast majority of main street investors will be unable to participate in their growth.  The potential lasting effects of such an outcome to the economy and society are, in two words, not good.” To remedy this decline, the Report makes recommendations in five areas: 1.      enhance several provisions of the Jumpstart Our Business Startups Act (the “JOBS Act”); 2.      encourage more research on emerging growth companies (“EGCs”)[3] and other small public companies; 3.      improve certain corporate governance, disclosure, and other regulatory requirements; 4.      address concerns relating to financial reporting; and 5.      tailor the equity market structure for small public companies. 1. Enhancing the JOBS Act Over the past six years, the JOBS Act has demonstrated that rules and regulations around capital raising can be modernized while maintaining investor protections.  Its accomodations have been widely adopted. The Report sets forth four recommendations to further enhance some of the key provisions of the JOBS Act: Extend Title I “on-ramp provisions.” The JOBS Act Title I “on-ramp” provisions  provide a number of significant benefits to EGCs, including confidential review of registration statements and streamlined financial and executive compensation disclosure requirements, among others.  The Report recommends that the benefits available to EGCs be extended from 5 years to 10 years after a company goes public.  The “on-ramp” provisions have been widely utilized by EGCs since enactment.  By increasing the length of time these benefits are available, the Report argues that even more companies may consider going public. Expand the “testing the waters” exemption to all issuers. The Report recommends that Section 5(d) of the Securities Act of 1933 (the “Securities Act”) be modified to permit all issuers, not just EGCs, to engage in “testing the waters” communications with qualified institutional buyers (“QIBs”) or institutional accredited investors to determine interest in a securities offering.  Consistent with this, in April 2018, SEC Director of Corporation Finance Bill Hinman reported to a congressional committee that the SEC is planning to expand the “testing the waters” benefit to all companies.  This change would allow companies to better understand investor interest prior to undertaking the expense of an IPO. Increase exemption for reporting on adequacy of internal controls from 5 to 10 years for EGCs. The JOBS Act gives EGCs a five-year exemption from Section 404(b) of the Sarbanes-Oxley Act, which requires external auditors to attest to the adequacy of the company’s internal control on financial reporting.  The Report recommends that this be extended from 5 years to 10 years for EGCs that have less than $50 million in revenue and less than $700 million in public float.  This change is designed to ensure that internal control reporting requirements, and associated costs, are appropriately scaled to the size of the company. Remove “phase out” rules relating to EGC status. The Report argues that the “phase out” rules related to EGC status should be removed, specifically given the overlap in certain status designations (e.g., companies who qualify as both a large accelerated filer and an EGC face uncertainty as to their status after going public. See Section 4 below).  Instead, issuers should be allowed to maintain their EGC status based on the JOBS Act definition.  The Report suggests that the SEC could still set a public float or other threshold requirement to limit the size of company that could benefit from the change in phase out triggers.[4] 2. Encourage More Research  Research coverage can increase interest from investors in a company, and a lack of research coverage can adversely impact liquidity for certain companies.  However, the Report notes that 61% of all companies listed on a major exchange with less than a $100 million market capitalization have no research coverage.  To address this disparity, the Report makes the following three recommendations: Amend the Securities Act Rule 139 research safe harbor to allow continuing research coverage for all issuers during an offering. The Report recommends that Rule 139 of the Securities Act be amended to provide that continued research analyst coverage does not constitute an offer or sale of securities, before, during, or after an offering by such issuer, regardless of whether the publishing broker-dealer is also an underwriter in the offering.  Currently, only issuers who are eligible to use Form S-3 qualify for the Rule 139 safe harbor.  As the Report notes, if an analyst has already been covering an issuer, there is no obvious logic to distinguishing companies that are S-3 eligible for the purposes of research coverage. Allow investment banking and research analysts to attend “pitch” meetings together. While the JOBS Act permits investment banks and analysts to jointly attend pitch meetings, given other restrictions on the content of what those discussions may contain, bankers and analysts typically refrain from jointly attending pitch meetings with IPO candidates.  The Report proposes that the SEC consider the removal of barriers prohibiting investment banks and analysts from jointly attending these meetings, as long as no direct or indirect promise of favorable research is given.  The Report also endorses reviewing the 2003 global research settlement between many large investment banks and the SEC, self-regulatory organizations, such as Financial Industry Regulatory Authority (“FINRA”), and other regulators regarding research analyst conflicts of interest (the “Global Research Settlement”).  The Global Research Settlement precludes settling firms from having research analysts attend EGC IPO pitch meetings, irrespective of the regulatory easing afforded by the JOBS Act.[5] Investigate why pre-IPO research remains limited. Despite the liberalization of “gun jumping” rules related to research as part of the JOBS Act, the Report states that very few investment banks have published any pre-IPO research.  The Report urges the SEC to investigate why the JOBS Act has not led to an increase in pre-IPO research.  This may be due to existing FINRA rules, the Global Research Settlement, and federal and state law liability concerns.  The Report advocates for the SEC to examine this issue in an effort to increase pre-IPO research coverage. 3. Improve Certain Corporate Governance, Disclosure and other Regulatory Requirements According to the 2011 IPO Task Force, a group convened in response to a capital access roundtable sponsored by the Department of the Treasury, 92% of U.S. public company CEOs have found the “administrative burden of public reporting” to be a significant barrier to completing an IPO.  In addition, pressure from activist investors (often supported by proxy advisory firms) can distract management from carrying out their management duties, which in turn costs shareholders.  In response to these and other pressures, the Report recommends the following eleven improvements to help deal with some of these issues: Institute reasonable and effective SEC oversight of proxy advisory firms. Proxy advisory firms have become so influential over public companies that they have in essence become the standard setters for corporate governance.  Two advisory firms effectively control the market: Institutional Shareholder Services (“ISS”) and Glass Lewis.  According to the Report, these firms operate with significant conflicts of interest and lack transparency, discouraging small and midsized companies from tapping into the public markets.  Legislation introduced in December 2017 would require proxy advisory firms to register with the SEC and to (1) disclose and manage their conflicts of interest, (2) provide issuers with reasonable time to respond to errors or flaws in advisory voting recommendations, and (3) demonstrate that they have the proper expertise to make accurate and objective recommendations.  The Report endorses the passage of this or similar legislation, and at a minimum, recommends the SEC’s withdrawal of the Egan-Jones Proxy Services (avail. May 27, 2004) and Institutional Shareholder Services, Inc. (avail. Sept. 15, 2004) no-action letters that minimize scrutiny of proxy advisory firms with respect to conflicts of interest. Reform shareholder proposal “resubmission thresholds” under Rule 14a-8 of the Securities Exchange Act of 1934 (the “Exchange Act”) to facilitate more meaningful shareholder engagement with management. Rule 14a-8 allows shareholders who own a relatively small amount of company shares to include qualifying proposals in a company’s proxy materials.  Under current law, Rule 14-8a(i)(12) (the “Resubmission Rule”) allows companies to exclude certain shareholder proposals that were voted on in recent years.  Specifically, a company may exclude a resubmitted proposal if in the last five years the proposal: was voted on once and received less than 3% of votes cast; was voted on twice and received less than 6% of votes cast the last time it was voted on; or was voted on three or more times and received less than 10% of votes cast the last time it was voted on. The Report asserts that the proxy process is currently subject to abuse by a “minority of special interests that use it to advance idiosyncratic agendas.”  The Report argues that raising these resubmission thresholds, as the SEC proposed in 1997 (6%, 15%, and 30%), is a “good starting point” to modernize the SEC’s shareholder proposal system. The Report also notes that the SEC should withdraw Staff Legal Bulletin 14H (Oct. 22, 2015), which effectively declawed Rule 14a-8(i)(9) that allowed companies to exclude certain shareholder proposals that directly conflict with a management proposal. Simplify quarterly reporting requirements. Due to the increased size and complexity of annual (Form 10-K) and quarterly (Form 10‑Q) reports, compliance has become increasingly costly and more difficult, especially for smaller companies.  The Report recommends granting EGCs the option of issuing a press release that includes quarterly earnings results in lieu of a full Form 10-Q.  This approach would simplify the quarterly reporting process for EGCs and reduce the burdens related to financial quarterly reporting, while at the same time still providing investors with necessary material information. The “materiality” standard for corporate disclosure should be maintained and certain disclosure requirements should be scaled for EGCs. The Report suggests that the SEC should maintain the longstanding “materiality” standard with respect to corporate disclosures.  The Report points to the conflict minerals and pay ratio rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) as examples of disclosure requirements that veer the application of securities laws away from their original mission to provide material information to investors.The Report also recommends that policymakers continue to scale down disclosure requirements for EGCs.  For example, the Report proposes exempting EGCs from conflict minerals, mine safety, and resources extraction disclosures implemented under the Dodd-Frank Act. Allow purchases of EGC shares to be qualifying investments for purposes of Registered Investment Adviser (“RIA”) exemption determinations. Under the Dodd-Frank Act, venture capital funds were meant to be exempt from the certain costs and requirements to become an RIA.  However, the definition of “venture capital fund” under the Investment Advisers Act is viewed by the Report as narrow, which limits the ability of these funds to invest in EGCs.  The Report argues that shares of EGCs should be considered qualifying investments, which would potentially expand investment in EGCs. Allow issuers of all sizes to be eligible to use Forms S-3 and F-3 for shelf registration. Many EGCs and small issuers are precluded from using the simplified registration statement Forms S-3 and F-3, which allows faster and cheaper access to public capital markets.  The Report, along with the SEC’s Annual Government-Business Forum on Small Business Capital Formation, recommends that all issuers be allowed to use Forms S-3 and F-3.[6]  In addition, the Report suggests eliminating the “baby-shelf” rules applicable to companies with a public float of less than $75 million, which limit the amount of capital a small-market cap company can raise using a shelf registration statement. Address unlawful activity related to short sales. There are currently no disclosure requirements applicable to investors who take short positions in publicly registered stock.  Although short selling can have positive effects on the overall market, the Report argues that such transactions can also lead to abusive activity that unduly harms investors or the reputation of a company.  The Report recommends that the SEC continue to take action against market manipulators who engage in unlawful activity that harms the market and ensure that there is sufficient public information with respect to potential market manipulation. Allow prospective underwriters to make offers of well-known seasoned issuer securities in advance of filing a registration statement. Since 2005, “well-known seasoned issuers” (or “WKSIs”) have been permitted to engage in oral or written communications in accordance with Securities Act Rule 163 in advance of filing a registration statement without violating “gun jumping” rules.  The SEC proposed an amendment in 2009 that would permit underwriters or dealers to engage in communications “by or on behalf of” WKSIs under similar circumstances, which would allow WKSIs to better gauge investor interest and market conditions prior to an offering.  The Report argues that this amendment should be enacted. Make eXtensible Business Reporting Language (“XBRL”) compliance optional for EGCs, smaller reporting companies (“SRCs”), and non-accelerated filers. Public companies are required to provide financial statements in XBRL, which imposes significant costs on EGCs and SRCs, and in the view of the Report, minimal benefit to investors.  Accordingly, the Report recommends exempting EGCs, SRCs, and non-accelerated filers from XBRL reporting requirements. Increase the diversified funds limit for mutual funds’ position in companies from current 10% of voting shares to 15%. Due to the increased size of mutual funds, the diversified fund thresholds have limited mutual funds’ ability to take meaningful positions in small-cap companies.  The Report argues that moving the threshold up from 10% to 15% would make investments in EGCs and other small-cap companies more attractive to mutual funds. Allow disclosure of selling stockholders to be done on a group basis. The Report recommends that disclosure of selling stockholders in registration statements should be permitted on a group or aggregate basis if each selling stockholder is (1) not a director or named executive officer of the registrant, and (2) holds less than 1% of outstanding shares. 4. Financial Reporting The SEC should consider aligning the SRC definition with the definition of a non-accelerated filer and institute a revenue-only test for pre- or low- revenue companies that may be highly valued. In 2016, the SEC proposed increasing the public float cap for SRCs from $75 million to $250 million, but did not do so with respect to non-accelerated filers that are subject to the same limit.  In the Report’s view, raising this cap for SRCs would help promote capital formation and reduce compliance costs for small companies, including scaled disclosure obligations under Regulation S-K for SRCs.  In addition, consideration should be given to whether the exemption available to non-accelerated filers from the requirement for auditor attestation over internal controls should also be extended to SRCs.  In particular, the Report points out that many companies may still choose to comply with auditor attestation requirements, noting that shareholders could also encourage issuers to maintain internal control systems similar to those called for by Sarbanes-Oxley Section 404(b).In addition, the 2016 SRC proposal introduced an alternative “revenue only” test for companies to qualify as an SRC if the company had less than $100 million in revenue, regardless of its public float.  The Report proposes that a revenue-only test should be considered as an alternative standard. Modernize the Public Company Accounting Oversight Board (“PCAOB”) inspection process related to internal control over financial reporting (“ICFR”). In 2007, the SEC issued Commission Guidance Regarding Management’s Report on Internal Controls over Financial Reporting under Section 13(a) or 15(d) of the Exchange Act (the “2007 Guidance”).  The 2007 Guidance was meant to allow companies to prioritize and focus on “what matters most” in assessing ICFR, principally those material issues that pose the greatest risk of material misstatements.  However, companies have continued to experience unintended ICFR-related burdens due to audit processes and PCAOB inspections.  The 2007 Guidance has not been effective due to changing interpretations of PCAOB standards for attestations during the inspection process.  Accordingly, the Report proposes that the 2007 Guidance should be updated to ensure that it is working as originally intended.  The Group also suggests that the PCAOB should consider an ICFR task force to address issues companies face as a result of the PCAOB inspection process and its consequences for audit firms and auditors.  Pre- and post-implementation reviews by the PCAOB would improve audit standard setting, prevent harmful impacts, and address the unintended consequences that result from implementation of new PCAOB auditing standards. 5. Tailoring Equity Market Structure for Small Public Companies While the overall U.S. equity markets have become more efficient due to venue competition and increased liquidity, some of these benefits have failed to reach small and mid-size stocks.  The Report makes two recommendations to address market structure challenges faced by these issuers: Examine tick sizes for EGCs and small capitalization stocks. The Report argues that the SEC should examine the appropriate tick size, which is the minimum price movement of a trading instrument, for EGCs and small capitalization stocks.  The Report notes that while stocks trading in penny increments may be an appropriate trading increment for large capitalization stocks, it may not be the best option for EGCs.  This is because narrower spreads resulting from penny increments may disincentivize market makers from trading in EGCs and small capitalization stocks.  Instead, individual exchanges should have the flexibility to develop tick sizes that are tailored for a limited number of stocks with distressed liquidity.[7] Allow EGCs or small issuers with distressed liquidity the choice to opt out of unlisted trading privileges. The Report recommends that a limited number of SRCs with distressed liquidity be able to opt out of unlisted trading privileges.  This would allow these less frequently traded stocks to focus their trading on fewer exchanges, thus enabling buyers and sellers to more easily find each other, providing more liquidity in these stocks.  This would also enable these companies to reduce fragmentation in trading, and simplify market making for these stocks. Conclusion Since at least 2012, the SEC and Congress have proposed various reforms[8] aimed at improving the attractiveness and competitiveness of the U.S. public capital markets.  In the last year, consistent with Chairman Clayton’s core principles,[9] the SEC has taken steps to further expand the benefits of the JOBS Act and the FAST Act to a broader range of companies, such as allowing non-EGCs to make confidential submissions of initial registration statements, permitting all companies to confidentially submit registration statements in connection with offerings within one year of an IPO and granting more waivers of financial statement requirements.  In addition, there have been a number of legislative proposals intended to further expand the benefits of the JOBS Act and the FAST Act.  The Report is consistent with these themes.  Congress and the SEC must now consider comprehensive reform in this vein and also consider how a complex system of regulations could be further simplified.  Ultimately, a company’s decision whether to go public is driven primarily by business rationales, including valuation, liquidity and investor considerations.  However, reducing the burdens of becoming and staying a public company without compromising investor protection will benefit both companies and investors, help ensure that the U.S. public capital markets remain attractive and competitive in the face of global competition, and provide more diverse investment opportunities for all investors.    [1]   SIFMA, Expanding the On-Ramp: Recommendations to Help More Companies Go and Stay Public, available at https://www.sifma.org/resources/submissions/expanding-the-on-ramp-recommendations-to-help-more-companies-go-and-stay-public (last visited April 27, 2018). Other organizations joining SIFMA in the Report included, among others, the U.S. Chamber of Commerce, the National Venture Capital Association, Biotechnology Innovation Organization (Bio), Technet and Nasdaq.    [2]   Id.    [3]   Under the JOBS Act, EGCs are defined as companies with less than $1.07 billion of annual revenue.    [4]   For a more complete discussion on the transition from EGC status, see our Alert from March 12, 2014, which is available at the following link:  https://www.gibsondunn.com/emerging-from-egc-status-transition-periods-for-former-egc-issuers-to-comply-with-reporting-and-corporate-governance-requirements/    [5]   For a more complete discussion of the interaction between the JOBS Act and the Global Research Settlement, see our alert from October 11, 2012, which is available at the following link: https://www.gibsondunn.com/jobs-act-finra-proposes-rule-changes-relating-to-research-analysts-and-underwriters/    [6]   See generally SEC Government-Business Forum on Small Capital Business Formation, which is available at the following link: https://www.sec.gov/files/gbfor36.pdf    [7]   For additional information, see the SEC’s investor alert titled “Investor Alert: Tick Size Pilot Program – What Investors Need to Know” which is available at the following link: https://www.sec.gov/oiea/investor-alerts-bulletins/ia_ticksize.html    [8]   For more information, see our post from October 13, 2017 titled “SEC Proposes Amendments to Securities Regulations to Modernize and Simplify Disclosure,” which is available at the following link: https://www.gibsondunn.com/sec-proposes-amendments-to-securities-regulations-to-modernize-and-simplify-disclosure/    [9]   See, e.g., “SEC to Tailor Disclosure Regime Under New Chair Clayton” (July 12, 2017), which is available at the following link: https://www.bna.com/sec-tailor-disclosure-n73014461648/ Gibson Dunn’s lawyers  are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Capital Markets or Securities Regulation and Corporate Governance practice groups, or the authors: Glenn R. Pollner – New York (+1 212-351-2333, gpollner@gibsondunn.com) Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) Jessica Annis – San Francisco (+1 415-393-8234, jannis@gibsondunn.com) Nicolas H.R. Dumont – New York (+1 212-351-3837, ndumont@gibsondunn.com) Sean Sullivan – San Francisco (+1 415–393–8275, ssullivan@gibsondunn.com) Victor Twu – Orange County, CA (+1 949-451-3870, vtwu@gibsondunn.com) Please also feel free to contact any of the following practice leaders: Capital Markets Group: Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com) Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com) Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com) Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) Securities Regulation and Corporate Governance Group: Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) James J. Moloney – Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com) Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

April 23, 2018 |
FinCEN Issues FAQs on Customer Due Diligence Regulation

Click for PDF On April 3, 2018, FinCEN issued its long-awaited Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions, FIN-2018-G001. https://www.fincen.gov/resources/statutes-regulations/guidance/frequently-asked-questions-regarding-customer-due-0.[1]  The timing of this guidance is very controversial, issued five weeks before the new Customer Due Diligence (“CDD”) regulation goes into effect on May 11, 2018.[2]  Most covered financial institutions (banks, broker-dealers, mutual funds, and futures commission merchants and introducing brokers in commodities) already have drafted policies, procedures, and internal controls and made IT systems changes to comply with the new regulation.  Covered financial institutions will need to review these FAQs carefully to ensure that their proposed CDD rule compliance measures are consistent with FinCEN’s guidance. The guidance is set forth in 37 questions.  As discussed below, some of the information is helpful, allaying financial institutions’ most significant concerns.  Other FAQs confirm what FinCEN has said in recent months informally to industry groups and at conferences.  A few FAQs raise additional questions, and others, particularly the FAQ on rollovers of certifications of deposit and loan renewals, are not responsive to industry concerns and may raise significant compliance burdens for covered financial institutions.  The guidance reflects FinCEN’s regulatory interpretations based on discussions within the government and with financial institutions and their trade associations.  The need for such extensive guidance on so many issues in the regulation illustrates the complexity of compliance and suggests that FinCEN should consider whether clarifications and technical corrections to the regulation should be made.  We provide below discussion of highlights from the FAQs, including areas of continued ambiguity and uncertainty in the regulation and FAQs. Highlights from the FAQs FAQ 1 and 2 discuss the threshold for obtaining and verifying beneficial ownership.  FinCEN states that financial institutions can “choose” to collect beneficial ownership information at a lower threshold than required under the regulation (25%), but does not acknowledge that financial institution regulators may expect a lower threshold for certain business lines or customer types or that there may be regulatory concerns if financial institutions adjust thresholds upward to meet the BSA regulatory threshold.  A covered financial institution may be in compliance with the regulatory threshold, but fall short of regulatory expectations. FAQ 7 states that a financial institution need not re-verify the identity of a beneficial owner of a legal entity customer if that beneficial owner is an existing customer of the financial institution on whom CIP has been conducted previously provided that the existing information is “up-to-date, accurate, and the legal entity’s customer’s representative certifies or confirms (verbally or in writing) the accuracy of the pre-existing CIP information.”  The example given suggests that no steps are expected to verify that the information is up-to-date and accurate beyond the representative’s confirmation or certification.  The beneficial ownership records must cross reference the individual’s CIP record. FAQs 9-12 address one of the most controversial aspects of the regulation, about which there has been much confusion: the requirement that, when an existing customer opens a new account, a financial institution must identify and verify beneficial ownership information.  FinCEN provides further clarity on what must be updated and how:Under FAQ 10, if a legal entity customer, for which the required beneficial ownership information has been obtained for an existing account, opens a new account, the financial institution can rely on the information obtained and verified previously “provided the customer certifies or confirms (verbally or in writing) that such information is up-to-date and accurate at the time each subsequent new account is opened,” and the financial institution has no knowledge that would “reasonably call into question” the reliability of the information.  The financial institution also would need to maintain a record of the certification or confirmation by the customer.There is no grace period.  If an account is opened on Tuesday, and a new account is opened on Thursday, the certification or confirmation is still required.  In advance planning for compliance, many financial institutions had included a grace period in their procedures. FAQ 11 provides that, when the financial institution opens a new account or subaccount for an existing legal entity customer whose beneficial ownership has been verified for the institution’s own recordkeeping and operational purposes and not at the customer’s request, there is no requirement to update the beneficial ownership information for the new account.  This is because the account would be considered opened by the financial institution and the requirement to update only applies to each new account opened by a customer.  This is consistent with what FinCEN representatives have said at recent conferences.The FAQ specifies that this would not apply to (1) accounts or subaccounts set up to accommodate a trading strategy of a different legal entity, e.g., a subsidiary of the customer, or (2) accounts of a customer of the existing legal entity customer, “i.e., accounts (or subaccounts) through which a customer of a financial institution’s existing legal entity carries out trading activity through the financial institution without intermediation from the existing legal entity customer.”  We believe the FAQ may fall far short of addressing all the concerns expressed to FinCEN on this issue by the securities industry. FAQ 12 addresses an issue which has been a major concern to the banking industry:  whether beneficial ownership information must be updated when a certificate of deposit (“CD”) is rolled over or a loan is renewed.  These actions are generally not considered opening of new accounts by banks.FinCEN continues to maintain that CD rollovers or loan renewals are openings of new accounts for purposes of the CDD regulation.  Therefore, the first time a CD or loan renewal for a legal entity customer occurs after May 11, 2018, the effective date of the CDD regulation, beneficial ownership information must be obtained and verified, and at each subsequent rollover or renewal, there must be confirmation that the information is current and accurate (consistent with FAQ 10) as for any other new account for an existing customer.  There is an exception or alternative approach authorized in FAQ 12 “because the risk of money laundering is very low”:  If, at the time of the rollover or renewal, the customer certifies its beneficial ownership information, and also agrees to notify the financial institution of any change in information in the future, no action will be required at subsequent renewals or rollovers.The response in FAQ 12 is not responsive to the concerns that have been expressed by the banking industry and will be burdensome for banks to administer.  Obtaining a certification in time, without disrupting the rollover or renewal, will be challenging, and it appears that if it the certification or promise to update is not obtained in time, the account may have to be closed. FAQs 13 through 17 address another aspect of the regulation that has generated extensive discussion: When (1) must beneficial ownership be obtained for an account opened before the effective date of the regulation, or (2) beneficial ownership information updated on existing accounts whose beneficial ownership has been obtained and verified.Following closely what was said in the preamble to the final rule, FAQ 13 states that the obligation is triggered when a financial institution “becomes aware of information about the customer during the course of normal monitoring relevant to assessing or reassessing the risk posed by the customer, and such information indicates a possible change in beneficial ownership.”FAQ 14 clarifies somewhat what is considered normal monitoring but is not perfectly clear what triggers obtaining and verifying beneficial ownership.  It is clear that there is no obligation to obtain or update beneficial ownership information in routine periodic CDD reviews (CDD refresh reviews) “absent specific risk-based concerns.” We would assume that means, following FAQ 13, concerns about the ownership of the customer.  Beyond that FAQ 14  is less clear.  It states that the obligation is triggered “when, in the course of normal monitoring a financial institution becomes aware of information about a customer or an account, including a possible change of beneficial ownership information, relevant to assessing or reassessing the customer’s overall risk profile.  Absent such a risk-related trigger or event, collecting or updating of beneficial ownership information is at the discretion of the covered financial institution.”The trigger or event may mean in the course of SAR monitoring or when conducting event-driven CDD reviews, e.g., when a subpoena is received or material negative news is identified – something that may change a risk profile.  Does the obligation then arise only if the risk profile change includes a concern about whether the financial institution has accurate ownership information?  That may be the intent, but is not clearly stated.  If the account is being considered for closure because of the change in risk profile, would the financial institution be released from the obligation to obtain beneficial ownership?   That would make sense, but is not stated.  This FAQ is in need of clarification and examples would be helpful.On another note, the language in FAQ 14 also is of interest because it may suggest, in FinCEN’s view, that periodic CDD reviews should be conducted on a risk basis, and CDD refresh reviews may not be expected for lower risk customers, as is the practice for some banks. FAQ 18 seems to address at least partially a technical issue with the regulation that arises because SEC-registered investment advisers are excluded from the definition of legal entity customer in the regulation, but U.S. pooled investment vehicles advised by them are not excluded.[3]  FAQ 18 states that, if the operator or adviser of a pooled investment vehicle is not excluded from the definition of legal entity customer, under the regulation, e.g., like a foreign bank, no beneficial ownership information is required to be obtained on the pooled investment vehicle under the ownership prong, but there must be compliance with beneficial ownership control party prong, i.e., verification of identity of a control party.  A control party could be a “portfolio manager” in these situations.FinCEN describes why no ownership information is required as follows:  “Because of the way the ownership of a pooled investment vehicle fluctuates, it would be impractical for covered financial institutions to collect and verify ownership identity for this type of entity.”  Thus, in the case where the operator or adviser of the pooled investment vehicle is excluded from the definition of legal entity, like an SEC-registered investment adviser, it would seem not to be an expectation to obtain beneficial ownership information under the ownership prong.  Nevertheless, the question of whether you need to obtain and verify the identity of a control party for a pooled investment vehicle advised by a SEC registered investment adviser is not squarely answered in the FAQ.  A technical correction to the regulation is still needed, but it is unlikely there would be regulatory or audit criticism for following the FAQ guidance at least with respect to the ownership prong. FAQ 19 clarifies that, when a beneficial owner is a trust (where the legal entity customer is owned more than 25% by a trust), the financial institution is only required to verify the identity of one trustee if there are multiple trustees. FAQ 20 deals with what to do if a trust holds more than a 25% beneficial interest in a legal entity customers and the trustee is not an individual, but a legal entity, like a bank or law firm.  Under the regulation, if a trust holds more than 25% beneficial ownership of a legal entity customer, the financial institution must verify the identity of the trustee to satisfy the ownership prong of the beneficial ownership requirement.  The ownership prong references identification of “individuals.”  Consequently, the language of the regulation does not seem to contemplate the situation where the trustee was a legal entity.FAQ 20 seems to suggest that, despite this issue with the regulation, CIP should be conducted on the legal entity trustee, but apparently, on a risk basis, not in every case:  “In circumstances where a natural person does not exist for purposes of the ownership/equity prong, a natural person would not be identified.  However, a covered financial institution should collect identification information on the legal entity trustee as part of its CIP, consistent with the covered institution’s risk assessment and customer risk profile.”  (Emphasis added.)More clarification is needed on this issue, and perhaps an amendment to the regulation to address this specific situation.  Pending additional guidance, the safest course appears to be to verify the identity of legal entity trustee consistent with CIP requirements, which may pose practical difficulties, e.g., will a law firm trustee easily provide its TIN?  Presumably, CIP would not be required on any legal entity trustee that is excepted from the definition of legal entity under 31 C.F.R. § 1010.230(e)(2). FAQ 21 addresses the question of how does a financial institution verify that a legal entity comes within one of the regulatory exceptions to the definition of legal entity customer in 31 C.F.R. § 1010.230(e)(2).  The answer is that the financial institution generally can rely on information provided by the customer if it has no knowledge of facts that would reasonably call into question the reliability of the information.  Nevertheless, that is not the end of the story.  The FAQ provides that the financial institution also must have risk-based policies and procedures that specify the type of information they will obtain and reasonably rely on to determine eligibility for exclusions. FAQ 24 may resolve another technical issue in the regulation.  The exceptions to the definition of legal entity in the regulation refer back to the BSA CIP exemption provisions, which in turn, cross reference the Currency Transaction Reporting (CTR) exemption for banks when granting so-called Tier One exemptions.  One category for the CTR exemption is “listed” entities, which includes NASDAQ listed entities, but excludes NASDAQ Capital Markets Companies, i.e., this category of NASDAQ listed entity is not subject to CIP or CTR Tier One exemptions.  31 C.F.R. § 1020.315(b)(4).  This carve out was not discussed in the preamble to the CDD final regulation or in FAQ 24.The FAQ simply states:  “[A]ny company (other than a bank) whose common stock or analogous equity interests are listed on the New York Stock Exchange, the American Stock Exchange (currently known as the NYSE American), or NASDAQ stock exchange” is excepted from the definition of legal entity.  In any event, as with the FAQ 18 issue, it would appear that a technical correction is needed on this point, but, given the FAQ, it is unlikely that a financial institution would be criticized if it treated NASDAQ Capital Markets Companies as excepted legal entities. FAQs 32 and 33 end the speculation that the CDD regulation impacts CTR compliance.  Consistent with FinCEN CTR guidance, under FAQ 32, the rule remains that, for purposes of CTR aggregation, the fact that two businesses share a common owner does not mean that a financial institution must aggregate the currency transactions of the two businesses for CTR reporting, except in the narrow situation where there is a reason to believe businesses are not being operated separately. Conclusion Financial institutions and their industry groups will likely continue to seek further guidance on the most problematic issues in the CDD regulation.  It is our understanding that FinCEN and the bank regulators also will address compliance with the CDD regulation in the upcoming update to the FFIEC Bank Secrecy Act/Anti-Money Laundering Examination Manual. Covered financial institutions already have spent, and will continue to spend, significant time and resources to meet the complex regulatory requirements and anticipated regulatory expectations.  In this flurry of activity to address regulatory risk, it is essential for financial institutions to continue to consider any money laundering risk of legal entity clients and that CDD not become simply mechanical.  It is not only a matter of documenting and updating all of the right information about beneficial ownership and control, but financial institutions should continue to assess whether the ownership structure makes sense for the business or whether it is overly complex for the business type and purposely opaque.  Also, it is important to consider whether it makes sense for a particular legal entity to be seeking a relationship with your financial institution and whether the legal entity is changing financial institutions voluntarily.  CDD measures to address regulatory risk and money laundering risk overlap but are not equivalent.    [1]   FinCEN also issued FAQs on the regulation on July 19, 2016. https://www.fincen.gov/sites/default/files/2016-09/FAQs_for_CDD_Final_Rule_%287_15_16%29.pdf.   FINRA issued guidance on the CDD regulation in FINRA Notice to Members 17-40 (Nov. 21, 2017). http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-40.pdf.    [2]   The Notice of Final Rulemaking was published on May 11, 2016 and provided a two-year implementation period.  81 Fed. Reg. 29,398 (May 11, 2016). https://www.gpo.gov/fdsys/pkg/FR-2016-05-11/pdf/2016-10567.pdf.  FinCEN made some slight amendments to the rule on September 29, 2017.  https://www.fincen.gov/sites/default/files/federal_register_notices/2017-09-29/CDD_Technical_Amendement_17-20777.pdf The new regulations are set forth in the BSA regulations at 31 C.F.R. § 1010.230 (beneficial ownership requirements); 31 C.F.R. § 1020.210(a)(5) (banks); 31 C.F.R. § 1023.210(b)(5) (broker-dealers); 31 C.F.R. § 1024.210(b)(4) (mutual funds); and 31 C.F.R. § 1026.210(b)(5) (future commission merchants and introducing brokers in commodities).    [3]   The regulation does not clearly address the beneficial ownership requirements for a U.S. pooled investment vehicle operated or controlled by a registered SEC investment adviser.  Pooled investment vehicles operated or advised by a “financial institution” regulated by a Federal functional regulator are not considered legal entities under the regulation.  31 C.F.R. § 1010.230(e)(2)(xi).  An SEC registered investment adviser, however, is not yet a financial institution under the BSA.  Under 31 C.F.R. § 1010.230(e)(3), a pooled investment vehicle that is operated or advised by a “financial institution” not excluded from the definition of legal entity is subject to the beneficial ownership control party prong. Gibson Dunn’s lawyers  are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or the authors: Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Linda Noonan – Washington, D.C. (+1 202-887-3595, lnoonan@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

April 5, 2018 |
M&A Report – AOL and Aruba Networks Continue Trend of Delaware Courts Deferring to Deal Price in Appraisal Actions

Click for PDF Two recent decisions confirm that, in the wake of the Delaware Supreme Court’s landmark decisions in Dell and DFC, Delaware courts are taking an increasingly skeptical view of claims in appraisal actions that the “fair value” of a company’s shares exceeds the deal price.[1] However, as demonstrated by each of these recent Delaware Court of Chancery decisions—In re Appraisal of AOL Inc. and Verition Partners Master Fund Limited v. Aruba Networks, Inc.—several key issues are continuing to evolve in the Delaware courts.[2] In particular, Delaware courts are refining the criteria in appraisal actions for determining whether a transaction was “Dell-compliant.” If so, then the court will likely look to market-based indicators of fair value, though which such indicator (unaffected share price or deal price) is the best evidence of fair value remains unresolved. If not, the court will likely conduct a valuation based on discounted cash flow (DCF) analysis or an alternative method to determine fair value. The development of these issues will help determine whether M&A appraisal litigation will continue to decline in frequency and will be critical for deal practitioners.[3] DFC and “Dell-Compliant” Transactions In DFC, the Delaware Supreme Court endorsed deal price as the “best evidence of fair value” in an arm’s-length merger resulting from a robust sale process. The Court held that, in determining fair value in such transactions, the lower court must “explain” any departure from deal price based on “economic facts,” and must justify its selection of alternative valuation methodologies and its weighting of those methodologies, setting forth whether such methodologies are grounded in market-based indicators (such as unaffected share price or deal price) or in other forms of analysis (such as DCF, comparable companies analysis or comparable transactions analysis). In Dell, the Court again focused on the factual contexts in which market-based indicators of fair value should be accorded greater weight. In particular, the Court found that if the target has certain attributes—for example, “many stockholders; no controlling stockholder; highly active trading; and if information is widely available and easily disseminated to the market”—and if the target was sold in an arm’s-length transaction, then the “deal price has heavy, if not overriding, probative value.” Aruba Networks and AOL: Marking the Boundaries for “Dell-Compliant” Transactions In Aruba Networks, the Delaware Court of Chancery concluded that an efficient market existed for the target’s stock, in light of the presence of a large number of stockholders, the absence of a controlling stockholder, the deep trading volume for the target’s stock and the broad dissemination of information about the target to the market. In addition, the court found that the target’s sale process had been robust, noting that the transaction was an arm’s-length merger that did not involve a controller squeeze-out or management buyout, the target’s board was disinterested and independent, and the deal protection provisions in the merger agreement were not impermissibly restrictive. On this basis, the Court determined that the transaction was “Dell-compliant” and, as a result, market-based indicators would provide the best evidence of fair value. The Court found that both the deal price and the unaffected stock price provided probative evidence of fair value, but in light of the significant quantum of synergies that the parties expected the transaction to generate, the Court elected to rely upon the unaffected stock price, which reflected “the collective judgment of the many based on all the publicly available information . . . and the value of its shares.” The Court observed that using the deal price and subtracting synergies, which may not be counted towards fair value under the appraisal statute,[4] would necessarily involve judgment and introduce a likelihood of error in the Court’s computation. By contrast, AOL involved facts much closer to falling under the rubric of a “Dell-compliant” transaction, but the Court nonetheless determined that the transaction was not “Dell-compliant.” At the time of the transaction, the target was well-known to be “likely in play” and had communicated with many potential bidders, no major conflicts of interest were present and the merger agreement did not include a prohibitively large breakup fee. Nonetheless, the Court focused on several facts that pointed to structural defects in the sale process, including that the merger agreement contained a no-shop period with unlimited three-day matching rights for the buyer and that the target failed to conduct a robust auction once the winning bidder emerged. In addition, and importantly, the Court took issue with certain public comments of the target’s chief executive officer indicating a high degree of commitment to the deal after it had been announced, which the Court took to signal “to potential market participants that the deal was done, and that they need not bother making an offer.” On this basis, the Court declined to ascribe any weight to the deal price and instead conducted a DCF analysis, from which it arrived at a fair value below the deal price. It attributed this gap to the inclusion of synergies in the deal price that are properly excluded from fair value. Parenthetically, the Court did take note of the fact that its computation of fair value was close to the deal price, which offered a “check on fair value analysis,” even if it did not factor into the Court’s computation. Key Takeaways Aruba Networks and AOL provide useful guidelines to M&A practitioners seeking to manage appraisal risk, while also leaving several open questions with which the Delaware courts will continue to grapple: Whether market-based indicators of fair value will receive deference from the Delaware courts (and, correspondingly, diminish the incentives for would-be appraisal arbitrageurs) depends upon whether the sale process could be considered “Dell-compliant.” This includes an assessment of both the robustness of the sale process, on which M&A practitioners seeking to manage appraisal risk would be well-advised to focus early, and the efficiency of the trading market for the target’s stock, to which litigators in appraisal actions should pay close attention. For those transactions found to be “Dell-compliant,” the best evidence of fair value will be a market-based indicator of the target’s stock. Whether such evidence will be the deal price, the unaffected stock price or a different measure remains an open question dependent upon the facts of the particular case. However, for those transactions in which synergies are anticipated by the parties to be a material driver of value, Aruba Networks suggests that the unaffected share price may be viewed as a measure of fair value that is less susceptible to errors or biases in judgment. For those transactions found not to be “Dell-compliant,” DCF analyses or other similar calculated valuation methodologies are more likely to be employed by courts to determine fair value. As AOL and other recent opinions indicate, however, there is no guarantee for stockholders that the result will yield a fair value in excess of the deal price—particularly given the statutory mandate to exclude expected synergies from the computation. [1] Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017); DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017). See our earlier discussion of Dell and DFC here. [2] In re Appraisal of AOL Inc., C.A. No. 11204-VCG, 2018 WL 1037450 (Del. Ch. Feb. 23, 2018); Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL, 2018 WL 922139 (Del. Ch. Feb. 15, 2018). [3] It is worth noting that, after DFC and Dell, the Delaware Supreme Court summarily affirmed the decision of the Court of Chancery in Merlin Partners, LP v. SWS Grp., Inc., No. 295, 2017, 2018 WL 1037477 (Table) (Del. Feb. 23, 2018), aff’g, In re Appraisal of SWS Grp., Inc., C.A. No. 10554-VCG, 2017 WL 2334852 (Del. Ch. May 30, 2017). The Court of Chancery decided SWS Group prior to the Delaware Supreme Court’s decisions in DFC and Dell. Nonetheless, it is clear that the court would have found the transaction at issue in SWS Group not to be “Dell-compliant,” as the transaction involved the sale of the target to a buyer that was also a lender to the target and so could exercise veto rights over any transaction. Indeed, no party to the SWS Group litigation argued that the deal price provided probative evidence of fair value. See our earlier discussion of the SWS Group decision by the Delaware Court of Chancery here. [4] See 8 Del. C. § 262(h) (“[T]he Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation . . . .”); see also Global GT LP v. Golden Telecom, Inc., 993 A.2d 497, 507 (Del. Ch.) (“The entity must be valued as a going concern based on its business plan at the time of the merger, and any synergies or other value expected from the merger giving rise to the appraisal proceeding itself must be disregarded.” (internal citations omitted)), aff’d, 11 A.3d 214 (Del. 2010). The following Gibson Dunn lawyers assisted in preparing this client update:  Barbara Becker, Jeffrey Chapman, Stephen Glover, Eduardo Gallardo, Jonathan Layne, Joshua Lipshutz, Brian Lutz, Adam Offenhartz, Aric Wu, Meryl Young, Daniel Alterbaum, Colin Davis, and Mark Mixon. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Mergers and Acquisitions practice group: Mergers and Acquisitions Group / Corporate Transactions: Barbara L. Becker – Co-Chair, New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman – Co-Chair, Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover – Co-Chair, Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Dennis J. Friedman – New York (+1 212-351-3900, dfriedman@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310-552-8641, jlayne@gibsondunn.com) Eduardo Gallardo – New York (+1 212-351-3847, egallardo@gibsondunn.com) Jonathan Corsico – Washington, D.C. (+1 202-887-3652), jcorsico@gibsondunn.com Mergers and Acquisitions Group / Litigation: Meryl L. Young – Orange County (+1 949-451-4229, myoung@gibsondunn.com) Brian M. Lutz – San Francisco (+1 415-393-8379, blutz@gibsondunn.com) Aric H. Wu – New York (+1 212-351-3820, awu@gibsondunn.com) Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com) Michael M. Farhang – Los Angeles (+1 213-229-7005, mfarhang@gibsondunn.com) Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com) Adam H. Offenhartz – New York (+1 212-351-3808, aoffenhartz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 20, 2018 |
Supreme Court Holds States May Hear Securities Fraud Class Actions Under The 1933 Act

Click for PDF Cyan, Inc. v. Beaver County Employees Retirement Fund, No. 15-1439 Decided March 20, 2018 Today, the Supreme Court held 9-0 that class actions alleging only federal claims under the Securities Act of 1933 may be heard in state court and, if brought in state court, cannot be removed to federal court. Background: Federal and state courts have traditionally shared jurisdiction over claims under the Securities Act of 1933. After the Private Securities Litigation Reform Act of 1995 (PSLRA) tightened standards for pleading and proving federal securities fraud class actions, plaintiffs began filing those claims in state court. In response, Congress enacted the Securities Litigation Uniform Standards Act of 1998 (SLUSA), which requires certain “covered class actions” alleging state law securities claims to be heard and dismissed in federal court. 15 U.S.C. § 77p(c). But courts were split over whether covered class actions filed in state court that allege only claims under the 1933 Act also must be heard in federal court. In this case, investors in Cyan, Inc. filed a class action in California state court alleging only claims under the 1933 Act. The California courts refused to dismiss the case for lack of subject-matter jurisdiction. Issues: (1) Whether state courts lack subject-matter jurisdiction over class actions that allege only Securities Act of 1933 claims, and (2) Whether defendants in class actions filed in state court that allege only 1933 Act claims may remove the cases to federal court. “[W]e will not revise [Congress’s] legislative choice, by reading a conforming amendment and a definition in a most improbable way, in an effort to make the world of securities litigation more consistent or pure.” Justice Kagan,writing for the Court Court’s Holding: SLUSA does not deprive state courts of subject-matter jurisdiction over class actions raising only claims under the 1933 Act and does not authorize defendants to remove such actions to federal court. What It Means: SLUSA has often been the subject of statutory-interpretation disputes. But here, the unanimous Court held that SLUSA’s “clear statutory language” does not preclude state courts from adjudicating class actions involving 1933 Act claims. SLUSA’s class-action bar and federal-court-channeling provision apply only to state law claims. Under SLUSA, covered securities class actions based on the 1934 Act must proceed in federal court. 15 U.S.C. § 78aa. But as a result of the Court’s decision today, covered class actions based only on the 1933 Act may proceed in state court. Either way, the Court emphasized, the substantive protections of the PSLRA (such as the safe harbor for forward-looking statements) apply to all claims under both the 1933 and 1934 Acts. The United States argued that SLUSA permits defendants in class actions filed in state court that raise 1933 Act claims to remove those actions to federal court. The Court disagreed. In the wake of this ruling, businesses should expect to see more securities class actions alleging violations of the 1933 Act in state court, because plaintiffs will seek to take advantage of state courts that are perceived to be friendlier to their interests. This significant loophole may prompt Congress to enact new legislation, similar to SLUSA, to ensure that plaintiffs are required to bring securities class actions in federal court. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice Caitlin J. Halligan +1 212.351.3909 challigan@gibsondunn.com Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com Nicole A. Saharsky +1 202.887.3669 nsaharsky@gibsondunn.com Related Practice: Securities Litigation Brian M. Lutz +1 415.393.8379 blutz@gibsondunn.com Robert F. Serio +1 212.351.3917 rserio@gibsondunn.com Meryl L. Young +1 949.451.4229 myoung@gibsondunn.com Related Practice: Class Actions Theodore J. Boutrous, Jr. +1 213.229.7804 tboutrous@gibsondunn.com Christopher Chorba +1 213.229.7396 cchorba@gibsondunn.com Theane Evangelis +1 213.229.7726 tevangelis@gibsondunn.com © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 16, 2018 |
Aerospace and Related Technologies – Key Developments in 2017 and Early 2018

Click for PDF This March 2018 edition of Gibson Dunn’s Aerospace and Related Technologies Update discusses newsworthy developments, trends, and key decisions from 2017 and early 2018 that are of interest to aerospace and defense, satellite, and drone companies; and new market entrants in the commercial space and related technology sectors, including the private equity and other financial institutions that support and enable their growth. Specifically, this update covers the following areas: (1) commercial unmanned aircraft systems (“UAS”), or drones; (2) government contracts litigation involving companies in the aerospace and defense industry; (3) the commercial space sector; and (4) cybersecurity and privacy issues related to the national airspace.  We discuss each of these areas in turn below. I.    COMMERCIAL UNMANNED AIRCRAFT SYSTEMS The commercial drone industry has continued to mature through advancements in technology, government relations, and public perception.  Commercial drones are being used for various sensory data collection, building inspections, utility inspections, agriculture monitoring and treatment, railway inspections, pipeline inspections, mapping of mines, and photography.  New drone applications are being created on a regular basis.  For example, the concept of flying drone taxis was validated in Dubai in September 2017 when an uncrewed two-seater drone successfully conducted its first test flight. Around a year and a half ago, United States regulations governing non-recreational drone operations were finalized.  Since then, the Federal Aviation Administration (“FAA”) has issued over 60,000 remote pilot certificates.  The FAA has and continues to make efforts to advance its technology, and it recently released a prototype application to provide operators with automatic approval of specific airspace authorizations.  The national beta test of this system will launch in 2018, and we will be sure to report back with the results. One of the biggest boons for the industry over the past 15 months was the positive public perception stemming from Hurricane Harvey relief efforts.  In the days following the disaster, drones worked in concert with government agencies to support search and rescue missions, inspect roads and railroads, and assess water plants, oil refineries, cell towers, and power lines.  Further, major insurance companies used drones to assess claims in a safer, faster, and more efficient manner.  The aftermath of this disaster demonstrated the value of drone technology and increasingly has driven a positive public perception of the industry.  Indeed, even aside from the disaster relief efforts, media sources continue to carry positive drone stories.  For example, in January 2018, Australian lifeguards were testing a drone with the ability to release an inflatable rescue pod; during its testing, the drone was called into action, and rescued two teenagers from drowning. The future is bright, but there are still many obstacles for the industry to overcome before it fully matures, such as clarity around low altitude airspace, privacy concerns, and the risk to people, property, and other aircraft. To get you caught up on 2017 and early 2018 drone developments, we have briefly summarized below: (A) highlights of drone litigation impacting airspace, including highlights from previous years for context; (B) drone registration; (C) privacy issues related to drones; (D) the United States government’s expanded use of drones; (E) drone countermeasures; (F) drone safety studies; and (G) the UAS airspace integration pilot program. A.    Litigation Highlights Regarding Airspace Huerta v. Haughwout, No. 3:16-cv-358, Dkt. No. 30 (D. Conn. Jul. 18, 2016) The latter half of 2016 featured an important decision regarding the FAA’s authority over low-level airspace.  The 2016 decision, Huerta v. Haughwout—also known as “the flamethrower drone case,” involved two YouTube videos posted by the Haughwouts.  One video featured a drone firing an attached handgun, while a second video showed a drone using an attached flamethrower to scorch a turkey.  After the videos were publicly uploaded, the FAA served the Haughwouts with an administrative subpoena to acquire further information about the activities featured in the videos.  The Haughwouts refused to comply with the FAA’s subpoenas, asserting that their activities were not subject to investigation by the FAA.  In response, the FAA sought enforcement of the subpoenas in the District of Connecticut.[1] Judge Jeffrey Meyer found the administrative subpoenas to be valid.  Most importantly, however, his order included dicta casting doubt on the FAA’s claim to control all airspace from the ground up:  “The FAA believes it has regulatory sovereignty over every inch of outdoor air in the United States…. [T]hat ambition may be difficult to reconcile with the terms of the FAA’s statute that refer to ‘navigable airspace.'”  While this dicta addressed the question of where the FAA’s authority begins, Judge Meyer also noted that “the case does not yet require an answer to that question.”[2]  Judge Meyer further stated: Congress surely understands that state and local authorities are (usually) well positioned to regulate what people do in their own backyards.  The Constitution creates a limited national government in recognition of the traditional police power of state and local government.  No clause in the Constitution vests the federal government with a general police power over all of the air or all objects that leave the ground.  Although the Commerce Clause allows for broad federal authority over interstate and foreign commerce, it is far from clear that Congress intends–or could constitutionally intend–to regulate all that is airborne on one’s own property and that poses no plausible threat to or substantial effect on air transport or interstate commerce in general.[3] 2017 featured the resolution of another lawsuit where the plaintiff attempted to extend the significance of Haughwout in an effort to get the courts to address the question of what “navigable airspace” means in the context of drones (see discussion of Singer v. City of Newton, infra). Boggs v. Merideth, No. 3:16-cv-00006 (W.D. Ky. Jan. 4, 2016) In Boggs v. Merideth—better known as “the Drone Slayer case”—a landowner shot down an operator’s drone with a shotgun in the Western District of Kentucky.[4]  The plaintiff flew his drone roughly 200 feet above the defendant’s property, causing the defendant—the self-anointed “Drone Slayer”—to claim the drone was trespassing and invading his privacy and shoot it down.  The plaintiff believed the airspace 200 feet above the ground was federal airspace and therefore the defendant could not claim the drone was trespassing. Following a state judge’s finding that the defendant acted “within his rights,” the drone operator filed a complaint in federal court for declaratory judgment to “define clearly the rights of aircraft operators and property owners.”[5]  The case had the potential to be a key decision on the scope of federal authority over the use of airspace.  Rather than claiming defense of property, however, the defendant moved to dismiss the complaint on jurisdictional grounds.  The plaintiff unsuccessfully attempted to rely on the decision in Huerta v. Haughwout for the proposition that all cases involving the regulation of drone flight should be resolved by federal courts.  The court rejected the plaintiff’s argument, noting that Haughwout only concerned the FAA’s ability to exercise subpoena power and enforce subpoenas in federal court.  In fact, the district court noted, the court in Haughwout “expressed serious skepticism as to whether all unmanned aircrafts are subject to FAA regulation.”[6]  In his March 2017 order, Senior District Court Judge Thomas B. Russell granted the defendant’s motion to dismiss for lack of federal jurisdiction, stating that the issue of whether or not the drone was in protected airspace only arises on the presumption that the defendant would raise the defense that he was defending his property.[7]  Consequently, there was no federal question jurisdiction and the case was thrown out without ever reaching its merits. While the answer to what exactly constitutes “navigable airspace” in the drone context remained unanswered in 2017, the year did mark the beginning of federal courts addressing the overlap between conflicting state, local, and federal drone laws. Singer v. City of Newton No. 1:17-cv-10071 (D. Mass. Jan. 17, 2017) On September 21, 2017, a federal judge in the District of Massachusetts held that portions of the City of Newton, Massachusetts’s (“Newton”) ordinance attempting to regulate unmanned aircraft operations within the city were invalid.[8] The case, Singer v. City of Newton, marks the first time a federal court has struck down a local ordinance attempting to regulate drones.  The court held the following four city ordinance provisions to be unenforceable: (1) a requirement that all owners register their drones with the city; (2) a ban on all drone operations under 400 feet that are over private property unless done with express permission of the property owner; (3) a ban on all drone operations over public property, regardless of altitude, unless done with the express permission of the city; and (4) a requirement that no drone be operated beyond the visual line of sight of its operator.[9] All four of these provisions of the Newton ordinance were found to be preempted by federal regulations promulgated by the FAA. In the course of holding that the four sections of Newton’s ordinance were each preempted, the court identified the congressional objectives each section inhibited.  One relevant congressional objective is to make the FAA the exclusive regulatory authority for registration of drones.  The Newton ordinance required the registration of drones with the City of Newton, which impeded Congress’s objective; thus, the court found that section to be preempted.[10] The court also identified a congressional objective for the FAA to develop a comprehensive plan to safely accelerate the integration of drones into the national airspace system.  The two sections of the Newton ordinance requiring prior permission to fly above both public and private property within the city effectively eliminated any drone activity without prior permission; thus those sections were held to interfere with the federal objective and were invalidated.[11] Lastly, the court found that the Newton ordinance’s provision barring drone usage beyond the visual line of sight of the operator conflicted with a less restrictive FAA rule allowing such usage if a waiver is obtained or if a separate visual observer can see the drone throughout its flight and assist the operator.[12] The Singer ruling marked the long-anticipated beginning of federal courts addressing overlapping state, local, and federal drone laws.  While the ruling is significant for invalidating sections of a local ordinance and thus establishing a framework that federal courts may follow to invalidate state and local drone laws elsewhere, it is important not to overstate the case’s current significance.  The court in Singer declined to hold that law relating to airspace was expressly preempted or field preempted, but rather decided it was conflict preempted.  Consequently, the case does not provide support for the assertion that all state and local drone laws related to airspace will be preempted by FAA regulations.  Further, the court did not opine on the lower limits of the National Airspace and whether it goes to the ground, an issue likely to come up in future litigation. The unchallenged portions of the Newton ordinance still stand, and the closing lines in the opinion recognize that Newton is free to redraft the invalidated portions to avoid direct conflict with FAA regulations.  Thus it remains possible, even in the District of Massachusetts, for federal law to coexist with state and local laws in this field.  In order to successfully avoid invalidation in the courts, however, state and local lawmakers must draft legislation that allows for compliance with federal regulations, and which does not interfere with any federal objectives. The year 2017 left much to still be determined by the courts.  While Newton demonstrated that preemption concerns do and will continue to exist, the case did not address the boundary of the National Airspace.  Haughwout did address the boundary—though only through dicta—and suggested that, when the issue is decided, the boundary will likely not extend to the ground.  Thus, as was the case at the start of 2017, where the boundary will be drawn remains to be seen. B.    Drone Registration: From Mandatory to Optional and Back to Mandatory In December 2015, days before tens of thousands of drones were gifted for the holidays, the FAA adopted rules requiring the registration of drones weighing more than 0.55 pounds prior to operation.  This registration requirement only impacted recreational users, as commercial users are required to register under Part 107.  This rule was challenged in Taylor v. Huerta, and on May 19, 2017, the U.S. Court of Appeals for the D.C. Circuit vacated the rule.[13]  The FAA instituted a program to issue refunds, and recreational pilots enjoyed the freedom of flying unregistered drones for the next seven months. The Circuit Court struck down the rule because the FAA lacked statutory authority to issue such a rule for recreational pilots.  Section 336 of the FAA Modernization and Reform Act of 2012 states that the “Administrator of the Federal Aviation Administration may not promulgate any rule or regulation regarding a model aircraft.”[14]  The Court held that the FAA’s registration rule “directly violates that clear statutory prohibition” and vacated the rule to the extent it applied to model aircraft.[15]  The FAA responded by offering $5 registration fee refunds and the option to have one’s information removed from the federal database, but encouraging recreational operators to voluntarily register their drones. However, in a turn of events, on December 12, 2017, the President signed the National Defense Authorization Act of 2018, which included a provision reinstating the rule: Restoration Of Rules For Registration And Marking Of Unmanned Aircraft.—The rules adopted by the Administrator of the Federal Aviation Administration in the matter of registration and marking requirements for small unmanned aircraft (FAA-2015-7396; published on December 16, 2015) that were vacated by the United States Court of Appeals for the District of Columbia Circuit in Taylor v. Huerta (No. 15-1495; decided on May 19, 2017) shall be restored to effect on the date of enactment of this Act.[16] As a result of the Act, both recreational and commercial pilots are now required to register their drones, and one can do so on the FAA’s website. C.    UAS and Privacy 1.    Voluntary Best Practices Remain Intact A 2015 Presidential Memorandum issued by then President Obama ordered the National Telecommunications and Information Administration (“NTIA”) of the U.S. Department of Commerce to create a private-sector engagement process to help develop voluntary best practices for privacy and transparency issues regarding commercial and private drone use.[17]  Since Part 107 of Title 14 of the Code of Federal Regulations (“Part 107”)[18] does not address privacy, privacy advocates hoped that the NTIA would force the FAA to promulgate privacy regulations.[19]  Prior attempts to petition the FAA to consider privacy concerns in its Notice of Proposed Rulemaking (“NPRM”) for Part 107 were unsuccessful.[20] The NTIA issued its voluntary best privacy practices for drones on May 19, 2016.[21]  While the final best practices found support from some privacy organizations and most of the commercial drone industry, other privacy groups raised concerns that the best practices neither established nor encouraged binding legal standards.[22]  Nonetheless, the best practices offer useful guidelines for companies testing and/or actively conducting drone operations. 2.    Litigation Regarding the FAA’s Role in Addressing Privacy As we discussed in an earlier update, the Electronic Privacy Information Center (“EPIC”) challenged the FAA’s decision to exclude privacy regulations from Part 107 in an August 2016 petition for review.[23]  In 2012, EPIC petitioned the FAA to promulgate privacy regulations applicable to drone use, which the FAA denied in February 2014.[24]  EPIC argued that the FAA Modernization and Reform Act of 2012 required the FAA to consider privacy issues in its NPRM.[25]  The FAA argued that while the Act directed the FAA to develop a comprehensive plan to safely integrate drones into the national airspace system, privacy considerations went “beyond the scope” of that plan.[26]  The D.C. Circuit dismissed EPIC’s petition for review on two grounds.[27]  First, the Court deemed EPIC’s petition for review “time-barred” because EPIC filed 65 days past the time allotted under 49 U.S.C. § 46110(a).[28]  Second, the Court held that the FAA’s “conclusion that privacy is beyond the scope of the NPRM” was not a final agency determination subject to judicial review.[29] After the rule became final, EPIC filed a new petition for review asking the court to vacate Part 107 and remand it to the FAA for further proceedings.[30]  Consolidated with a related case, Taylor v. FAA, No. 16-1302 (D.C. Cir. filed August 29, 2016), EPIC argues that the FAA violated the Act by: (1) refusing to consider “privacy hazards,” and (2) refusing to “conduct comprehensive drone rulemaking,” which necessarily includes issues related to privacy.[31]  The FAA argues: (1) EPIC lacks standing, (2) the FAA reasonably decided not to address privacy concerns, and (3) even if EPIC has standing, Section 333 of the Act does not require the FAA to promulgate privacy regulations.[32]  Judge Merrick Garland, Judge David Sentelle, and Judge A. Raymond Randolph heard oral arguments in the consolidated cases on January 25, 2018.[33]  All eyes thus remain on the D.C. Circuit to determine whether the FAA must issue regulations covering privacy concerns raised by increased drone use. D.    The United States Government Expands Its Use of Drones Four years after the U.S. Department of Defense (“DoD”) issued its 25-year “vision and strategy for the continued development, production, test, training, operation, and sustainment of unmanned [aircraft] systems technology,”[34] the drone defense industry continues to experience rapid growth.  A recent market report estimated that commercial and government drone sales will surpass $12 billion by 2021.[35]  However, that estimate is likely conservative when considering that the DoD allocated almost $5.7 billion to drone acquisition and research in 2017 alone.[36]  Likewise, the DoD allocates almost $7 billion to drone technology in its 2018 fiscal year Defense Budget.[37]  Additionally, Goldman Sachs forecasted a $70 billion market opportunity for military drones by 2020.[38]  According to Goldman Sachs: “Current drone technology has already surpassed manned aircraft in endurance, range, safety and cost efficiency — but research and development is far from over.  The next generation of drones will widen the gap between manned and unmanned flight even further, adding greater stealth, sensory, payload, range, autonomous, and communications capabilities.”[39]  It should thus come as no surprise that organizations developing defense-specific drones will expect increased demand for complete systems and parts in the coming years. 1.    United States Government’s Domestic Use Drones The U.S. government mostly acquires drones for overseas military operations, a trend dating back to the deployment of the Predator drone in post-9/11 conflict territories.[40]  Domestic use of DoD-owned drones remains subject to strict governmental approval, and armed drones are prohibited on U.S. soil.[41]  In February 2015, the Deputy Secretary of Defense issued Policy Memorandum 15-002 entitled “Guidance for the Domestic Use of Unmanned Aircraft Systems.”[42]  Under the policy, the Secretary of Defense must approve all domestic use of DoD-owned UAVs, with one exception—domestic search and rescue missions overseen by the Air Force Rescue Coordination Center.[43]  However, DoD personnel may use drones to surveil U.S. persons where permitted by law and where approved by the Secretary.[44]  The policy expired on February 17, 2018,[45] and it remains to be seen how the Trump administration will handle domestic use of DoD-owned drones and the integration of UAVs into day-to-day civilian operations. E.    Drone Countermeasures In response to the rapid growth of militarized consumer drones, particularly in ISIS-controlled territories,[48] 2017 saw an increased offering of anti-drone technologies in the U.S.[49]  In April 2017, the U.S. Army’s Rapid Equipment Force purchased 50 of Radio Hill Technologies’ “Dronebuster” radar guns.[50]  The Dronebuster uses radio frequency technology to interrupt the control of drones by effectively jamming the control frequency or the GPS signal.[51]  The end-user can overwhelm the drone and deprive its operator of control or cause the drone to “fall out of the sky.”[52]  Handheld radar-type guns like the Dronebuster weigh about five pounds and cost an average of $30,000.[53]  The U.S. military also experimented with the Mobile High-Energy Laser-equipped Stryker vehicle.[54]  Similar to the Dronebuster, the 5 to 10kW laser overwhelms target drones’ control systems with high bursts of energy.[55]  It can shoot down drones 600 meters away, all without making a sound.[56] F.    Drone Safety Studies Making UAS operations commonplace in urban airspace will be a big step in the technological and economic advancement of the U.S.; however, there are obstacles to overcome in ensuring the safe operation of drones in urban areas.  On April 28, 2017, the Alliance for System Safety of UAS through Research Excellence (“ASSURE”) released the results of a study that explored the severity of a UAS collision with people and property on the ground.[57]  First, ASSURE determined the most likely impact scenarios by reviewing various operating environments for UAS and determining their likely exposure to people and other manned aircraft.[58]  Then the team conducted crash tests and analyzed crash dynamics by measuring kinetic energy transfer.[59]  The results revealed that earlier measurements of the danger of collision grossly overestimate the risk of injury from a drone.[60]  ASSURE concluded that the DJI Phantom 3 drone has a 0.03% chance of causing a head injury if it falls on a person’s head.[61]  This is a very low probability considering blocks of steel or wood of the same weight have a 99% risk of causing a head injury in the same scenario.[62]  The disparity in probability of head injury is largely due to the fact that the DJI Phantom 3 drone absorbs most of the energy resulting from a collision, and therefore less energy is transferred on impact from the drone than from a block of steel or wood in the same collision.[63] In fact there are numerous steps that drone designers and manufacturers can take to reduce the likelihood of injury in the event of a collision.[64]  Projectile mass and velocity, as well as stiffness of the UAS, are the primary drivers of impact damage.[65]  As such, multi-rotor drones tend to be safer because they fall more slowly due to the drag of the rotors as the drones fall through the air.[66]  The study made clear that blade guards should be a design requirement for drones used in close proximity to people in order to minimize the lacerations that can result from a collision.[67]  Moreover, ASSURE found that the more flexible the structure of the drone, the more energy the drone retains during impact, causing less harm to the impacted object of the collision.[68] Regarding crashes with other manned aircraft, however, the study revealed that the impact of a drone can be much more severe than the impact of a bird of equivalent size and speed.[69]  As such, the structural components of a commercial aircraft that allows it to withstand bird strikes from birds up to eight pounds are not an appropriate guideline for preventing damage from a UAS strike.[70]  The study also examined the dangers associated with lithium batteries, which are used to power most drones, in collisions.[71]  The major concern is the risk of a battery fire.[72]  The study found that typical high-speed impacts cause complete destruction of the battery, eliminating any concerns about battery fires.[73]  However, the lower impact crashes, which are mainly associated with take-off and landing, left parts of the battery intact, posing a risk of battery fire.[74] While the ASSURE study is the first of its kind, it certainly marks the need for more studies that analyze the practical aspects of collisions and how to reduce risk to minimize harm.  The hazards associated with commonplace drone operation are many.[75]  Analysis of the physical impact of a collision is one aspect of minimizing UAS risks.  There is still much work to be done in order to minimize other collateral risks, such as the risk of technology failures, which range from UAS platform failures, to failures of hardware or communication links controlling the UAS.[76]  Environmental hazards, such as the effect of rain, lightning, and other types of weather remains to be studied.[77]  Ways to safeguard against human error or intentional interference is another aspect of UAS safety that has yet to be studied in detail.[78]  Data link spoofing, jamming, or hijacking poses significant safety hazards, particularly as incidents of data breaches become more and more common.[79]  Before the integration of UAS into national airspace can be fully implemented, industry stakeholders must collaborate to conduct studies that will help inform legislators about what kind of technological requirements and operational regulations are necessary. G.    UAS Airspace Integration Pilot Program In October 2017, the U.S. Department of Transportation (“DOT”) announced that it was launching the Unmanned Aircraft Systems Integration Pilot Program.[80]  The program, which was established in response to a presidential directive, is meant to accelerate the integration of UAS into the national airspace through the creation of public-private partnerships between UAS operators, governmental entities, and other private stakeholders.[81]  The program is designed to establish greater regulatory certainty and stability regarding drone use.[82]  After reviewing the applications, DOT will select a minimum of five partnerships with the goal of collaborating with the selected industry stakeholder in order to evaluate certain advanced UAS operational concepts, such as night operations, flights beyond the pilot’s line of sight, detect-and-avoid technologies, flights over people, counter-UAS security operations, package delivery, the integrity and dependability of data links between pilot and aircraft, and cooperation between local authorities and the FAA in overseeing UAS operations.[83] One such application was made by the City of Palo Alto, in partnership with the Stanford Blood Center, Stanford hospital, and Matternet, a private drone company.[84]  The City of Palo Alto has proposed the use of drones to deliver units of blood from the Stanford Blood Center to Stanford hospital, which would involve establishing an approved flight path for drones to transfer the units of blood in urgent situations.[85]  Matternet has already tested its drones’ capacity for transporting blood and other medical samples in Switzerland.[86]  A second project proposed by the City of Palo Alto involves the use of drones in order to monitor the perimeter of the Palo Alto Airport.[87]  This project involves a partnership between the city and a company called Multirotor, a German drone company that has experience working with the German army and the Berlin Police Department to integrate UAS as tools for law enforcement activities.[88] The creation of the pilot program has given stakeholders the sense that the current administration is supportive of integrating drones into the national airspace.  The support of the government has created the potential for unprecedented growth in an industry that could bring lucrative returns to its stakeholders.  The DOT has already received over 2,800 interested party applications.[89]  The majority of these applications have come from commercial drone companies, as well as various other stakeholders including energy companies, law enforcement agencies, and insurance providers.[90]  The UAS Pilot Program is to last for three years.[91]  The projected economic benefit of integrated UAS is estimated to equal $82 billion, creating up to 100,000 jobs.[92]  Industries that could see immediate returns from the program include precision agriculture, infrastructure inspection and monitoring, photography, commerce, and crisis management.[93]  The advent of established, government-sanctioned rules for the operation of UAS will motivate industry stakeholders both in the public and private sectors to push forward with new and innovative ways to use drones. II.    GOVERNMENT CONTRACTS LITIGATION IN THE AEROSPACE AND DEFENSE INDUSTRY Gibson Dunn’s 2017 Year-End Government Contracts Litigation Update and 2017 Mid-Year Government Contracts Litigation Update cover the waterfront of the most important opinions issued by the U.S. Court of Appeals for the Federal Circuit, U.S. Court of Federal Claims, Armed Services Board of Contract Appeals (“ASBCA”), and Civilian Board of Contract Appeals among other tribunals.  We invite you to review those publications for a full report on case law developments in the government contracts arena. In this update, we (A) summarize key court decisions related to government contracting from 2017 that involve players in the aerospace and defense industry.  The cases discussed herein, and in the Government Contracts Litigation Updates referenced above, address a wide range of issues with which government contractors in the aerospace and defense industry are likely familiar. A.    Select Decisions Related to Government Contractors in the Aerospace and Defense Industry Technology Systems, Inc., ASBCA No. 59577 (Jan. 12, 2017) TSI held four cost-plus-fixed-fee contracts with the Navy for research and development.  Several years into the contracts, the government disallowed expenses that had not been questioned in prior years.  TSI appealed to the ASBCA, arguing that it relied to its detriment on the government’s failure to challenge those same expenses in prior years. The Board (Prouty, A.J.) held that the challenged costs were “largely not allowable” and that “the principle of retroactive disallowance,” which it deemed “a theory for challenging audits whose heyday has come and gone,” did not apply because the same costs had simply not come up in the prior audits.  The theory of retroactive disallowance, first articulated in a Court of Claims case in 1971, prevents the government from challenging costs already incurred when the cost previously had been accepted following final audit of historical costs; the contractor reasonably believed that it would continue to be approved; and it detrimentally relied on the prior acceptance.  Tracing the precedent discussing the principle, the Board cited the Federal Circuit’s decision in Rumsfeld v. United Technologies Corp., 315 F.3d 1361 (Fed. Cir. 2003), which stated that “affirmative misconduct” on the part of the government would be required for the principle of retroactive disallowance to apply because it is a form of estoppel against the government.  The Board “sum[med] up: there is no way to read our recent precedent or the Federal Circuit’s except to include an affirmative misconduct requirement amongst the elements of retroactive disallowance.  Period.”  Further, the Board held that the government’s failure to challenge the same costs in prior years did not constitute a “course of conduct precluding the government from disallowing the costs in subsequent audits.” Delfasco LLC, ASBCA No. 59153 (Feb. 14, 2017) Delfasco had a contract with the Army for the manufacture and delivery of a specified number of munition suspension lugs.  The Army thereafter exercised an option to double the number of lugs required.  When Delfasco stopped making deliveries due to an inability to pay its subcontractor, the Army terminated the contract for default.  Delfasco appealed to the ASBCA, asserting that the government had waived its right to terminate for untimely performance by allegedly stringing Delfasco along even after the notice of termination. The Board (Prouty, A.J.) set out the test for waiver in a case involving termination for default due to late delivery as follows:  “(1) failure to terminate within a reasonable time after the default under circumstances indicating forbearance, and (2) reliance by the contractor on the failure to terminate and continued performance by him under the contract with the Government’s knowledge and implied or express consent.”  The Board held that Delfasco failed to satisfy the first prong because the government’s show cause letter placed Delfasco on notice that any continued performance would only be for the purpose of mitigating damages.  Moreover, Delfasco failed to satisfy the second prong because Delfasco’s payment to its subcontractor after the show cause letter would have been owed regardless, and was not paid in reliance upon the government’s failure to terminate.  Therefore, the Board found that the government had not waived its right to terminate, and denied the appeal. Raytheon Co., ASBCA Nos. 57743 et al. (Apr. 17, 2017) Raytheon appealed from three final decisions determining that an assortment of costs—including those associated with consultants, lobbyists, a corporate development database, and executive aircraft—were expressly unallowable and thus subject to penalties.  After a two-week trial, the Board (Scott, A.J.) sided largely with Raytheon in a wide-ranging decision that covers a number of important cost principles issues. First, the Board rejected the government’s argument that the consultant costs were expressly unallowable simply because the government was dissatisfied with the level of written detail of the work product submitted to support the costs.  Judge Scott noted that written work product is not a requirement to support a consultant’s services under FAR 31.205-33(f), particularly not where, as here, much of the consultants’ work was delivered orally due to the classified nature of the work performed.  The Board found that not only were the consultant costs not expressly unallowable, but indeed were allowable.  This is a significant ruling because the documentation of consultant costs is a recurring issue as government auditors frequently make demands concerning the amount of documentation required to support these costs during audits. Second, the government sought to impose penalties for costs that inadvertently were not withdrawn in accordance with an advance agreement between Raytheon and the government concerning two executive aircraft.  Raytheon agreed that the costs should have been withdrawn and agreed to withdraw them when the error was brought to its attention, but asserted that the costs were not expressly unallowable and subject to penalty.  The Board agreed, holding that the advance agreements did not themselves clearly name and state the costs to be unallowable, and further that advance agreements do not have the ability to create penalties because a cost must be named and stated to be unallowable in a cost principle (not an advance agreement) to be subject to penalties.  This ruling could have significance for future disputes arising out of advance agreements. Third, the government alleged that costs associated with the design and development of a database to support the operations of Raytheon’s Corporate Development office were expressly unallowable organizational costs under FAR 31.205-27.  The Board disagreed, validating Raytheon’s argument that a significant purpose of the Corporate Development office was allowable generalized long-range management planning under FAR 31.205-12, thus rendering the costs allowable (not expressly unallowable). The only cost for which the Board denied Raytheon’s appeals concerned the salary costs of government relations personnel engaged in lobbying activities.  Raytheon presented evidence that it had a robust process for withdrawing these costs as unallowable under FAR 31.205-22, but inadvertently missed certain costs in this instance due to, among other things, “spreadsheet errors.”  Raytheon agreed that the costs were unallowable and should be withdrawn, but disputed that the costs of employee compensation (a generally allowable cost) were expressly unallowable and further argued that the contracting officer should have waived penalties under FAR 42.709-5(c) based on expert evidence that Raytheon’s control systems for excluding unallowable costs were “best in class.”  The Board found that salary costs associated with unallowable lobbying activities are expressly unallowable and that the contracting officer did not abuse his discretion in denying the penalty waiver. L-3 Comms. Integrated Sys. L.P. v. United States, No. 16-1265C (Fed. Cl. May 31, 2017) L-3 entered an “undefinitized contractual action” (“UCA”) with the Air Force in which it agreed to provide certain training services while still negotiating the terms of the contract.  After the parties failed to reach agreement on the prices for two line items in the UCA, the Air Force issued a unilateral contract modification, setting prices for those line items and definitizing the contract.  L-3 argued that the Air Force’s price determination was unreasonable, arbitrary and capricious, and in violation of the FAR, and filed suit seeking damages.  The government moved to dismiss for lack of subject matter jurisdiction. The Court of Federal Claims (Kaplan, J.) dismissed L-3’s complaint, concurring with the government that L-3 had never presented a certified claim to the contracting officer for payment “of a sum certain to cover the losses it allegedly suffered.”  The court found that the proposals L-3 had presented to the Air Force were not “claims,” but rather proposals made during contract negotiations that did not contain the requisite claim certification language. Innoventor, Inc., ASBCA No. 59903 (July 11, 2017) In 2011, the government entered into a fixed-price contract with Innoventor for the design and manufacture of a dynamic brake test stand.  As part of the contract’s purchase specifications, the new design had to undergo and pass certain testing.  After problems arose in the testing process, Innoventor submitted a proposal to modify certain design components and applied for an equitable adjustment due to “instability of expectations.”  The contracting officer denied Innoventor’s request for an equitable adjustment, stating that the government had not issued a modification directing a change that would give rise to such an adjustment.  Innoventor submitted a claim, which the contracting officer denied, and Innoventor appealed. The Board (Sweet, A.J.) held that the government was entitled to judgment as a matter of law because there was no evidence that the government changed Innoventor’s performance requirements, let alone that anyone with authority directed any constructive changes.  Here, the contract was clear that Innoventor’s design had to pass certain tests, and because it failed some of them, and did not perform pursuant to the contract terms, there was no change in the original contract terms that would give rise to a constructive change.  The Board also found that there was no evidence that any person beyond the contracting officer had authority to direct a change because the contract expressly provided that only the contracting officer has authority to change a contract.  Accordingly, the Board denied Innoventor’s appeal. L-3 Commc’ns Integrated Sys., L.P., ASBCA Nos. 60713 et al. (Sept. 27, 2017) L-3 appealed from multiple final decisions asserting government claims for the recovery of purportedly unallowable airfare costs.  Rather than audit and challenge specific airfare costs, the Defense Contract Audit Agency simply applied a 79% “decrement factor” to all of L-3’s international airfare costs over a specified dollar amount, claiming that this was justified based on prior-year audits.  After filing the appeals, L-3 moved to dismiss for lack of jurisdiction on the grounds that the government had failed to provide adequate notice of its claims by failing to identify which specific airfare costs were alleged to be unallowable, as well as the basis for those allegations. The Board (D’Alessandris, A.J.) denied the motion to dismiss, holding that the contracting officer’s final decisions sufficiently stated a claim in that they set forth a sum certain and a basis for such a claim.  The Board held that L-3 had enough information to understand how the government reached its claim, and its contention that this was not a valid basis for the disallowance of costs for the year in dispute went to the merits and not the sufficiency of the final decisions. Scott v. United States, No. 17-471 (Fed. Cl. Oct. 24, 2017) Brian X. Scott brought a pro se claim in the Court of Federal Claims seeking monetary and injunctive relief for alleged harms arising from the Air Force’s handling of his unsolicited proposal for contractual work.  Scott was an Air Force employee who submitted a proposal for countering the threat of a drone strike at the base where he was stationed.  The proposal was rejected, but Scott alleged that portions of the proposal were later partially implemented.  Scott sued, claiming that the Air Force failed properly to review his proposal and that his intellectual property was being misappropriated.  Scott argued that jurisdiction was proper under the Tucker Act because an implied-in-fact contract arose that prohibited the Air Force from using any data, concept, or idea from his proposal, which was submitted to a contracting officer with a restrictive legend consistent with FAR § 15.608. The Court of Federal Claims (Lettow, J.) found that it had jurisdiction under the Tucker Act because an implied-in-fact contract was formed when the Air Force became obligated to follow the FAR’s regulatory constraints with regard to Scott’s proposal.  Nevertheless, the Court granted the government’s motion to dismiss because Scott’s factual allegations, even taken in the light most favorable to him, did not plausibly establish that the government acted unreasonably or failed to properly evaluate his unsolicited proposal by using concepts from the proposal where Scott’s proposal addressed a previously published agency requirement. III.    COMMERCIAL SPACE SECTOR A.    Overview of Private Space Launches and Significant Milestones Space exploration is always fascinating—2017 and early 2018 was no exception.  Starting off in February 2017, India’s Polar Satellite Launch Vehicle launched 104 satellites, setting a record for the number of satellites launched from a single rocket.[101]  In June, NASA finally unveiled its 12 chosen candidates for its astronaut program out of a pool of over 18,000 applicants, which was a record-breaking number.[102]  A few months later, NASA’s Cassini spacecraft was intentionally plunged into Saturn, ending over a decade’s worth of service.[103]  President Donald Trump also signed Space Policy Directive 1, which instructs NASA to send astronauts back to the moon, which President Trump noted would help establish a foundation for an eventual mission to Mars.[104] In what was widely expected to be a record year for private space launches, SpaceX and other private space companies clearly delivered.  In 2017, SpaceX, the company founded and run by Elon Musk, flew a record 18 missions utilizing the Falcon 9 rocket.[105]  Blue Origin, the company founded by Jeff Bezos, also made significant progress.  It was able to launch a new version of its New Shepard vehicle on its first flight, which Bezos hopes will lay the foundation for potential crewed missions.[106]  Then, in late December, California startup Made in Space sent a machine designed to make exotic ZBLAN optical fiber to the International Space Station.[107]  Without a doubt, 2017 played witness to many significant milestones in space exploration. Additional milestones have already been surpassed in early 2018.  February 6, 2018 was a historic date for Space technology and exploration—SpaceX’s Falcon Heavy had its maiden launch.  The Falcon Heavy can carry payloads larger than any available commercial rocket, and it has the potential to launch payloads outside of Earth’s orbit.  In fact, the Falcon Heavy did just that by launching a Tesla Roadster, driven by “Starman” into interplanetary space.  Starman will likely continue driving its orbit for millions of years.  It is only a matter of time until Starman is replaced with astronauts and the destination becomes Mars—SpaceX plans to launch such a mission in 2024. B.    Update on Outer Space Treaty and Surrounding Debate The Treaty on Principles Governing the Activities of States in the Exploration and Use of Outer Space, Including the Moon and Other Celestial Bodies, otherwise known as the Outer Space Treaty, recently celebrated its 50th anniversary.  Signed in 1967 and designed to prevent a new form of colonial competition, the Treaty was lauded for its principal framework on international space law.  Indeed, shortly after the Treaty was entered into force, the United States and the Soviet Union successfully collaborated on many space missions and exercises.[108] The Treaty is not complex.  Consisting of 17 short articles, the Treaty obligates its signatories to perform space exploration “for the benefit and interest of all countries” and to not “place in orbit around the Earth any objects carrying nuclear weapons or any other kinds of weapons of mass destruction.”[109]  Having been in force for over 50 years, there have recently been discussions regarding whether the Treaty is ripe for an update.  Only as far back as half a decade ago, experts met in Australia to discuss moon-mining of anything from water and fuel to rare minerals in what was then a world’s first “Off-Earth Mining Forum.”[110]  Discussion surrounded the legality of such mining under the Treaty.  Then in 2014, NASA accepted applications from companies that desired to mine rare moon minerals in a program called “Lunar Cargo Transportation and Landing by Soft Touchdown.”[111]  This once again sparked a debate on the legality of such actions, specifically lunar property rights. In 2017, the focus turned toward private and commercial space flight, and spurred conversation as to whether the 50-year-old treaty needed an update.  For one, the Treaty was designed, and has been entirely focused, on only individual countries.  Thus, there is an argument that the Treaty does not apply to private appropriation of celestial territory.  Second, the quaint nature of the Treaty has spawned efforts at tackling the private appropriation issues.  For instance, the United States passed the Space Act of 2015, which provides for private commercial “exploration and exploitation of space resources.”[112]  The Act has incited further debate on the various legal loopholes that inherently afflict the Treaty and its ban on countries owning celestial territory. Meanwhile, the U.S. government has continued to find methods of regulation, specifically those involving the FAA and the Federal Communications Commission (“FCC”), among others.[113]  Now, lawmakers are purportedly discussing legislation that would provide a regulatory framework for private commercial space travel to adhere to the Treaty, as there currently does not exist a framework for the U.S. government to oversee the launch of private space stations.[114] Moreover, Senator Ted Cruz (R-TX) has been leading the charge on updating the Treaty to address issues related to modern spaceflight, where private commercial entities are playing an ever-increasing role.[115]  In May, Senator Cruz, the chairman of the Subcommittee on Space, Science, and Competitiveness, convened a hearing to “examine U.S. government obligations under the [Treaty]” and to also “explore the Treaty’s potential impacts on expansion of our nation’s commerce and settlement in space.”[116]  Featuring a panel of legal experts and a panel of commercial space business leaders, the hearing raised a number of different viewpoints with one apparently unifying message: the Treaty should not be amended.  One of the panel members, Peter Marquez, while acknowledging that the Treaty is not perfect, expressed concern that opening up the Treaty to modifications would leave the space industry worse off, and would be a detriment to national and international security.[117] One area of particular interest was Article VI of the Treaty, which provides that nations authorize and supervise space activities performed by non-governmental entities, such as a private commercial space company.  The CEO of Moon Express, Bob Richards, noted that while the Treaty should remain unchanged, the U.S. should adopt a streamlined regulatory procedure and process to make approvals for space activities more efficient and clear.[118]  One of the legal experts sitting on the panel, Laura Montgomery, expressed her belief that the U.S. need not further regulate new commercial space because a close reading of the Treaty would indicate that mining and other similar activities do not require such governmental approvals.[119] While the ultimate general consensus appeared to be that no change to the Treaty was necessary to accomplish the goals of private commercial space enterprises, the hearing did bring to light the issues that currently confront modern space protocols. C.    The American Space Commerce Free Enterprise Act of 2017, Which Seeks to Overhaul U.S. Commercial Space Licensing Regime, Passes Committee but Stalls in House On June 7, 2017, House members led by Rep. Lamar Smith (R-TX), Chairman of the U.S. House Science, Space, and Technology Committee, introduced H.R. 2809—the American Space, Commerce, and Free Enterprise Act of 2017 (“ASCFEA”).[120]  The bill, if adopted, would amend Title 51 of the United States Code to liberalize licensing requirements to conduct a variety of commercial space activities, while consolidating the licensing approval process for such activities under the authority of the U.S. Department of Commerce (“DOC”).[121] The regulation of commercial space activities historically has been distributed among a variety of agencies—with the National Oceanic and Atmospheric Administration (“NOAA”) governing remote sensing, the FCC governing communications satellites,[122] and the FAA/AST regulating launch, reentry, and some other non-traditional activities.[123]  But with that patchwork of authority, proponents of the Act believe there exists a regulatory gap for overseeing and authorizing new and innovative space activities.[124]  A primary goal of the Act is to address this perceived uncertainty, and in so doing, resolve long-standing questions associated with the United States’ responsibility to regulate commercial space activities under the Outer Space Treaty,[125] which the bill’s text references extensively. In its current form, the bill would grant the Office of Space Commerce (within the DOC) “the authority to issue certifications to U.S. nationals and nongovernmental entities for the operation of:  (1) specified human-made objects manufactured or assembled in outer space . . . and (2) all items carried on such objects that are intended for use in outer space.”[126]  The bill further eliminates the Commercial Remote Sensing Regulatory Affairs Office of the NOAA, and vests authority to issue permits for remote sensing systems, again, in the DOC.[127]  The bill also creates a certification process for other “commercial payloads not otherwise licensed by the government,” thereby providing fallback legislation for “non-traditional applications like satellite servicing, commercial space stations and lunar landers.”[128]  The DOC hence would occupy all the regulatory authority for commercial space activities, except for the FCC and FAA/AST’s current authority, which those agencies would maintain.[129] The commercial space industry supports the bill, and in particular the bill’s apparent presumption in favor of regulatory approval.[130]  Industry also supports the bill’s overhaul of the regulation of remote sensing—for example, the bill requires the DOC to issue a certification decision within just 60 days (or else the application is granted),[131] provide an explanation for any rejections, and grant every application that seeks authorization for activities involving “the same or substantially similar capabilities, derived data, products, or services are already commercially available or reasonably expected to be made available in the next 3 years in the international or domestic marketplace.”[132] Some opponents of the bill contend that the consolidation of regulatory approval will limit interagency review, which is important because the DoD, State Department, and the intelligence community currently play some regulatory role in the review of aspects of new commercial space activities that are perceived to potentially pose a threat to national security.[133]  Others contend that the Office of Space Commerce has inadequate resources and experience to handle the regulatory approvals.  The bill seeks to ameliorate these concerns by authorizing $5 million in funding for the Office in 2018.[134]  The Department of Justice also has voiced some constitutional concerns.[135] The House referred the bill to the House Committee on Science, Space, and Technology,[136] which on June 8, 2017 passed three amendments by voice vote.[137]  Since being marked up in committee, the bill has seen no further action by the House.[138]  The DOC currently is seeking public input on possible changes to commercial space operations licensing more broadly.[139] D.    Industry and Government Regulators Call for Changes to NOAA’s Licensing of Remote Sensing Technology ASCFEA’s effort to strip NOAA of its authority to regulate remote sensing technology coincides with a growing number of complaints from the remote sensing industry and government regulators concerning NOAA’s ability to handle an increased number of licensing applications.[140] The Land Remote Sensing Policy Act of 1992 authorized the Secretary of Commerce to “license private sector parties to operate private remote sensing space systems.”[141]  But despite a sea change in remote sensing technology and activities since 1992, that law remains the main source of authority for remote sensing licensing, and Congress has made few modifications to the law since its inception.[142]  Given the speed of technological change, and increased industry competition, remote sensing companies are advocating for NOAA to adopt a “permissive” approach to licensing, akin to the language proposed in the ASCFEA.[143] NOAA’s issues have been exacerbated by the fact that license applications are now more varied and complex than they were previously.[144]   Representatives from NOAA describe how prior to 2011, it took an average of 51 days to review license applications, since many applications sought permission for similar concepts for satellite systems.[145]  Even though the Land Remote Sensing Policy Act of 1992 calls for a 120-day approval window, in practice, applications now extend far longer than that—and further, NOAA sometimes provides little to no explanation about why it rejects particular applications.[146]  Under the ASCFEA, the DOC would be required to approve applications using the “same or substantially similar capabilities, derived data, products, or services as are already commercially available or reasonably expected to be made available in the next 3 years in the international or domestic marketplace.”[147] Another complexity is that many companies develop technology that do not solely or traditionally perform remote sensing functions, but have remote sensing capabilities.[148]  The ASCFEA addresses this problem by offering exceptions for “De Minimis” uses of remote sensing technology.[150] E.    Commercial Space Policy in the Trump Era On December 11, 2017, President Trump signed White House Space Policy Directive 1, entitled “Reinvigorating America’s Human Space Exploration Program.”[151]  As the subject suggests, the Directive’s goal is to bring a renewed focus on human space flight at a time when the United States lacks an organic capability to send American astronauts into low-Earth orbit, let alone beyond.[152]  Fittingly, President Trump signed the directive on the forty-fifth anniversary of the lunar landing of Apollo 17, with Apollo 17 astronaut Senator Harrison Schmitt present at the ceremony.[153] According to the Directive, the United States will “[l]ead an innovative and sustainable program of exploration with commercial and international partners to enable human expansion across the solar system….”[154]  The directive calls for missions beyond low-Earth orbit, with the United States “lead[ing] the return of humans to the Moon for long-term exploration and utilization, followed by human missions to Mars and other destinations.”[155] NASA is already working with several commercial entities to develop transportation to and from low-Earth orbit, as well as to the International Space Station.[156]  And a call for a return to the moon for use as a stepping-stone to other destinations is not new with President Trump; previous administrations have expressed a similar desire.[157]  What remains to be seen is how this “long-term exploration” will be funded, with a good indicator being what “will be reflected in NASA’s FISCAL Year 2019 budget request.”[158]  Until then, “No bucks, no Buck Rogers.”[159] F.    Updates on Space Law in Luxembourg, India, and Australia Luxembourg Continues its Push for Commercial Space Prominence The small country of Luxembourg, a signatory to the Outer Space Treaty,[160] has major commercial space ambitions.  In 2016, Luxembourg passed a law to set aside €200 million to fund commercial space mining activities, and also offered to help interested companies obtain private financing.[161]  On July 13, 2017, following the United States’ lead,[162] Luxembourg passed a law that gives qualifying companies the right to own any space resources they extract from celestial bodies including asteroids.[163]  The law further outlines a regulatory framework for “the government to authorize and supervise resource extraction and other space activities,” except for communications satellites, which a different Luxembourg agency regulates.[164]  To qualify for a space mining license, companies must be centrally administered and own a registered office in Luxembourg, and also must obtain regulatory approval.[165]  It is as of now unclear whether the Luxembourg law (as well as the U.S.’s analogous law) violate the Outer Space Treaty, which prohibits companies from claiming territory on celestial bodies, but does not clarify whether that prohibition extends to materials extracted from those celestial bodies.[166] India Unveils Draft of New Commercial Space Law; Sets Satellite Launch Record In November 2017, the India Department of Space released and sought comments for the “Space Activities Act, 2017.”[167]  The stated goal of the bill is to “encourage enhanced participation of non-governmental/private sector agencies in space activities in India.”[168]  The bill as currently drafted vests authority in the Indian Government to formulate a licensing scheme for any and all “Commercial Space Activity,” and states that licenses may be granted if the sought activity does not jeopardize public health or safety, and does not violate India’s international treaty obligations, such as the Outer Space Treaty, to which India is a signatory.[169] India’s space agency also made headlines this year when it sent 104 satellites into space in 18 minutes—purportedly tripling the prior record for single-day satellite launches.[170]  The New York Times reports that satellite and other orbital companies closely scrutinized the launch, since India’s space agency is cheaper to employ for satellite launches than its European and North American counterparts.[171] Australia Announced that It Will Create a Space Agency; Details Pending In September 2017, Australia’s Acting Minister for Industry, Innovation and Science announced that Australia will create a national space agency.[172]  While details are still pending, Australia’s goal purportedly is to take advantage of the $300-$400 billion space economy, while creating Australian jobs in the process.[173] IV.    CYBERSECURITY AND PRIVACY ISSUES IN THE NATIONAL AIRSPACE A.    Cybersecurity Issues The Federal Aviation Administration (FAA) has lagged behind other sectors in establishing robust cybersecurity and privacy safeguards in the national airspace, although federal policy identifies the transportation sector (which includes the aviation industry) as one of the 16 “critical infrastructure” sectors that have the ability to impact significantly the nation’s security, economy, and public health and safety.[174]  The need for the FAA to establish robust safeguards is obvious, as the catastrophic impact of a cyber attack on the national airspace is not hard to imagine post-9/11.  Recently, one hacker claimed he compromised the cabin-based in-flight entertainment system to control a commercial airline engine in flight. One development of note is the reintroduction of the Cybersecurity Standards for Aircraft to Improve Resilience Act of 2017 by U.S. Senators Edward Markey and Richard Blumenthal.[175] Senator Markey first introduced legislation aimed at improving aircraft cyber security protection in April 2016, following a 2015 survey of U.S. airline CEOs to discover standard cybersecurity protocols used by the aviation industry.  If signed into law, the bill would require the U.S. Department of Transportation to work with DoD, Homeland Security, the Director of National Intelligence, and the FCC to incorporate requirements relating to cybersecurity into the requirements for certification.  Additionally, the bill would establish standard protections for all “entry points” to the electronic systems of aircraft operating in the U.S.  This would include the use of isolation measures to separate critical software systems from noncritical software systems. B.    UAS Privacy Concerns UAS are equipped with highly sophisticated surveillance technology with the ability to collect personal information, including physical location.  Senator Ayotte, Chair of the Subcommittee on Aviation Operations, Safety, and Security, summarized the privacy concerns drones pose as follows: “Unlimited surveillance by government or private actors is not something that our society is ready or willing or should accept.  Because [drones] can significantly lower the threshold for observation, the risk of abuse and the risk of abusive surveillance increases.”  We describe below several recent federal and state efforts to address this issue. 1.    State Legislation Addressing Privacy Concerns At least five out of the twenty-one states that either passed legislation or adopted resolutions related to UAS in 2017 specifically addressed privacy concerns.[176] Colorado HB 1070 requires the center of excellence within the department of public safety to perform a study that identifies ways to integrate UAS within local and state government functions relating to firefighting, search and rescue, accident reconstruction, crime scene documentation, emergency management, and emergencies involving significant property loss, injury or death.  The study must consider privacy concerns, in addition to costs and timeliness of deployment, for each of these uses. New Jersey SB 3370 allows UAS operation that is consistent with federal law, but also creates criminal offenses for certain UAS surveillance and privacy violations.  For example, using a UAS to conduct surveillance of a correction facility is a third degree crime.  Additionally, the law also applies the operation of UAS to limitations within restraining orders and specifies that convictions under the law are separate from other convictions such as harassment, stalking, and invasion of privacy. South Dakota SB 22 also prohibits operation of drones over the grounds of correctional and military facilities, making such operation a class 1 misdemeanor.  Further, the law modifies the crime of unlawful surveillance to include intentional use of a drone to observe, photograph or record someone in a private place with a reasonable expectation of privacy, and landing a drone on the property of an individual without that person’s consent.  Such purportedly unlawful surveillance is a class 1 misdemeanor unless the individual is operating the drone for commercial or agricultural purposes, or the individual is acting within his or her capacity as an emergency management worker. Utah HB 217 modifies criminal trespass to include drones entering and remaining unlawfully over property with specified intent.  Depending on the intent, a violation is either a class B misdemeanor, a class A misdemeanor, or an infraction, unless the person is operating a UAS for legitimate commercial or educational purposes consistent with FAA regulations.  Utah HB 217 also modifies the offense of voyeurism, a class B misdemeanor, to include the use of any type of technology, including UAS, to secretly record video of a person in certain instances. Virginia HB 2350 makes it a Class 1 misdemeanor to use UAS to trespass upon the property of another for the purpose of secretly or furtively peeping, spying, or attempting to peep or spy into a dwelling or occupied building located on such property. 2.    UAS Identification and Tracking Report The FAA chartered an Aviation Rulemaking Committee (“ARC”) in June 2017 to provide recommendations on the technologies available for remote identification and tracking of UAS, and how remote identification may be implemented.[177]  However, the ARC’s 213 page final report, dated September 30, 2017, notes that the ARC lacked sufficient time to fully address privacy and data protection concerns, and that therefore those topics were not addressed: [T]he ARC also lacks sufficient time to perform an exhaustive analysis of all the privacy implications of remote ID, tracking, or UTM, and did not specifically engage with privacy experts, from industry or otherwise, during this ARC.  These members agree, however, that it is fundamentally important that privacy be fully considered and that appropriate privacy protections are in place before data collection and sharing by any party (either through remote ID and/or UTM) is required for operations.  A non-exhaustive list of important privacy considerations include, amongst other issues, any data collection, retention, sharing, use and access.  Privacy must be considered with regard to both PII and historical tracking information.  The privacy of all individuals (including operators and customers) should be addressed, and privacy should be a consideration during the rulemaking for remote ID and tracking. Accordingly, the ARC recognizes the fundamental importance of fully addressing privacy and data protection concerns, and we anticipate that future rulemaking will address these issues. IV.    CONCLUSION We will continue to keep you informed on these and other related issues as they develop. [1] See Huerta, No. 3:16-cv-358, Dkt. No. 30. [2] Id. [3] Id. [4] See Boggs, No. 3:16-cv-00006, Dkt. No. 1 (W.D. Ky. Jan. 4, 2016). [5] See id. [6] See Boggs, No. 3:16-cv-00006, Dkt. No. 20 (W.D. Ky. Jan. 4, 2016). [7] See id. [8] See Singer, No. 1:17-cv-10071, Dkt. N. 63 (D. Mass. Jan. 17, 2017). [9] See id. [10] See id. [11] See id. [12] See id. [13] See Taylor v. Huerta, 856 F.3d 1089 (D.C. Cir. 2017). [14] See Pub. L. No. 112–95, § 336(a), 126 Stat. 11, 77 (2012) (codified at 49 U.S.C. § 40101 note). [15] See Taylor, 856 F.3d at 1090. [16] See Pub. L. No. 115–91, § 3 1092(d), (2017). [17] The White House, Office of the Press Secretary, Presidential Memorandum:  Promoting Economic Competitiveness While Safeguarding Privacy, Civil Rights, and Civil Liberties in Domestic Use of Unmanned Aircraft Systems, Feb. 15, 2015, available at https://obamawhitehouse.archives.gov/the-press-office/2015/02/15/presidential-memorandum-promoting-economic-competitiveness-while-safegua. [18] Operation and Certification of Small Unmanned Aircraft Systems, 81 Fed. Reg. 42064 (June 28, 2016). [19] Electronic Privacy Information Center (“EPIC”), EPIC v. FAA: Challenging the FAA’s Failure to Establish Drone Privacy Rules, https://epic.org/privacy/litigation/apa/faa/drones/ (last visited Jan. 18, 2018). [20] See generally Electronic Privacy Information Center v. FAA (EPIC I), 821 F.3d 39, 41-42 (D.C. Cir. 2016) (noting that FAA denied EPIC’s petition for rulemaking requesting that the FAA consider privacy concerns). [21] Voluntary Best Practices for UAS Privacy, Transparency, and Accountability, NTIA-Convened Multistakeholder Process (May 18, 2016), https://www.ntia.doc.gov/files/ntia/publications/ uas_privacy_best_practices_6-21-16.pdf. [22] EPIC, supra, note xix. [23] EPIC I, supra, note xx, at 41. [24] Id. 41-42. [25] Id. [26] Id. [27] Id. at 42-43. [28] Id. at 42. [29] Id. at 43. [30] Pet. For Review, Electronic Privacy Information Center v. FAA (EPIC II), Nos. 16-1297, 16-1302 (Filed Aug. 22, 2016), https://epic.org/privacy/litigation/apa/faa/drones/EPIC-Petition-08222016.pdf. [31] Appellant Opening Br., EPIC II, Nos. 16-1297, 16-1302 (Filed Feb. 28, 2017), https://epic.org/privacy/litigation/apa/faa/drones/1663292-EPIC-Brief.pdf. [32] Appellee Reply Br., EPIC II, Nos. 16-1297, 16-1302 (Filed April 27, 2017), https://epic.org/privacy/litigation/apa/faa/drones/1673002-FAA-Reply-Brief.pdf. [33] United States Court of Appeals District of Columbia Circuit, Oral Argument Calendar, https://www.cadc.uscourts.gov/internet/sixtyday.nsf/fullcalendar?OpenView&count=1000 (last visited Jan. 18, 2018). [34] United States Department of Defense, Unmanned Systems Integrated Roadmap (2013), https://www.defense.gov/Portals/1/Documents/pubs/DOD-USRM-2013.pdf. [35] Andrew Meola, Drone Marker Shows Positive Outlook with Strong Industry Growth and Trends, Business Insider, July 13, 2017, available at http://www.businessinsider.com/drone-industry-analysis-market-trends-growth-forecasts-2017-7. [36] Office of the Under Secretary of Defense, U.S. Department of Defense Fiscal Year 2017 Budget Request (Feb. 2016). [37] Office of the Under Secretary of Defense, U.S. Department of Defense Fiscal Year 2018 Budget Request (May 2017). [38] Goldman Sachs, Drones: Reporting for Work, http://www.goldmansachs.com/our-thinking/technology-driving-innovation/drones/ (last visited Jan. 18, 2017). [39] Id. [40] Chris Woods, The Story of America’s Very First Drone Strike, The Atlantic, May 30, 2016, available at https://www.theatlantic.com/international/archive/2015/05/america-first-drone-strike-afghanistan/394463/. [41] Deputy Secretary of Defense, Policy Memorandum 15-002, “Guidance for the Domestic Use of Unmanned Aircraft Systems” (Feb. 17, 2015), https://www.defense.gov/Portals/1/Documents/Policy%20Memorandum%2015-002%20_Guidance%20for%20the%20Domestic%20Use%20of%20Unmanned%20Aircraft%20Systems_.pdf. [42] Id. [43] Id. [44] Id. [45] Id. [47] Id. [48] Eric Schmitt, Pentagon Tests Lasers and Nets to Combat Vexing Foe: ISIS Drones, N.Y. Times, Sept. 23, 2017, available at https://www.nytimes.com/2017/09/23/world/middleeast/isis-drones-pentagon-experiments.html. [49] Id. [50] Christopher Woody, The Pentagon is Getting Better at Stopping Enemy Drones—and Testing Its Own for Delivering Gear to the Battlefield, Business Insider, Apr. 24, 2017, available at https://www.businessinsider.com/military-adding-drones-and-drone-defense-to-its-arensal-2017-4. [51] Id. [52] Radio Hill Technology, Birth of the Dronebuster, http://www.radiohill.com/product/ (last visited Jan. 18, 2018). [53] Id. [54] Kyle Mizokami, The Army’s Drone-Killing Lasers are Getting a Tenfold Power Boost, Popular Mechanics, July 18, 2017, available at http://www.popularmechanics.com/military/research/news/a27381/us-army-drone-killing-laser-power/. [55] Sydney J. Freedberg Jr., Drone Killing Laser Stars in Army Field Test, Breaking Defense, May 11, 2017, available at https://breakingdefense.com/2017/05/drone-killing-laser-stars-in-army-field-test/. [56] Mizokami, supra, note lv. [57] ASSURE, UAS Ground Collision Severity Evaluation Final Report, United States (2017), available at http://www.assureuas.org/projects/deliverables/sUASGroundCollisionReport.php?Code=230 (ASSURE Study). [58] Id. [59] Id. [60] Id. [61] DJI, DJI Welcomes FAA-Commissioned Report Analyzing Drone Safety Near People, Newsroom News, Apr. 28, 2017, available at https://www.dji.com/newsroom/news/dji-welcomes-faa-commissioned-report-analyzing-drone-safety-near-people. [62] Id. [63] Id. [64] ASSURE Study, supra note lviii. [65] Id. [66] Id. [67] Id. [68] Id. [69] ASSURE, FAA and Assure Announce Results of Air-to-Air Collision Study, ASSURE: Alliance for System Safety of UAS through Research Excellence, Nov. 27, 2017, available at https://pr.cirlot.com/faa-and-assure-announce-results-of-air-to-air-collision-study/. [70] Id. [71] ASSURE Study, supra note lviii. [72] Id. [73] Id. [74] Id. [75] See Pathiyil, et al., Issues of Safety and Risk management for Unmanned Aircraft Operations in Urban Airspace, 2017 Workshop on Research, Education and Development of Unmanned Aerial Systems (RED-UAS), Oct. 3, 2017, available at http://ieeexplore.ieee.org/stamp/stamp.jsp?arnumber=8101671. [76] Id. [77] Id. [78] Id. [79] Id. [80] Patrick C. Miller, 2,800 Interested Parties Apply for UAS Integration Pilot Program, UAS Magazine, Jan. 3, 2018, available at http://www.uasmagazine.com/articles/1801/2-800-interested-parties-apply-for-uas-integration-pilot-program. [81] Unmanned Aircraft Systems Integration Pilot Program, 82 Fed. Reg. 50,301 (Oct. 25, 2017) (Presidential directive creating the program); see also Unmanned Aircraft Systems Integration Pilot Program—Announcement of Establishment of Program and Request for Applications, 82 Fed. Reg. 215 (Nov. 8, 2017) (Department of Transportation Notice of the UAS Pilot Program). [82] See id. [83] See id. [84] Elaine Goodman, Blood Deliveries by Drone Proposed—City Submits Unique Ideas to FAA, Daily Post, Jan. 5, 2018, available at http://padailypost.com/2018/01/05/blood-deliveries-by-drone-proposed-city-submits-unique-ideas-to-faa/. [85] Id. [86] Id. [87] Id. [88] Id. [89] Miller, supra note lxxxi. [90] Id. [91] Id. [92] Id. [93] Id. [101]   NASA Spaceflight, India’s PSLV deploys a record 104 satellites (Feb. 14, 2017), available at https://www.nasaspaceflight.com/2017/02/indias-pslv-record-104-satellites/. [102]   NASA, NASA’s Newest Astronaut Recruits to Conduct Research off the Earth, For the Earth and Deep Space Missions (June 7, 2017), available at https://www.nasa.gov/press-release/nasa-s-newest-astronaut-recruits-to-conduct-research-off-the-earth-for-the-earth-and. [103]   NASA, Cassini Spacecraft Ends Its Historic Exploration of Saturn (Sept. 15, 2017), available at https://www.nasa.gov/press-release/nasa-s-cassini-spacecraft-ends-its-historic-exploration-of-saturn. [104]   NASA, New Space Policy Directive Calls for Human Expansion Across Solar System (Dec. 11, 2017), available at https://www.nasa.gov/press-release/new-space-policy-directive-calls-for-human-expansion-across-solar-system. [105]   TechCrunch, SpaceX caps a record year with 18th successful launch of 2017 (Dec. 22, 2017), available at https://techcrunch.com/2017/12/22/spacex-caps-a-record-year-with-18th-successful-launch-of-2017/. [106]   The Verge, After a year away from test flights, Blue Origin launches and lands its rocket again (Dec. 12, 2017), available at https://www.theverge.com/2017/12/12/16759934/blue-origin-new-shepard-test-flight-launch-landing. [107]   Space.com, SpaceX Launches (and Lands) Used Rocket on Historic NASA Cargo Mission (Dec. 15, 2017), available at https://www.space.com/39063-spacex-launches-used-rocket-dragon-spacecraft-for-nasa.html. [108]   U.S. Department of State, Treaty on Principles Governing the Activities of States in the Exploration and Use of Outer Space, Including the Moon and Other Celestial Bodies, available at https://www.state.gov/t/isn/5181.htm#treaty. [109] NTI, Treaty on Principles Governing the Activities of States in the Exploration and Use of Outer Space, Including the Moon and Other Celestial Bodies (Outer Space Treaty) (Feb. 1, 2017), available at http://www.nti.org/learn/treaties-and-regimes/treaty-principles-governing-activities-states-exploration-and-use-outer-space-including-moon-and-other-celestial-bodies-outer-space-treaty/. [110] PHYS.ORG, Space likely for rare earth search, scientists say (Feb. 20, 2013), available at https://phys.org/news/2013-02-space-rare-earths-scientists.html. [111]   NASA, Lunar CATALYST (Jan. 16, 2014), available at https://www.nasa.gov/content/lunar-catalyst/#.WmLx1qinGHs. [112]   The Conversation, The Outer Space Treaty has been remarkably successful – but is it fit for the modern age? (Jan. 27, 2017), available at http://theconversation.com/the-outer-space-treaty-has-been-remarkably-successful-but-is-it-fit-for-the-modern-age-71381. [113]   The Verge, How an international treaty signed 50 years ago became the backbone for space law (Jan. 27, 2017), available at https://www.theverge.com/2017/1/27/14398492/outer-space-treaty-50-anniversary-exploration-guidelines. [114]   Id. [115]   The Space Review, Is it time to update the Outer Space Treaty? (June 5, 2017), available at http://www.thespacereview.com/article/3256/1. [116]   U.S. Senate, Reopening the American Frontier:  Exploring How the Outer Space Treaty Will Impact American Commerce and Settlement in Space (May 23, 2017), available at https://www.commerce.senate.gov/public/index.cfm/hearings?ID=5A91CD95-CDA5-46F2-8E18-2D2DFCAE4355. [117]   The Space Review, supra note cxvi. [118]   Id. [119]   Id. [120] H.R. Rep No. 2809 (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/2809.  The other primary sponsors of the bill are Brian Babin (R-TX), chairman of the space subcommittee; and Rep. Jim Bridenstine (R-OK). [121] Sandy Mazza, Space exploration regulations need overhaul, new report says, Daily Breeze (Dec. 2, 2017), https://www.dailybreeze.com/2017/12/02/space-exploration-regulations-need-overhaul-new-report-says/.  The Act’s stated purpose is to “provide greater transparency, greater efficiency, and less administrative burden for nongovernmental entities of the United States seeking to conduct space activities.”  H.R. Rep No. 2809 (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/2809 (Section 2(c)). [122] Jeff Foust, House bill seeks to streamline oversight of commercial space activities, Space News (June 8, 2017), http://spacenews.com/house-bill-seeks-to-streamline-oversight-of-commercial-space-activities/. [123] Marcia Smith, New Commercial Space Bill Clears House Committee, Space Policy Online (June 8, 2017), https://spacepolicyonline.com/news/new-commercial-space-bill-clears-house-committee/. [124] Under the Obama administration, many in government and industry presumed that the regulation of new space activities would fall to FAA/AST.  See Marcia Smith, New Commercial Space Bill Clears House Committee, Space Policy Online (June 8, 2017), https://spacepolicyonline.com/news/new-commercial-space-bill-clears-house-committee/ (In fact, the agency heads of the FAA/AST, and the Office of Science and Technology Policy, recommended the same). [125] Marcia Smith, Companies Agree FAA Best Agency to Regulate Non-Traditional Space Activities, Space Policy Online (Nov. 15, 2017), https://spacepolicyonline.com/news/companies-agree-faa-best-agency-to-regulate-non-traditional-space-activities/. [126] H.R. Rep No. 2809 (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/2809. [127] Id. [128] Jeff Foust, House bill seeks to streamline oversight of commercial space activities, Space News (June 8, 2017), http://spacenews.com/house-bill-seeks-to-streamline-oversight-of-commercial-space-activities/. [129] Marcia Smith, New Commercial Space Bill Clears House Committee, Space Policy Online (June 8, 2017), https://spacepolicyonline.com/news/new-commercial-space-bill-clears-house-committee/. [130] Marcia Smith, New Commercial Space Bill Clears House Committee, Space Policy Online (June 8, 2017), https://spacepolicyonline.com/news/new-commercial-space-bill-clears-house-committee/; Marcia Smith, Companies Agree FAA Best Agency to Regulate Non-Traditional Space Activities, Space Policy Online (Nov. 15, 2017), https://spacepolicyonline.com/news/companies-agree-faa-best-agency-to-regulate-non-traditional-space-activities/.  The bill, for example, requires e the Secretary of Commerce to issue certifications or permits for commercial space activities, unless, for example, the Secretary finds by “clear and convincing evidence” that the permit would violate the Outer Space Treaty.  Bob Zimmerman, What You Need To Know About The Space Law Congress Is Considering, The Federalist (July 11, 2017), http://thefederalist.com/2017/07/11/need-know-space-law-congress-considering/.  Indeed, the policy section of the bill finds that “United States citizens and entities are free to explore and use space, including the utilization of outer space and resources contained therein, without conditions or limitations” and “this freedom is only to be limited when necessary to assure United States national security interests are met” or fulfill treaty obligations.  H.R. Rep No. 2809 (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/2809. [131] Jeff Foust, House bill seeks to streamline oversight of commercial space activities, Space News (June 8, 2017), http://spacenews.com/house-bill-seeks-to-streamline-oversight-of-commercial-space-activities/. [132] Joshua Hampson, The American Space Commerce Free Enterprise Act, Niskanen Center (June 15, 2017), https://niskanencenter.org/blog/american-space-commerce-free-enterprise-act/. [133] Jeff Foust, House bill seeks to streamline oversight of commercial space activities, Space News (June 8, 2017), http://spacenews.com/house-bill-seeks-to-streamline-oversight-of-commercial-space-activities/. [134] Jeff Foust, House bill seeks to streamline oversight of commercial space activities, Space News (June 8, 2017), http://spacenews.com/house-bill-seeks-to-streamline-oversight-of-commercial-space-activities/; Congressional Budget Office Cost Estimate, Congressional Budget Office (July 7, 2017), https://www.cbo.gov/system/files/115th-congress-2017-2018/costestimate/hr2809.pdf. [135] Samuel R. Ramer, Letter from the Office of the Assistant Attorney General, Justice Department (July 17, 2017), https://www.justice.gov/ola/page/file/995646/download. [136] H.R. Rep No. 2809 (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/2809/all-actions. [137] Marcia Smith, New Commercial Space Bill Clears House Committee, Space Policy Online (June 8, 2017), https://spacepolicyonline.com/news/new-commercial-space-bill-clears-house-committee/. [138] Jeffrey Hill, Congressman Babin Hints that Cybersecurity Could be Included in Larger Commercial Space Legislative Package, Satellite Today (Nov. 7, 2017), http://www.satellitetoday.com/government/2017/11/07/cybersecurity-featured-space-commerce-act/. [139] Commerce Department Now Accepting Public Inputs on Regulatory Streamlining, Space Commerce (Oct. 27, 2017), http://www.space.commerce.gov/commerce-department-now-accepting-public-inputs-on-regulatory-streamlining/; Sandy Mazza, Space exploration regulations need overhaul, new report says, Daily Breeze (Dec. 2, 2017), https://www.dailybreeze.com/2017/12/02/space-exploration-regulations-need-overhaul-new-report-says/. [140] Sean Kelly, The new national security strategy prioritizes space, The Hill (Jan. 3, 2018), http://thehill.com/opinion/national-security/367240-the-new-national-security-strategy-prioritizes-space; Jeff Foust, House panel criticizes commercial remote sensing licensing, Space News (Sept. 8, 2016), http://spacenews.com/house-panel-criticizes-commercial-remote-sensing-licensing/.  Critics argue that the NOAA’s approval pace is harming U.S. companies to the benefit of foreign competitors. Randy Showstack, Remote Sensing Regulations Come Under Congressional Scrutiny, EOS (Sept. 14, 2016), https://eos.org/articles/remote-sensing-regulations-come-under-congressional-scrutiny. [141] H.R. Rep No. 6133 (1992), available at https://www.congress.gov/bill/102nd-congress/house-bill/6133. [142] Randy Showstack, Remote Sensing Regulations Come Under Congressional Scrutiny, EOS (Sept. 14, 2016), https://eos.org/articles/remote-sensing-regulations-come-under-congressional-scrutiny.  Indeed, the Commercial Space Launch Competitiveness Act, signed into law in November 2016, requires the Department of Commerce to analyze possible statutory updates to the remote sensing licensing scheme.  Jeff Foust, House panel criticizes commercial remote sensing licensing, Space News (Sept. 8, 2016), http://spacenews.com/house-panel-criticizes-commercial-remote-sensing-licensing/.  The text of the ASCFEA also recognizes that since “the passage of the Land Remote Sensing Policy Act of 1992, the National Oceanic and Atmospheric Administration’s Office of Commercial Remote Sensing has experienced a significant increase in applications for private remote sensing space system licenses . . .”  H.R. Rep No. 2809 (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/2809. [143] Joshua Hampson, The American Space Commerce Free Enterprise Act, Niskanen Center (June 15, 2017), https://niskanencenter.org/blog/american-space-commerce-free-enterprise-act/.  The ASCFEA defines a Space-Based Remote Sensing System as “a space object in Earth orbit that is “(A) designed to image the Earth; or (B) capable of imaging a space object in Earth orbit operated by the Federal Government.”  H.R. Rep No. 2809 (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/2809. [144] Jeff Foust, Commercial remote sensing companies seek streamlined regulations, Space News (Mar. 17, 2017), http://spacenews.com/commercial-remote-sensing-companies-seek-streamlined-regulations/. [145] Id. [146] Jeff Foust, House panel criticizes commercial remote sensing licensing, Space News (Sept. 8, 2016), http://spacenews.com/house-panel-criticizes-commercial-remote-sensing-licensing/. [147] H.R. Rep No. 2809 (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/2809 (Chapter 8012 § 80202(e)(1)). [148] Jeff Foust, Commercial remote sensing companies seek streamlined regulations, Space News (Mar. 17, 2017), http://spacenews.com/commercial-remote-sensing-companies-seek-streamlined-regulations/. [150] H.R. Rep No. 2809 (2017), available at https://www.congress.gov/bill/115th-congress/house-bill/2809 (Chapter 802 § 80201(d)). [151] Reinvigorating America’s Human Space Exploration Program, 82 Fed. Reg. 59501 (Dec. 11, 2017) [152] Nell Greenfieldboyce, President Trump Is Sending NASA Back to the Moon (Dec. 11, 2017) available at https://www.npr.org/sections/thetwo-way/2017/12/11/569936446/president-trump-is-sending-nasa-back-to-the-moon. [153] See Press Release, NASA, New Space Policy Directive Calls for Human Expansion Across Solar System (Dec. 11, 2017); see also NASA, https://www.nasa.gov/mission_pages/apollo/missions/apollo17.html (last visited Jan. 21, 2018). [154] Reinvigorating America’s Human Space Exploration Program, supra note clii. [155] Id. [156] NASA, Commercial Crew Program – The Essentials, available at https://www.nasa.gov/content/commercial-crew-program-the-essentials/#.VjOJ3berRaT. [157] Michael Sheetz, Trump Orders NASA to Send American Astronauts to the Moon, Mars, CNBC (Dec. 11, 2017) available at https://www.cnbc.com/2017/12/11/trump-orders-nasa-to-send-american-astronauts-to-the-moon-mars.html. [158] See New Space Policy Directive Calls for Human Expansion Across Solar System, supra note cv; see also Christian Davenport, Trump Vows Americans Will Return to the Moon.  The Question Is How?, (Dec. 11, 2017) available at https://www.washingtonpost.com/news/the-switch/wp/2017/12/11/trump-vows-americans-will-return-to-the-moon-the-question-is-how/?utm_term=.4ceb20131cdf. [159] The Right Stuff (The Ladd Company 1983). [160] Laurent Thailly and Fiona Schneider, Luxembourg set to become Europe’s commercial space exploration hub with new Space law, Ogier (Jan. 8, 2017), https://www.ogier.com/news/the-luxembourg-space-law. [161] Reuters Staff, Luxembourg sets aside 200 million euros to fund space mining ventures, Reuters (June 3, 2016), https://www.reuters.com/article/us-luxembourg-space-mining/luxembourg-sets-aside-200-million-euros-to-fund-space-mining-ventures-idUSKCN0YP22H; Laurent Thailly and Fiona Schneider, Luxembourg set to become Europe’s commercial space exploration hub with new Space law, Ogier (Jan. 8, 2017), https://www.ogier.com/news/the-luxembourg-space-law.  Luxembourg invested €23 million in U.S. company Planetary Resources, and now owns a 10% share in the company.  Kenneth Chang, If no one owns the moon, can anyone make money up there?, The Independent (Dec. 4, 2017), http://www.independent.co.uk/news/long_reads/if-no-one-owns-the-moon-can-anyone-make-money-up-there-space-astronomy-a8087126.html. [162] In 2015, the U.S. passed the Commercial Space Launch Competitiveness Act, which clarified that companies that extract materials from celestial bodies can own those materials.  Andrew Silver, Luxembourg passes first EU space mining law. One can possess the Spice, The Register (July 14, 2017), https://www.theregister.co.uk/2017/07/14/luxembourg_passes_space_mining_law/. [163] Jeff Foust, Luxembourg adopts space resources law, Space News (July 17, 2017), http://spacenews.com/luxembourg-adopts-space-resources-law/. [164] Jeff Foust, Luxembourg adopts space resources law, Space News (July 17, 2017), http://spacenews.com/luxembourg-adopts-space-resources-law;  Paul Zenners, Press Release, Space Resources (July 13, 2017), http://www.spaceresources.public.lu/content/dam/spaceresources/press-release/2017/2017_07_13%20PressRelease_Law_Space_Resources_EN.pdf. [165] Laurent Thailly and Fiona Schneider, Luxembourg set to become Europe’s commercial space exploration hub with new Space law, Ogier (Jan. 8, 2017), https://www.ogier.com/news/the-luxembourg-space-law.  Reportedly, two American companies already plan to move to Luxembourg:  Deep Space Industries and Planetary Resources. Vasudevan Mukunth, Fiat Luxembourg: How a Tiny European Nation is Leading the Evolution of Space Law, The Wire (July 15, 2017), https://thewire.in/157687/luxembourg-space-asteroid-mining-dsi/. [166] Andrew Silver, Luxembourg passes first EU space mining law. One can possess the Spice, The Register (July 14, 2017), https://www.theregister.co.uk/2017/07/14/luxembourg_passes_space_mining_law/;  Mark Kaufman, Luxembourg’s Asteroid Mining is Legal Says Space Law Expert, inverse.com (Aug. 1, 2017), https://www.inverse.com/article/34935-luxembourg-s-asteroid-mining-is-legal-says-space-law-expert. [167] Antariksh Bhavan, Seeking comments on Draft “Space Activities Bill, 2017” from the stake holders/public-regarding, ISRO (Nov. 21, 2017), https://www.isro.gov.in/update/21-nov-2017/seeking-comments-draft-space-activities-bill-2017-stake-holders-public-regarding;  Special Correspondent, Govt. unveils draft of law to regulate space sector, The Hindu (Nov. 22, 2017), http://www.thehindu.com/sci-tech/science/govt-unveils-draft-of-law-to-regulate-space-sector/article20629386.ece;  Raghu Krishnan & T E Narasimhan, Draft space law gives private firms a grip on rocket, satellite making, Business Standard (Nov. 22, 2017), http://www.business-standard.com/article/economy-policy/draft-space-law-gives-private-firms-a-grip-on-rocket-satellite-making-117112101234_1.html. [168] Antariksh Bhavan, Seeking comments on Draft “Space Activities Bill, 2017” from the stake holders/public-regarding, ISRO (Nov. 21, 2017), https://www.isro.gov.in/update/21-nov-2017/seeking-comments-draft-space-activities-bill-2017-stake-holders-public-regarding. [169] Id. [170] Ellen Barry, India Launches 104 Satellites From a Single Rocket, Ramping Up a Space Race, The New York Times (Feb. 15, 2017), https://www.nytimes.com/2017/02/15/world/asia/india-satellites-rocket.html. [171] Id. [172] Yes, Australia will have a space agency. What does this mean? Experts respond, The Conversation (Sept. 25, 2017), http://theconversation.com/yes-australia-will-have-a-space-agency-what-does-this-mean-experts-respond-84588;  Jordan Chong, Better late than never, Australia heads (back) to space, Australian Aviation (Dec. 29, 2017), http://australianaviation.com.au/2017/12/better-late-than-never-australia-heads-back-to-space/. [173] Andrew Griffin, Australia launches brand new space agency in attempt to flee the Earth, The Independent (Sept. 25, 2017), http://www.independent.co.uk/news/science/australia-space-agency-nasa-earth-roscosmos-malcolm-turnbull-economy-a7966751.html;  Henry Belot, Australian space agency to employ thousands and tap $420b industry, Government says, ABC (Sept. 25, 2017), http://www.abc.net.au/news/2017-09-25/government-to-establish-national-space-agency/8980268. [174]   White House, Critical Infrastructure Security and Resilience, Presidential Policy Directive/PPD-21 (Feb. 12, 2013). [175]   Woodrow Bellamy III, Senators Reintroduce Aircraft Cyber Security Legislation, Aviation Today (Mar. 24, 2017), http://www.aviationtoday.com/2017/03/24/senators-reintroduce-aircraft-cyber-security-legislation/. [176]   The eighteen states that passed UAS legislation in 2017 were Colorado, Connecticut, Florida, Georgia, Indiana, Kentucky, Louisiana, Minnesota, Montana, Nevada, New Jersey, North Carolina, Oregon, South Dakota, Texas, Utah, Virginia and Wyoming. The three states that passed resolutions related to UAS were Alaska, North Dakota and Utah. [177]   Under Section 2202 of the FAA Extension, Safety, and Security Act of 2016, Pub. L. 114-190, Congress directed the FAA to convene industry stakeholders to facilitate the development of consensus standards for identifying operators and UAS owners.  The final report identifies the following as the ARC’s stated objectives: The stated objectives of the ARC charter were: to identify, categorize and recommend available and emerging technology for the remote identification and tracking of UAS; to identify the requirements for meeting the security and public safety needs of the law enforcement, homeland defense, and national security communities for the remote identification and tracking of UAS; and to evaluate the feasibility and affordability of available technical solutions, and determine how well those technologies address the needs of the law enforcement and air traffic control communities. The final ARC report is available at: https://www.faa.gov/regulations_policies/rulemaking/committees/documents/media/UAS%20ID%20ARC%20Final%20Report%20with%20Appendices.pdf. Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding the issues discussed above. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the Aerospace and Related Technologies industry group, or any of the following: Washington, D.C. Karen L. Manos – Co-Chair (+1 202-955-8536, kmanos@gibsondunn.com) Lindsay M. Paulin (+1 202-887-3701, lpaulin@gibsondunn.com) Erin N. Rankin (+1 202-955-8246, erankin@gibsondunn.com) Christopher T. Timura (+1 202-887-3690, ctimura@gibsondunn.com) Justin P. Accomando (+1 202-887-3796, jaccomando@gibsondunn.com) Brian M. Lipshutz (+1 202-887-3514, blipshutz@gibsondunn.com) Melinda R. Biancuzzo (+1 202-887-3724, mbiancuzzo@gibsondunn.com) New York David M. Wilf – Co-Chair (+1 212-351-4027, dwilf@gibsondunn.com) Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com) Nicolas H.R. Dumont (+1 212-351-3837, ndumont@gibsondunn.com) Eun Sung Lim (+1 212-351-2483, elim@gibsondunn.com) Los Angeles William J. Peters – Co-Chair (+1 213-229-7515, wpeters@gibsondunn.com) David A. Battaglia (+1 213-229-7380, dbattaglia@gibsondunn.com) Perlette M. Jura (+1 213-229-7121, pjura@gibsondunn.com) Eric D. Vandevelde (+1 213-229-7186, evandevelde@gibsondunn.com) Matthew B. Dubeck (+1 213-229-7622, mdubeck@gibsondunn.com) Lauren M. Fischer (+1 213-229-7983, lfischer@gibsondunn.com) Dhananjay S. Manthripragada (+1 213-229-7366, dmanthripragada@gibsondunn.com) James A. Santiago (+1 213-229-7929, jsantiago@gibsondunn.com) Denver Jared Greenberg (+1 303-298-5707, jgreenberg@gibsondunn.com) London Mitri J. Najjar (+44 (0)20 7071 4262, mnajjar@gibsondunn.com) Orange County Casper J. Yen (+1 949-451-4105, cyen@gibsondunn.com) Rustin K. Mangum (+1 949-451-4069, rmangum@gibsondunn.com) Sydney Sherman (+1 949-451-3804, ssherman@gibsondunn.com) Paris Ahmed Baladi (+33 (0)1 56 43 13 00, abaladi@gibsondunn.com) San Francisco Kristin A. Linsley (+1 415-393-8395, klinsley@gibsondunn.com) Matthew Reagan (+1 415-393-8314, mreagan@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 2, 2018 |
ALJs Check Their Own Work, With Unsurprising Results

San Francisco partner Marc Fagel is the author of “ALJs Check Their Own Work, With Unsurprising Results,” [PDF] published by Law360 on March 2, 2018.

March 5, 2018 |
Supreme Court Settles Circuit Split Concerning Bankruptcy Code “Safe Harbor”

Click for PDF On February 27, 2018, the U.S. Supreme Court issued a decision in Merit Management Group, LP v. FTI Consulting, Inc. (No. 16-784), settling a circuit split regarding the “safe harbor” provision in § 546(e) of the Bankruptcy Code.  That section bars the avoidance of certain types of securities and commodities transactions that are made by, to or for the benefit of covered entities including financial institutions, stockbrokers and securities clearing agencies. Circuits had split regarding whether the safe harbor protects a transfer that passes through a covered entity, where the entity only acts as a conduit and has no beneficial interest in the property transferred.  In Merit Management, the Court held that the safe harbor does not apply when a covered entity only acts as a conduit, and that the safe harbor only applies when the “relevant transfer” (i.e., the “overarching” transfer sought to be avoided) is by, to or for the benefit of a covered entity.  As a result, the Court held that the safe harbor did not protect a private securities transaction where neither the buyer nor the seller was a covered entity, even though the funds passed through covered entities. The Bankruptcy Code “Safe Harbor” The Bankruptcy Code permits a trustee to bring claims to “avoid” (or undo) for the benefit of the bankruptcy estate certain prepetition transfers or obligations, including claims to avoid a preference (11 U.S.C. § 547) or fraudulent transfer (11 U.S.C. § 548(a)).  Section 546(e) limits those avoidance powers by providing that, “[n]otwithstanding” the trustee’s avoidance powers, “the trustee may not avoid a transfer that is” (1) a “margin payment” or “settlement payment” “made by or to (or for the benefit of)” a covered entity, or (2) “a transfer made by or to (or for the benefit of)” a covered entity “in connection with a securities contract . . . or forward contract.”  11 U.S.C. § 546(e).  The sole exception to the safe harbor is a claim for “actual fraudulent transfer” under § 548(a)(1)(A).  Id. Background Merit Management involved the acquisition of a “racino” (a combined horse racing and casino business) by its competitor.  To consummate the transaction, the buyer’s bank wired $55 million to another bank that acted as a third-party escrow agent, which disbursed the funds to the seller’s shareholders in exchange for their stock in the seller.  The buyer subsequently filed for Chapter 11 bankruptcy protection and a litigation trust was established pursuant to the buyer’s confirmed reorganization plan.  The trustee sued one of the selling shareholders that received $16.5 million from the buyer, alleging that the transaction was a constructive fraudulent transfer under § 548(a)(1)(B) because the buyer was insolvent at the time of the purchase and “significantly overpaid” for the stock. The district court held that the safe harbor barred the fraudulent transfer claim because the transaction was a securities settlement payment involving intermediate transfers “by” and “to” covered entities (the banks).  The Seventh Circuit reversed, holding that the safe harbor did not apply because the banks only acted as conduits and neither the buyer nor the shareholder was a covered entity.  In so holding, the Seventh Circuit diverged from other circuits that had applied the safe harbor to transactions consummated through a covered entity acting as a conduit.[1]  Those circuits interpreted the disjunctive language in the safe harbor that protects transfers “by or to (or for the benefit of)” a covered entity to mean that a transfer “by” or “to” a covered entity is protected even if the transfer is not “for the benefit of” the covered entity.  The Supreme Court granted certiorari to settle the circuit split. The Supreme Court Holds That the Safe Harbor Does Not Protect a Transfer When a Covered Entity Only Acts as a Conduit   The Supreme Court affirmed the Seventh Circuit’s decision, holding that the safe harbor does not protect a transfer when a covered entity only acts as a conduit.  The crux of the decision is that a safe harbor analysis must focus on whether the “relevant transfer,” meaning the “overarching” or “end-to-end” transfer that the trustee seeks to avoid, was by, to or for the benefit of a covered entity.  Whether an intermediate or “component” transfer was made by or to a covered entity is “simply irrelevant to the analysis under § 546(e).”[2]  The Court reasoned that, as an express limitation on the trustee’s avoidance powers, § 546(e) must be applied in relation to the trustee’s exercise of those powers with respect to the transfer that the trustee seeks to avoid, not component transfers that the trustee does not seek to avoid.[3]  In the case before it, because the trustee sought to avoid the “end-to-end” transfer from the buyer to the shareholder, and neither was a covered entity, the safe harbor did not apply. The Court Avoids Adjudicating a Potentially Significant Defense The shareholder did not argue in the lower courts that the buyer or the shareholder was a covered entity.  In its briefing in the Supreme Court, the shareholder argued that the buyer and seller were both covered entities because they were customers of the banks that facilitated the transaction, and the definition of “financial institution” in 11 U.S.C. § 101(22)(A) includes a “customer” of a financial institution when the institution “is acting as agent or custodian for a customer.”  During oral argument, Justice Breyer indicated that he might have been receptive to that potentially dispositive argument.  However, the decision expressly avoids adjudicating the argument on the basis that the shareholder raised the point “only in footnotes and did not argue that it somehow dictates the outcome in this case.”  Id. at n. 2.  As a result, the “customer-as-financial-institution defense” will likely be litigated in the lower courts going forward. Impact of Merit Management As a result of Merit Management, parties to securities and commodities transactions should expect that, in the event of a bankruptcy filing, the safe harbor will not protect a transaction unless the transferor, transferee or beneficiary of the “overarching” transfer is a covered entity.  Routing a transfer through a covered entity will no longer protect the transaction.  Given the increased importance placed on whether a party to the overarching transfer is a covered entity, Merit Management may lead to a new wave of litigation regarding the scope of the covered entities, including the circumstances in which the customer of a financial institution constitutes a covered entity, and related planning strategies to fall within such scope.    [1]   See, e.g., In re Quebecor World (USA) Inc., 719 F. 3d 94, 99 (2d Cir. 2013); In re QSI Holdings, Inc., 571 F. 3d 545, 551 (6th Cir. 2009); Contemporary Indus. Corp. v. Frost, 564 F. 3d 981, 987 (8th Cir. 2009); In re Resorts Int’l, Inc., 181 F. 3d 505, 516 (3d Cir. 1999); In re Kaiser Steel Corp., 952 F. 2d 1230, 1240 (10th Cir. 1991).    [2]   Decision at p. 14.    [3]   See id. at pp. 11-14 (“If a trustee properly identifies an avoidable transfer . . . the court has no reason to examine the relevance of component parts when considering a limit to the avoiding power, where that limit is defined by reference to an otherwise avoidable transfer, as is the case with §546(e). . . .”). Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors: Oscar Garza – Orange County, CA (+1 949-451-3849, ogarza@gibsondunn.com) Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) Douglas G Levin – Orange County, CA (+1 949-451-4196, dlevin@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

February 28, 2018 |
Webcast: Shareholder Engagement & Activism – Preparing for the 2018 Proxy Season

The subject of shareholder engagement and activism rightfully continues to be the focus of discussion in boardrooms and in-house legal departments across the country. With no public company “too big” to be the subject of an activist intervention, it is imperative for corporations to proactively manage the risk of a disruptive activist campaign. Our team of experienced corporate, governance and litigation attorneys will be joined by proxy solicitation and public relations experts from Innisfree and Joele Frank to discuss the steps that corporations should be taking to prepare for the 2018 proxy season. View Slides [PDF] PANELISTS: Eduardo Gallardo is a partner in Gibson Dunn’s New York office. His practice focuses on mergers and acquisitions and corporate governance matters. Mr. Gallardo has extensive experience representing public and private acquirers and targets in connection with mergers, acquisitions and takeovers, both negotiated and contested. He has also represented public and private companies in connection with proxy contests, leveraged buyouts, spinoffs, divestitures, restructurings, recapitalizations, joint ventures and other complex corporate transactions. Mr. Gallardo also advises corporations, their boards of directors and special board committees in connection with corporate governance and compliance matters, shareholder activism, takeover preparedness and other corporate matters. Brian Lutz is a partner in Gibson Dunn’s San Francisco and New York offices where he is Co-Chair of the Firm’s National Securities Litigation Practice Group. Mr. Lutz has experience in a wide range of complex commercial litigation, with an emphasis on corporate control contests, securities litigation, and shareholder actions alleging breaches of fiduciary duties. He represents public companies, private equity firms, investment banks and clients across a variety of industries, including bio-pharma, tech, finance, retail, health care, energy, accounting and insurance. Mr. Lutz has twice been named a Rising Star by Law360 in the Securities category—a distinction awarded annually to five attorneys nationwide under the age of 40. He also has been named a Leading Lawyer in M&A Defense by Legal 500. Mr. Lutz was named “Litigator of the Week” by AmLaw Litigation Daily (an American Lawyer publication) for his work in securing a rare preliminary injunction that prevented a hostile takeover attempt of the pharmaceutical company Depomed, Inc. Lori Zyskowski is a partner in Gibson Dunn’s New York office where she is a member of the Firm’s Securities Regulation and Corporate Governance Practice Group. Ms. Zyskowski advises public companies and their boards of directors on a wide range of corporate law matters, including corporate governance, compliance with U.S. federal securities laws and the requirements of the major U.S. stock exchanges, and shareholder engagement and activism matters. She formerly served as Executive Counsel, Corporate, Securities & Finance at the General Electric Company, where she advised GE’s board of directors and senior management on corporate governance and securities law issues. Matthew Sherman is President, a Partner and a founding member of JOELE FRANK, a leading strategic financial communications and investor relations firm.  Mr. Sherman has more than 22 years of experience providing strategic corporate, financial and crisis communications counsel to Boards of Directors and executive leadership of public corporations and private equity firms involved in M&A, hostile takeovers, proxy contests, shareholder activism defense, spin-offs, reorganizations, financial restructurings, management changes, litigation, regulatory actions and a wide range of corporate crises. Scott Winter is a Managing Director of Innisfree M&A Incorporated. Mr. Winter advises companies and investors on all aspects of shareholder engagement focusing on hostile and friendly acquisitions, shareholder activism, contested shareholder meetings, corporate governance, and other proxy solicitation matters. Mr. Winter has been involved in most of the significant U.S. hostile takeovers in the past decade as well as activism situations involving, among others, Barington, Corvex, Elliott Management, Engaged Capital, Icahn Associates, Land & Buildings, Lone Star Value, JANA Partners, Marcato, Pershing Square, SachemHead, Sandell, Starboard Value, Third Point, Trian, and ValueAct. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.00 credit hour may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast.  Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 hour. California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.  

February 21, 2018 |
Supreme Court Says Whistleblowers Must Report to the SEC Before Suing for Retaliation Under Dodd-Frank

Click for PDF Today, the Supreme Court held 9-0 that whistleblowers must report alleged misconduct to the SEC before they can sue under the Dodd-Frank Act’s anti-retaliation provision. Background: The Dodd-Frank Act prohibits retaliating against a “whistleblower” because that person reported misconduct to the SEC; initiated, testified in, or assisted with an SEC proceeding; or made certain required or protected disclosures. 15 U.S.C. § 78u-6(h)(1)(A). The Act defines a “whistleblower” as a person who reports misconduct to the SEC. 15 U.S.C. § 78u-6(a)(6). Paul Somers reported suspected misconduct to his employer but not to the SEC. After he was fired, he sued his former employer for retaliation under the Dodd-Frank Act. Issue: Whether the Dodd-Frank Act’s anti-retaliation provision extends to individuals who have not reported alleged misconduct to the SEC. Court’s Holding: Whistleblowers must report suspected misconduct to the SEC to be able to sue for retaliation under the Dodd-Frank Act. “Courts are not at liberty to dispense with the condition—tell the SEC—Congress imposed.”          Justice Ginsburg, writing for the Court What It Means: The Court premised its decision on the statute’s text. Even though purpose-based arguments were made for extending the anti-retaliation provision to individuals who do not report to the SEC, the Court declined to take that step because the statute clearly defines a “whistleblower” as a person who reported alleged misconduct to the SEC. The Court rejected the SEC’s contrary interpretation of the statute, which was contained in a regulation. The Court also dismissed concerns that the ruling would undermine protection for “auditors, attorneys, and other employees subject to internal-reporting requirements,” explaining that they already had protection under Sarbanes-Oxley and would also be protected under Dodd-Frank once they provided the relevant information to the SEC. Recall that the Court addressed a similar issue in Lawson v. FMR LLC, 134 S. Ct. 1158 (2014). In that case, the Court held for the whistleblower, ruling that contractors and subcontractors of a public company may sue for retaliation under the Sarbanes-Oxley Act. It is important to note that the Sarbanes-Oxley Act does not include a requirement that a whistleblower report to the SEC. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice Caitlin J. Halligan +1 212.351.3909challigan@gibsondunn.com Mark A. Perry +1 202.887.3667mperry@gibsondunn.com Nicole A. Saharsky +1 202.887.3669 nsaharsky@gibsondunn.com   Related Practices: Labor and Employment Catherine A. Conway+1 213-229-7822 cconway@gibsondunn.com Eugene Scalia+1 202-955-8206 escalia@gibsondunn.com Jason C. Schwartz+1 202-955-8242 jschwartz@gibsondunn.com © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

February 1, 2018 |
Compliance – Was ist das eigentlich?

Munich partner Mark Zimmer is the author of “Compliance – Was ist das eigentlich?,” [PDF] published in the February 2018 issue of the German publication BWV (Bundesverwehrverwaltung).  The article explains the relevance of compliance for business and governmental agencies.

November 15, 2017 |
Domaine public : Le Conseil d’État précise les conditions dans lesquelles une promesse de vente de biens relevant du domaine public pouvait être régulièrement conclue avant l’entrée en vigueur de l’article L. 3112-4 du CGPPP et indique que la réduction significative du périmètre d’une concession de service public en constitue une modification substantielle, en tant que telle illégale

Paris senior associate Grégory Marson is the author of “Domaine public : Le Conseil d’État précise les conditions dans lesquelles une promesse de vente de biens relevant du domaine public pouvait être régulièrement conclue avant l’entrée en vigueur de l’article L. 3112-4 du CGPPP et indique que la réduction significative du périmètre d’une concession de service public en constitue une modification substantielle, en tant que telle illégale (SEMEPA),” [PDF] published in Concurrences on November 15, 2017. The commentary focuses on the conditions in which an agreement to sell goods belonging in the public domain can be validly executed prior to the entry into force of the new article L. 3112-4 of the French general code of public property. The French Council of State indicates that a significant reduction in the scope of a concession contract constitutes a substantial change and is therefore illegal. It also confirms that the illicit object of a contract leads to its illegality.

February 14, 2018 |
Webcast: IPO and Public Company Readiness: Oil and Gas Industry Issues

Oil and gas prices are recovering and there is a friendlier regulatory climate in Washington for capital raising. Times may never be better for considering an initial public offering for your company. There are many advantages and challenges to becoming a public company. This panel identifies the issues and opportunities for companies in the oil and gas sector to consider in deciding whether to become a public company. View Slides [PDF] PANELISTS: Hillary Holmes focuses on securities offerings and SEC and governance counseling for master limited partnerships (MLPs) and corporations in all sectors of the oil & gas energy industry. She represents public companies, private companies, MLPs and investment banks in all forms of capital raising transactions, including IPOs, registered offerings of debt and equity securities, private placements of debt and equity securities, and spin-offs. She also advises boards of directors, conflicts committees, and financial advisors of energy companies in complex transactions. Gerry Spedale focuses on capital markets, mergers and acquisitions, joint ventures and corporate governance matters for companies in the energy industry, including MLPs. He has extensive experience representing issuers and investment banks in both public and private debt and equity offerings, including initial public offerings, convertible note offerings and offerings of preferred securities. He also has substantial experience in public and private company acquisitions and dispositions and board committee representations. James Chenoweth counsels clients regarding tax-efficient structuring of energy transactions, including MLPs, IPOs and follow-on offerings, as well as acquisitions and dispositions, taxable sales and the formation of joint ventures, particularly in the oil and gas upstream and midstream sectors. James represents clients regarding the funding, formation, transfer and acquisition of upstream drilling joint ventures in cash and carry transactions and similar arrangements forming tax partnerships in various shale plays, including the Eagle Ford, Utica, Three Forks, Marcellus and Niobrara. Brian Lane counsels companies on the most sophisticated corporate governance and regulatory issues under the federal securities laws. He is nationally recognized in his field as an author, media commentator, and conference speaker. Brian ended a 16 year career with the Securities and Exchange Commission as the Director of the Division of Corporation Finance where he supervised over 300 attorneys and accountants in all matters related to disclosure and accounting by public companies (e.g. M&A, capital raising, disclosure in periodic reports and proxy statements). In his practice, Brian has advised on dozens of IPOs. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.00 credit hour may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast.  Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 hour. California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.

February 6, 2018 |
DOJ Policy Statements Signal Changes in False Claims Act Enforcement

Click for PDF The Department of Justice issued two internal memoranda in January that, taken together, reflect the Trump Administration’s first significant policy statements on False Claims Act (FCA) enforcement.  The first memorandum directs government attorneys evaluating a recommendation to decline intervention in a qui tam FCA suit to consider in addition whether to exercise DOJ’s authority to seek dismissal of the case outright.  The second prohibits DOJ from relying on a defendant’s failure to comply with other agencies’ guidance documents as a basis for proving violations of applicable law in affirmative civil enforcement actions.  The practical effects of these statements on FCA enforcement will only be clear when we see how – and how often – they are applied in actual cases.  But particularly when coupled with the Supreme Court’s landmark decision on scienter and materiality in Universal Health Services v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016), these DOJ memoranda provide substantial arguments for FCA defendants in seeking to defeat FCA claims. Exercise of DOJ’s Dismissal Authority On January 10, 2018, Michael Granston, the Director of the Fraud Section of DOJ’s Civil Division, issued a memorandum directing government lawyers evaluating a recommendation to decline intervention in a qui tam FCA action to “consider whether the government’s interests are served . . . by seeking dismissal pursuant to 31 U.S.C. § 3730(c)(2)(A).”  DOJ did not publicly release the memorandum at the time, but it has now been widely reported and is available here. DOJ has authority under section 3730(c)(2)(A) to seek dismissal of qui tam FCA suits.  Traditionally, the government has exercised this authority only sparingly.  But, as we discussed in our year-end FCA update (found here), Mr. Granston hinted previously at a change in policy with respect to dismissal of meritless qui tam suits.  Despite DOJ’s denial at the time that any policy changes had been implemented, the memorandum appears to confirm a policy shift in favor of more actively seeking dismissal of certain qui tam FCA actions. The memorandum notes that DOJ “has seen record increases in qui tam actions” filed under the FCA, and while the “number of filings has increased substantially over time,” DOJ’s “rate of intervention has remained relatively static.”  Emphasizing that DOJ “plays an important gatekeeper role in protecting the False Claims Act,” the memorandum identifies dismissal as “an important tool to advance the government’s interests, preserve limited resources, and avoid adverse precedent.” Under the memorandum, DOJ attorneys should consider dismissal: Where “a qui tam complaint is facially lacking in merit,” or where, after completing an investigation, the government concludes that the relator’s allegations lack merit. Where a qui tam action “duplicates a pre-existing government investigation and adds no useful information to the investigation.” Where “an agency has determined that a qui tam action threatens to interfere with an agency’s policies or the administration of its programs and has recommended dismissal to avoid these effects.” Where “necessary to protect the Department’s litigation prerogatives,” such as “to avoid interference with pending Federal Torts Claim Act action” or “to avoid the risk of unfavorable precedent.” When necessary “to safeguard classified information,” particularly in cases “involving intelligence agencies or military procurement contracts.” To preserve government resources “when the government’s expected costs are likely to exceed any expected gain,” (e.g., in situations where the government will incur the costs of  “monitor[ing] or participat[ing] in ongoing litigation, including responding to discovery requests”). Where there are “problems with the relator’s action that frustrate the government’s efforts to conduct a proper investigation.” The memorandum cites cases illustrating each factor.  This list, the memorandum observes, is not exhaustive, and the seven factors are not mutually exclusive.  Further, “there may be other reasons for concluding that the government’s interests are best served by the dismissal of a qui tam action.”  The memorandum also notes that “there may be alternative grounds for seeking dismissal,” such as under “the first to file bar, the public disclosure bar, the tax bar, the bar on pro se relators, or Federal Rule of Civil Procedure 9(b).” The federal courts have split on the extent of DOJ’s authority to dismiss qui tam actions under section 3730(c)(2)(A).  While DOJ takes the position that it has “unfettered” discretion to dismiss qui tam FCA suits, the memorandum advises attorneys to argue in jurisdictions that adopt a “rational basis” standard that the standard was intended to be “highly deferential.”  In jurisdictions where the standard of review is not settled, the memorandum instructs DOJ attorneys “to identify the government’s basis for dismissal and to argue that it satisfies any potential standard for dismissal under section 3730(c)(2)(A).” Reliance on Agency Guidance in Affirmative Civil Enforcement Cases Associate Attorney General Rachel Brand, the Department’s third-ranking official, issued a memorandum on January 25, 2018, that prohibits DOJ from using noncompliance with other agencies’ “guidance documents as a basis for proving violations of applicable law in” affirmative civil enforcement cases (ACE cases), and from using “its enforcement authority to effectively convert agency guidance documents into binding rules.”  The memorandum is available here. Agencies commonly issue guidance documents interpreting legislation and regulations, and the government has sometimes employed evidence that a defendant violated such guidance to prove a violation of the underlying statute or regulation.   The memorandum explicitly prohibits DOJ attorneys from engaging in this practice.  Under the new policy, DOJ “may continue to use agency guidance documents for proper purposes.”  For instance, where a guidance document “simply explain[s] or paraphrase[s] legal mandates from existing statutes or regulations,” DOJ “may use evidence that a party read such a guidance document to help prove that the party had requisite knowledge of the mandate.”  Notably, the memorandum applies to both “future ACE actions brought by the Department, as well as (wherever practicable) to those matters pending as of the date of this memorandum.” The Brand memorandum carries forward to ACE actions a policy established by Attorney General Jeff Sessions in a November 16, 2017, memorandum.  In that memorandum, Attorney General Sessions prohibited Department components from issuing guidance documents that purport to create rights or obligations binding on persons “without undergoing the rulemaking process,” and from “using its guidance documents to coerce regulated parties into taking any action or refraining from taking any action beyond what is required by the terms of the applicable statute or lawful regulation.”  The Brand memorandum provides that the principles articulated by Attorney General Sessions “should guide Department litigators in determining the legal relevance of other agencies’ guidance documents.” While the policy articulated in the Brand memorandum applies to more than just FCA suits, the memorandum specifically emphasizes that it “applies when the Department is enforcing the False Claims Act, alleging that a party knowingly submitted a false claim for payment by falsely certifying compliance with material statutory or regulatory requirements.”  That the memorandum uses FCA enforcement suits as its only illustrative example could suggest that the Department is particularly focused on the policy’s application to FCA cases. Analysis The Granston and Brand memoranda reflect the most significant policy statements on FCA enforcement from DOJ under Attorney General Sessions.  As our year-end update explained, FCA enforcement remained robust in the first year of the Trump Administration, and on several occasions the new DOJ leadership expressed public support for continued strong enforcement of the law.  The policy statements  signal a shift in approach, at least in some cases.  The full effect of these policy statements will be determined over time as they are applied in actual cases, but a few observations are warranted now.  First, although the Granston memorandum may have some salutary effects for FCA defendants (as noted below), the Brand memorandum is likely to be the more significant development, especially in the wake of Escobar.  Recently, courts have relied on Escobar to set aside judgments on the ground that alleged misrepresentations were not material to the government’s payment decision.In a 2017 decision, for example, the Fifth Circuit overturned a $663 million judgment—the largest judgment in FCA history—on the ground that a purported misrepresentation was not material because the government knew of the misrepresentation and yet continued to pay.  United States ex rel. Harman v. Trinity Industries, 872 F.3d 645, 663 (5th Cir. 2017).  In assessing materiality, the Fifth Circuit also relied on the fact that DOJ declined to intervene in the suit.  Likewise, in January 2018, a district court vacated a $350 million jury verdict after concluding that the relator failed to offer any evidence that the misrepresentation was material.  There, again, the government was aware of the alleged regulatory noncompliance underlying the suit but nevertheless continued to pay the defendants’ claims.  The court recognized this as “strong” and uncontroverted evidence that noncompliance with the requirement was immaterial.  United States ex rel. Ruckh v. GMC II LLC et al., 2018 WL 375720, at *10 (M.D. Fla. Jan. 11, 2008).The Brand memorandum, coupled with courts taking Escobar‘s materiality discussion seriously, has the potential to be a strong pro-defendant development.  Historically, agency guidance documents appeared frequently in FCA cases.  Before the Brand memorandum, it looked likely that, as the government contended with heightened materiality requirements under Escobar, it would routinely invoke such guidance documents to establish the importance of a misrepresentation to a payment decision.  Now, where a defendant can show that the guidance document does more than merely restate the underlying law, DOJ will not be able to make such arguments. This may have important ramifications for FCA defendants from several industries.  For example, a significant number of Medicare-based FCA cases could be affected if the Medicare Benefit Policy Manual is considered an “agency guidance document.”  Moreover, many anti-kickback cases rely on guidance documents issued by the Office of Inspector General (OIG) of the Department of Health and Human Services.  By eliminating agency guidance documents as a means to establish liability, the Brand memorandum could significantly reduce the range and scope of conduct that can give rise to FCA liability. The Brand memorandum also dovetails with the Granston memorandum.  Suppose that a relator asserts a claim under the FCA that is based on a theory that a defendant falsely certified compliance with a requirement, but that requirement is found only in an agency guidance document.  FCA defendants can rely on materiality arguments at the motion to dismiss or summary judgment stages, but could also rely on the Granston memorandum to advocate that DOJ recommend dismissal at the point of declination, on the grounds that dismissal is “necessary to protect the Department’s litigation prerogatives” (namely, DOJ’s policy of not using noncompliance with other agencies’ guidance documents as a basis for proving violations of applicable law). Finally, the Brand memorandum is part of a broader trend that has reduced the ways in which a claim can be “false.”  A growing number of courts have declined to find false claims where there is no evidence of an “objective falsehood,” such as in cases where a claim is premised on battling expert interpretations of an ambiguous statute or regulation, or where based on competing medical opinions.  The Brand memorandum will make it harder than ever for DOJ to prove, for example, that a claim was “false” because it sought payment for services that were not “medically necessary.”  First, in line with recent court decisions, DOJ cannot, in attempting to prove falsity, rely solely on its own expert’s disagreement with the treating provider about what was “necessary.”  Second, under the Brand memorandum, DOJ cannot rely on agency guidance documents construing what is “medically necessary” to prove liability.  While this prohibition could eliminate the Medical Benefit Policy Manual as a source for proving falsity, it will also presumably rule out national and local coverage determinations issued by program contractors, determinations that DOJ attorneys previously claimed were binding. Second, nothing in the Brand memorandum suggests that the government will be able to use this policy decision to limit a defendant’s use of guidance documents to defend itself.  To the contrary, the courts have been clear that all evidence that impacts a defendant’s state of mind, including government statements, is admissible on the FCA’s scienter element.  See, e.g., United States ex rel. Walker v. R&F Props. Of Lake Cnty, Inc., 433 F.3d 1349, 1356–58 (11th Cir. 2005) (deeming Medicare manuals and expert testimony relevant to show “the reasonableness of [defendant’s] claimed understanding of that language,” and rejecting the district court’s holding that such evidence was “irrelevant . . . because none of it held the force of law.”).And although it has been reported that DOJ criminal attorneys have emphasized that they are not bound by the Brand memorandum, the underlying legal principle applies equally to criminal cases: the executive branch should not, through agency documents, define the substantive scope of penal laws.  Cf., e.g., Carter v. Welles-Bowen Realty, Inc., 736 F.3d 722, 730 (6th Cir. 2013) (Sutton, J., concurring) (“[T]he rule of lenity forbids deference to the executive branch’s interpretation of a crime-creating law.”). Third, DOJ’s commitment to exercise its authority to dismiss qui tam actions is welcome news to FCA defendants given that relators have pursued cases more frequently even when DOJ has declined to intervene.  Historically, declined cases rarely led to significant recoveries, a sign of the relative weakness of such cases overall.  In 2017, the government recovered nearly $426 million in cases where it declined to intervene, the second-highest amount on record.  Although that amount accounted for just 11% of all federal recoveries in 2017, the promise of significant recoveries in declined cases might tempt relators to pursue weak cases.  To the extent that DOJ attorneys employ the Granston memorandum’s factors to terminate such cases before defendants incur further litigation costs, defendants may enjoy some relief from the active relators’ bar.On the other hand, the memorandum also observes that declination decisions frequently cause relators to dismiss their claims, and that that the number of voluntarily dismissed actions “has significantly reduced the number of cases where the government might otherwise have considered seeking dismissal pursuant to section 3730(c)(2)(A).”  This point could reflect DOJ’s view that the pool of cases in which dismissal is appropriate is small.  Further, the Granston memorandum does not apply to FCA retaliation claims, or to claims brought under state FCA statutes.  The memorandum could encourage qui tam plaintiffs to assert these sorts of claims in order to prevent their suits from being dismissed outright.  These dynamics may limit the practical benefits of the memorandum for some FCA defendants. Fourth, the Granston memorandum equips qui tam defendants with an arsenal of relevant arguments supporting dismissal.  In the past, FCA defendants have been forced to guess what arguments DOJ might find persuasive in deciding whether to invoke its authority under section 3730(c)(2)(A).  By specifying key factors and articulating the overall standard, the memorandum provides FCA defendants an analytical structure for advocating to DOJ that a relator’s case is meritless and should be dismissed before litigation (i.e., before incurring the expenses associated with motion to dismiss briefing, discovery, and summary judgment briefing).  The Granston memorandum also cites cases illustrating each dismissal factor.  Qui tam defendants should consider whether their case is factually similar to these illustrative cases.  DOJ will likely hesitate to move for dismissal of a qui tam suit unless they are confident the motion will be granted.  FCA defendants who are able to show that precedent supports dismissal of their case have an increased likelihood of persuading DOJ to seek dismissal.Relatedly, the memorandum also will spur increased internal scrutiny within DOJ of dismissal questions.  The assigned DOJ case team will internally review whether dismissal is appropriate at every declination decision, and the case team’s dismissal decision will be reviewed by component supervisors and tracked as a statistic by DOJ.  In other circumstances, just by tracking statistics on a policy shift of this nature, DOJ has nudged its attorneys toward the intended result.  Here, internal attention and tracking should increase the likelihood that DOJ attorneys recommend dismissing qui tam FCA suits. * * * * * In sum, there is reason to be optimistic that these two DOJ memoranda will have the effect of scaling back FCA enforcement.  Moreover, because the Brand memorandum applies to cases currently pending as of its issuance “wherever practicable,” companies currently facing FCA liability should carefully consider whether the enforcement theory is rooted in the underlying statute or regulation, or is only supported by a guidance document. The following Gibson Dunn lawyers assisted in preparing this client update: Stuart Delery, Winston Chan, John Partridge, Stephen Payne, Jonathan Phillips, Charles Stevens and Justin Epner. Gibson Dunn’s lawyers have handled hundreds of FCA investigations and have a long track record of litigation success.  Among other significant victories, Gibson Dunn successfully argued the landmark Allison Engine case in the Supreme Court, a unanimous decision that prompted Congressional action.  See Allison Engine Co. v. United States ex rel. Sanders, 128 S. Ct. 2123 (2008).  Our win rate and immersion in FCA issues gives us the ability to frame strategies to quickly dispose of FCA cases.  The firm has more than 30 attorneys with substantive FCA expertise and more than 30 former Assistant U.S. Attorneys and DOJ attorneys. As always, Gibson Dunn’s lawyers are available to assist in addressing any questions you may have about these developments.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following. Washington, D.C. F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com) Joseph D. West (+1 202-955-8658, jwest@gibsondunn.com) Andrew S. Tulumello (+1 202-955-8657, atulumello@gibsondunn.com) Stuart F. Delery (+1 202-887-3650, sdelery@gibsondunn.com) Caroline Krass (+1 202-887-3784, ckrass@gibsondunn.com) Karen L. Manos (+1 202-955-8536, kmanos@gibsondunn.com) Stephen C. Payne (+1 202-887-3693, spayne@gibsondunn.com) Jonathan M. Phillips (+1 202-887-3546, jphillips@gibsondunn.com) New York Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com) John D.W. Partridge (+1 303-298-5931, jpartridge@gibsondunn.com) Ryan T. Bergsieker (+1 303-298-5774, rbergsieker@gibsondunn.com) Dallas Robert C. Walters (+1 214-698-3114, rwalters@gibsondunn.com) Los Angeles Timothy J. Hatch (+1 213-229-7368, thatch@gibsondunn.com) James L. Zelenay Jr. (+1 213-229-7449, jzelenay@gibsondunn.com) Palo Alto Benjamin Wagner (+1 650-849-5395, bwagner@gibsondunn.com) San Francisco Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com)Winston Y. Chan (+1 415-393-8362, wchan@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 24, 2018 |
The Most Important Government Contract Cost and Pricing Decisions of 2017

Washington, D.C. partner Karen Manos is the author of “The Most Important Government Contract Cost and Pricing Decisions of 2017,” [PDF] published in Thomson Reuters’ The Government Contractor on January 24, 2018.

January 24, 2018 |
Webcast – Challenges in Compliance and Corporate Governance -14th Annual Briefing

Our constantly-evolving regulatory landscape expands existing obligations while creating new compliance risks for companies big and small. Join our panel of experts as they review key developments in 2017 and offer valuable insight on how to address challenges forecasted for 2018. Topics discussed include: Global Enforcement and Regulatory Developments Change and Continuity in the New Administration Key Tips for Identifying and Addressing Top Areas of Compliance Risk Practical Recommendations for Improving Corporate Compliance DOJ and SEC Priorities, Policies, and Penalties Update on Key Governance Issues and Regulatory Requirements View Slides [PDF] PANELISTS: This year’s presentation assembles a deep bench of experts with broad expertise. The following panelists join moderator Joe Warin for the 14th annual installment of ‘Challenges in Compliance and Corporate Governance’: Gibson Dunn partner Stephanie L. Brooker, Co-Chair of the firm’s Financial Institutions Practice Group, is former Director of the Enforcement Division at the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN). As a federal prosecutor, Stephanie served as the Chief of the Asset Forfeiture and Money Laundering Section in the U.S. Attorney’s Office for the District of Columbia. She represents financial institutions, multi-national companies, and individuals in connection with criminal, regulatory, and civil enforcement actions involving anti-money laundering (AML)/Bank Secrecy Act (BSA), sanctions, anti-corruption, securities, tax, and wire fraud New Gibson Dunn partner Avi S. Garbow, the former EPA General Counsel and co-chair of Gibson Dunn’s Environmental Litigation and Mass Tort Practice Group. As General Counsel, he successfully managed one of the most active regulatory and defensive litigation dockets among large federal agencies. Avi previously held positions in EPA’s enforcement office and served as a distinguished prosecutor in DOJ’s Environmental Crimes Section New Gibson Dunn partner Caroline Krass, the former CIA General Counsel and chair of Gibson Dunn’s National Security Practice Group. As General Counsel, Caroline oversaw more than 150 attorneys and advised on complex, highly sensitive issues, including cybersecurity, foreign investment in the U.S. and export controls, government investigations and litigation, and crisis management.  Previously, Caroline served as Acting Assistant Attorney General at the Department of Justice, as Special Counsel to the President for National Security Affairs, as a federal prosecutor, at the National Security Council, and at the Treasury and State Departments. Gibson Dunn partner Stuart Delery, the former Acting Associate Attorney General, the No. 3 position in the Justice Department. In that role, Stuart was a member of DOJ’s senior management and oversaw the civil and criminal work of five litigating divisions — Antitrust, Civil, Tax, Civil Rights, and Environment and Natural Resources — as well as other components. Previously, Stuart led the Civil Division, overseeing litigation involving the False Claims Act among other matters. Gibson Dunn partner Adam M. Smith, an experienced international trade lawyer who previously served in the Obama Administration as the Senior Advisor to the Director of OFAC and as the Director for Multilateral Affairs on the National Security Council. Adam focuses on international trade compliance and white collar investigations, including with respect to federal and state economic sanctions enforcement, the FCPA, embargoes, and export controls. Gibson Dunn partner Lori Zyskowski, a member of the firm’s Securities Regulation and Corporate Governance Practice Group who was previously Executive Counsel, Corporate, Securities & Finance at GE. Lori advises clients on a wide array of securities, compliance and corporate governance issues, and provides a unique perspective gained from over 12 years working in-house at S&P 500 corporations. Gibson Dunn partner F. Joseph Warin, Co-Chair of the firm’s White Collar Defense and Investigations practice and former Assistant United States Attorney in Washington, D.C. Joe is one of only ten lawyers in the United States with Chambers rankings in five categories. Chambers recently honored him with the Outstanding Contribution to the Legal Profession Award in 2017. Chambers Global 2017 ranked Mr. Warin a “Star” in USA – FCPA “with exceptional expertise across all aspects of anti-corruption law”. Chambers USA 2017 ranked him a “Star” in Nationwide FCPA and D.C. Litigation: White Collar Crime & Government Investigations. Chambers USA 2017 also selected him as a Leading Lawyer in the nation in the areas of Securities Regulation Enforcement and Securities Litigation, as well as in D.C. Securities Litigation. From 2015–2017, he has been selected by Chambers Latin America as a top-tier lawyer in Latin America-wide, Fraud & Corporate Investigations. In 2017, Who’s Who Legal selected him as a “Thought Leader: Investigations,” including “only the best of the best” of those listed in their guides and who obtained the biggest number of nominations from peers, corporate counsel and other market sources. In 2016, Who’s Who Legal and Global Investigations Review also named Mr. Warin to their list of World’s Ten-Most Highly Regarded Investigations Lawyers. He has been listed in The Best Lawyers in America® every year from 2006 – 2017 for White Collar Criminal Defense. BTI Consulting named Mr. Warin to its 2017 BTI Client Service All-Stars list, recognizing lawyers who “truly stand out as delivering the absolute best client service.” Best Lawyers® also named Mr. Warin 2016 Lawyer of the Year for White Collar Criminal Defense in the District of Columbia. In 2016, he was named among the Lawdragon 500 Leading Lawyers in America. Mr. Warin also was recognized by Latinvex as one of its 2017 Latin America’s Top 100 Lawyers. He was selected as a 2015 Top Lawyer for Criminal Defense by Washingtonian magazine. U.S. Legal 500 has repeatedly named Mr. Warin a Leading Lawyer for White Collar Criminal Defense Litigation. Benchmark Litigation has recognized him as a U.S. White Collar Crime Litigator Star for seven consecutive years (2011–2017). MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 3.0 credit hours, of which 3.00 credit hours may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast.  Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 2.50 hours. California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.

January 16, 2018 |
2017 Year-End Government Contracts Update

Click for PDF In this year-end analysis of government contracts litigation, Gibson Dunn examines trends and summarizes key decisions of interest to government contractors from the second half of 2017.  This publication covers the waterfront of the opinions most important to this audience issued by the U.S. Court of Appeals for the Federal Circuit, U.S. Court of Federal Claims, Armed Services Board of Contract Appeals (“ASBCA”), and Civilian Board of Contract Appeals (“CBCA”). The last six months of 2017 yielded 3 government contracts-related opinions of note from the Federal Circuit, excluding decisions related to bid protests.  From July 1 through December 31, 2017, the U.S. Court of Federal Claims issued 7 notable non-bid protest government contracts-related decisions, and the ASBCA and CBCA published 48 and 40 substantive government contracts decisions, respectively.  As discussed herein, these cases address a wide range of issues with which government contractors should be familiar, including matters of cost allowability, jurisdictional requirements, contract interpretation, terminations, and the various topics of federal common law that have developed in the government contracts arena.  Before addressing each of these areas, we briefly provide background concerning the tribunals that adjudicate government contracts disputes. I.     THE TRIBUNALS THAT ADJUDICATE GOVERNMENT CONTRACT DISPUTES Under the doctrine of sovereign immunity, the United States generally is immune from liability unless it waives its immunity and consents to suit.  Pursuant to statute, the government has waived immunity over certain claims arising under or related to federal contracts through the Contract Disputes Act (“CDA”), 41 U.S.C. §§ 7101 – 7109, and through the Tucker Act, 28 U.S.C. § 1491.  Under the CDA, any claim arising out of or relating to a government contract must be decided first by a contracting officer.  A contractor may contest the contracting officer’s final decision by either filing a complaint in the U.S. Court of Federal Claims or appealing to a board of contract appeals.  The Tucker Act, in turn, waives the government’s sovereign immunity with respect to certain claims arising under statute, regulation, or express or implied contract, and grants jurisdiction to the Court of Federal Claims to hear such claims. The Court of Federal Claims thus has jurisdiction over a wide range of monetary claims brought against the U.S. government including, but not limited to, contract disputes and bid protests pursuant to both the CDA and the Tucker Act.  If a contractor’s claim is founded on the Constitution or a statute instead of a contract, there is no CDA jurisdiction in any tribunal, but the Court of Federal Claims would have jurisdiction under the Tucker Act as long as the substantive source of law grants the right to recover damages.  Thus, the Court of Federal Claims’ jurisdiction is broader than that of the boards of contract appeals. In addition to establishing jurisdiction for certain causes of action in the Court of Federal Claims, the CDA establishes four administrative boards of contract appeals:  the Armed Services Board, the Civilian Board, the Tennessee Valley Authority Board, and the Postal Service Board.  See 41 U.S.C. § 7105.  The ASBCA hears and decides post-award contract disputes between contractors and the Department of Defense and its military departments, as well as the National Aeronautics and Space Administration (“NASA”).  In addition, the ASBCA adjudicates contract disputes for other departments and agencies by agreement.  For example, the U.S. Agency for International Development has designated the ASBCA to decide disputes arising under USAID contracts.  The ASBCA has jurisdiction pursuant to the CDA, its Charter, and certain remedy-granting contract provisions.  The CBCA hears and decides contract disputes between contractors and civilian executive agencies under the provisions of the CDA.  The CBCA’s authority extends to all agencies of the federal government except the Department of Defense and its constituent agencies, NASA, the U.S. Postal Service, the Postal Regulatory Commission, and the Tennessee Valley Authority.  In addition, the CBCA has jurisdiction, along with federal district courts, over Indian Self-Determination Act contracts. The U.S. Court of Appeals for the Federal Circuit hears and decides appeals from decisions of the Court of Federal Claims, the ASBCA, and the CBCA, among numerous other tribunals outside the area of government contract disputes.  Significantly, the Federal Circuit has a substantial patent and trademark docket, hearing appeals from the U.S. Patent and Trademark Office and federal district courts that by volume of cases greatly exceeds its government contracts litigation docket.  Of 1,542 cases pending before the Federal Circuit as of September 30, 2017, 11 were appeals from the boards of contract appeals and 144 were appeals from the Court of Federal Claims—cumulatively comprising just over 10% of the appellate court’s docket. Only 4% of the appeals filed at the Federal Circuit in FY 2017 were Contracts cases. Nevertheless, the Federal Circuit is the court of review for most government contracts disputes. On September 30, 2017, the founding, and longtime, Chairman of the CBCA, Judge Stephen M. Daniels, retired from the bench after 51 years of federal service, including 30 years as a judge.  Following Judge Daniels’ retirement, Judge Jeri K. Somers was appointed to be the new Chair of the CBCA and Judge Erica Beardsley was appointed the new Vice Chair. Two new judges were appointed to the ASBCA during the summer of 2017.  Prior to his appointment in June, Judge Christopher M. McNulty was a Senior Trial Attorney with the Air Force, where he had served since 2009 after spending decades in private practice.  Judge Heidi L. Osterhout was appointed to the Board in July 2017 after serving three years as a Trial Attorney in DOJ’s Commercial Litigation Branch and twenty years in the Air Force before that. On September 28, 2017, President Trump nominated Ryan T. Holte for one of the four remaining vacancies on the Court of Federal Claims.  If confirmed, Mr. Holte will fill the seat left vacant when Judge Nancy B. Firestone assumed senior status in October 2013.  Mr. Holte is currently an Associate Professor of Law at the University of Akron School of Law.  He is also the General Counsel of Counter Echo Solutions, an electrical engineering technology company, and previously served as an attorney with the Federal Trade Commission, and as a law firm associate. President Trump’s first two nominees to the Court of Federal Claims, Damien Schiff and Stephen Schwartz, were not on the list of nominations re-submitted by the White House to Congress last week, after their initial nominations were not carried over into the new year under Senate rules. II.     COST ALLOWABILITY The ASBCA issued several important decisions during the second half of 2017 addressing the merits of cost allowability issues under the Federal Acquisition Regulation (“FAR”).  Pursuant to FAR 31.202, a cost is allowable if it (1) is reasonable; (2) is allocable; (3) complies with applicable accounting principles; (4) complies with the terms of the contract; and (5) complies with any express limitations set out in FAR Subpart 31. Luna Innovations, Inc., ASBCA No. 60086 (Nov. 29, 2017) As a public company, Luna is required to account for employee stock options exercisable in future years at the time the options are awarded.  Luna used the “Black-Scholes” method of estimating the value of those stock options, which the contracting officer determined was expressly unallowable because one of the five variables used by the model is stock price variance among comparable companies, and FAR 31.205-6(i) does not allow for reimbursement of compensation calculated based on variances in stock price.  Luna argued that because stock volatility is only one of five variables in the Black-Scholes model, it is not “based on” the underlying stock volatility. The Board (D’Alessandris, A.J.) found that the Black-Scholes method did result in unallowable costs under the “plain language” of the FAR provision, because stock volatility is a primary factor in determining the value of the employee stock options.  Importantly, however, the Board found that Luna’s cost claims were not expressly unallowable.  Noting “the complexity of the circumstances, the fact that the use of the Black-Scholes model is a question of first impression, the need to review the differential equations comprising the Black-Scholes model, and the fact that there could be a reasonable difference of opinion regarding the costs,” the Board concluded that “it was not ‘unreasonable under all the circumstances’ for Luna to claim the employee stock option costs.”  Thus, the costs were only unallowable and not expressly unallowable and subject to penalties. Access Personnel Servs., Inc., ASBCA No. 59900 (Sept. 7, 2017) The dispute in this case arose under a contract incorporating the pre-2007 version of FAR 52.232-7, Payments Under Time-And-Materials And Labor-Hour Contracts.  APS subcontracted a portion of the work, and instructed the subcontractor to bill APS at the fixed hourly rates specified in the prime contract.  But the subcontractor failed to follow this instruction and submitted two separate sets of invoices—one for work hours and a second set for vacation time.  Because the total of the invoices was the same as APS’s combined rates, APS submitted the entire cost to the Navy.  The Navy focused on only the first set of invoices relating to the work year and disallowed the difference between APS’s and the subcontractor’s rates, claiming that APS was billing the government a rate higher than the rate billed to it by its subcontractor and that the subcontractor’s vacation and holiday pay should have been included in its direct labor rate. Relying on the plain language of FAR 52.232-7, the Board (McNulty, A.J.) held that APS was entitled to the payment of costs, not the fixed hourly rates specified in the prime contract, for subcontract labor.  Because the Navy paid APS less than the full amount of costs that APS incurred in paying its subcontractor, the Board sustained the appeal on entitlement and remanded to the parties to validate APS’s contention that the total of the subcontractor invoices was the same. Am. Boys Constr. Co., ASBCA No. 60515 (Sept. 13, 2017) The government awarded ABC a contract for the installation of a “sniper screen” at a base in Afghanistan.  After ABC had purchased materials for the contract, but before ABC otherwise commenced work, the government issued a stop-work order and terminated the contract for convenience.  ABC sought to recover the cost of the materials it purchased and stand-by costs. The Board (Prouty, A.J.) denied ABC’s appeal.  Although the contract allowed for payment for costs of work that would be performed prior to contract termination, the Board agreed with the government that it was premature to purchase materials prior to receiving approval of the purchase.  The Board also found that because the government had not issued a notice to proceed, there was no time pressure driving the need to purchase the materials when ABC did.  Finally, the Board found that while reasonable stand-by costs incurred prior to a notice to proceed may be recoverable, ABC failed to provide evidence of its incurred stand-by costs. III.     JURISDICTIONAL ISSUES As is frequently the case, jurisdictional issues dominated the landscape of key government contracts decisions during the second half of 2017. A.     Requirement for a Valid Contract In order for there to be Contract Disputes Act jurisdiction over a claim, there must be a contract from which that claim arises.  See FAR 33.201 (defining a “claim” as “a written demand or written assertion by one of the contracting parties seeking . . . relief arising under or relating to this contract“).  The CDA applies to contracts made by an executive agency for: (1) the procurement of property, other than real property in being; (2) the procurement of services; (3) the procurement of construction, alteration, repair, or maintenance of real property; and (4) the disposal of personal property.  41 U.S.C. § 7102(a)(1)-(4). Safeco Ins. Co. of Am., ASBCA No. 60952 (July 25, 2017) Safeco issued payment and performance bonds as surety for a contract between the U.S. Army Corps of Engineers and I.L. Fleming, Inc.  Safeco requested that the Corp not release funds to Fleming without Safeco’s written consent.  Nevertheless, the Corps made final payment directly to Fleming.  Subsequently, Safeco filed a certified claim for the amount of the final payment plus a contract balance, which the contracting officer denied.  In its appeal, Safeco characterized its allegations as an equitable subrogation claim or, secondarily, an implied-in-fact contract. The Board (Clarke, A.J.) held that it did not have jurisdiction to hear a subrogation claim under the CDA, notwithstanding case law concerning the Court of Federal Claims’ jurisdiction to hear such cases under the latter tribunal’s Tucker Act jurisdiction.  The Board also rejected Safeco’s arguments of an implied-in-fact contract because Safeco failed to allege the existence of such a contract in its complaint or claim.  Further, even if such a claim had been alleged, the Board would still reject Safeco’s position because there was no plausible evidence of an implied-in-fact contract.  Therefore, the Board dismissed Safeco’s appeal. Ikhana, LLC, ASBCA Nos. 60462 et al. (Oct. 18, 2017) The government awarded a contract to Ikhana to construct secured access lanes and remote screening facilities at the Pentagon.  Ikhana executed performance and payment bonds with its surety.  As part of an indemnity agreement for these bonds, Ikhana agreed that in the event of a default, it would assign to the surety a possessory right to collateral, including “contract rights.”  After performance issues arose, the government terminated the contract for default and Ikhana appealed to the ASBCA seeking:  (1) to convert the termination to one of convenience; and (2) damages for breach of contract.  The government moved to dismiss, or in the alternative for summary judgment, arguing that Ikhana lacked standing because the surety was the real party in interest.  The surety also moved to intervene and to withdraw the appeals. The Board (Sweet, A.J.) explained that the fundamental issues underlying the pending motions were whether Ikhana assigned the claims underlying these appeals to the surety, and if so, whether that assignment precluded Ikhana from bringing the appeals.  The Board held that assuming, without deciding, that there was an assignment, that assignment would not preclude Ikhana from bringing these appeals.  Relying on Burnside-Ott Aviation Training Ctr. v. Dalton, 107 F.3d 854 (Fed. Cir. 1997), the Board held that the indemnification agreement and settlement agreement between the Government and surety “impermissibly attempt to deprive us of our power to hear these appeals, which otherwise fall under the CDA.” Eng’g Solutions & Prods., ASBCA No. 58633 (Aug. 4, 2017) ESP leased a warehouse and then subleased it to the Army.  After the Army suggested that it would be interested in leasing more warehouse space from ESP, ESP entered into a 10-year lease for the warehouse.  After five years, the Army vacated the warehouse.  ESP submitted a claim for an early termination fee, the sixth year of rent, and other costs.  After the claim was denied, ESP appealed arguing that there was an implied-in-fact contract with the Army. The Board (D’Alessandris, A.J.) held that there was no implied-in-fact contract.  First, the Board noted that to establish such a contract, ESP would have to prove that there was mutuality of intent to contract, consideration, unambiguous offer and acceptance, and actual authority on the part of the government.  The Board focused only on the issue of mutuality of intent to contract, which it found dispositive.  It found that ESP had not established that anyone with authority to bind the Army was a party to the alleged implied-in-fact contract.  The Board also found that there was no ratification with respect to contracting authority.  Lastly, ESP failed to establish entitlement for the services provided since there was no implied-in-fact contract, and the government had already paid for any benefits it received.  Accordingly, ESP’s appeal was denied. Scott v. United States, No. 17-471 (Fed. Cl. Oct. 24, 2017) Brian X. Scott brought a pro se claim in the Court of Federal Claims seeking monetary and injunctive relief for alleged harms arising from the Air Force’s handling of his unsolicited proposal for contractual work.  Scott was an Air Force employee who submitted a proposal for countering the threat of a drone strike at the base where he was stationed.  The proposal was rejected, but Scott alleged that portions of the proposal were later partially implemented.  Scott sued, claiming that the Air Force failed properly to review his proposal and that his intellectual property was being misappropriated.  Scott argued that jurisdiction was proper under the Tucker Act because an implied-in-fact contract arose that prohibited the Air Force from using any data, concept, or idea from his proposal, which was submitted to a contracting officer with a restrictive legend consistent with FAR § 15.608. The Court of Federal Claims (Lettow, J.) found that it had jurisdiction under the Tucker Act because an implied-in-fact contract was formed when the Air Force became obligated to follow the FAR’s regulatory constraints with regard to Scott’s proposal.  Nevertheless, the Court granted the government’s motion to dismiss because Scott’s factual allegations, even taken in the light most favorable to him, did not plausibly establish that the government acted unreasonably or failed to properly evaluate his unsolicited proposal by using concepts from the proposal where Scott’s proposal addressed a previously published agency requirement. Lee’s Ford Dock, Inc. v. Secretary of the Army, 865 F.3d 1361 (Fed. Cir. 2017) LFD operated a marina on land leased from the Army Corps of Engineers at Lake Cumberland, Kentucky.  In the lease, the Corps retained the right to manipulate the water levels on the lake as necessary.  During the term of the lease, the Corps drew down the lake’s level while it worked on repairs to a dam in the area.  LFD submitted a certified claim to the contracting officer seeking equitable reformation of the contract, which the contracting officer denied.  LFD appealed to the ASBCA and subsequently raised the new argument that the Corps breached its lease contract by failing to disclose its superior knowledge of the dam’s state of repair and corresponding need to draw down the lake’s water level.  The Board in 2016 granted summary judgment to the Corps.  LFD appealed to the Federal Circuit. The Federal Circuit (Schall, J.) first rejected the government’s jurisdictional argument that lease claims are not subject to the CDA, holding that the lease was a contract for the disposal of personal property under the CDA.  Turning to the merits of the Board’s decision, however, the Court held that both it and the Board lacked jurisdiction over the “misrepresentation by silence” claim because it was never submitted to the contracting officer as part of LFD’s certified claim.  Further, the Federal Circuit affirmed the Board’s grant of summary judgment to the Corps on the breach of contract claim because the lease provided the Corps with the clear right to manipulate water levels and even if reasonableness was a requirement, there was no evidence the Corps acted unreasonably. Coast to Coast Computer Prods. v. Dep’t of Agric., CBCA Nos. 3516 et al. (Aug. 14, 2017) Coast to Coast was awarded a blanket purchase agreement (“BPA”) by the U.S. Forest Service to provide and install printers and plotters.  Coast to Coast subsequently requested an equitable adjustment based on constructive changes that arose from requests to create or modify a related web portal.  This request was denied by the contracting officer and Coast to Coast appealed to the CBCA. The Board (Zischkau, A.J.) held that a BPA is not a contract under the CDA, but rather “a framework for future contracts, which come into being when orders are placed and accepted under it.”  However, the Board further held that CDA jurisdiction can arise from individual orders placed under the BPA, which do create contractual obligations.  The Board therefore determined it had jurisdiction over claims arising from individual call orders issued by the Forest Service to the contractor under the blanket purchase agreement, though not over claims arising from the BPA itself.  After denying the claims premised only on the BPA for lack of jurisdiction, the Board denied Coast to Coast’s claims arising from the calls orders on the merits, thus denying the appeals in their entirety. B.     Adequacy of the Claim Another common issue arising before the tribunals that hear government contracts disputes is whether the contractor appealed a valid CDA claim.  FAR 33.201 defines a “claim” as “a written demand or written assertion by one of the contracting parties seeking, as a matter of right, the payment of money in a sum certain, the adjustment or interpretation of contract terms, or other relief arising under or relating to this contract.”  Under the CDA, a claim for more than $100,000 must be certified.  In the second half of 2017, the boards considered what constitutes a “claim,” including when a contracting officer’s final decision adequately states a government claim under the CDA. Magwood Servs., Inc. v. Gen. Servs. Admin., CBCA No. 5869 (Oct. 30, 2017) On September 22, 2016, a GSA contracting officer issued a notice of termination for default to Magwood.  The notice stated in plain terms that it was the “final decision of the contracting officer.”  Magwood subsequently submitted to the contracting officer a “formal request to amend this determination to reflect a Termination for Convenience,” as well as a request for $12,153.78 for unpaid “reimbursement.”  The contracting officer responded that the prior letter was the final decision and that “no request for appeal or reconsideration should be directed” to GSA.  On October 2, 2017, Magwood filed a notice of appeal with the CBCA, asserting that the second letter from the contracting officer (from December 2016) was the final decision. The CBCA (Chadwick, A.J.) dismissed the appeal for lack of jurisdiction.  The Board held that the letter from Magwood, despite seeking a sum certain, was styled as a “formal request to amend the default termination.”  Because Magwood was seeking a response and not prompt payment, the CBCA determined that a contracting officer could not have been expected to understand the request as a CDA claim.  Therefore, Magwood could not treat the contracting officer’s alleged failure to respond as a deemed denial and the operative final decision was the September 2016 letter, for which the appeal period has already run. L-3 Commc’ns Integrated Sys., L.P., ASBCA Nos. 60713 et al. (Sept. 27, 2017) L-3 appealed from multiple final decisions asserting government claims for the recovery of purportedly unallowable airfare costs.  Rather than audit and challenge specific airfare costs, the Defense Contract Audit Agency simply applied a 79% “decrement factor” to all of L-3’s international airfare costs over a specified dollar amount, claiming that this was justified based on prior-year audits.  After filing the appeals, L-3 moved to dismiss for lack of jurisdiction on the grounds that the government had failed to provide adequate notice of its claims by failing to identify which specific airfare costs were alleged to be unallowable, as well as the basis for those allegations. The Board (D’Alessandris, A.J.) denied the motion to dismiss, holding that the contracting officer’s final decisions sufficiently stated a claim in that they set forth a sum certain and a basis for such a claim.  The Board held that L-3 had enough information to understand how the government reached its claim, and its contention that this was not a valid basis for the disallowance of costs for the year in dispute went to the merits and not the sufficiency of the final decisions. C.     Requirement for a Contracting Officer’s Final Decision A number of decisions from the tribunals that hear government contracts disputes dealt with the CDA’s requirement that a claim have been “the subject of a contracting officer’s final decision.” *** Kings Bay Support Servs., ASBCA Nos. 59213 et al. (July 10, 2017) KBSS held a Navy contract for base operating support.  After KBSS sought additional compensation for maintenance work, which the government denied, KBSS appealed and the government subsequently filed a motion for summary judgment. The Board (Kinner, A.J.) denied the government’s motion.  In addition to finding a genuine dispute of material fact, the Board rejected the government’s argument that the Board was without jurisdiction because KBSS used terminology in its briefing that differed from that in its certified claim.  The Board held that KBSS’s arguments were materially the same as those presented to the contracting officer and that the use of different terminology in its briefing did not change the operative facts or claims. Emiabata v. United States, No. 17-44C (Fed. Cl. Nov. 17, 2017) Philip Emiabata was awarded a U.S. Postal Service delivery contract.  The contracting officer thereafter terminated the contract for default, citing a number of alleged deficiencies.  Emiabata waited 364 days and filed a complaint pro se in the Court of Federal Claims alleging wrongful termination and a variety of breach of contract claims.  The government moved to dismiss. The Court of Federal Claims (Campbell-Smith, J.) granted the government’s motion to dismiss the breach of contract claims because Emiabata failed to present them to the contracting officer, thus depriving the Court of jurisdiction pursuant to the CDA.  With respect to the wrongful termination claim, the Court directed the government to submit a new motion for summary judgment. Vanquish Worldwide, LLC v. United States, No. 17-335 (Fed. Cl. Sept. 19, 2017) Vanquish Worldwide held a contract to provide shipping and logistics services for the U.S. Army in Afghanistan.  After 12 of the contractor’s shipments disappeared, the CO posted a “Marginal” performance evaluation in the Contractor Performance Assessment Reporting System (“CPARS”).  Vanquish Worldwide timely disputed the rating through CPARS and requested that the evaluation be raised to “Satisfactory,” but the reviewing official concurred with the rating and rejected the explanations for the disappearance of the shipments.  Vanquish Worldwide filed suit in the Court of Federal Claims seeking a declaratory judgment vacating the evaluation and remanding the matter to the agency. The Court of Federal Claims (Kaplan, J.) granted the government’s motion to dismiss Vanquish Worldwide’s complaint, holding that the continuing correspondence with the agency about the evaluation never ripened into a claim before the contracting officer.  The Court noted that the correspondence not only failed to request a final decision, but it also seemed to contemplate further dialogue. *** Under the CDA, if a contracting officer does not within 60 days issue a decision on a certified claim, or provide a date by which a decision will be issued, the contractor may appeal from a “deemed” denial of its claim or may petition a Board to direct the contracting officer to issue a decision.  41 U.S.C. § 7103(f).  In a recent case, the CBCA issued guidance concerning the ability to petition for a directed decision. CTA I, LLC v. Dep’t of Veteran Affairs, CBCA 5800 (Aug. 22, 2017) On February 15, 2017, CTA submitted a certified claim to the VA for labor inefficiencies, delay, and other costs that arose from its contract to construct a dialysis center in Virginia.  The contracting officer stated he would respond to CTA’s claims by July 10, 2017.  Rather than wait, CTA petitioned the CBCA for an order directing the contracting officer to issue a decision “no later than June 1, 2017,” which the Board denied because there was insufficient time to resolve the matter by June 1.  When July 10 arrived, the VA stated that a commercial claims consultant was needed to evaluate CTA’s claim, and informed CTA it would issue a final decision by September 8, 2017.  CTA filed this case on July 25, 2017, alleging that the VA engaged in “bad faith delaying tactics” and asking the Board to direct the VA to issue a final decision by the September 8 deadline.  In its brief, the VA indicated that no consultant had been retained and that it did not anticipate meeting the September 8 deadline. The Board (Chadwick, A.J.) held that the VA had failed to adhere to its CDA deadlines, but CTA’s only relief was to treat this failure as a deemed denial and file an appeal from the same with the Board.  The Board noted that the government does not have a right to a second extension set outside the initial 60 days, and that any deadline for a decision that the contracting officer establishes at the end of the 60-day period is firm.  But if a contracting officer does not act on the claim within 60 days, or misses his own extended deadline, the contractor’s options are to exercise its immediate right to appeal, or await a tardy contracting officer decision on the claim. IV.     TERMINATIONS The ASBCA issued three noteworthy decisions during the second half of 2017 arising from contract terminations.  In the first, the Board strictly construed the one-year time limit to submit a termination settlement proposal in accordance with the FAR’s termination for convenience clause. Black Bear Construction Co., ASBCA 61181 (Nov. 14, 2017) Black Bear appealed a contracting officer’s denial of a claim seeking settlement costs resulting from the government’s termination for convenience of its contract for runway improvement construction in Afghanistan.  The government filed a motion for summary judgment, arguing that Black Bear waited more than the required one year to file its settlement proposal.  FAR 52.249-2 provides:  “After termination, the Contractor shall submit a final termination settlement proposal to the Contracting Officer . . . promptly, but not later than 1 year from the effective date of termination, unless extended in writing by the Contracting Officer upon written request of the Contractor within this 1-year period.”  The government terminated the contract on August 12, 2012, and Black Bear did not submit its termination settlement claim until March 25, 2017. The Board (Osterhout, A.J.) found no evidence that Black Bear had requested an extension of time from the contracting officer.  Because no extension of time was ever sought, much less granted, the claim was untimely.  Therefore, the appeal was denied. *** In two cases, the ASBCA addressed when the government’s waiver of a delivery schedule fails to justify converting a termination for default into once for convenience. Avant Assessment, LLC, ASBCA Nos. 58903 et al. (Aug. 21, 2017) Avant held several contracts for the development and delivery of foreign-language test items for the Defense Language Institute.  For one contract, the parties implemented a new delivery schedule, but the government nevertheless terminated the contract for default based on Avant’s failure to meet the original schedule. The Board (McIlmail, A.J.) held that the government must justify the termination for default.  By implementing a new delivery schedule, the government effectively waived the prior delivery schedule.  Accordingly, there could not be a default termination, and the government failed to justify the termination.  The Board therefore sustained the appeal. Asia Commerce Network, ASBCA No. 58623 (Oct. 4, 2017) Similarly, a termination for default was converted into one for convenience where the Defense Logistics Agency waived default in delivery.  DLA awarded a contract to ACN for the delivery of jet fuel to Bagram Air Field, Afghanistan.  ACN had six months to achieve operational status and begin delivering fuel.  ACN did not meet the six-month deadline, and DLA issued a cure notice requesting an explanation for the delay and additional information.  ACN continued working on its pipeline and, when DLA subsequently terminated the contract for default, was within a few days of completion. The Board (O’Sullivan, A.J.) held that under these facts, the termination for default was not justified because the government is deemed to have waived default in delivery if “the contractor relies on the government’s failure to terminate and continues to perform under the contract, with government knowledge and implied or express consent.”  The Board found that ACN relied on the government’s failure to terminate and continued to perform the contract up until the day it received the termination notice.  As a result, the Board converted the default termination to a termination for convenience. V.     CONTRACT INTERPRETATION A number of noteworthy decisions from the second half of 2017 articulate broadly applicable contract interpretation principles that should be considered by government contractors. James M. Fogg Farms, Inc., et al. v. United States, No. 17-188C (Fed. Cl. Sept. 27, 2017) The key question presented in this case was whether a federal statute may be read into a government contract as a contractual term that may give rise to breach.  Plaintiffs alleged that the government underpaid them pursuant to their Conservation Security Program contracts and that the regulation the National Resources Conservation Service implemented, laying out payment formulas for program participants, was contrary to the 2002 Farm Bill, 16 U.S.C. § 3838a et seq., which created the conservation program. The Court of Federal Claims (Wheeler, J.) granted the government’s motion to dismiss, holding that where the contract expressly incorporated regulations, but did not incorporate not the statutory provision on which the plaintiff relied, there was no contractual term entitling plaintiffs to relief. *** A number of cases before the ASBCA and CBCA addressed whether a constructive change had occurred that justified an equitable adjustment of the contract price.  In order to recover for a constructive change, the contractor must prove that (1) the contracting officer compelled the contractor to perform work not required under the contract; (2) the person directing the change had contractual authority unilaterally to alter the contractor’s duties; (3) the performance requirements were enlarged; and (4) the added work was not volunteered, but rather was at the direction of the contracting officer. Innoventor, Inc., ASBCA No. 59903 (July 11, 2017) In 2011, the government entered into a fixed-price contract with Innoventor for the design and manufacture of a dynamic brake test stand.  As part of the contract’s purchase specifications, the new design had to undergo and pass certain testing.  After problems arose in the testing process, Innoventor submitted a proposal to modify certain design components and applied for an equitable adjustment due to “instability of expectations.”  The contracting officer denied Innoventor’s request for an equitable adjustment, stating that the government had not issued a modification directing a change that would give rise to such an adjustment.  Innoventor submitted a claim, which the contracting officer denied, and Innoventor appealed. The Board (Sweet, A.J.) held that the government was entitled to judgment as a matter of law because there was no evidence that the government changed Innoventor’s performance requirements, let alone that anyone with authority directed any constructive changes.  Here, the contract was clear that Innoventor’s design had to pass certain tests, and because it failed some of them, and did not perform pursuant to the contract terms, there was no change in the original contract terms that would give rise to a constructive change.  The Board also found that there was no evidence that any person beyond the contracting officer had authority to direct a change because the contract expressly provided that only the contracting officer has authority to change a contract.  Accordingly, the Board denied Innoventor’s appeal. Indus. Maint. Servs., Inc. v. Dep’t of Veterans Affairs, CBCA No. 5618 (Sept. 15, 2017) After IMS was awarded a contract to provide labor, materials, equipment, and supervision of an upgrade to a medical center, IMS and the VA entered into a bilateral modification that changed the contract work and increased the contract price, but without changing the completion date.  Correspondence exchanged when entering into the modification suggested that any concerns as to the impact on the schedule would be addressed separately, and IMS reserved its right to be compensated for additional days.  When IMS later submitted a request for equitable adjustment based on the additional time and expense incurred as a result of the modification, the VA denied it and IMS appealed. The Board (Vergilio, A.J.) determined IMS was entitled to its additional costs, as the bilateral modification did not foreclose additional time or costs that followed the change.  Further, the VA had failed to value the cost of the modification properly by omitting a cost for the value of impacted work to be performed.  The Board granted in part IMS’s request, requiring the VA to correct its calculations and for the contractor to prove its actual costs and the value of impacted work. *** The ASBCA and Federal Circuit each considered whether contractor claims were foreclosed by a prior release clause. Cent. Tex. Express Metalwork LLC, ASBCA No. 61109 (Sept. 7, 2017) CTEM held a contract for the repair and replacement of various ventilation, heating, and air conditioning systems at Lackland Air Force Base.  After various payment disputes arose, CTEM entered into a release with the Air Force for a specific amount to be delivered to CTEM.  However, CTEM then opted not to receive the payment, and instead certified a claim for a greater amount, which the government denied on the grounds that CTEM had already released its claim.  CTEM appealed and the government filed a motion for summary judgment. The Board (Sweet, A.J.) first found that CTEM could not genuinely dispute that it agreed to release its claims.  A release followed by final payment generally bars a contractor from seeking recovery of its claims.  Here, CTEM had signed a final release, and the government had tendered payment.  Second, the Board rejected CTEM’s argument that the release was not binding because it had refused to accept the government’s payment.  The Board noted that the release was a binding contract with CTEM and once it was signed, which triggered the government’s obligation to tender payment, CTEM’s refusal to accept payment was an interference of the government’s obligation.  Third, the Board rejected CTEM’s argument that there was no consideration for the release.  In support, the Board found that when a contract called for a release at the time of final payment, the contract itself becomes the consideration.  Accordingly, the Board denied the appeal and granted summary judgment in favor of the government. Ingham Reg’l Med. Ctr. v. United States, No. 874 F.3d 1341 (Fed. Cir. 2017) In our 2016 Mid-Year Government Contracts Litigation Update, we covered the decision by the Court of Federal Claims (Horn, J.) that plaintiff hospital operators participating in the military TRICARE program failed to establish CDA jurisdiction over alleged underpayments that were predicated on certain non-contractual documents.  In this decision, the Federal Circuit considered an appeal from a different part of the lower court’s decision finding that Ingham’s breach of contract claims were barred by a release clause. The Federal Circuit (Hughes, J.) found that the release in question did not bar the claims because the release the government relied upon was in the very same contract it was accused of breaching. The Court found that DoD’s promise to follow an agreed-upon methodology was part of the consideration for Ingham’s agreement to provide the release, and that DoD could not therefore use the release to bar Ingham’s claim that DoD breached its obligations under the same contract.  However, the Court affirmed the Court of Federal Claims’ dismissal of Ingham’s money mandating claims for failure to state a claim in light of the deference due to DoD’s interpretation of the statute underlying the dispute. VI.     COMMON LAW PRINCIPLES The boards of contract appeals and Court of Federal Claims addressed a number of issues during the second half of 2017 arising out of the body of federal common law that has developed in the context of government contracts. A.     Christian Doctrine Under the Christian doctrine, a mandatory contract clause that expresses a significant or deeply ingrained strand of procurement policy is considered to be included in a contract by operation of law.  G.L. Christian & Assocs. v. United States, 312 F.2d 418 (Ct. Cl. 1963). Atlas Sahil Construction Co., ASBCA No. 58951 (Nov. 9, 2017) Atlas Sahil appealed the denial of a certified claim seeking to recover costs resulting from the Army’s termination for convenience of a contract to expand a forward operating base in Afghanistan.  The government did not substantially contest the contractor’s entitlement to recover termination costs.  Rather, the dispute arose over Atlas Sahil’s argument that it was entitled to recover amounts based on the contract’s line item prices, rather than on the cost of construction performed.  Atlas argued that the termination for convenience clause applicable to supply and service contracts, FAR 52.249-2, should be read into the contract under the Christian doctrine.  The government responded that the governing provision was that expressly incorporated into the contract, the termination for convenience clause applicable to construction contracts, FAR 52.249-2, Alt. I. The Board (Younger, A.J.) agreed with the government and denied the appeal.  The Board found that the Christian doctrine did not require the insertion of a different termination clause, since the parties agreed on the one incorporated into the contract. B.     Fraud We have been following in our recent publications developments in the law of whether and to what extent the boards of contract appeals may exercise jurisdiction over claims and defenses sounding in fraud when the alleged fraud affects the administration of government contracts.  For example, in our 2016 Year-End Government Contracts Litigation Update, we covered the Federal Circuit’s decision in Laguna Construction Company, Inc. v. Carter, 828 F.3d 1364 (Fed. Cir. 2016), which held that as long as the ASBCA can rely upon prior factual determinations from other tribunals (such as through a guilty plea), the Board has jurisdiction to adjudicate legal defenses based upon those prior determinations.  We also covered the ASBCA’s decision in Kellogg Brown & Root Services, Inc., ASBCA Nos. 57530 et al. (Nov. 8, 2016), where the Board interpreted Laguna to hold that nothing mandates that the Board “suspend appeals indefinitely [where] the government has merely filed a fraud cause elsewhere that might establish an affirmative defense of prior material breach if and whenever proven.” ABS Dev. Corp., ASBCA Nos. 60022 et al. (Aug. 30, 2017) The government sought to amend its answers in two appeals to assert the defense that the contract at issue was void ab initio due to fraud.  The Board (McIlmail, A.J.) permitted the amendments, rejecting ABS’s argument that the Board lacked jurisdiction because no third party had made factual determinations regarding any alleged fraud and reasserting that the Board possesses jurisdiction to determine for itself whether a contract is void because of fraud.  The Board stated that there is a “big difference” between whether the government is asserting an affirmative fraud claim over which the Board does not possess jurisdiction, as the Federal Circuit discussed in Laguna Construction Co., and whether a contractor can establish that it has a contract with the government in the first place. Yates-Desbuild Joint Ventures v. Dep’t of State, CBCA Nos. 3350-R et al. (Dec. 8, 2017) Yates alleged that it incurred delay damages on its contract with the State Department to construct a nine-building consulate compound in Mumbai, and that the State Department withheld superior knowledge that the Government of India would not act upon construction permits in an effort to strong arm the State Department into helping it recoup unpaid taxes from the U.S. government.  In the initial decision on the matter, the CBCA agreed that the State Department had superior knowledge that Indian officials would withhold permits, but by the time those government-caused delays began, Yates was itself nearly a year behind schedule.  Yates moved for reconsideration, arguing that under a theory of first material breach, it was entitled to recover damages “that would place it in the position it would have occupied had it never entered the contract in the first place.” The Board (Lester, A.J.) denied Yates’s motion for reconsideration, finding that Yates waived its prior material breach argument.  The CBCA noted that Yates had not squarely placed the first material breach argument in dispute, thereby preventing the State Department from developing a record on this issue.  The Board also found that Yates’s prior material breach defense was without merit.  Though a prior material breach may discharge a party from future performance, not all breaches do so.  Where a party can show fraud on the part of the government, the breach is per se material and the prior material breach doctrine is triggered.  However, the Board found that this appeal did not involve fraud, and it was not the State Department’s withholding of information that caused the first material performance failures on the project. C.     Good Faith & Fair Dealing K2 Solutions, Inc., ASBCA No. 60907 (July 13, 2017) K2 held a Navy contract to provide improvised explosive device detector dogs and related services.  K2 alleged that the Navy failed to exercise full delivery of the services contemplated in the base year, and that the government’s notice to exercise the first option year suggested a reduction in requirements from the original contract.  K2 brought numerous claims against the government, which the government moved to dismiss for failure to state a claim. The Board (Sweet, A.J.) held that the claims for breach of contract and improper exercise of the option year failed to state a claim because the attempted option exercise was ineffective, so there was no option exercise that could have violated the contract.  An option in a contract is to keep an offer open for a set period of time, which conferred upon the government the right to accept or reject the offer.  A notice of acceptance that is not an entire acceptance of the option is not acceptance at all.  Thus, since the government did not actually accept the option year as set out in the contract, the government could not have breached the option year contract.  With K2’s claim for breach of the duty of good faith, however, the Board held that this survived the government’s motion to dismiss.  A typical “bait and switch,” such as when the government awards a contract only to eliminate the benefit shortly thereafter, breaches the duty of good faith and fair dealing.  The Board found that while the modification was an ineffective exercise of the option, it could also plausibly be considered a new offer that K2 accepted by continuing to perform.  Thus, because the claim alleged that the government breached the duty after the modification reduced the scope of the work, the Board denied the government’s motion to dismiss this claim. Michael Johnson Logging v. Dep’t of Agric., CBCA No. 5089 (Dec. 22, 2017) After the Department of Agriculture awarded the Big Shrew South timber sale to Michael Johnson Logging, a dispute arose concerning “skid trails” that allow access to the timber.  Rather than the straight and wide corridors proposed by the plaintiff, the Department of Agriculture insisted on “zigzagging” skid trails to avoid “cutting legacy trees or damaging the forest.”  This allegedly led to project delays and Michael Johnson Logging filed a claim for damages.  The Department of Agriculture denied the claim, Michael Johnson Logging filed the instant appeal, and the Department of Agriculture moved for summary judgment. The CBCA (O’Rourke, A.J.) denied the motion for summary judgment as to the breach claim.  The Board noted that although plaintiff’s claim and its complaint did not include a reference to a violation of the duty of good faith and fair dealing, and plaintiff raised it for the first time in response to the Department of Agriculture’s motion for summary relief, there was enough in the complaint to support the claim for breach of implied terms of the contract and the claim was therefore not new.  However, the Board sided with the Department of Agriculture in awarding summary judgment on the contractor’s claim for “business devastation,” a claim that arises where “a contractor asserts that the Government’s actions caused the destruction” of a contractor’s business.  The Board found that claims for business devastation are granted sparingly due to the difficulty of showing a nexus between government action and the failure of the business of the whole.  Finding here that the record did not support a nexus between the government’s actions and the failure of Michael Johnson Logging’s business, the Board granted summary judgment in favor of the Department of Agriculture on that claim. MW Builders, Inc. v. United States, No. 13-1023 (Fed. Cl. Oct. 18, 2017) MW Builders held an Army Corps of Engineers contract for electrical utility services necessary to build an Army Reserve Center in Sloan, Nevada.  The contract was silent as to who was responsible for securing easements for this work.  But when delays arose because of difficulties relating to these easements, the Army claimed MW Builders was responsible and refused to pay on a cost claim associated with the delay.  When MW Builders brought suit in the Court of Federal Claims, the Army counterclaimed in fraud because the contractor submitted costs based on estimates, rather than actual costs. The Court of Federal Claims (Braden, J.) determined that the Corps breached its contract with MW Builders and violated the duty of good faith and fair dealing.  In reaching its decision, the Court noted that MW Builders had a “reasonable expectation,” consistent with industry practice, that the Corps was obligated to make arrangements for the easements.  The Court further dismissed the government’s counterclaims for fraud stating that, “[t]he fact that MW Builders should have used actual costs, instead of estimated costs, does not evidence that MW Builders acted with a specific intent to defraud the Government.” D.     Sovereign Acts Doctrine Another important common law limitation on a contractor’s ability to obtain damages from the government is the sovereign acts doctrine, which insulates the government from liability for acts taken in its sovereign (not contractual) capacity. ANHAM FZCO, LLC, ASBCA No. 59283 (July 20, 2017) ANHAM held a contract for the procurement, storage, and distribution of food and non-food items to the military and other federal customers in the Middle East.  ANHAM was responsible for maintaining proper inventory and forecasting monthly demand.  Shortly before the government finalized the decision to pull many of its troops from the region, ANHAM became concerned about proper inventory in light of that expected decision.  Instead of supporting ANHAM’s decision to reduce supply, the government advised ANHAM that it had to maintain a full inventory in order to fulfill performance of the contract.  Although delivery orders declined as troops were withdrawn, ANHAM had already renewed the lease for its largest warehouse.  Due to the number of troops being withdrawn, ANHAM submitted a claim to the contracting officer for the costs it incurred for the lease of the warehouse.  ANHAM argued that the government actively misled it regarding the impending departure of U.S. forces from Iraq by insisting throughout 2011 that it possessed no information about the withdrawal of U.S. troops, when the government had established a military departure date in a classified operational order, OPORD 11-01, issued January 6, 2011, which directed the removal of all U.S. troops from Iraq by the middle of December 2011.  The contracting officer denied ANHMA’s claim.  ANHAM appealed, and the government subsequently filed a motion for summary judgment. The Board (Kinner, A.J.) held that the government was not entitled to summary judgment because there were numerous disputes of material fact.  For one, the government did not address ANHAM’s allegations that it had been actively misled regarding the impending departure of the troops.  The Board also noted that whether the government knew about the withdrawal of troops was material to the government’s representations to ANHAM, and the timing of the order removing the troops from the Middle East was material as well.  The Board also found that there was a prima facie case of breach of the duty of good faith and fair dealing in that the government’s plan to withdraw troops was vital information for ANHAM and that ANHAM did not assume the risk that the government would withhold or falsify information regarding the amount of supplies needed.  Second, the Board found that the decision to renew the warehouse lease was dictated by the government’s representation of the numbers of troops, thus obligating ANHAM to lease the space to continue its performance obligations.  The Board also rejected the government’s argument that the sovereign acts doctrine precluded ANHAM’s breach claims because the decision to withdraw troops from the Middle East was a sovereign act.  Here, the withdrawal of troops did not prevent the government from acting in good faith and fair dealing.  Noting that all contracts implicitly contain a covenant of good faith and fair dealing, the Board stated:  “Good faith in contractual relations means ‘honesty in fact in the conduct or transaction concerned.'” The Board found that “[t]he government’s alleged actions fail that standard even if it could offer a legitimate legal basis for withholding or misrepresenting the information.” VII.     DAMAGES The Court of Federal Claims issued two decisions addressing the proper calculation of damages. Omran Holding Grp., Inc. v. United States, No. 16-446C et al. (Fed. Cl. Oct. 20, 2017) Omran is an Afghan construction and engineering firm providing services to the U.S. Army Corps of Engineers in Afghanistan.  Upon performance, the Corps was obligated to pay Omran in Afghani (AFN), the local Afghan currency.  Omran contended that the government did not use the appropriate rate of pay and sought damages totaling $1,418,925.22. The Court of Federal Claims (Williams, J.) held that, while the Corps paid Omran using the wrong currency conversion rate, Omran could not recover damages because the incorrect rate used was higher than what Omran was entitled to receive under the contract.  There can be no damages where Omran was “in at least as good, if not better, a position as it expected . . ., and it has not shown any particular harm to itself flowing from the alleged breach.” Agility Def. & Gov’t Servs. Inc. v. United States, Nos. 13-55C et al. (Fed. Cl. Oct. 18, 2017) We covered the Federal Circuit’s decision in Agility Defense, 847 F.3d 1345 (Fed. Circ. 2017), in our 2017 Mid-Year Government Contracts Litigation Update.  There the Federal Circuit (Moore, J.) reversed a decision of the Court of Federal Claims and held that the government failed to provide Agility with a realistic workload estimate in violation of FAR 16.503, and thus Agility could claim additional costs under its fixed price surplus military property contract due to a “surge of equipment and material” known to the government but not Agility. On remand, the Court of Federal Claims (Wheeler, J.) found that Agility was entitled to a total equitable adjustment of $6,906,339.20, plus interest, under the actual cost method. The Court based this conclusion on a finding that this calculation accurately captures the cost of additional, unanticipated work Agility had to perform on the contract as a result of the government’s negligent estimates.  The Court noted that: “When the Government provides a negligent estimate and a contractor reasonably relies on that estimate to its financial detriment, an equitable adjustment is the proper remedy.” VIII.     CONCLUSION We will continue to keep you informed on these and other related issues as they develop. The following Gibson Dunn lawyers assisted in preparing this client update: Karen L. Manos, John W.F. Chesley, Lindsay M. Paulin, Melinda Biancuzzo, Lauren M. Assaf, Matthew P. O’Sullivan, Pooja R. Patel and Casper J. Yen. Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding the issues discussed above.  Please contact the Gibson Dunn lawyer with whom you usually work, or any of the following: Washington, D.C. Karen L. Manos (+1 202-955-8536, kmanos@gibsondunn.com) Joseph D. West (+1 202-955-8658, jwest@gibsondunn.com) John W.F. Chesley (+1 202-887-3788, jchesley@gibsondunn.com) David P. Burns (+1 202-887-3786, dburns@gibsondunn.com) Michael Diamant (+1 202-887-3604, mdiamant@gibsondunn.com) Caroline Krass (+1 202-887-3784, ckrass@gibsondunn.com) Michael K. Murphy(+1 202-995-8238, mmurphy@gibsondunn.com) Jonathan M. Phillips (+1 202-887-3546, jphillips@gibsondunn.com)> Melinda R. Biancuzzo (+1 202-887-3724, mbiancuzzo@gibsondunn.com) Michael R. Dziuban (+1 202-887-8252, mdziuban@gibsondunn.com) Ella Alves Capone (+1 202-887-3511, ecapone@gibsondunn.com) Melissa L. Farrar (+1 202-887-3579, mfarrar@gibsondunn.com) Lindsay M. Paulin (+1 202-887-3701, lpaulin@gibsondunn.com) Laura J. Plack (+1 202-887-3678, lplack@gibsondunn.com) Erin N. Rankin (+1 202-955-8246, erankin@gibsondunn.com) Jeffrey S. Rosenberg (+1 202-955-8297, jrosenberg@gibsondunn.com) Jin I. Yoo (+1 202-887-3797, jyoo@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Jeremy S. Ochsenbein (+1 303-298-5773, jochsenbein@gibsondunn.com) Los Angeles Marcellus McRae (+1 213-229-7675, mmcrae@gibsondunn.com) Maurice M. Suh (+1 213-229-7260, msuh@gibsondunn.com) James L. Zelenay, Jr. (+1 213-229-7449, jzelenay@gibsondunn.com) Dhananjay S. Manthripragada (+1 213-229-7366, dmanthripragada@gibsondunn.com) Sean S. Twomey (+1 213-229-7284, stwomey@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 7, 2018 |
2017 Year-End German Law Update

Click for PDF “May you live in interesting times” goes the old Chinese proverb, which is not meant for a friend but for an enemy. Whoever expressed such wish, interesting times have certainly come to pass for the German economy. Germany is an economic giant focused on the export of its sophisticated manufactured goods to the world’s leading markets, but it is also, in some ways, a military dwarf in a third-tier role in the re-sketching of the new world order. Germany’s globally admired engineering know-how and reputation has been severely damaged by the Volkswagen scandal and is structurally challenged by disruptive technologies and regulatory changes that may be calling for the end of the era of internal combustion engines. The top item on Germany’s foreign policy agenda, the further integration of the EU-member states into a powerful economic and political union, has for some years now given rise to daily crisis management, first caused by the financial crisis and, since last year, by the uncertainties of BREXIT. As if this was not enough, internal politics is still handling the social integration of more than a million refugees that entered the country in 2015, who rightly expect fair and just treatment, education, medical care and a future. It has been best practice to address such manifold issues with a strong and hands-on government, but – unfortunately – this is also currently missing. While the acting government is doing its best to handle the day-to-day tasks, one should not expect any bold move or strategic initiative before a stable, yet to be negotiated parliamentary coalition majority has installed new leadership, likely again under Angela Merkel. All that will drag well into 2018 and will not make life any easier. In stark contrast to the difficult situation the EU is facing in light of BREXIT, the single most impacting piece of regulation that will come into effect in May 2018 will be a European Regulation, the General Data Protection Regulation, which will harmonize data protection law across the EU and start a new era of data protection. Because of its broad scope and its extensive extraterritorial reach, combined with onerous penalties for non-compliance, it will open a new chapter in the way companies world-wide have to treat and process personal data. In all other areas of the law, we observe the continuation of a drive towards ever more transparency, whether through the introduction of new transparency registers disclosing relevant ultimate beneficial owner information or misconduct, through obligatory disclosure regimes (in the field of tax law), or through the automatic exchange under the OECD’s Common Reporting Standard of Information that hitherto fell under the protection of bank secrecy laws. While all these initiatives are well intentioned, they present formidable challenges for companies to comply with the increased complexity and adequately respond to the increased availability and flow of sensitive information. Even more powerful than the regulatory push is the combination of cyber-attacks, investigative journalism, and social media: within a heartbeat, companies or individuals may find themselves exposed on a global scale to severe allegations or fundamental challenges to the way they did or do business. While this trend is not of a legal nature, but a consequence of how we now communicate and whom we trust (or distrust), for those affected it may have immediate legal implications that are often highly complex and difficult to control and deal with. Interesting times usually are good times for lawyers that are determined to solve problems and tackle issues. This is what we love doing and what Gibson Dunn has done best time and again in the last 125 years. We therefore remain optimistic, even in view of the rough waters ahead which we and our clients will have to navigate. We want to thank you for your trust in our services in Germany and your business that we enjoy here and world-wide. We do hope that you will gain valuable insights from our Year-End Alert of legal developments in Germany that will help you to successfully focus and resource your projects and investments in Germany in 2018 and beyond; and we promise to be at your side if you need a partner to help you with sound and hands-on legal advice for your business in and with Germany or to help manage challenging or forward looking issues in the upcoming exciting times. ________________________________ Table of Contents 1.  Corporate, M&A 2.  Tax 3.  Financing and Restructuring 4.  Labor and Employment 5.  Real Estate 6.  Data Protection 7.  Compliance 8.  Antitrust and Merger Control ________________________________ 1. Corporate, M&A 1.1       Corporate, M&A – Transparency Register – New Transparency Obligations on Beneficial Ownership As part of the implementation of the 4th European Money Laundering Directive into German law, Germany has created a new central electronic register for information about the beneficial owners of legal persons organized under German private law as well as registered partnerships incorporated within Germany. Under the restated German Money Laundering Act (Geldwäschegesetz – GWG) which took effect on June 26, 2017, legal persons of German private law (e.g. capital corporations like stock corporations (AG) or limited liability companies (GmbH), registered associations (eingetragener Verein – e.V.), incorporated foundations (rechtsfähige Stiftungen)) and all registered partnerships (e.g. offene Handelsgesellschaft (OHG), Kommanditgesellschaft (KG) and GmbH & Co. KG) are now obliged to “obtain, keep on record and keep up to date” certain information about their “beneficial owners” (namely: first and last name, date of birth, place of residence and details of the beneficial interest) and to file the respective information with the transparency register without undue delay (section 20 (1) GWG). A “beneficial owner“ in this sense is a natural person who directly or indirectly holds or controls more than 25% of the capital or voting rights, or exercises control in a similar way (section 3 (2) GWG). Special rules apply for registered associations, trusts, non-charitable unregulated associations and similar legal arrangements. “Obtaining” the information does not require the entities to carry out extensive investigations, potentially through multi-national and multi-level chains of companies. It suffices to diligently review the information on record and to have in place appropriate internal structures to enable it to make a required filing without undue delay. The duty to keep the information up to date generally requires that the company checks at least on an annual basis whether there have been any changes in their beneficial owners and files an update, if necessary. A filing to the transparency register, however, is not required if the relevant information on the beneficial owner(s) is already contained in certain electronic registers (e.g. the commercial register or the so-called “Unternehmensregister“). This exemption only applies if all relevant data about the beneficial owners is included in the respective documents and the respective registers are still up to date. This essentially requires the obliged entities to diligently review the information available in the respective electronic registers. Furthermore, as a matter of principle, companies listed on a regulated market in the European Union (“EU“) or the European Economic Area (“EEA“) (excluding listings on unregulated markets such as e.g. the Entry Standard of the Frankfurt Stock Exchange) or on a stock exchange with equivalent transparency obligations with respect to voting rights are never required to make any filings to the transparency register. In order to enable the relevant entity to comply with its obligations, shareholders who qualify as beneficial owners or who are directly controlled by a beneficial owner, irrespective of their place of residence, must provide the relevant entity with the relevant information. If a direct shareholder is only indirectly controlled by a beneficial owner, the beneficial owner himself (and not the direct shareholder) must inform the company and provide it with the necessary information (section 20 (3) sentence 4 GWG). Non-compliance with these filing and information obligations may result in administrative fines of up to EUR 100,000. Serious, repeated or systematic breaches may even trigger sanctions up to the higher fine threshold of EUR 1 million or twice the economic benefit of the breach. The information submitted to the transparency register is not generally freely accessible. There are staggered access rights with only certain public authorities, including the Financial Intelligence Unit, law enforcement and tax authorities, having full access rights. Persons subject to know-your-customer (“KYC“) obligations under the Money Laundering Act such as e.g. financial institutions are only given access to the extent the information is required for them to fulfil their own KYC obligations. Other persons or the general public may only gain access if they can demonstrate a legitimate interest in such information. Going forward, every entity subject to the Money Laundering Act should verify whether it is beneficially owned within the aforementioned sense, and, if so, make the respective filing to the transparency register unless the relevant information is already contained in a public electronic register. Furthermore, relevant entities should check (at least) annually whether the information on their beneficial owner(s) as filed with the transparency or other public register is still correct. Also, appropriate internal procedures need to be set up to ensure that any relevant information is received by a person in charge of making filings to the registers. Back to Top 1.2       Corporate, M&A – New CSR Disclosure Obligations for German Public Interest Companies  Effective for fiscal years commencing on or after January 1, 2017, large companies with more than 500 employees are required to include certain non-financial information regarding their management of social and environmental challenges in their annual reporting (“CSR Information“). The new corporate social responsibility reporting rules (“CSR Reporting Rules“) implement the European CSR Directive into German law and are intended to help investors, consumers, policy makers and other stakeholders to evaluate the non-financial performance of large companies and encourage companies to develop a responsible and sustainable approach to business. The CSR Reporting Rules apply to companies with a balance sheet sum in excess of EUR 20 million and an annual turnover in excess of EUR 40 million, whose securities (stock or bonds etc.) are listed on a regulated market in the EU or the EEA as well as large banks and large insurance companies. It is estimated that approximately 550 companies in Germany are covered. Exemptions apply to consolidated subsidiaries if the parent company publishes the CSR Information in the group reporting. The CSR Reporting Rules require the relevant companies to inform on the policies they implemented, the results of such policies and the business risks in relation to (i) environmental protection, (ii) treatment of employees, (iii) social responsibility, (iv) respect for human rights and (v) anti-corruption and bribery. In addition, listed stock corporations are also obliged to inform with regard to diversity on their company boards. If a company has not implemented any such policy, an explicit and justified disclosure is required (“comply or explain”). Companies must further include significant non-financial performance indicators and must also include information on the amounts reported in this respect in their financial statements. The CSR Information can either be included in the annual report or by way of a separate CSR report, to be published on the company’s website or together with its regular annual report with the German Federal Gazette (Bundesanzeiger). The CSR Reporting Rules will certainly increase the administrative burden placed on companies when preparing their annual reporting documentation. It remains to be seen if the new rules will actually meet the expectations of the European legislator and foster and create a more sustainable approach of large companies to doing business in the future . Back to Top 1.3       Corporate, M&A – Corporate Governance Code Refines Standards for Compliance, Transparency and Supervisory Board Composition Since its first publication in 2002, the German Corporate Governance Code (Deutscher Corporate Governance Kodex – DCGK) which contains standards for good and responsible governance for German listed companies, has been revised nearly annually. Even though the DCGK contains only soft law (“comply or explain”) framed in the form of recommendations and suggestions, its regular updates can serve as barometer for trends in the public discussion and sometimes are also a forerunner for more binding legislative measures in the near future. The main changes in the most recent revision of the DCGK in February 2017 deal with aspects of compliance, transparency and supervisory board composition. Compliance The general concept of “compliance” was introduced by the DCGK in 2007. In this respect, the recent revision of the DCGK brought along two noteworthy new aspects. On the one hand, the DCGK now stresses in its preamble that good governance and management does not only require compliance with the law and internal policies but also ethically sound and responsive behavior (the “reputable businessperson concept”). On the other hand, the DCGK now recommends the introduction of a compliance management system (“CMS“). In keeping with the common principle of individually tailored compliance management systems that take into account the company’s specific risk situation, the DCGK now recommends appropriate measures reflecting the company’s risk situation and disclosing the main features of the CMS publically, thus enabling investors to make an informed decision on whether the CMS meets their expectations. It is further expressly recommended to provide employees with the opportunity to blow the whistle and also suggested to open up such whistle-blowing programs to third parties. Supervisory Board In line with the ongoing international trend of focusing on supervisory board composition, the DCGK now also recommends that the supervisory board not only should determine concrete objectives for its composition, but also develop a tailored skills and expertise profile for the entire board and to disclose in the corporate governance report to which extent such benchmarks and targets have been implemented in practice. In addition, the significance of having sufficient independent members on the supervisory board is emphasized by a new recommendation pursuant to which the supervisory board should disclose the appropriate number of independent supervisory board members as well as the members which meet the “independence” criteria in the corporate governance report. In accordance with international best practice, it is now also recommended to provide CVs for candidates for the supervisory board including inter alia relevant knowledge, skills and experience and to publish this information on the company’s website. With regard to supervisory board transparency, the DCGK now also recommends that the chairman of the supervisory board should be prepared, within an appropriate framework, to discuss topics relevant to the supervisory board with investors (please see in this regard our 2016-Year-End Alert, section 1.2). These new 2017 recommendations further highlight the significance of compliance and the role of the supervisory board not only for legislators but also for investors and other stakeholders. As soon as the annual declarations of non-conformity (“comply or explain”) are published over the coming weeks and months, it will be possible to assess how well these new recommendations will be received as well as what responses there will be to the planned additional supervisory board transparency (including, in particular, by family-controlled companies with employee co-determination on the supervisory board). Back to Top 1.4       Corporate, M&A – Employee Co-Determination: No European Extension As set out in greater detail in past alerts (please see in this regard our 2016 Year-End Alert, section 1.3 with further references), the scope and geographic reach of the German co-determination rules (as set out in the German Co-Determination Act; Mitbestimmungsgesetz – MitbestG and in the One-Third-Participation Act; Drittelbeteiligungsgesetz – DrittelbG) were the subject of several ongoing court cases. This discussion has been put to rest in 2017 by a decision of the European Court of Justice (ECJ, C-566/15 – July 18, 2017) that held that German co-determination rules and their restriction to German-based employees as the numeric basis for the relevant employee thresholds and as populace entitled to vote for such co-determined supervisory boards do not infringe against EU law principles of anti-discrimination and freedom of movement. The judgment has been received positively by both German trade unions and corporate players because it preserves the existing German co-determination regime and its traditional, local values against what many commentators would have perceived to be an undue pan-Europeanization of the thresholds and the right to vote for such bodies. In particular, the judgment averts the risk that many supervisory boards would have had to be re-elected based on a pan-European rather than solely German employee base. Back to Top 1.5       Corporate, M&A – Germany Tightens Rules on Foreign Takeovers On July 18, 2017, the amended provisions on foreign direct investments under the Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung – AWV), expanding and specifying the right of the Federal Ministry for Economic Affairs and Energy (“Ministry“) to review whether the takeover of domestic companies by investors outside the EU or the European Free Trade Area poses a danger to the public order or security of the Federal Republic of Germany came into force. The amendment has the following five main effects which will have a considerable impact on the M&A practice: (i) (non-exclusive) standard categories of companies and industries which are relevant to the public order or security for cross-sector review are introduced, (ii) the stricter sector-specific rules for industries of essential security interest (such as defense and IT-security) are expanded and specified, (iii) there is a reporting requirement for all takeovers within the relevant categories, (iv) the time periods for the review process are extended, and (v) there are stricter and more specific restrictions to prevent possible circumventions. Under the new rules, a special review by the German government is possible in cases of foreign takeovers of domestic companies which operate particularly in the following sectors: (i) critical infrastructure amenities, such as the energy, IT and telecommunications, transport, health, water, food and finance/insurance sectors (to the extent they are very important for the functioning of the community), (ii) sector-specific software for the operation of these critical infrastructure amenities, (iii) telecom carriers and surveillance technology and equipment, (iv) cloud computing services and (v) telematics services and components. The stricter sector-specific rules for foreign takeovers within the defense and IT-security industry are also expanded and now also apply to the manufacturers of defense equipment for reconnaissance and support. Furthermore, the reporting requirement no longer applies only to transactions within the defense and IT-security sectors, but also to all foreign takeovers that fall within the newly introduced cross-sector standard categories described above. The time periods allowed for the Ministry to intervene have been extended throughout. In particular, if an application for a clearance certificate is filed, the clearance certificate will be deemed granted in the absence of a formal review two months following receipt of the application rather than one month as in the past, and the review periods are suspended if the Ministry conducts negotiations with the parties involved. Further, a review may be commenced until five years after the signing of the purchase agreement, which in practice will likely result in an increase of applications for a clearance certificate in order to obtain more transaction certainty. Finally, the new rules provide for stricter and more specific restrictions of possible circumventions by, for example, the use of so-called “front companies” domiciled in the EU or the European Free Trade Area and will trigger the Ministry’s right to review if there are indications that an improper structuring or evasive transaction was at least partly chosen to circumvent the review by the Ministry. Although the scope of the German government’s ability to intervene in M&A processes has been expanded where critical industries are concerned, it is not clear yet to what extent stronger interference or more prohibitions or restrictions will actually occur in practice. And even though the new law provides further guidance, there are still areas of legal uncertainty which can have an impact on valuations and third party financing unless a clearance certificate is obtained. Due to the suspension of the review period in the case of negotiations with the Ministry, the review procedure has, at least in theory, no firm time limit. As a result, the M&A advisory practice has to be prepared for a more time-consuming and onerous process for transactions in the critical industries and may thus be forced to allow for more time between signing and closing. In addition, appropriate termination clauses (and possibly break fees) must be considered for purposes of the share purchase agreement in case a prohibition or restriction of the transaction on the basis of the amended AWV cannot be excluded. Back to Top 2. Tax 2.1       Tax – Unconstitutionality of German Change-of-Control Rules Tax loss carry forwards are an important asset in every M&A transaction. Over the past ten years the German change-of-control rules, which limit the use of losses and loss carry forwards (“Losses“) of a German target company, have undergone fundamental legislative changes. The current change-of-control rules may now face another significant revision as – according to the German Federal Constitutional Court (Bundesverfassungsgericht – BVerfG) and the Lower Tax Court of Hamburg – the current tax regime of the change-of-control rules violates the constitution. Under the current change-of-control rules, Losses of a German corporation will be forfeited on a pro rata basis if within a period of five years more than 25% but not more than 50% of the shares in the German loss-making corporation are transferred (directly or indirectly) to a new shareholder or group of shareholders with aligned interests. If more than 50% are transferred, Losses will be forfeited in total. There are exceptions to this rule for certain intragroup restructurings, built-in gains and – since 2016 – for business continuations, especially in the venture capital industry. On March 29, 2017, the German Federal Constitutional Court ruled that the pro rata forfeiture of Losses (share transfer of more than 25% but not more than 50%) is not in line with the constitution. The BVerfG held that the provision leads to unequal treatment of companies. The aim of avoiding legal but undesired tax optimizations does not justify the broad and general scope of the provision. The BVerfG has asked the German legislator to amend the change-of-control rules retroactively for the period from January 1, 2008 until December 31, 2015 and bring them in line with the constitution. The legislative changes need to be finalized by December 31, 2018. Furthermore, in another case on August 29, 2017, the Lower Tax Court of Hamburg held that the change-of-control rules, which result in a full forfeiture of Losses after a transfer of more than 50% of the shares in a German corporation, are also incompatible with the constitution. The ruling is based on the 2008 wording of the change-of-control rules but the wording of these rules is similar to that of the current forfeiture rules. In view of the March 2017 ruling of the Federal Constitutional Court on the pro-rata forfeiture, the Lower Tax Court referred this case also to the Federal Constitutional Court to rule on this issue as well. If the Federal Constitutional Court decides in favor of the taxpayer the German tax legislator may completely revise the current tax loss limitation regime and limit its scope to, for example, abusive cases. A decision by the Federal Constitutional Court is expected in the course of 2018. Affected market participants are therefore well advised to closely monitor further developments and consider the impact of potential changes on past and future M&A deals with German entities. Appeals against tax assessments should be filed and stays of proceedings applied for by reference to the case before the Federal Constitutional Court in order to benefit from a potential retroactive amendment of the change-of-control rules. Back to Top 2.2       Tax – New German Tax Disclosure Rules for Tax Planning Schemes In light of the Panama and Paradise leaks, the respective Finance Ministers of the German federal states (Bundesländer) created a working group in November 2017 to establish how the new EU Disclosure Rules for advisers and taxpayers as published by the European Commission (“Commission“) on July 25, 2017 can be implemented into German law. Within the member states of the EU, mandatory tax disclosure rules for tax planning schemes already exist in the UK, Ireland and Portugal. Under the new EU disclosure rules certain tax planners and advisers (intermediaries) or certain tax payers themselves must disclose potentially aggressive cross-border tax planning arrangements to the tax authorities in their jurisdiction. This new requirement is a result of the disclosure rules as proposed by the OECD in its Base Erosion and Profit Shifting (BEPS) Action 12 report, among others. The proposal requires tax authorities in the EU to automatically exchange reported information with other tax authorities in the EU. Pursuant to the Commission’s proposal, an “intermediary” is the party responsible for designing, marketing, organizing or managing the implementation of a tax payer´s reportable cross border arrangement, while also providing that taxpayer with tax related services. If there is no intermediary, the proposal requires the taxpayer to report the arrangement directly. This is, for example, the case if the taxpayer designs and implements an arrangement in-house, if the intermediary in question does not have a presence within the EU or in case the intermediary cannot disclose the information because of legal professional privilege. The proposal does not define what “arrangement” or “aggressive” tax planning means but lists characteristics (so-called “hallmarks“) of cross-border tax planning schemes that would strongly indicate whether tax avoidance or abuse occurred. These hallmarks can either be generic or specific. Generic hallmarks include arrangements where the tax payer has complied with a confidentiality provision not to disclose how the arrangement could secure a tax advantage or where the intermediary is entitled to receive a fee with reference to the amount of the tax advantage derived from the arrangement. Specific hallmarks include arrangements that create hybrid mismatches or involve deductible cross border payments between related parties with a preferential tax regime in the recipient’s tax resident jurisdiction. The information to be exchanged includes the identities of the tax payer and the intermediary, details about the hallmarks, the date of the arrangement, the value of the transactions and the EU member states involved. The implementation of such mandatory disclosure rules on tax planning schemes are heavily discussed in Germany especially among the respective bar associations. Elements of the Commission’s proposal are regarded as a disproportionate burden for intermediaries and taxpayers in relation to the objective. Further clarity is needed to align the proposal with the general principle of legal certainty. Certain elements of the proposal may contravene EU law or even the German constitution. And the interaction with the duty of professional secrecy for lawyers and tax advisors is also still unclear. Major efforts are therefore needed for the German legislator to make such a disclosure regime workable both for taxpayers/intermediaries and the tax administrations. It remains to be seen how the Commission proposal will be implemented into German law in 2018 and how tax structuring will be affected. Back to Top 2.3       Tax – Voluntary Self-Disclosure to German Tax Authorities Becomes More Challenging German tax law allows voluntary self-disclosure to correct or supplement an incorrect or incomplete tax return. Valid self-disclosure precludes criminal liability for tax evasion. Such exemption from criminal prosecution, however, does not apply if the tax evasion has already been “detected” at the time of the self-disclosure and this is at least foreseeable for the tax payer. On May 5, 2017 the German Federal Supreme Court (Bundesgerichtshof – BGH) further specified the criteria for voluntary self-disclosure to secure an exemption from criminal prosecution (BGH, 1 StR 265/16 – May 9, 2017). The BGH ruled that exemption from criminal liability might not apply if a foreign authority had already discovered the non- or underreported tax amounts prior to such self-disclosure. Underlying the decision of the BGH was the case of a German employee of a German defense company, who had received payments from a Greek business partner, but declared neither the received payments nor the resulting income in his tax declaration. The payment was a reward for his contribution in selling weapons to the Greek government. The Greek authorities learned of the payment to the German employee early in 2004 in the course of an anti-bribery investigation and obtained account statements proving the payment through intermediary companies and foreign banks. On January 6, 2014, the German employee filed a voluntary self-disclosure to the German tax authorities declaring the previously omitted payments. The respective German tax authority found that this self-disclosure was not submitted in time to exempt the employee from criminal liability. The issue in this case was by whom and at what moment in time the tax evasion needed to be detected in order to render self-disclosure invalid. The BGH ruled that the voluntary self-disclosure by the German employee was futile due to the fact that the payment at issue had already been detected by the Greek authorities at the time of the self-disclosure. In this context, the BGH emphasized that it was not necessary for the competent tax authorities to have detected the tax evasion, but it was sufficient if any other authority was aware of the tax evasion. The BGH made clear that this included foreign authorities. Thus, a prior detection is relevant if on the basis of a preliminary assessment of the facts a conviction is ultimately likely to occur. This requirement is for example met if it can be expected that the foreign authority that detected the incorrect, incomplete or omitted fact will forward this information to the German tax authorities as in the case before the BGH. In particular, there was an international assistance procedure in place between German and Greek tax authorities and the way the payments were made by using intermediaries and foreign banks made it obvious to the Greek authorities that the relevant amounts had not been declared in Germany. Due to the media coverage of the case, this was also at least foreseeable for the German employee. This case is yet another cautionary tale for tax payers not to underestimate the effects of increased international cooperation of tax authorities. Back to Top 3. Financing and Restructuring 3.1       Financing and Restructuring – Upfront Banking Fees Held Void by German Federal Supreme Court On July 4, 2017, the German Federal Supreme Court (Bundesgerichtshof – BGH) handed down two important rulings on the permissibility of upfront banking fees in German law governed loan agreements. According to the BGH, boilerplate clauses imposing handling, processing or arrangement fees on borrowers are void if included in standard terms and conditions (Allgemeine Geschäftsbedingungen). With this case, the court extended its prior rulings on consumer loans to commercial loans. The BGH argued that clauses imposing a bank’s upfront fee on a borrower fundamentally contradict the German statutory law concept that the consideration for granting a loan is the payment of interest. If ancillary pricing arrangements (Preisnebenabreden) pass further costs and expenses on to the borrower, the borrower is unreasonably disadvantaged by the user (Verwender) of standard business terms, unless the additional consideration is agreed for specific services that go beyond the mere granting of the loan and the handling, processing or arrangement thereof. In the cases at hand, the borrowers were thus awarded repayment of the relevant fee. The implications of these rulings for the German loan market are far-reaching. The rulings affect all types of upfront fees for a lender’s services which are routinely passed on to borrowers even though they would otherwise be owed by the lender pursuant to statutory law, a regulatory regime or under a contract or which are conducted in the lender’s own interest. Consequently, this covers fees imposed on the borrower for the risk assessment (Bonitätsprüfung), the valuation of collateral, expenses for the collection of information on the assessment of a borrower’s financing requirements and the like. At this stage, it is not yet certain if, for example, agency fees or syndication fees could also be covered by the decision. There are, however, good arguments to reason that services rendered in connection with a syndication are not otherwise legally or contractually owed by a lender. Upfront fees paid in the past, i.e. in 2015 or later, can be reclaimed by borrowers. The BGH applied the general statutory three year limitation period and argued that the limitation period commenced at the end of 2011 after Higher District Courts (Oberlandesgerichte) had held upfront banking fees void in deviation from previous rulings. As of such time, borrowers should have been aware that a repayment claim of such fees was possible and could have filed a court action even though the enforcement of the repayment was not risk-free. Going forward, it can be expected that lenders will need to modify their approach as a result of the rulings: Choosing a foreign (i.e. non-German) law for a separate fee agreement could be an option for lenders, at least, if either the lender or the borrower is domiciled in the relevant jurisdiction or if there is a certain other connection to the jurisdiction of the chosen law. If the loan is granted by a German lender to a German borrower, the choice of foreign law would also be generally recognized, but under EU conflict of law provisions mandatory domestic law (such as the German law on standard terms) would likely still continue to apply. In response to the ruling, lenders are also currently considering alternative fee structures: Firstly, the relevant costs and expenses underlying such fees are being factored into the calculation of the interest and the borrower is then given the option to choose an upfront fee or a (higher) margin. This may, however, not always turn out to be practical, in particular given that a loan may be refinanced prior to generating the equivalent interest income. Secondly, a fee could be agreed in a separate fee letter which specifically sets out services which go beyond the typical services a bank renders in its own interest. It may, however be difficult to determine services which actually justify a fee. Finally, a lender might charge typical upfront fees following genuine individual negotiations. This requires that the lender not only shows that it was willing to negotiate the amount of the relevant fee, but also that it was generally willing to forego the typical upfront fee entirely. However, if the borrower rejects the upfront fee, the lender still needs to rely on alternative fee arrangements. Further elaboration by the courts and market practice should be closely monitored by lenders and borrowers alike. Back to Top 3.2       Financing and Restructuring – Lingering Uncertainty about Tax Relief for Restructuring Profits Ever since the German Federal Ministry of Finance issued an administrative order in 2003 (“Restructuring Order“) the restructuring of distressed companies has benefited from tax relief for income tax on “restructuring profits”. In Germany, restructuring profits arise as a consequence of debt to equity swaps or debt waivers with regard to the portion of such debt that is unsustainable. Debtors and creditors typically ensured the application of the Restructuring Order by way of a binding advance tax ruling by the tax authorities thus providing for legal certainty in distressed debt scenarios for the parties involved. However, in November 2016, the German Federal Tax Court (Bundesfinanzhof – BFH) put an end to such preferential treatment of restructuring profits. The BFH held the Restructuring Order to be void arguing that the Federal Ministry of Finance had lacked the authority to issue the Restructuring Order. It held that such a measure would need to be adopted by the German legislator instead. The Ministry of Finance and the German restructuring market reacted with concern. As an immediate response to the ruling the Ministry of Finance issued a further order on April 27, 2017 (“Continuation Order”) to the effect that the Restructuring Order continued to apply in all cases in which creditors finally and with binding effect waived claims on or before February 8, 2017 (the date on which the ruling of the Federal Tax Court was published). But the battle continued. In August 2017, the Federal Tax Court also set aside this order for lack of authority by the Federal Ministry of Finance. In the meantime, the German Bundestag and the Bundesrat have passed legislation on tax relief for restructuring profits, but the German tax relief legislation will only enter into force once the European Commission issues a certificate of non-objection confirming the new German statutory tax relief’s compliance with EU restrictions on state aid. This leaves uncertainty as to whether the new law will enter into force in its current wording and when. Also, the new legislation will only cover debt waivers/restructuring profits arising after February 8, 2017 but at this stage does not provide for the treatment of cases before such time. In the absence of the 2003 Restructuring Order and the 2017 Continuation Order, tax relief would only be possible on the basis of equitable relief in exceptional circumstances. It appears obvious that no reliable restructuring concept can be based on potential equitable relief. Thus, it is advisable to look out for alternative structuring options in the interim: Subordination of debt: while this may eliminate an insolvency filing requirement for illiquidity or over indebtedness, the debt continues to exist. This may make it difficult for the debtor to obtain financing in the future. In certain circumstances, a carve-out of the assets together with a sustainable portion of the debt into a new vehicle while leaving behind and subordinating the remainder of the unsustainable portion of the debt, could be a feasible option. As the debt subsists, a silent liquidation of the debtor may not be possible considering the lingering tax burden on restructuring profits. Also, any such carve-out measures by which the debtor is stripped of assets may be challenged in case of a later insolvency of the debtor. A debt hive up without recourse may be a possible option, but a shareholder or its affiliates are not always willing to assume the debt. Also, as tax authorities have not issued any guidelines on the tax treatment of debt hive ups, a binding advance tax ruling from the tax authorities should be obtained before the debt hive up is executed. Still, a debt hive up could be an option if the replacement debtor is domiciled in a jurisdiction which does not impose detrimental tax consequences on the waiver of unsustainable debt. Converting the debt into a hybrid instrument which constitutes debt for German tax purposes and equity from a German GAAP perspective is no longer feasible. Pursuant to a tax decree from May 2016, the tax authorities argue that the creation of a hybrid instrument amounts to a taxable waiver of debt on the basis that tax accounting follows commercial accounting. It follows that irrespective of potential alternative structures which may suit a specific set of facts and circumstances, restructuring transactions in Germany continue to be challenging pending the entry into force of the new tax relief legislation. Back to Top 4. Labor and Employment 4.1       Labor and Employment – Defined Contribution Schemes Now Allowed In an effort to promote company pension schemes and to allow more flexible investments, the German Company Pension Act (Betriebsrentengesetz – BetrAVG) was amended considerably with effect as of January 1, 2018. The most salient novelty is the introduction of a purely defined contribution pension scheme, which had not been permitted in the past. Until now, the employer would always be ultimately liable for any kind of company pension scheme irrespective of the vehicle it was administered through. This is no longer the case with the newly introduced defined contribution scheme. The defined contribution scheme also entails considerable other easements for employers, e.g. pension adjustment obligations or the requirement of insolvency insurance no longer apply. As a consequence, a company offering a defined contribution pension scheme does not have to deal with the intricacies of providing a suitable investment to fulfil its pension promise, but will have met its duty in relation to the pension simply by paying the promised contribution (“pay and forget”). However, the introduction of such defined contribution schemes requires a legal basis either in a collective bargaining agreement (with a trade union) or in a works council agreement, if the union agreement so allows. If these requirements are met though, the new legal situation brings relief not only for employers offering company pension schemes but also for potential investors into German businesses for whom the German-specific defined benefit schemes have always been a great burden. Back to Top 4.2     Labor and Employment – Federal Labor Court Facilitates Compliance Investigations In a decision much acclaimed by the business community, the German Federal Labor Court (Bundesarbeitsgericht – BAG) held that intrusive investigative measures by companies against their employees do not necessarily require a suspicion of a criminal act by an employee; rather, less severe forms of misconduct can also trigger compliance investigations against employees (BAG, 2 AZR 597/16 – June 29, 2017). In the case at hand, an employee had taken sick leave, but during his sick leave proceeded to work for the company owned by his sons who happened to be competing against his current employer. After customers had dropped corresponding hints, the company assigned a detective to ascertain the employee’s violation of his contractual duties and subsequently fired the employee based on the detective’s findings. In the dismissal protection trial, the employee argued that German law only allowed such intrusive investigation measures if criminal acts were suspected. This restriction was, however, rejected by the BAG. This judgment ends a heated debate about the permissibility of internal investigation measures in the case of compliance violations. However, employers should always adhere to a last-resort principle when investigating possible violations. For instance, employees must not be seamlessly monitored at their workplace by way of a so-called “key logger” as the Federal Labor Court held in a different decision (BAG, 2 AZR 681/16 – July 27, 2017). Also, employers should keep in mind a recent ruling of the European Court of Human Rights of September 5, 2017 (ECHR, 61496/08). Accordingly, the workforce should be informed in advance that and how their email correspondence at the workplace can be monitored. Back to Top 5. Real Estate Real Estate – Invalidity of Written Form Remediation Clauses for Long-term Lease Agreements On September 27, 2017, the German Federal Supreme Court (Bundesgerichtshof – BGH) ruled that so-called “written form remediation clauses” (Schriftformheilungsklauseln) in lease agreements are invalid because they are incompatible with the mandatory provisions of section 550 of the German Civil Code (Bürgerliches Gesetzbuch – BGB; BGH, XII ZR 114/16 – September 27, 2017). The written form for lease agreements requires that all material agreements concerning the lease, in particular the lease term, identification of the leased premises and the rent amount, must be made in writing. If a lease agreement entered into for a period of more than one year does not comply with this written form requirement, mandatory German law allows either lease party to terminate the lease agreement with the statutory notice period irrespective of whether or not a fixed lease term was agreed upon. The statutory notice period for commercial lease agreements is six months (less three business days) to the end of any calendar quarter. To avoid the risk of termination for non-compliance with the written form requirement, German commercial lease agreements regularly contain a general written form remediation clause. Pursuant to such clause, the parties of the lease agreement undertake to remediate any defect in the written form upon request of one of the parties. While such general written form remediation clauses were upheld in several decisions by various Higher District Courts (Oberlandesgerichte) in the past, the BGH had already rejected the validity of such clauses vis-à-vis the purchasers of real property in 2014. With this new decision, the BGH has gone one step further and denied the validity of general written form remediation clauses altogether. Only in exceptional circumstances, the lease parties are not entitled to invoke the non-compliance with the written form requirement on account of a breach of the good faith principle. Such exceptional circumstances may exist, for example, if the other party faced insolvency if the lease were terminated early as a result of the non-compliance or if the lease parties had agreed in the lease agreement to remediate such specific written form defect. This new decision of the BGH forces the parties to long-term commercial lease agreements to put even greater emphasis on ensuring that their lease agreements comply with the written form requirement at all times because remediation clauses as potential second lines of defense no longer apply. Likewise, the due diligence process of German real estate transactions will have to focus even more on the compliance of lease agreements with the written form requirement. Back to Top 6.  Data Protection Data Protection – Employee Data Protection Under New EU Regulation After a two-year transition period, the EU General Data Protection Regulation (“GDPR“) will enter into force on May 25, 2018. The GDPR has several implications for data protection law covering German employees, which is already very strictly regulated. For example, under the GDPR any handling of personnel data by the employer requires a legal basis. In addition to statutory laws or collective agreements, another possible legal basis is the employee’s explicit written consent. The transfer of personnel data to a country outside of the European Union (“EU“) will have to comply with the requirements prescribed by the GDPR. If the target country has not been regarded as having an adequate data protection level by the EU Commission, additional safeguards will be required to protect the personnel data upon transfer outside of the EU. Otherwise, a data transfer is generally not permitted. The most threatening consequence of the GDPR is the introduction of a new sanctions regime. It now allows fines against companies of up to 4% of the entire group’s revenue worldwide. Consequently, these new features, especially the drastic new sanction regime, call for assessments of, and adequate changes to, existing compliance management systems with regard to data protection issues. Back to Top 7. Compliance 7.1       Compliance – Misalignment of International Sanction Regimes Requires Enhanced Attention to the EU Blocking Regulation and the German Anti-Boycott Provisions The Trump administration has been very active in broadening the scope and reach of the U.S. sanctions regime, most recently with the implementation of “Countering America’s Adversaries Through Sanctions Act (H.R. 3364) (‘CAATSA‘)” on August 2, 2017 and the guidance documents that followed. CAATSA includes significant new law codifying and expanding U.S. sanctions on Russia, North Korea, and Iran. The European Union (“EU“) has not followed suit. More so, the EU and European leaders openly stated their frustration about both a perceived lack of consultation during the process and the substance of the new U.S. sanctions. Specifically, the EU and European leaders are concerned about the fact that CAATSA authorizes secondary sanctions on any person supporting a range of activities. Among these are the development of Russian energy export pipeline projects, certain transactions with the Russian intelligence or defense sectors or investing in or otherwise facilitating privatizations of Russia’s state-owned assets that unjustly benefits Russian officials or their close associates or family members. The U.S. sanctions regime differentiates between primary sanctions that apply to U.S. persons (U.S. citizens, permanent U.S. residents and companies under U.S. jurisdiction) and U.S. origin goods, and secondary sanctions that expand the reach of U.S. sanctions by penalizing non-U.S. persons for their involvement in certain targeted activities. Secondary sanctions can take many forms but generally operate by restricting or threatening to restrict non-U.S. person access to the U.S. market, including its global financial institutions. European, especially export-heavy and internationally operating German companies are thus facing a dilemma. While they have to fear possible U.S. secondary sanctions for not complying with U.S. regulations, potential penalties also loom from European member state authorities when doing so. These problems are grounded in European and German legislation aimed at protecting from and counteracting financial and economic sanctions issued by countries outside of the EU and Germany, unless such sanctions are themselves authorized under relevant UN, European, and German sanctions legislation. On the European level, Council Regulation (EC) No 2271/96 of November, 22 1996 as amended (“EU Blocking Regulation“) is aimed at protecting European persons against the effects of the extra-territorial application of laws, such as certain U.S. sanctions directed at Cuba, Iran and Libya. Furthermore, it also aims to counteract the effects of the extra-territorial application of such sanctions by prohibiting European persons from complying with any requirement or prohibition, including requests of foreign courts, based on or resulting, directly or indirectly, from such U.S. sanctions. For companies subject to German jurisdiction, section 7 of the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung – AWV), states that “[t]he issuing of a declaration in foreign trade and payments transactions whereby a resident participates in a boycott against another country (boycott declaration) shall be prohibited” to the extent such a declaration would be contradictory to UN, EU and German policy. With the sanctions regime on the one hand and the blocking legislation at EU and German level on the other hand, committing to full compliance with U.S. sanctions whilst falling within German jurisdiction, could be deemed a violation of the AWV.  Violating the AWV can lead to fines by the German authorities and, under German civil law, might render a relevant contractual provision invalid. For companies conducting business transactions on a global scale, the developing non-alignment of U.S. and European / German sanctions requires special attention. Specifically, covenants with respect to compliance with U.S. or other non-EU sanctions should be reviewed and carefully drafted in light of the diverging developments of U.S. and other non-EU sanctions on the one hand and European / German sanctions on the other hand. Back to Top 7.2       Compliance – Restated (Anti-) Money Laundering Act – Significant New Requirements for the Non-Financial Sector and Good Traders On June 26, 2017, the restated German Money Laundering Act (Geldwäschegesetz – GWG), which transposes the 4th European Anti-Money Laundering Directive (Directive (EU 2015/849 of the European Parliament and of the Council) into German law, became effective. While the scope of businesses that are required to conduct anti-money laundering procedures remains generally unchanged, the GWG introduced a number of new requirements, in particular for non-financial businesses, and significantly increases the sanctions for non-compliance with these obligations. The GWG now extends anti money laundering (“AML“) risk management concepts previously known from the financial sector also to non-financial businesses including good traders. As a matter of principle, all obliged businesses are now required to undertake a written risk analysis for their business and have in place internal risk management procedures proportionate to the type and scope of the business and the risks involved in order to effectively mitigate and manage the risks of money laundering and terrorist financing. In case the obliged business is the parent company of a group, a group-wide risk analysis and group-wide risk management procedures are required covering subsidiaries worldwide who also engage in relevant businesses. The risk analysis must be reviewed regularly, updated if required and submitted to the supervisory authority upon request. Internal risk management procedures include, in particular, client due diligence (“know-your customer”), which requires the identification and verification of customers, persons acting on behalf of customers as well as of beneficial owners of the customer (see also section 1.1 above on the Transparency Register). In addition, staff must be monitored for their reliability and trained regularly on methods and types of money laundering and terrorist financing and the applicable legal obligations under the GWG as well as data protection law, and whistle-blowing systems must be implemented. Furthermore, businesses of the financial and insurance sector as well as providers of gambling services must appoint a money laundering officer (“MLO“) at senior management level as well as a deputy, who are responsible for ensuring compliance with AML rules. Other businesses may also be ordered by their supervisory authority to appoint a MLO and a deputy. Good traders including conventional industrial companies are subject to the AML requirements under the GWG, irrespective of the type of goods they are trading in. However, some of the requirements either do not apply or are significantly eased. Good traders must only conduct a risk analysis and have in place internal AML risk management procedures if they accept or make (!) cash payments of EUR 10,000 or more. Furthermore, client due diligence is only required with respect to transactions in which they make or accept cash payments of EUR 10,000 or more, or in case there is a suspicion of money laundering or terrorist financing. Suspicious transactions must be reported to the Financial Intelligence Unit (“FIU“) without undue delay. As a result, also low cash or cash free good traders are well advised to train their staff to enable them to detect suspicious transactions and to have in place appropriate documentation and reporting lines to make sure that suspicious transactions are filed with the FIU. Non-compliance with the GWG obligations can be punished with administrative fines of up to EUR 100,000. Serious, repeated or systematic breaches may even trigger sanctions up to the higher fine threshold of EUR 1 million or twice the economic benefit of the breach. For the financial sector, even higher fines of up to the higher of EUR 5 million or 10% of the total annual turnover are possible. Furthermore, offenders will be published with their names by relevant supervisory authorities (“naming and shaming”). Relevant non-financial businesses are thus well advised to review their existing AML compliance system in order to ensure that the new requirements are covered. For good traders prohibiting cash transactions of EUR 10,000 or more and implementing appropriate safeguards to ensure that the threshold is not circumvented by splitting a transaction into various smaller sums, is a first and vital step. Furthermore, holding companies businesses who mainly acquire and hold participations (e.g. certain private equity companies), must keep in mind that enterprises qualifying as “finance enterprise” within the meaning of section 1 (3) of the German Banking Act (Kreditwesengesetz – KWG) are subject to the GWG with no exemptions. Back to Top  7.3       Compliance – Protection of the Attorney Client Privilege in Germany Remains Unusual The constitutional complaint (Verfassungsbeschwerde) brought by Volkswagen AG’s external legal counsel requesting the return of work product prepared during the internal investigation for Volkswagen AG remains pending before the German Federal Constitutional Court (Bundesverfassungsgericht – BVerfG). The Munich public prosecutors had seized these documents in a dawn raid of the law firm’s offices. While the BVerfG has granted injunctive relief (BVerfG, 2 BvR 1287/17, 2 BvR 1583/17 – July 25, 2017) and ordered the authorities, pending a decision on the merits of the case, to refrain from reviewing the seized material, this case is a timely reminder that the concept of the attorney client privilege in Germany is very different to that in common law jurisdictions. In a nutshell: In-house lawyers do not enjoy legal privilege. Material that would otherwise be privileged can be seized on the client’s premises – with the exception of correspondence with and work product from / for criminal defense counsel. The German courts are divided on the question of whether corporate clients can already appoint criminal defense counsel as soon as they are concerned that they may be the target of a future criminal investigation, or only when they have been formally made the subject of such an investigation. Searches and seizures at a law firm, however, are a different matter. A couple of years ago, the German legislator changed the German Code of Criminal Procedure (Strafprozessordnung – StPO) to give attorneys in general, not only criminal defense counsel, more protection against investigative measures (section 160a StPO). Despite this legislation, the first and second instance judges involved in the matter decided in favor of the prosecutors. As noted above, the German Federal Constitutional Court has put an end to this, at least for now. According to the court, the complaints of the external legal counsel and its clients were not “obviously without any merits” and, therefore, needed to be considered in the proceedings on the merits of the case. In order not to moot these proceedings, the court ordered the prosecutors to desist from a review of the seized material, and put it under seal until a full decision on the merits is available. In the interim period, the interest of the external legal counsel and its clients to protect the privilege outweighed the public interest in a speedy criminal investigation. At this stage, it is unclear when and how the court will decide on the merits. Back to Top 7.4       Compliance – The European Public Prosecutor’s Office Will Be Established – Eventually After approximately four years of discussions, 20 out of the 28 EU member states agreed in June 2017 on the creation of a European Public Prosecutor’s Office (“EPPO“). In October, the relevant member states adopted the corresponding regulation (Regulation (EU) 2017/1939 – “Regulation“). The EPPO will be in charge of investigating, prosecuting and bringing to justice the perpetrators of offences against the EU’s financial interests. The EPPO is intended to be a decentralized authority, which operates via and on the basis of European Delegated Prosecutors located in each member state. The central office in Luxembourg will have a European Chief Prosecutor supported by 20 European Prosecutors, as well as technical and investigatory staff. While EU officials praise this Regulation as an “important step in European justice cooperation“, it remains to be seen whether this really is a measure which ensures that “criminals [who] act across borders […] are brought to justice and […] taxpayers’ money is recovered” (U. Reinsalu, Estonian Minister of Justice). It will take at least until 2020 until the EPPO is established, and criminals will certainly not restrict their activities to the territories of those 20 countries which will cooperate under the new authority (being: Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Estonia, Germany, Greece, Finland, France, Italy, Latvia, Lithuania, Luxembourg, Portugal, Romania, Slovenia, Slovakia and Spain). In addition, as the national sovereignty of the EU member states in judicial matters remains completely intact, the EPPO will not truly investigate “on the ground”, but mainly assume a coordinating role. Last but not least, its jurisdiction will be limited to “offences against the EU’s financial interests”, in particular criminal VAT evasion, subsidy fraud and corruption involving EU officials. A strong enforcement, at least prima facie, looks different. To end on a positive note, however: the new body is certainly an improvement on the status quo in which the local prosecutors from 28 member states often lack coordination and team spirit. Back to Top 7.5       Compliance – Court Allows for Reduced Fines in Compliance Defense Case The German Federal Supreme Court (Bundesgerichtshof – BGH) handed down a decision recognizing for the first time that a company’s implementation of a compliance management system (“CMS“) constitutes a mitigating factor for the assessment of fines imposed on such company where violations committed by its employees are imputed to the company (BGH 1 StR 265/16 – May 9, 2017). According to the BGH, not only the implementation of a compliance management system at the time of the detection of the offense should be considered, but the court may also take into account subsequent efforts of a company to enhance its respective internal processes that were found deficient. The BGH held that such remediation measures can be considered as a mitigating factor when assessing the amount of fines if they are deemed suitable to “substantially prevent an equivalent violation in the future.” The BGH’s ruling has finally clarified the highest German court’s views on a long-lasting discussion about whether establishing and maintaining a CMS may limit a company’s liability for legal infringements. The recognition of a company’s efforts to establish, maintain and improve an effective CMS should encourage companies to continue working on their compliance culture, processes and systems. Similarly, management’s efforts to establish, maintain and enhance a CMS, and conduct timely remediation measures, upon becoming aware of deficiencies in the CMS, may become relevant factors when assessing potential civil liability exposure of corporate executives pursuant to section. 43 German Limited Liability Companies Act (Gesetz betreffend Gesellschaften mit beschränkter Haftung – GmbHG) and section 93 (German Stock Companies Act (Aktiengesetz – AktG). Consequently, the implications of this landmark decision are important both for corporations and their senior executives. Back to Top 8.  Antitrust and Merger Control In 2017, the German Federal Cartel Office (Bundeskartellamt – BKartA) examined about 1,300 merger filings, imposed fines in the amount of approximately EUR 60 million on companies for cartel agreements and conducted several infringement proceedings. On June 9, 2017, the ninth amendment to the German Act against Restraints of Competition (Gesetz gegen Wettbewerbsbeschränkungen – GWB) came into force. The most important changes concern the implementation of the European Damages Directive (Directive 2014/104/EU of the European Parliament and of the Council of November, 26 2014), but a new merger control threshold was also introduced into law. Implementation of the European Damages Directive The amendment introduced various procedural facilitations for claimants in civil cartel damage proceedings. There is now a refutable presumption in favor of cartel victims that a cartel caused damage. However, the claimant still has the burden of proof regarding the often difficult to argue fact, if it was actually affected by the cartel and the amount of damages attributable to the infringement. The implemented passing-on defense allows indirect customer claimants to prove that they suffered damages from the cartel – even if not direct customers of the cartel members – because the intermediary was presumably able to pass on the cartel overcharge to his own customers (the claimants). The underlying refutable presumption that overcharges were passed on is not available in the relationship between the cartel member and its direct customer because the passing-on defense must not benefit the cartel members. In deviation from general principles of German civil procedural law, according to which each party has to produce the relevant evidence for the facts it relies on, the GWB amendment has significantly broadened the scope for requesting disclosure of documents. The right to request disclosure from the opposing party now to a certain degree resembles discovery proceedings in Anglo-American jurisdictions and has therefore also been referred to as “discovery light”. However, the documents still need to be identified as precisely as possible and the request must be reasonable, i.e., not place an undue burden on the opposing party. Documents can also be requested from third parties. Leniency applications and settlement documents are not captured by the disclosure provisions. Furthermore, certain exceptions to the principle of joint and several liability of cartelists for damage claims in relation to (i) internal regress against small and medium-sized enterprises, (ii) leniency applicants, and (iii) settlements between cartelists and claimants were implemented. In the latter case, non-settling cartelists may not recover contribution for the remaining claim from settling cartelists. Finally, the regular limitation period for antitrust damages claims has been extended from three to five years. Cartel Enforcement and Corporate Liability Parent companies can now also be held liable for their subsidiary’s anti-competitive conduct under the GWB even if they were not party to the infringement themselves. The crucial factor – comparable to existing European practice – is the exercise of decisive control. Furthermore, legal universal successors and economic successors of the infringer can also be held liable for cartel fines. This prevents companies from escaping cartel fines by restructuring their business. Publicity The Bundeskartellamt has further been assigned the duty to inform the public about decisions on cartel fines by publishing details about such decisions on its webpage. Taking into account recent efforts to establish a competition register for public procurement procedures, companies will face increased public attention for competition law infringements, which may result in infringers being barred from public or private contracting. Whistleblower Hotline Following the example of the Bundeskartellamt and other antitrust authorities, the European Commission (“Commission“) has implemented a whistleblowing mailbox. The IT-based system operated by an external service provider allows anonymous hints to or bilateral exchanges with the Commission – in particular to strengthen its cartel enforcement activities. The hope is that the whistleblower hotline will add to the Commission’s enforcement strengths and will balance out potentially decreasing leniency applications due to companies applying for leniency increasingly facing the risk of private cartel damage litigation once the cartel has been disclosed. Merger Control Thresholds To provide for control over transactions that do not meet the current thresholds but may nevertheless have significant impact on the domestic market (in particular in the digital economy), a “size of transaction test” was implemented; mergers with a purchase price or other consideration in excess of EUR 400 million now require approval by the Bundeskartellamt if at least two parties to the transaction achieve at least EUR 25 million and EUR 5 million in domestic turnover, respectively. Likewise, in Austria a similar threshold was established (EUR 200 million consideration plus a domestic turnover of at least EUR 15 million). The concept of ministerial approval (Ministererlaubnis), i.e., an extra-judicial instrument for the Minister of Economic Affairs to exceptionally approve mergers prohibited by the Bundeskartellamt, has been reformed by accelerating and substantiating the process. In May 2017, the Bundeskartellamt published guidance on remedies in merger control making the assessment of commitments more transparent. Remedies such as the acceptance of conditions (Bedingungen) and obligations (Auflagen) can facilitate clearance of a merger even if the merger actually fulfils the requirements for a prohibition. The English version of the guidance is available at: http://www.bundeskartellamt.de/SharedDocs/Publikation/EN/Leitlinien/Guidance%20on%20Remedies%20in%20Merger%20Control.html; jsessionid=5EA81D6D85D9FD8891765A5EA9C26E68.1_cid378?nn=3600108. Case Law Finally on January 26, 2017, there has been a noteworthy decision by the Higher District Court of Düsseldorf (OLG Düsseldorf, Az. V-4 Kart 4/15 OWI – January 26, 2017; not yet final): The court confirmed a decision of the Bundeskartellamt that had imposed fines on several sweets manufacturers for exchanging competitively sensitive information and even increased the fines. This case demonstrates the different approach taken by courts in calculating cartel fines based on the group turnover instead of revenues achieved in the German market. Back to Top     The following Gibson Dunn lawyers assisted in preparing this client update:  Birgit Friedl, Marcus Geiss, Jutta Otto, Silke Beiter, Peter Decker, Ferdinand Fromholzer, Daniel Gebauer, Kai Gesing, Franziska Gruber, Johanna Hauser, Maximilian Hoffmann, Markus Nauheim, Richard Roeder, Katharina Saulich, Martin Schmid, Sebastian Schoon, Benno Schwarz, Michael Walther, Finn Zeidler, Mark Zimmer and Caroline Ziser Smith. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. The two German offices of Gibson Dunn in Munich and Frankfurt bring together lawyers with extensive knowledge of corporate / M&A, financing, restructuring and bankruptcy, tax, labor, real estate, antitrust, intellectual property law and extensive compliance / white collar crime experience. The German offices are comprised of seasoned lawyers with a breadth of experience who have assisted clients in various industries and in jurisdictions around the world. Our German lawyers work closely with the firm’s practice groups in other jurisdictions to provide cutting-edge legal advice and guidance in the most complex transactions and legal matters. For further information, please contact the Gibson Dunn lawyer with whom you work or any of the following members of the German offices: General Corporate, Corporate Transactions and Capital Markets Lutz Englisch (+49 89 189 33 150), lenglisch@gibsondunn.com) Markus Nauheim (+49 89 189 33 122, mnauheim@gibsondunn.com) Ferdinand Fromholzer (+49 89 189 33 170, ffromholzer@gibsondunn.com) Dirk Oberbracht (+49 69 247 411 510, doberbracht@gibsondunn.com) Wilhelm Reinhardt (+49 69 247 411 520, wreinhardt@gibsondunn.com) Birgit Friedl (+49 89 189 33 180, bfriedl@gibsondunn.com) Silke Beiter (+49 89 189 33 170, sbeiter@gibsondunn.com) Marcus Geiss (+49 89 189 33 122, mgeiss@gibsondunn.com) Annekatrin Pelster (+49 69 247 411 521, apelster@gibsondunn.com) Finance, Restructuring and Insolvency Sebastian Schoon (+49 89 189 33 160, sschoon@gibsondunn.com) Birgit Friedl (+49 89 189 33 180, bfriedl@gibsondunn.com) Marcus Geiss (+49 89 189 33 122, mgeiss@gibsondunn.com) Tax Hans Martin Schmid (+49 89 189 33 110, mschmid@gibsondunn.com) Labor Law Mark Zimmer (+49 89 189 33 130, mzimmer@gibsondunn.com) Real Estate Peter Decker (+49 89 189 33 115, pdecker@gibsondunn.com) Daniel Gebauer (+ 49 89 189 33 115, dgebauer@gibsondunn.com) Technology Transactions / Intellectual Property / Data Privacy Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com) Corporate Compliance / White Collar Matters Benno Schwarz (+49 89 189 33 110, bschwarz@gibsondunn.com) Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Mark Zimmer (+49 89 189 33 130, mzimmer@gibsondunn.com) Finn Zeidler (+49 69 247 411 530, fzeidler@gibsondunn.com) Antitrust and Merger Control Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP, 333 South Grand Avenue, Los Angeles, CA 90071 Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

December 26, 2017 |
SEC Staff Provides Important Guidance for Disclosure and Accounting Implications of the Tax Cuts and Jobs Act – Practical Considerations for Reporting Companies

​On December 22, 2017, the Securities and Exchange Commission’s Office of the Chief Accountant and Division of Corporation Finance (“Staff”) issued important guidance that provides significant relief and helpful answers on some of the accounting and disclosure issues raised by the comprehensive tax act, commonly called the Tax Cut and Jobs Act,[1] that was signed into law on that same date (the “Tax Act”).  The Staff’s guidance is contained in two pronouncements:  (1) Staff Accounting Bulletin No. 118 (“SAB 118”), which essentially allows companies to take a reasonable period of time to assess, measure and record the effects of the Tax Act; and (2) Compliance and Disclosure Interpretation 110.02 (“CDI 110.02”) under Exchange Act Form 8-K, which confirms that the accounting implications of the Tax Act will generally not trigger impairment reporting under Form 8-K. A statement jointly issued by Chairman Jay Clayton, Commissioner Kara Stein, and Commissioner Michael Piwowar,[2] available here, indicates the guidance “reflects the approach taken in similar situations where legislative changes could significantly affect financial reporting.”  In a  press release available here, Chief Accountant Wes Bricker stated that “[a]llowing entities to take a reasonable period to measure and recognize the effects of the [Tax] Act, while requiring robust disclosures to investors during that period, is a responsible step that promotes the provision of relevant, timely, and decision-useful information to investors.” Staff Accounting Bulletin No. 118 SAB 118, available here, expresses the Staff’s views on how the standard on accounting for income taxes (Financial Accounting Standards Codification Topic 740, Income Taxes (“ASC 740”))[3] should be applied in the context of the Tax Act.  Specifically, given the magnitude of the changes in the Tax Act and the fact that it was signed into law shortly before many companies’ fiscal year or fiscal quarter end, SAB 118 addresses situations where a company is not able to complete its assessment of some or all of the income tax effects of the Tax Act by the time the company issues its financial statements for the fiscal period that includes December 22, 2017, the date on which the Tax Act was signed into law.  Thus, if December 22, 2017 occured during a company’s fourth quarter, SAB 118 will be available to provide reporting relief beginning with that company’s Form 10-K. SAB 118 presents the following approach to accounting for the Tax Act’s impact on a company’s financial statements: To the extent that the company has completed its assessment under ASC 740 of the income tax effect of a provision of the Tax Act on its financial statements, the company must reflect the income tax effect in its financial statements for the fiscal period that includes December 22, 2017. To the extent that a company has not completed its assessment under ASC 740 of the income tax effect of a provision of the Tax Act on its financial statements, but can determine a “reasonable estimate” of the effect on its financial statements, the company should reflect the reasonable estimate in its financial statements as a “provisional amount,” and identify it as such. To the extent that a company cannot determine a “reasonable estimate” of the income tax effect of a provision of the Tax Act on its financial statements, the company should continue to apply the provisions of the tax laws that were in effect immediately prior to enactment of the Tax Act. In other words, in this scenario, the company does not need to take into account the impact of the Tax Act. In SAB 118, the Staff utilizes the concept of a “measurement period,” which begins in the fiscal quarter that includes December 22, 2017 and ends when the company has all of the information it needs to complete its assessment of all aspects of the Tax Act on its financial statements.  The Staff expects companies to act in good faith in working toward completing the accounting required under ASC 740 and believes that in no circumstance should the measurement period extend beyond December 22, 2018.  For each fiscal period during the measurement period, a company should perform the three-part analysis set forth above to account for the impact of the Tax Act.  As a result of that process, a company may need to: (1) adjust or finalize a previously reported provisional amount; and/or (2) report additional tax effects that were not initially reported as provisional amounts.[4] SAB 118 also sets forth disclosures that the Staff expects companies to provide during the “measurement period”[5] to provide information about material financial reporting impacts of the Tax Act.  SAB 118 states that such disclosures include: Qualitative disclosures of the income tax effects of the Tax Act for which the accounting is incomplete; Disclosures of items reported as provisional amounts; Disclosures of existing current or deferred tax amounts for which the income tax effects of the Tax Act have not been completed; The reason why the initial accounting is incomplete; The additional information that is needed to be obtained, prepared, or analyzed in order to complete the accounting requirements under ASC 740; The nature and amount of any measurement period adjustments recognized during the reporting period; and The effect of measurement period adjustments on the effective tax rate. SAB 118 states that companies also should disclose when their accounting for the income tax effects of the Tax Act has been completed. Form 8-K Compliance and Disclosure Interpretation 110.02 CDI 110.02, available here, addresses important aspects of the interaction of the Tax Act’s provisions with public companies’ reporting requirements under Exchange Act Form 8-K.  First, reflecting the fact that companies with a deferred tax asset will have to revalue that asset based upon the 21% nominal tax rate applicable under the Tax Act instead of the higher tax rates that previously applied, CDI 110.02 states that the re-measurement of a deferred tax asset in this situation is not an impairment, and thus will not trigger the obligations for impairment reporting under Item 2.06 of Form 8-K. In addition, recognizing that the effects of new tax rates or other provisions under the Tax Act could impact other valuations on a company’s financial statements, CDI 110.02 states that during the “measurement period” provided for under SAB 118, a company is able to address those effects in its next periodic report instead of filing a Form 8-K.  Specifically, because of the “measurement period” provided for under SAB 118, any assessment of the impact of the Tax Act will be exempt from the Form 8-K impairment reporting requirements under the “note” to Form 8‑K Item 2.06 stating that a Form 8-K is not required for impairments determinations “made in connection with the preparation [or] review … of financial statements required to be included in the next periodic report due to be filed under the Exchange Act.” Practical Considerations in Light of the Staff’s Guidance As companies undertake the challenge of developing, preparing, and analyzing the information (including running the computations) necessary to complete the accounting process under ASC 740, they should consider the following points: Voluntary Disclosures. SAB 118 addresses financial reporting in the context of issuing a company’s financial statements in periodic reports filed with the Commission.  Although not addressed in SAB 118, we assume that the same reporting standards are available and apply to financial statements included in a company’s earnings release.  Although earnings release financial statements typically do not include the notes that accompany financial statements included in periodic reports, companies should remain mindful of the disclosures called for in SAB 118 and consider the extent to which it is appropriate to include such disclosures in their earnings release.  Among other things, companies may want to specifically identify amounts that are provisional and include a paragraph explaining the extent to which the impact of the Tax Act is or is not reflected in their earnings release financial statements.  In addition, companies should address both positive and negative tax accounting effects of the Tax Act to the extent that they have completed their ASC 740 assessment of such effects or are providing a provisional assessment of those effects.  Companies should also consider discussing when provisions of the Tax Act will start to impact their financial statements, since some provisions of the Tax Act do not become effective until future years.  We expect many companies will include cautionary language that they are continuing to assess the tax accounting effects of the Tax Act or that the effects of Tax Act provisions are still being identified and evaluated. Regulation FD. The Tax Act’s impact on public companies’ financial reporting will be of great interest to the marketplace and yet often will be difficult to determine.  While some companies may maintain a “quiet period” policy and determine not to address the impact of the Tax Act in advance of their next required periodic report, others may determine to address various aspects of the financial reporting effects of the Tax Act in advance of their earnings releases.  Companies that intend to discuss these issues before issuing their financial results should consider their Regulation FD obligations, as such disclosures may be material since investors may not be able to assess the impact of the Tax Act based on past disclosures. Item 2.02 of Form 8-K. Item 2.02 of Form 8-K applies to more than just a company’s earnings release, and instead is triggered by any public disclosure of material non-public information regarding a company’s results of operations or financial condition for a completed quarterly or annual fiscal period.  Thus, any disclosures regarding material tax accounting effects of the Tax Act that relate to, but are made after the end of, the fiscal period that includes December 22, 2017 could trigger a required Item 2.02 Form 8-K.  For example, if an executive of a calendar year company publicly comments on material tax accounting effects of the Tax Act during the first week of January 2018, the company may need to furnish such disclosures on a Form 8-K. Non-GAAP Financial Measures. To the extent that a company has not reflected the impact of the Tax Act in its financial statements (either on a provisional basis or as a result of having completed its assessment of such effect), and instead reports its financial results based on the tax laws as in effect immediately before enactment of the Tax Act, such disclosures continue to qualify as GAAP as a result of SAB 118.  However, to the extent that a company has completed or provisionally provided for its assessment of the tax accounting effects of an aspect of the Tax Act and reflected those effects in its financial statements, but then backs out that impact to address period-over-period comparability, the company should be mindful of the non-GAAP rules.  For example, if a company has accounted for the impact of a provision of the Tax Act in its year-end financial results, but then states what its results would have been “excluding the impact of the Tax Act,” the company is presenting a non-GAAP financial measure that triggers the GAAP/non-GAAP presentation and reconciliation requirements of Regulation G and Regulation S-K Item 10(e). As noted above, the Tax Act will have far-reaching and on-going impacts on the tax accounting and financial statement disclosures of public companies.  The Staff’s guidance reflects a practical and welcome approach to the accounting and disclosure implications of the Tax Act.  As described by Director of the Division of Corporation Finance Bill Hinman, SAB 118 will result in “high-quality information” being presented in companies’ financial statements and financial statement footnotes.  Particularly significant, by eschewing deadlines other than the one-year measurement period, the Staff guidance accommodates the fact that the Tax Act will have significantly different implications for different companies and may require extensive information gathering. Many Tax Act accounting and disclosure issues remain to be addressed over the coming months during companies’ measurement periods, some of which may require guidance or consultations with regulators such as the Commission and the Treasury/Internal Revenue Service.  For example, the Staff’s guidance does not expressly address the implications of filing a new Securities Act registration statement or conducting an offering off of an already effective registration statement during a company’s measurement period.  The Commission’s press release notes that the Staff encourages publicly traded companies, auditors, and others to consult with the Staff for interpretative assistance.  In addition, Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about these developments.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, or any of the lawyers in the firm’s Securities Regulation and Corporate Governance practice group. __________________________ [1]   The official title of the Tax Act is “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.”  Prior to an amendment, the Tax Act was originally titled the “Tax Cuts and Jobs Act.” [2]   Ironically, the statement was not a statement by the Commission because separately, on December 22, 2017, the Senate confirmed Hester Peirce and Robert Jackson as commissioners, marking the first time that the SEC has had five commissioners since 2015. [3]   As noted in SAB 118, ASC 740 addresses the recognition of taxes payable or refundable for the current year and the recognition of deferred tax liabilities and deferred tax assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns.  As particularly relevant with respect to the Tax Act, ASC 740 also addresses adjusting (or re-measuring) deferred tax liabilities and deferred tax assets, as well as evaluating whether a valuation allowance is needed for deferred tax assets, and other income tax accounting effects of a change in tax laws or tax rates. [4]   Provisional amounts or adjustments included in an entity’s financial statements during the measurement period should be included in income from continuing operations as either an adjustment to tax expense or benefit in the reporting period the amounts are determined. [5]   That is, for any fiscal period in which the company’s assessment under ASC 740 of the income tax effect of the Tax Act on its financial statements is not complete. The following Gibson Dunn lawyers assisted in the preparation of this client update: Ronald O. Mueller, Elizabeth Ising, Michael Scanlon, Brian Lane, Andrew Fabens, Hillary Holmes and David Korvin. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following lawyers in the firm’s Securities Regulation and Corporate Governance and Capital Markets practice groups: Securities Regulation and Corporate Governance Group: Elizabeth Ising – Co-Chair, Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) James J. Moloney – Co-Chair, Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com) Brian J. Lane – Washington, D.C. (+1 202-887-3646, blane@gibsondunn.com) Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com) Michael J. Scanlon – Washington, D.C. (+1 202-887-3668, mscanlon@gibsondunn.com) Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com) Gillian McPhee – Washington, D.C. (+1 202-955-8201, gmcphee@gibsondunn.com) Maia Gez – New York (+1 212-351-2612, mgez@gibsondunn.com) Julia Lapitskaya – New York (+1 212-351-2354, jlapitskaya@gibsondunn.com) Capital Markets Group: Stewart L. McDowell – Co-Chair, San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com) Peter W. Wardle – Co-Chair, Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com) Andrew L. Fabens – Co-Chair, New York (+1 212-351-4034, afabens@gibsondunn.com) Hillary H. 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