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November 25, 2020 |
UAE to Allow 100% Foreign Ownership of Businesses

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On 23 November 2020 the UAE government announced that Sheikh Khalifa bin Zayed Al Nahyan, President of the UAE, had issued a decree (the “New Decree”) amending Law No. 2 of 2015 on Commercial Companies (the “2015 Law”). The New Decree is yet to be published, but it will reportedly overhaul the foreign ownership rules in respect of commercial companies in the UAE. Under the 2015 Law (and its predecessors), foreign investors were permitted to hold up to a maximum of 49% of the shares of locally incorporated “onshore” companies, with the remaining 51% required to be held by UAE national(s).

In its latest bid to attract foreign investment and strengthen its position as an international hub, the UAE has overhauled the 2015 Law, removing the requirement for a UAE shareholder to hold at least 51% of the shares of onshore companies (other than in relation to certain strategically important sectors).

Some foreign investors and business owners have, in the past, hesitated to establish or invest in onshore companies because of such ownership restrictions. The new measures, which are expected to take effect from 1 December 2020, should facilitate making investments into and doing business in the UAE and provide flexibility for foreign business owners wishing to operate outside of free zones. In particular, the New Decree should open up UAE-based businesses to investment from international private equity houses and venture capital firms without the need to resort to complex structuring arrangements.

The New Decree builds on Federal Legislative Decree No. 19 of 2018 (the “FDI Law”) which signaled an initial shift away from the strict foreign ownership restrictions by opening up certain activities (a “positive list”) to 100% foreign ownership through an approval process. While the New Decree supersedes (and effectively cancels) the provisions of the FDI Law on foreign ownership requirements, the relaxation will not apply to ownership of state-owned entities and companies that are deemed to operate in strategically important sectors, such as, for example, oil and gas exploration, utilities and transport.

The New Decree represents a clear break from the past and we anticipate that it will strengthen the UAE’s position as a leading international financial center and lead to an increase in foreign direct investment. While the terms of the New Decree are yet to be made available, the announcement is positive and encouraging.


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

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

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

Hardeep Plahe (+971 (0) 4 318 4611, hplahe@gibsondunn.com)

Fraser Dawson (+971 (0) 4 318 4619, fdawson@gibsondunn.com)

Aly Kassam (+971 (0) 4 318 4641, akassam@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 18, 2020 |
The UK’s New National Security Regime

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The UK Government (the “Government”) has announced plans to upgrade and widen significantly its intervention powers on grounds of national security.

The proposal is for a ‘hybrid regime’ whereby notification and approval would be mandatory prior to completing certain deals (described further below) in specified areas of the economy deemed particularly sensitive. Here, clearance would be required to be obtained prior to closing. Further, any failure to notify would result in a transaction that is ‘legally void’,[1] sanctions would be applicable and the Government would have a potentially indefinite period to ‘call-in’ the deal (a period which would be reduced to 6 months if the Secretary of State for Business, Energy and Industrial Strategy (the “SoS”) becomes aware of the deal). Notification will otherwise be voluntary. However, the Government will be able to ‘call-in’ such transactions for a period of up to 5 years (again, this period would be reduced to a period of 6 months if the SoS becomes aware of the deal). Once a transaction has been called in and assessed, where necessary and proportionate, the Government will have the power to impose a range of remedies to address any national security concerns. The proposed regime represents a significant expansion and extension of the current rules, including a significant broadening of the nature of transactions that can be reviewed (e.g. removing safe harbours based on turnover and market share and including acquisitions of certain qualifying assets, including acquisitions of land, physical assets and IP).[2] It is expected to result in significantly higher levels of scrutiny going forward. Indeed, the Government estimates that around 1,000-1,830 notifications could be received a year with 70-95 cases called in for a full national security assessment under the new regime. However, practitioners are of the view that the bill and the proposed secondary legislation detailing the sensitive sectors (as currently drafted) could result in many more notifications. The Government, however, continues to emphasise the importance of foreign direct investment projects in the UK and the need to ensure that the UK remains an attractive place to invest. Indeed, the Government’s commitment to staying open to foreign investment is reflected in the Prime Minister’s recent announcement of the creation of the Office for Investment. This is a Government unit aimed at driving foreign investment into the UK (tasked to land high value investment opportunities and to resolve potential barriers to landing ‘top tier’ investments).[3] The Business Secretary Alok Sharma also specifically stated on the bills introduction to Parliament that: “The UK remains one of the most attractive investment destinations in the world and we want to keep it that way […] This Bill will mean that we can continue to welcome job-creating investment to our shores, while shutting out those who could threaten the safety of the British people.” The emphasis of the new proposals is thus on encouraging engagement, so that the Government becomes aware of a greater number of deals and can check that they do not pose risks to the UK’s national security. It has been emphasised that a targeted and proportionate approach to enforcement will be adopted, and that most transactions will be cleared without intervention (albeit that conditions will be required to be imposed in some cases and reviews will impact transaction timetables). The regime also introduces a clearer and more defined process for national security reviews than is currently the case, which should assist with transaction planning.[4] The proposal is set out in the ‘National Security and Investment Bill’ (the “NSIB”) which will be subject to Parliamentary scrutiny before being passed into law.[5] However, in the interim, investors will need to be aware that the proposed legislation will give the Government the retroactive power from commencement to open an investigation into a transaction that has been completed following the introduction of the NSIB to Parliament  (i.e. on or from 12 November 2020) but prior to the commencement of the Act. In such circumstances, the Government will have 6 months from the commencement day to intervene, if the SoS previously became aware of the transaction. Otherwise, the Government will be able to ‘call-in’ the deal up to 5 year’s following the commencement date, unless the SoS becomes aware of the transaction earlier in which case this period is reduced to 6 months from when the SoS becomes aware of the deal.[6] Key aspects of the proposed new regime are detailed below. At the end of this briefing, we also include some practical tips for transacting parties. Mandatory vs voluntary notification
  • The NSIB provides for the mandatory pre-closing notification of certain acquisitions of voting rights or shares (see “Trigger events/qualifying transactions”, below) in entities active in specified sectors and involved in activities considered higher risk.
  • The Government is currently consulting on the proposed sectors, and which parts of each sector, should fall within the scope of the mandatory regime, which will later be defined through secondary legislation.[7]
  • As currently proposed, the following 17 sectors would be affected: advanced materials; advanced robotics; artificial intelligence; civil nuclear; communications; computing hardware; critical suppliers to government; critical suppliers to the emergency services; cryptographic authentication; data infrastructure; defence; energy; engineering biology; military or dual-use technologies; quantum technologies; satellite and space technologies and transport.
  • The NSIB will provide the Government with powers to amend the types of transactions in scope of the mandatory notification regime – which will include powers to amend the sectors subject to mandatory notification as well as the nature of transactions giving rise to mandatory notification requirements (discussed further below) and exempting certain types of acquisition. It is not clear as yet the circumstances in which dispensations will be granted – it is expected that these will be developed over time (if, for example, the Government finds that certain types of transactions caught by the mandatory regime routinely do not require remedies and thus do not present sufficient security concerns – this may, for example, be based on the characteristics of the investors involved or the type of transaction).
  • The fact that sectors of the economy giving rise to mandatory notification requirements will be defined in secondary legislation gives ministers significant discretion to alter the regime without full parliamentary scrutiny. Indeed, it has been specifically called out by the Government that such sectors are ‘highly likely to change over time’, in response to changing risks.
  • As mentioned above, if parties fail to notify a trigger event that is subject to mandatory notification, the Government can call it in whenever it is discovered – albeit that the Government is under a 6 month deadline from which the SoS becomes aware of the transaction to call-in the deal. This does not apply to events which take place prior to the commencement of the NSIB, as no mandatory notification requirement will apply until that point.
  • In addition to the mandatory regime, parties will be able to voluntary notify deals. The NSIB will permit ministers to ‘call-in’ transactions (not subject to the mandatory regime) up to 6 months after the SoS becomes aware of the transaction (including potentially, through coverage of the deal in a national news publication[8]) provided that this is done within 5 years and there is a ‘reasonable suspicion’ that it may give rise to a national security risk (a transaction cannot be ‘called-in’ for any broader economic interest issues such as employment).[9]

Trigger events / qualifying transactions

  • The NSIB envisages that a number of transactions will give rise to so called ‘trigger events’, which will provide an opportunity for the Government to review a transaction. These include acquisitions of:
    1. More than 25%, 50% and 75% of the voting rights or shares of an entity (with increases in shareholding passing over these thresholds notifiable);
    2. Voting rights that ‘enable or prevent the passage of any class of resolution governing the affairs of the entity’;
    3. ‘Material influence’ over an entity’s policy; and

The concept of ‘material influence’ is an existing concept under the UK’s competition regime. It can be based on an acquirer’s shareholding, its board representation or other factors. For shareholdings, the CMA may examine shareholdings of 15% or more to determine whether an acquirer will have material influence. Even a shareholding of less than 15% might attract scrutiny in exceptional cases (where other factors indicate that the ability to exercise material influence over policy are present).

    1. A right or interest in, or in relation to, a qualifying asset providing the ability to:
      1. use the asset, or use it to a greater extent than prior to the acquisition; or
      2. direct or control how the asset is used, or direct or control how the asset is used to a greater extent than prior to the acquisition.

Assets in scope of the regime will be defined in the NSIB – as currently proposed, this includes land, tangible moveable property,[10] and ideas, information, or techniques with industrial, commercial or other economic value (including, for example, trade secrets, databases, algorithms, formulae, non-physical designs and models, plans, drawings and specifications, software, source code and IP).

  • The mandatory notification requirement would apply to the trigger events specified in (i) and (ii), above, plus an acquisition of 15% or more of the voting rights or shares of an entity. Whilst the latter is not a ‘trigger event’ for notification per se, it is designed to bring transactions to the attention of the SoS so that they can decide whether trigger event (iii) has occurred.
  • So, in summary, the NSIB envisages that it could apply to shareholding as low as 10-15% and will cover deals involving a broad range of asset types.
  • Moreover there are currently no safe harbour provisions (e.g. in terms of UK market share or turnover requirements) pursuant to which the Government would not have jurisdiction to review the transaction. However, transactions will require a UK nexus (as discussed below).

UK nexus

  • The new regime will apply to investors from any country, including where acquirers and sellers do not have a direct link to the UK. To intervene in such circumstances, the SoS must be satisfied that:
    1. in respect of a target entity formed or recognised under laws outside of the UK, the entity carries on activities in the UK or supplies goods or services to persons in the UK; and
    2. in respect of a target asset situated outside of the UK or intellectual property, the asset must be used in connection with activities carried on in the UK or the supply of goods or services to persons in the UK.[11]
  • This means, for example, that a business in one country acquiring a business in another country may fall within the regime if the latter carries out activities or provides services or goods in the UK with national security implications. This is also the case in relation to assets which may be used in connection with goods or services provided to UK persons e.g. deep-sea cables located outside of the UK’s geographical borders delivering energy to the UK or intellectual property located outside of the UK but key to the provision of critical functions in the UK.
  • The Government intends to legislate for a tighter nexus test in the case of mandatory transactions, but this would not preclude the Government from using the call-in power to intervene in transactions with less direct links to the UK.

Likelihood of intervening  - voluntary notifications

  • The Government intends to publish a Statutory Statement of Policy Intent (which will be reviewed at least every 5 years), setting out when the Government expects to use its call-in power. This document will assist with the assessment of when a voluntary notification is more likely to be called in – however, a large amount of discretion will still be exercisable when deciding whether or not to intervene.
  • The current draft Statutory Statement of Policy Intent, published alongside the NSIB,[12] states that the SoS will consider three factors when deciding whether or not to exercise its powers, namely:
    1. Acquirer risk (i.e. the extent to which the acquirer raises national security concerns);
    2. Target risk (i.e. the nature of the target and whether it is active in an area of the economy where the Government considers risks more likely to arise e.g. within the headline sectors where mandatory notification is required); and
    3. Trigger event risk (i.e. the type and level of control being acquired and how this could be used in practice to undermine national security).

Examples of trigger event risk include – but are not limited to – the potential for: (i) disruptive or destructive actions: the ability to corrupt processes or systems; (ii) espionage: the ability to have unauthorised access to sensitive information; (iii) inappropriate leverage: the ability to exploit an investment to influence the UK; and (iv) gaining control of a crucial supply chain or obtaining access to sensitive sites, with the potential to exploit them. The risk will be assessed according to the practical ability of a party to use an acquisition to undermine national security.

  • The type of asset acquisitions where Government may encourage a notification will also be set out in the Statutory Statement of Policy Intent. The current draft suggests that the SoS will intervene ‘very rarely’ in asset transactions. However, where assets are integral or closely related to activities deemed particularly sensitive (e.g. in sectors subject to the mandatory regime) or, in the case of land, where it is or is proximate to a sensitive site or location (e.g. critical national infrastructure sites or government buildings), acquisitions are more likely to be called in. The SoS may also take into account the intended use of the land.

Procedure

  • Unsurprisingly, decisions will be taken by the SoS (currently responsible for making decisions in most national security cases under the current regime) rather than an independent body (as with competition cases).
  • The SoS will be supported by the Investment Security Unit, which will sit within the Department for Business, Energy and Industrial Strategy and provide a single point of contact for businesses wishing to understand the NSIB and notify the Government about transactions. The unit will also coordinate cross-government activity to identify, assess and respond to national security risks arising through market activity.
  • Where a notification has been made (whether mandatory or voluntary) the SoS will have an initial 30 working day ‘screening period’ to issue a ‘call-in’ notice. Where a transaction is ‘called in’ (including for non-notified transactions), the Government will then have a 30 working day preliminary assessment period. This period would be extendable by a further 45 working days where the initial assessment period is not sufficient to fully assess the risks involved. Further extensions, beyond 75 working days, may be agreed between the acquirer and the SoS for problematic transactions. The SoS will also have the ability to ‘stop the clock’ through formally issuing an information notice or attendance notice during the process, until such a notice is complied with.
  • At the end of its review, the SoS will either clear the transaction or must decide to issue a final order, if satisfied that the transaction poses, or would pose, a national security risk (on the balance of probabilities). Such orders may impose conditions or may rule that the transaction should be blocked or unwound.
  • The SoS will have a range of remedies available to address national security risks associated with transactions, both while assessments take place and after their completion.
  • It is not intended, as under the current regime, that parties will be able to voluntarily offer up undertakings to address concerns (however, parties will be encouraged to maintain a dialogue with the Government throughout the assessment process and it is anticipated that these conversations will assist in designing remedies; further, there will be opportunity for the parties to make representations on remedies during the assessment process). All conditions to approval will be formalised in an order and enforceable through sanctions.
  • During an investigation, the Government may also issue interim orders to prevent parties from completing a transaction or, where deals have closed, integrating their operations. Such orders may have extra-territorial effects.
  • Legal challenges to decisions will be subject to the standard judicial review process (subject, for certain decisions, to a shortened time limit – 28 days as opposed to the usual three-month period, although the court can give permission to bring the claim after the expiry of the 28 days). The key implication being that it will not be possible to open up decisions for a full appeal on the merits (except in respect of decisions relating to civil penalties, for which a full merits appeal will be available). Close material procedures (“CMPs”) will be utilised to ensure that sensitive materials are not improperly disclosed.[13]

Sanctions

  • The proposed legislation creates a number of sanctions, civil and criminal, that will apply in the event of non-compliance. For instance, criminal and civil sanctions are applicable where an acquirer progresses to completion an acquisition subject to the mandatory notification regime, without first obtaining clearance from the SoS. The recommendation would thus be to engage early with the Government and complete the notification process in such circumstances.[14]

Anticipated impact

According to Government data, the NSIB could result in approximately 1,000-1,830 notifications a year, with call-ins/full national security assessments conducted in 70-95 cases a year and remedies anticipated in around 10 cases a year.

By comparison, the UK’s competition regime typically investigates less than 100 deals per year whilst the EU merger control regime – which is one of the toughest in the world – covered 645 cases in 2019 (283 of which were under its simplified procedure regime). Further, the current regime has involved just 12 interventions on a national security basis since 2002 (the peak year for interventions being 2019, in which 4 interventions were issued).

If enacted, this would clearly take the UK from having one of the lightest touch regimes in Europe to arguably one of the most expansive. However, it is also clear that, whilst the Government expects to be engaged and have the opportunity to review transactions (which may have consequences in terms of deal timelines and give rise to hold separate obligations in anticipated and/or completed deals), most transactions will be cleared without any intervention by way of remedies.

Timing and next steps

It is anticipated that the National Security and Investment Act will commence during the first half of next year. The Second Reading of the NSIB took place on Tuesday 17 November 2020. The committee stage (where the bill will undergo a line by line examination, with every clause agreed to, changed or removed) is scheduled for 24 November 2020.

The consultation period on the mandatory notification sectors closes on 6 January 2021. Industry is encouraged to respond and provide views on the scope of the sectors and activities currently covered by this process – as currently drafted, there a number of areas where the scope is potentially over-reaching and insightful, technical input from the market will be welcome.

Other points of note

The national security assessment will run in parallel to any competition assessment for a transaction (which will continue to be conducted by the UK Competition and Markets Authority, the “CMA”). However, whilst the two processes will be separate, there will be interactions and, in practice, outcomes will be intertwined. In particular, the legislation will include a power that would allow the SoS to intervene where competition remedies run contrary to national security interests, where this is considered necessary and proportionate. Further, the Government’s intention is that, as far as possible, any national security remedies will be aligned with competition remedies (and that the timetables will be aligned, to the extent possible, within the statutory framework to achieve this).

The Government is clear that any conflict between competition remedies and risks posed to national security will be resolved after consultation with the CMA and that mutually beneficial remedies will be imposed wherever possible. Interaction between the two regimes will be covered in more detail in a Memorandum of Understanding with the CMA. The CMA will also be under a duty to share information with the SoS and provide other assistance reasonable required to perform its functions. What does this mean for transacting parties? This new proposal will have a potentially significant impact on targets, sellers and acquirers alike. For targets and sellers, it will be incumbent to undertake a review of the target’s business and activities to consider if they fall within one of the sensitive sectors and to be alive to this risk in conjunction with future capital raises, share transfers or sales of all or parts of the business, including sales of key assets, going forwards. There may be structuring options to consider. If targets or sellers are undertaking sale processes, there will also need to be greater scrutiny of acquirers in assessing transaction risk. Auction processes should also take into account the risk that a bidder may pose. For acquirers (whether domestic or foreign – as the regime is not only designed to capture non-UK parties) consideration should be given to their ultimate controllers, the track record of those people in relation to other acquisitions or holdings, whether the acquirer has control or significant holdings in other entities active in the same sector and any relevant criminal offences or known affiliations of parties involved in the transaction, whereby an acquirer may be regarded as giving rise to acquirer risk from the SoS perspective. It is not clear to what extent parties may be able to pre-clear or seek constructive guidance in advance from the Government. There is reference in the proposals, for example, to parties having informal discussions with the Government earlier on in a sale process. However, these appear to envisage a situation whereby a specific transaction is under contemplation. Further, the Government has flagged that in a competitive process any mandatory or voluntary notification should only be made by the final bidder or acquirer in the process. Transactions and investment deals will need to be structured to accommodate this additional risk including through introducing additional conditionality. The UK has always been open to foreign investment and, consistent with this, no transaction has been blocked to date on national security concerns. However, strict conditions have been required for deals to be cleared under the current regime. Such implications need to be considered up-front by an acquirer when planning a transaction (and risk, procedural and timing impacts appropriately factored into contractual documentation). Given the increasing and widening emphasis on screening transactions for national security concerns, it will be important to analyse early on the risks of Government intervention/concerns arising for a transaction. Whilst concerns will be highest in the context of a takeover by a buyer affiliated to a ‘hostile state or actor’ or where a buyer owes allegiance to a hostile state or organisation, foreign nationality more generally has been considered a risk factor under the current regime. Interventions have been launched, for example, in the past, in response to investments from the United States, Canada and elsewhere in Europe. Any foreign entity may thus face close scrutiny. Concerns over asset stripping and rationalisation motivations may also provoke investigations when the acquiring company is a UK entity.

Appendix – Government Guidance, Flow Charts on Process [15]


  [1]  Although, the Government will have the power to retrospectively validate a transaction.

  [2]  ‘Entities’ are also broadly defined , covering any entity (whether or not a legal person) but not individuals. This includes a company, LLPs, other body corporates, partnerships, unincorporated associations and trusts.

  [3]  See further: https://www.gov.uk/government/news/new-office-for-investment-to-drive-foreign-investment-into-the-uk. The draft Statutory Statement of Policy Intent published concerning the new national security regime also specified with respect to the new regime that: “Its use will not be designed to limit market access for individual countries; the transparency, predictability, and clarity of the legislation surrounding the call-in power is designed to support foreign direct investment in the UK, not to limit it.

  [4]  See further the Government’s press release on this development, available here: https://www.gov.uk/government/news/new-powers-to-protect-uk-from-malicious-investment-and-strengthen-economic-resilience.

  [6]  See Section 2(4) of the NSIB.

  [8]  See, to this effect, the draft Statement of Policy Intent published: https://www.gov.uk/government/publications/national-security-and-investment-bill-2020/statement-of-policy-intent.

  [9]  The regime only applies to issues of national security. Other public interest issues concerning e.g. media plurality, financial stability or the UK’s ability to maintain in the UK the capability to combat, and to mitigate the effects of, public health emergencies, will continue to be dealt with through the existing channels and processes.

[10]  The types of tangible moveable property of greatest national security interest will vary across sectors but are likely to be closely linked to the activities of companies in areas more likely to raise national security concerns (as identified through the requirements of the mandatory notification regime). Examples of such assets may include physical designs and models, technical office equipment, and machinery.

[11]  See Sections 7(3) and (7) of the NSIB.

[13]  CMPs are civil proceedings in which the court is provided with evidence by one party that is not shown to another party to the proceedings. Any restricted evidence is heard in closed hearings, with the other party(ies) excluded and their interests represented by a Special Advocate. The rationale behind CMPs is to ensure that evidence can still be used in the proceedings, rather than being excluded completely under the doctrine of public interest immunity (and, specifically, on grounds of national security).

[14]  Further examples are listed below -  however, this is not an exhaustive list of proposed sanctions.

      Failure to notify or non-compliance with interim or final orders could result in fines of up to 5% of total worldwide turnover or £10 million (whichever is higher) on businesses and prison sentences and/or fines for individuals. Failing to comply, without reasonable excuse, with an information or attendance request could results in fines on companies and fines and/or imprisonment for individuals. It will also be an offence to knowingly or recklessly supply information that is false or misleading in a material respect – punishable through fines and/or through the sentencing of individuals to prison. There would also be an opportunity for the SoS to reconsider decisions and (re-)review a trigger event in these circumstances, even if outside of the prescribed ‘call-in’ period for voluntary transactions. Unauthorised use or disclosure of regime information would also see individuals subject to imprisonment and/or a fine.


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

Ali Nikpay - Partner - Head of Competition and Consumer Law, London (+44 (0) 20 7071 4273, anikpay@gibsondunn.com)

Attila Borsos - Partner - Competition and Trade, Brussels (+32 2 554 72 11, aborsos@gibsondunn.com)

Selina S. Sagayam - Partner - International Corporate, London (+44 (0) 20 7071 4263, ssagayam@gibsondunn.com)

Sarah Parker - Associate - Competition and Consumer Law, London (+44 (0) 78 3324 5958, sparker@gibsondunn.com)

Tamas Lorinczy - Associate - Corporate, London (+44 (0) 20 7071 4218, tlorinczy@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 11, 2020 |
Update on German Foreign Investment Control: New EU Cooperation Mechanism & Overview of Recent Changes

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On October 29, 2020, the 16th amendment to the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung or “AWV”) entered into force. The amendment is the final step of implementing the EU-wide cooperation mechanism introduced by Regulation (EU) 2019/452 of March 19, 2019 establishing a framework for screening of foreign direct investments into the EU (the “EU Screening Regulation”).

New EU-Wide Cooperation Mechanism

The EU Screening Regulation directly applies as of October 11, 2020 which marks the beginning of a coordinated cooperation among EU member states on foreign direct investments (the “FDIs”). This means that, going forward, the German Federal Ministry for Economic Affairs and Energy (the “German Ministry”) will exchange information on FDIs undergoing screening in Germany with the European Commission and fellow EU member states which, in turn, may issue comments or, in case of the European Commission, an opinion. While such comments and/or opinions are non-binding, they need to be given ‘due consideration’ and, thus, may influence the screening decision rendered by the German Ministry. For details on the EU Screening Regulation, see our Client Alert of March 5, 2019.

In order for the German Ministry to be able to consider the potential impact of an FDI on the public order or security of one or more fellow EU member states as well as on projects or programs of EU interest, the grounds for screening under German FDI rules had to be expanded accordingly. For the same reason, the standard under which an FDI may be prohibited or restrictive measures may be imposed has been tightened from “endangering” (Gefährdung) to “likely to affect” (voraussichtliche Beeinträchtigung) the public order or security, as to reflect the EU Screening Regulation. More or less a side effect, this gives the German Ministry more discretion and room to maneuver as it no longer has to determine an “actual and serious threat” (tatsächliche und hinreichend schwere Gefährdung) but now could prohibit a transaction in order to prevent an impairment that has not yet materialized but that is likely to occur as a result of the contemplated FDI.

Recent Changes to German FDI Rules

In light of the implementation of the EU-wide cooperation mechanism, we want to use the opportunity to recap this year’s key changes to the German FDI screening process. We refer to our client alert of May 27, 2020 (available here) for an overview on the overall screening process and a detailed outline of the most relevant amendments (and contemplated changes) to German FDI rules thus far in 2020.

Changes Effective as of October 29, 2020
  • Expanding the Grounds for Screening. As described above, the grounds for screening have been expanded to include public order or security of a fellow EU member state as well as effects on projects or programs of EU interest.
  • Tightening the Standard. As described above, the standard under which an FDI may be prohibited or restrictive measures may be imposed has been tightened from “endangering” (Gefährdung) to “likely to affect” (voraussichtliche Beeinträchtigung) the public order or security.

Key Changes Effective as of June 3, 2020

  • Health-Care Related Additions. As a response to the COVID-19 crisis, the catalog of select industries subject to cross-sector review was expanded to include personal protective equipment, pharmaceuticals that are essential for safeguarding the provision of healthcare to the population as well as medical products and in-vitro-diagnostics used in connection with life-threatening and highly contagious diseases.
  • Governmental Communication Infrastructure. Also added to the catalog of select industries subject to cross-sector review, and thus, triggering mandatory notification to the German Ministry, have been FDIs acquiring 10% or more of the voting rights in companies providing services ensuring the interference-free operation and functioning of governmental communication infrastructure.
  • Investor-Related Screening Factors. In line with the EU Screening Regulation, the German Ministry may now consider screening factors that focus on the background and activities of the individual investor. In particular, the German Ministry may now take into account whether the foreign investor (i) is directly or indirectly controlled by the government, including state bodies or armed forces, of a third country, including through ownership structure or more than insignificant funding, (ii) has already been involved in activities affecting the public order or security of the Federal Republic of Germany or of a fellow EU member state, or (iii) whether there is a serious risk that the foreign investor, or persons acting on behalf of it, were or are engaged in activities that, in Germany, would be punishable as a certain criminal or administrative offence, such as terrorist financing, money laundering, fraud, corruption, or violations of the foreign trade or war weapon control rules.
  • Applicability to Share and Asset Deals. Since June 3, 2020 it has been codified that German FDI control is not limited to the acquisition of shares but equally applies to asset deals.
  • Notification Modalities. It was further clarified that FDIs triggering a notification obligation are to be notified immediately after signing of the acquisition agreement. The notification generally has to be submitted by the direct acquirer (even if the acquisition vehicle itself is not “foreign”) but may also be made by the indirect acquirer instead.

Key Changes Effective as of July 17, 2020

  • Effects on Consummating Transactions. In addition to transactions subject to sector-specific review (i.e., the defense industry and certain parts of the IT security industry), all transactions falling under cross-sector review that are notifiable (i.e., FDIs of 10% or more of the voting rights in companies active in industries listed in the catalog of select industries) may only be consummated upon conclusion of the screening process (condition precedent). Note that this has a tangible impact on the transaction practice given the broad range of notifiable FDIs in the cross-sector category, which are affected by this change. Foreign investors need to carefully assess if the target company operates in one of the listed industry categories. From a drafting perspective, acquisition agreements regarding notifiable FDIs should include a closing condition that the FDI is (deemed) cleared by the German Ministry. Buyers should further make sure to include a mechanism allowing for the amendment or termination of the acquisition agreement in case the German Ministry imposes (comprehensive) restrictive measures.
  • Penalizing the Disclosure of Security-Relevant Information and Certain Consummation Actions Pending Screening. The following actions are now penalized by way of imprisonment of up to five years or fine (in case of willful infringements and attempted infringements) or with a fine of up to EUR 500,000 (in case of negligence):
    • Enabling the investor to, directly or indirectly, exercise voting rights;
    • Granting the investor dividends or any economic equivalent;
    • Providing or otherwise disclosing to the investor information on the German target company with respect to company objects and divisions that are subject to screening on grounds of essential security interests of the Federal Republic of Germany, or of particular importance when screening for effects on public order and security of the Federal Republic of Germany, or that have been declared as ‘significant’ by the German Ministry;
    • Non-compliance with enforceable restrictive measures (vollziehbare Anordnungen) imposed by the German Ministry.

The introduction of criminal liability will lead to even greater focus on whether or not the transaction requires FDI clearing. The seller de facto will be forced to include the clearing by the German Ministry as a closing condition to avoid exposure to criminal liability.

According to the explanatory notes (Gesetzesbegründung), the prohibition to disclose security-sensitive information as described above will usually not apply to purely or other company-related commercial information that is exchanged in the course of a transaction in order to allow the investor to conduct a sound evaluation of the economic opportunities and risks of the FDI. Nonetheless, the seller will need to be cautious when preparing the due diligence process, in particular when populating the virtual data room. Typically, security-sensitive information as described above will not be shared with potential buyers prior to closing of the transaction anyway. Should the need arise, however, the use of a red data room and special disclosure and confidentiality obligations based on a clean team agreement are advisable.

  • Time Periods. In view of necessary adjustments to the timeframe of the screening process to integrate the EU-wide cooperation mechanism, the German legislator took the opportunity to overhaul the framework of screening periods altogether. Time periods are now set forth directly in the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz or “AWG”) instead of the AWV. This way, time periods can only be adjusted by way of legislative procedure, i.e. with involvement of the German parliament, and may no longer be changed unilaterally by executive order of the German government.Note the following changes to the timeline of the screening process (which will only apply to FDIs of which the German Ministry became aware of after July 17, 2020):
    • Standardized Time Periods. The same review periods apply to sector-specific (i.e., the defense industry and certain parts of the IT security industry) and to cross-sector (i.e., all industry sectors except for defense/certain IT security) FDIs alike. The German Ministry now has two months from becoming aware of the reviewable FDI – instead of previously three months (sector-specific review) or even four months (cross-sector review) – to decide whether to initiate formal proceedings. Making a mandatory notification or filing for a certificate of non-objection will equally trigger the two-month pre-assessment period. In addition, the formal screening period was standardized and may now take up to four months regardless of the sector.
    • Extension of Time Periods. The German Ministry may extend the four-month screening period by three months if the individual case is particularly difficult in either a factual or a legal manner. A further extension by one month is possible if the Federal Ministry of Defense puts forward that defense interests of Germany are notably affected. Moreover, periods may now be extended with the investor’s approval.
    • Suspension of Time Periods. The screening period is suspended in case the German Ministry later requests further information on the FDI. Previously, the screening period was not set in motion before the German Ministry received all (initially or later) requested information on the FDI. This change most likely is meant to allow for requests of fellow EU member states for additional information on the FDI within the cooperation process under the EU Screening Regulation while, at the same time, keeping the delay in the screening process to a minimum.
    • Resetting of Time Periods. Time periods will reset and start anew in the event that an FDI clearance or certificate of non-objection was revoked or altered (e.g., in case of willful deceit or the subsequent occurrence of facts). Equally, the time period will also reset if a restrictive measure or a contractual provision with the German Ministry is set aside, partly or in full, by a court decision.
  • Submission of Information. Being a triggering point for the screening period, the submission of information also was moved from the AWV to the AWG and, therefore, may only be amended by the German parliament.
    • Triggering of Screening Period. Previously, the screening period was only triggered once all information had been submitted to the German Ministry. It is now provided that the four-month screening period starts when all initially requested information has been submitted which includes, as before, all information set forth in the corresponding general ordinance issued by the German Ministry, and, as of now, all information that the German Ministry additionally may request in its decision to initiate formal screening proceedings.
    • Subsequent Request for Additional Information. The German Ministry may, also later in the screening process, request further information from anyone directly or indirectly involved in the acquisition. Although the screening period will be suspended until submission of the requested information, the overall duration of the screening process remains calculable for the investor who can limit the suspension by actively working towards a speedy submission.
  • More Effective Monitoring of Compliance with Measures. Investors and target companies are to expect more monitoring activity by the German Ministry which now has a right of information as well as a right to carry out examinations (including access to stored data, respective data processing systems, and business premises, in each case also by use of third-party representatives (Beauftragte)) in order to better monitor the investor’s and/or target company’s compliance with contractually agreed or imposed measures.
  • Imposing Restrictive Measures without Consent of the German Government. Previously, restrictive measures regarding FDIs subject to cross-sector review could only be imposed with the consent of the German government. Now, restrictive measures may be imposed in agreement with and/or consultation of certain federal ministries instead. For the sake of clarity, the German Ministry still requires the consent of the German government if it wants to prohibit an FDI that is subject to cross-sector review. This has not changed.

What Is Next?

Further changes to the AWV are announced to follow in the 17th amendment to the AWV. In particular, the German Ministry plans to expand the catalog of critical industries which are notifiable and subject to cross-sector review from the acquisition of 10% or more of the voting rights. Based on earlier announcements by the German Ministry on this subject, we expect artificial intelligence, robotics, semiconductors, biotechnology and quantum technology to be potentially declared critical industries. The German Ministry stresses that it will take special consideration of feedback provided by the affected industry circles when proposing the expansion of critical industries to the German government.


Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. For further information, please feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the team in Frankfurt or Munich, or the following authors:

Markus Nauheim - Munich (+49 89 189 33 122, mnauheim@gibsondunn.com) Wilhelm Reinhardt - Frankfurt (+49 69 247 411 502, wreinhardt@gibsondunn.com) Stefanie Zirkel - Frankfurt (+49 69 247 411 513, szirkel@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 5, 2020 |
Leading German Legal Publication JUVE Recommends Frankfurt, Munich and Brussels Offices in its Annual Handbook 2020/2021

The leading German legal publication JUVE recommended Gibson Dunn’s Frankfurt, Munich and Brussels offices in the 2020/2021 edition of its annual directory.  Gibson Dunn was named among the top 50 law firms in Germany. It was recommended in the Brussels, Frankfurt and Munich regions and recognized in the Antitrust, Compliance and Internal Investigations, Corporate, Dispute Resolution, M&A and Private Equity categories.

November 5, 2020 |
Gibson Dunn Named Among Top 50 Law Firms in Germany

German publication Kanzleimonitor 2020/2021 listed Gibson Dunn among the top 50 law firms in Germany recommended by in-house lawyers. In the categories of Stock Corporation and Corporate Governance Law, Munich partner Ferdinand Fromholzer was one of two most recommended lawyers, Munich of counsel Silke Beiter was frequently recommended, and the firm was ranked among the top 10 in Germany. Partners who are also frequently recommended were Frankfurt partners Dirk Oberbracht in Mergers & Acquisitions and Georg Weidenbach in the area of Antitrust Law. Gibson Dunn’s German offices were also recommended among the leading law firms for Compliance, Corporate Law, IP, and Mergers & Acquisitions. The study, based on approximately 5,610 recommendations by 603 in-house legal departments and set up by Deutsches Institut fuer Rechtsabteilungen & Unternehmensjuristen (diruj), was published on October 26, 2020.

October 15, 2020 |
Common Shareholding and Competition in Europe

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On 29 September 2020, the European Commission (“Commission”) issued its first report on concomitant minority shareholdings by institutional investors in companies active in the same market (“Common Shareholdings”)(“Report”).[1] The findings of the 320 page Report were drawn upon lessons learned from five sectors which are considered by the Commission to be relatively concentrated, namely: Oil & Gas, Electricity, Mobile Telecoms, Trading Platforms, and Beverages.

The Report was triggered by the identification of an increasing number of Common Shareholdings in recent years. For instance, in 2014, 60% of U.S. public firms had a shareholder that held at least 5% both in the firm itself and in a competitor.[2] In Europe, Common Shareholdings with at least 5% participation concerned 67% of listed companies in 2016.[3]

Traditionally, Common Shareholdings have not been an antitrust issue as institutional investors usually held small minority stakes, falling far below the level necessary to give them the ability to exercise control, and implemented passive investment strategies. However, in recent years, Common Shareholdings have attracted the attention of antitrust enforcement agencies in Europe and the U.S.[4], given that fund managers have accumulated more substantial shareholdings, together with the related voting rights, in a large number of firms that are often direct competitors.

A number of economists have also raised concerns about this perceived concentration of power, the influence that could be exerted over the management of the companies affected, and the potential incentives to collude amongst the investors.

Overview of the competition assessments made thus far

To date, empirical research on the competitive effects of Common Shareholdings has been focused on the U.S. Specifically, two major studies of the retail banking and airline sectors have concluded that Common Shareholdings in those sectors were associated with higher prices (for banking deposit services and airline tickets respectively) and accordingly may have had a detrimental effect on competition.[5] Following the publication of those studies, the U.S. Federal Trade Commission held a hearing on Common Shareholdings in December 2018.[6]

In the EU, the Commission has examined the potential effects of Common Shareholdings in two recent merger cases: Dow/DuPont[7] and Bayer/Monsanto.[8] As a result of high levels of Common Shareholdings, the Commission concluded that the usual market share indicators (including the HHI Index) were likely to underestimate the level of market concentration, which would lead it to “underestimate the expected non-coordinated effects of the Transaction”.[9] The Commission’s analysis noted in particular that Common Shareholdings may reduce the likelihood of companies to invest in R&D efforts where this would harm the interests of competing firms held in the same institutional investor portfolio.[10] In addition, the Commission observed that passive investors “exert influence on individual firms with an industry-wide perspective”, and also that dispersed ownership exaggerates that influence.[11]

In 2018, Commission Vice-President Margrethe Vestager indicated that the Commission would be looking “carefully” at the prevalence of Common Shareholdings in the EU.[12] Consistent with this approach, the German Monopolies Commission also concluded in a lengthy report that institutional investors may have the means to influence certain of their portfolio companies’ decisions and recommended that the issue receive more attention at EU level.[13] In early 2019, the European Parliament’s Economic and Monetary Affairs Committee agreed to commission research to examine the prevalence of Common Shareholdings in the EU.

The Report’s findings

The Report sets out evidence on the presence and extent of Common Shareholdings across the EU and its possible anticompetitive effects, without putting forward any concrete policy proposals. Its main findings are as follows:

  • More than two-thirds of all listed firms active in the EU (67%) are cross-held by Common Shareholdings of at least 5% in each company.
  • Portfolios of Common Shareholdings continue to be especially large – in some cases including between 30% to 40% of active companies – in the electricity, financial instruments, telecommunications, and beverage sectors.
  • Despite the wide presence of Common Shareholdings, a causal link with competitive outcomes is still challenging, not least because of the definition of the relevant market, the measurement of the Common Shareholding itself, the choice of an appropriate competition indicator (market dominance, concentration levels), or data availability at firm or product level.
  • The Report introduces a detailed study of the beverages sector, concluding that a 2009 merger between two institutional investors may have had an effect on the margins of the beverage firms in their portfolios.
  • Nonetheless, the Report stresses that more detailed analysis is needed in specific cases regarding the precise causal link between a given Common Shareholding and any actual impact on competition.

Takeaway

As was clear from the Commission’s Dow/DuPont and Bayer/Monsanto merger Decisions, Common Shareholdings are likely to become a more established element in the Commission’s scrutiny of mergers, particularly in concentrated markets.

Following the publication of the Report, in cases where it believes that market shares and other traditional analytical tools underestimate the effect of a concentration the Commission may be inclined to argue that a material impact on competition is more likely where a Common Shareholding is present. This could result in even more complex merger review procedures, potentially including a review of investment histories and strategies.

The Report shows, however, that there are no hard and fast theories of harm of Common Shareholdings. We are currently none the wiser as to whether the Commission will seek to build such an analysis into its existing “coordinated effects”[14] theories or as part of a broader analysis in so-called “gap” cases.[15] It is, therefore, unlikely that the Commission will rely solely on Common Shareholdings to veto a merger. Nonetheless, it is likely that the Commission will view Common Shareholding as an “element of context” capable of magnifying anticompetitive concerns raised by other elements of the investigation.

__________________________

[1] Full report available here. The Report was undertaken by the Finance & Economy Unit of the Commission’s Joint Research Centre at the request of the Commission’s Directorate-General for Competition, as part of a project reviewing “Possible anti-competitive effects of common ownership”.

[2] See OECD, ‘Common Ownership by Institutional Investors and its Impact on Competition’, Background Note by the Secretariat, 5-6 December 2017, p. 13, available at: https://one.oecd.org/document/DAF/COMP(2017)10/en/pdf.

[3] Common Shareholding Report, op. cit., at p. 2.

[4] OECD Background Note, op. cit., at p. 13.

[5] Jose Azar, Sahil Raina and Martin C Schmalz, ‘Ultimate Ownership and Bank Competition’, May 2019; Jose Azar, Martin C Schmalz and Isabel Tecu, ‘Anticompetitive Effects of Common Ownership’, Journal of Finance 28(4), 2018.

[6] FTC Hearing #8: Competition and Consumer Protection in the 21st Century, 6 December 2018, transcript available here.

[7] Case M.7932 Dow/DuPont.

[8] Case M.8084 Bayer/Monsanto.

[9] Case M.7932 Dow/DuPont, Annex 5, paras. 4 and 81; Case M.8084 Bayer/Monsanto, para. 229.

[10] Case M.7932 Dow/DuPont, Annex 5

[11] Case M.7932 Dow/DuPont, Annex 5, para. 7.

[12] Full speech accessible at: https://wayback.archive-it.org/12090/20191129215248/https://ec.europa.eu/commission/commissioners/2014-2019/vestager/announcements/competition-changing-times-0_en; see also https://globalcompetitionreview.com/dg-comp-looking-common-ownership-says-vestager.

[13] Full report available here.

[14] Coordinated effects occur where as a result of the merger, the merging parties and their competitors will successfully be able to coordinate their behaviour in an anti-competitive way, for example by tacit or explicit collusion.

[15] Mergers in oligopolistic markets which the Commission believes would significantly lessen competition without creating or strengthening a dominant position in the marketplace.


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

Jens-Olrik Murach (+32 2 554 7240, jmurach@gibsondunn.com) David Wood (+32 2 554 7210, dwood@gibsondunn.com) Peter Alexiadis (+32 2 554 7200, palexiadis@gibsondunn.com)

Antitrust and Competition Group in Europe:

Brussels Peter Alexiadis (+32 2 554 7200, palexiadis@gibsondunn.com) Attila Borsos (+32 2 554 72 11, aborsos@gibsondunn.com) Jens-Olrik Murach (+32 2 554 7240, jmurach@gibsondunn.com) Christian Riis-Madsen (+32 2 554 72 05, criis@gibsondunn.com) Lena Sandberg (+32 2 554 72 60, lsandberg@gibsondunn.com) David Wood (+32 2 554 7210, dwood@gibsondunn.com)

Munich Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com)

London Patrick Doris (+44 20 7071 4276, pdoris@gibsondunn.com) Charles Falconer (+44 20 7071 4270, cfalconer@gibsondunn.com) Ali Nikpay (+44 20 7071 4273, anikpay@gibsondunn.com) Philip Rocher (+44 20 7071 4202, procher@gibsondunn.com) Deirdre Taylor (+44 20 7071 4274, dtaylor2@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 9, 2020 |
M&A Report – 2020 Mid-Year Activism Update

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This Client Alert provides an update on shareholder activism activity involving NYSE- and Nasdaq-listed companies with equity market capitalizations in excess of $1 billion and below $100 billion (as of the close of trading on June 30, 2020) during the first half of 2020. As the markets weathered the dislocation caused by the novel coronavirus (COVID-19) pandemic, shareholder activist activity decreased dramatically. Relative to the first half of 2019, the number of public activist actions declined from 51 to 28, the number of activist investors taking actions declined from 33 to 10 and the number of companies targeted by such actions declined from 46 to 22.

By the Numbers – H1 2020 Public Activism Trends

Chart

Additional statistical analyses may be found in the complete Activism Update linked below. 

The decline in shareholder activism activity brought concentration among those investors engaged in activist activity during the first half of 2020. For example, during the first half of 2020, NorthStar Asset Management launched six campaigns and Starboard Value LP launched four campaigns. Three activists represented half of the total public activist actions that began during the first half of 2020.

In addition, as compared to the first half of 2019, activists turned their focus away from agitating for particular transactions as the animating rationale for the campaigns they launched. While changes in board composition remained the leading rationale for campaigns initiated in the first half of 2019 and the first half of 2020, M&A (which includes advocacy for or against spin-offs, acquisitions and sales) and acquisitions of control, which served as the rationale for 24% and 8%, respectively, of activist campaigns in the first half of 2019, declined to 9% and 0%, respectively, in the first half of 2020. By contrast, advocacy for changes in governance, which emerged in 6% of campaigns in the first half of 2019, became the principal rationale for 28% of campaigns in the first half of 2020. Business strategy also remained a high-priority area of focus for shareholder activists, representing the rationale for 22% of campaigns begun in the first half of 2019 and 24% of campaigns begun in the first half of 2020. The rate at which activists engaged in proxy solicitation remained consistent at 24% in the first half of 2019 and 21% in the first half of 2020. (Note that the percentages for campaign rationales described in this paragraph sum to over 100%, as certain activist campaigns had multiple rationales.)

Publicly filed settlement agreements declined alongside the decrease in shareholder activism activity. Nine settlement agreements were filed during the first half of 2020, as compared to 17 such agreements during the first half of 2019. Nonetheless, the settlement agreements into which activists and companies entered contained many of the same features noted in prior reviews, including voting agreements and standstill periods as well as non-disparagement covenants and minimum and/or maximum share ownership covenants. Expense reimbursement provisions appeared in two thirds of the settlement agreements reviewed, which represented an increase relative to historical trends. We delve further into the data and the details in the latter half of this Client Alert.

We hope you find Gibson Dunn’s 2020 Mid-Year Activism Update informative. If you have any questions, please do not hesitate to reach out to a member of your Gibson Dunn team.

Gibson Dunn 2018 Year-end Activism Update - Click here for complete update


Gibson Dunn's lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this publication. For further information, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following authors in the firm's New York office:

Barbara L. Becker (+1 212.351.4062, bbecker@gibsondunn.com) Dennis J. Friedman (+1 212.351.3900, dfriedman@gibsondunn.com) Richard J. Birns (+1 212.351.4032, rbirns@gibsondunn.com) Eduardo Gallardo (+1 212.351.3847, egallardo@gibsondunn.com) Saee Muzumdar (+1 212.351.3966, smuzumdar@gibsondunn.com) Daniel S. Alterbaum (+1 212.351.4084, dalterbaum@gibsondunn.com) Jessica L. Bondy (+1 212.351.3802, jbondy@gibsondunn.com)

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

Mergers and Acquisitions Group: Jeffrey A. Chapman - Dallas (+1 214.698.3120, jchapman@gibsondunn.com) Stephen I. Glover - Washington, D.C. (+1 202.955.8593, siglover@gibsondunn.com) Jonathan K. Layne - Los Angeles (+1 310.552.8641, jlayne@gibsondunn.com)

Securities Regulation and Corporate Governance Group: 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) James J. Moloney - Orange County, CA (+1 949.451.4343, jmoloney@gibsondunn.com) Elizabeth Ising - Washington, D.C. (+1 202.955.8287, eising@gibsondunn.com) Lori Zyskowski - New York (+1 212.351.2309, lzyskowski@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 7, 2020 |
33 Gibson Dunn Partners Recognized in Banking, Finance and Transactional Expert Guide

Expert Guides has named 33 Gibson Dunn partners to the 2020 edition of its Banking, Finance and Transactional Guide, which recognizes the top legal practitioners in the industry.  Selection to this guide is determined by a survey of fellow legal practitioners in more than 80 jurisdictions.  The Gibson Dunn partners included in the guide are Frankfurt partner Dirk Oberbracht, Hong Kong partners Albert Cho, John Fadely, Scott Jalowayski, Michael Nicklin, and Patricia Tan Openshaw, Houston partner Hilary Holmes, London partners Christopher Haynes and Steve Thierbach, Los Angeles partners Jennifer Bellah Maguire, Dennis Arnold and Robert Klyman, New York partners Barbara BeckerAndrew Fabens, David Feldman, Dennis Friedman, Sean GriffithsShukie Grossman, Michael RosenthalRoger Singer, and Edward Sopher, Orange County partners Jonathan Layne and James Moloney, Palo Alto partner Russell Hansen, San Francisco partners Stewart McDowell, Robert Nelson and Douglas Smith, Singapore partner Brad Roach, and Washington, D.C. partners Mark Director, Stephen Glover, Elizabeth Ising, Brian Lane and Ronald Mueller.  The guide was published on September 21, 2020.

October 5, 2020 |
Gibson Dunn Ranked in the 2021 UK Legal 500

Gibson Dunn earned 13 practice area rankings in the 2021 edition of The Legal 500 UK. Four partners were named to Legal 500’s Hall of Fame, recognizing individuals who receive consistent feedback from their clients for continued excellence, and four other partners were named Leading Lawyers in their respective practices. The firm was recognized in the following categories:

  • Corporate and Commercial: Corporate Tax
  • Corporate and Commercial: Equity Capital Markets – Mid-High Cap
  • Corporate and Commercial: EU and Competition
  • Corporate and Commercial: M&A: upper mid-market and premium deals, £500m+
  • Dispute Resolution: Commercial Litigation: Premium
  • Dispute Resolution: International Arbitration
  • Dispute Resolution: Public International Law
  • Human Resources: Employment – Employers
  • Projects, Energy and Natural Resources: Oil and Gas
  • Public Sector: Administrative and Public Law
  • Real Estate: Commercial Property – Investment
  • Real Estate: Property Finance
  • Risk Advisory: Regulatory Investigations and Corporate Crime (advice to corporates)
Legal 500’s Hall of Fame for 2021 consists of: Steve Thierbach – Corporate and Commercial: Equity Capital Markets; Philip Rocher – Dispute Resolution: Commercial Litigation; Cyrus Benson – Dispute Resolution: International Arbitration; and Alan Samson – Real Estate: Commercial Property – Investment and Real Estate: Property Finance. The partners named as Leading Lawyers are Sandy Bhogal – Corporate and Commercial: Corporate Tax; Ali Nikpay – Corporate and Commercial: EU and Competition; Jeffrey Sullivan – Dispute Resolution: International Arbitration; and Anna Howell – Projects, Energy and Natural Resources: Oil and Gas. Benjamin Fryer has been named a Next Generation Partner for Corporate and Commercial: Corporate Tax. Additionally, Claibourne Harrison has been named a Rising Star for Real Estate: Commercial Property – Investment, and Mitasha Chandok has been named a Rising Star for Projects, Energy and Natural Resources: Oil and Gas. The guide was published on September 30, 2020. Gibson Dunn’s London office offers full-service English and U.S. law capability, including corporate, finance, dispute resolution, competition/antitrust, real estate, labor and employment, and tax.  Our lawyers advise international corporations, financial institutions, private equity funds and governments on complex and challenging transactions and disputes.

October 5, 2020 |
Stock-for-Stock Mergers During the Coronavirus (COVID-19) Crisis – A Potential Strategic Solution

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The widespread economic uncertainty caused by COVID-19 poses distinct challenges for buyers and sellers seeking to identify M&A opportunities, as companies evaluate the impact of the pandemic on their businesses to date, and seek to predict its future impact. Continued volatility in the financial markets and the lack of visibility into how the pandemic will affect the global economy in the near or longer term, as well as the pace and scope of economic recovery, introduce elements of conjecture into the valuation process. Securing financing for a transaction is also likely to be difficult, as traditional credit providers may be reluctant to lend, particularly to borrowers in sectors that have been more severely impacted by the crisis.

Buyers and sellers struggling with these challenges may find that stock-for-stock mergers offer an attractive option. Transactions based on stock consideration can enable the parties to sidestep some of the difficulties involved in agreeing on a cash price for a target, by instead focusing on the target’s and the buyer’s relative valuations. In addition, using stock as consideration allows buyers to conserve cash and increase closing certainty by eliminating the need to obtain financing to complete a transaction.

The extent and duration of COVID-19’s impact on M&A activity, and whether companies will trend toward stock-for-stock mergers in lieu of cash acquisitions, remains unclear. However, recent stock-for-stock deal announcements such as Analog Devices’s $21 billion acquisition of Maxim Integrated Products, Just Eat Takeaway’s $7.3 billion acquisition of Grubhub, Uber’s $2.65 billion acquisition of Postmates, Chevron’s $5 billion acquisition of Noble Energy, Clarivate plc’s $6.8 billion acquisition of CPA Global and Builders FirstSource’s $2.46 billion acquisition of BMC Stock Holdings suggest that companies may be more inclined to opt for stock-for-stock mergers against the backdrop of continued valuation and financing risks.

While stock-for-stock mergers may help parties address certain issues posed by the current climate, these transactions also raise concerns that do not arise in cash acquisitions. In particular, a company contemplating a stock-for-stock merger should consider the following:

Valuation issues. Setting the exchange ratio in a stock-for-stock merger requires the parties to determine their relative valuations, which, at first blush may seem easier than agreeing on a direct value for the target in a cash merger. However, stock-for-stock mergers do not eliminate difficult valuation issues, particularly if the parties are in different industries or at different stages of their development. The pandemic is likely to make valuation issues even more challenging if the parties have been impacted in dissimilar ways or levels of severity by the effects of COVID-19, or if the parties have different outlooks regarding the pace and scope of their respective recoveries.

The parties must also determine if a control premium is appropriate, and the size of any premium. A target will generally seek a premium to its current market value for a sale of control, and the demand for a premium may become more forceful if the target believes that its shares are undervalued due to general market or industry conditions. The buyer may resist this demand, arguing that the shares are not undervalued, and that in a stock-for-stock deal, unlike a cash deal, the target’s stockholders will have an ongoing equity stake in the combined company enabling them to benefit from any merger gains. In most cases, however, the buyer accepts the target’s arguments and agrees to build a premium into the exchange ratio.

Not every stock-for-stock transaction will include a premium, however. In a deal that the parties characterize as a merger of equals, the parties may agree that a premium will not be paid because neither party is acquiring control. They reason that the two companies’ respective stockholders should benefit pro rata from gains realized by the combined company, and set the exchange ratio so that it simply reflects the companies’ relative valuations.

Decisions regarding whether a premium is appropriate and the size of the premium will be carefully scrutinized by stockholders, activists and plaintiffs’ lawyers. As a result, the parties should be prepared to defend their deal based on the companies’ relative valuations, the prospects of the post-merger business and applicable factors impacting industry or stock market conditions generally.

Fixed vs floating exchange ratios. Stock-for-stock deals are structured using either a fixed exchange ratio or a floating exchange ratio. Fixed exchange ratios are based on the relative market values of the buyer and the target; floating exchange ratios are designed to ensure that target stockholders receive buyer shares with a specified dollar value. Floating exchange ratio deals do not present the same advantages as fixed exchange ratio deals in today’s environment. The parties cannot simply assess relative market values, but instead must determine a fixed value per target share, which is a difficult exercise when markets are volatile and forecasting future performance is difficult. But if the target successfully demands that its stockholders receive a specified price, the buyer may acquiesce, reasoning that a floating exchange ratio deal remains attractive because it can avoid using cash, reduce financing risk and increase closing certainty.

Collars and walk-away rights. Using stock consideration poses certain risks. When the exchange ratio floats, the buyer takes the risk that its stock price falls between signing and closing, forcing it to issue more shares at closing and diluting its existing stockholders; when the exchange ratio is fixed, the buyer takes the risk that its stock price rises between signing and closing and it overpays for the target. The target’s risks run in the opposite direction: it takes the risk that the buyer’s stock price falls between signing and closing when the exchange ratio is fixed, or that the buyer’s stock price rises between signing and closing when the exchange ratio floats, and, in each case, that its stockholders feel they have received insufficient value.

Pandemic-related market volatility and uncertainty about the pace of economic recovery may make parties more sensitive to the risks of using stock consideration. To address these risks, parties to a stock-for-stock merger may consider using mechanisms that were not commonly used before the pandemic: collars and/or walk-away rights based on stock price.

Collars provide a hedge against significant fluctuations in the buyer’s stock price between signing and closing by establishing upper and lower limits on the number of buyer shares and/or the value of the consideration that will be required to be delivered to target stockholders. A collar assures each party that the merger consideration and dilutive effect of the transaction will remain within negotiated parameters.

To further mitigate risk, the buyer and target may include a “walk-away” right for one or both of the parties if the value of the buyer’s stock drops below a designated threshold (walk-away rights are rarely triggered by increases in the buyer’s stock price). This right may be structured as either a closing condition or termination right (with or without associated termination fees). If the walk-away provisions are used together with a collar, the walk-away price may be set at, below or above the level of the collar’s “floor.” Like collars, the parties have broad flexibility to craft the walk-away provisions to achieve their desired results. For example, if the exchange ratio is fixed, the agreement may provide that if the buyer’s stock price falls below the negotiated threshold: the buyer may elect to “top-up” the consideration either through cash or shares, otherwise, the target can walk away, or that the target may choose to either walk away or require the buyer to issue more shares by flipping to a floating exchange ratio.[1]

Walk-away rights have not been used frequently in the past, in part, because a board of directors considering whether or not to exercise a walk-away right is in a difficult position. Issues a board must resolve include: should the board undertake a new analysis of the fairness of the transaction, including obtaining an updated fairness opinion? If the company's stockholders have already approved the merger, how should this affect the answers to these questions? Board decisions regarding walk-away rights are likely to be subject to the same scrutiny, second-guessing and challenges as the board’s decision to approve the merger. If the board chooses not to exercise a walk-away right, and the merger ultimately turns out badly for the company's stockholders, will the directors be sued? If the board does exercise a walk-away right and, in hindsight, it appears that the merger would have benefitted the company’s stockholders, will the directors be sued?

As noted above, collars and walk-away rights were not common pre-pandemic, and we have not noted a significant increase in their use in recent months. However, parties may consider using these somewhat unusual features in response to these highly unusual times.

Fiduciary duty issues for boards. The COVID-19 pandemic may place additional pressure on a board’s decision to approve a business combination (or to exercise a walk-away right). In Delaware, a stock-for-stock merger in which no single person or “group” will control the combined company is generally not subject to the value maximization imperative of a sale of control or to enhanced judicial scrutiny under Revlon Inc. v. MacAndrews & Forbes Holdings, Inc. If the target does not have a controlling stockholder, and a majority of its directors are disinterested, the decision to merge should be entitled to the protection of the business judgement rule. As a result, the directors should have broad discretion to approve a stock-for-stock merger that the board believes in good faith is in the best interests of the company and its stockholders.

Even if Revlon duties do not apply, the target board is likely to feel significant pressure to make the best deal possible under the circumstances. The board’s decision to combine is highly likely to be second-guessed under any circumstances, and even more so if the transaction is undertaken during a period of perceived overall economic risk. The board must assess whether it makes sense to combine at this time despite the current difficulty in projecting the companies’ respective future recovery, growth and prospects. Target stockholders may criticize the board for selling too low if the buyer is seen as taking advantage of the target’s falling stock price. If the company believes it has a solid plan for recovery, it must consider whether the company will be better off on a standalone basis, or if the combination will bolster its recovery. Before approving the merger, the board should be comfortable that it can defend its decision that the merger is in the company’s best interests.

Governance issues. Because target stockholders will have a stake in the combined company post-closing, the parties to a stock-for-stock merger are more likely to be sensitive to governance and social issues than they would be in a cash merger. The relevant issues include, among others, the composition of the combined company board and senior management team and the name of the combined company. Negotiations of these issues can be tricky, particularly in a deal that the parties consider a merger of equals, where there is likely to be even more intense focus on who serves in management roles at the combined company. The current economic crisis may raise the stakes riding on the outcome of the governance negotiations, particularly if the parties’ respective management teams have different strategies for dealing with the pandemic and its consequences. Enforcing post-closing agreements on these matters is also difficult. To address post-closing enforcement concerns, the parties may consider expressly including their agreement on governance matters in the combined company’s charter, to be effective as of the closing, and requiring supermajority board and/or stockholder approvals to amend the relevant charter provisions.

COVID-related deal terms. Deal negotiators should consider whether and how the merger agreement terms, such as representations, MAE definitions and post-signing covenants, should be revised as a result of the pandemic. Please refer to Gibson Dunn’s Client Alert entitled “M&A Amid the Coronavirus (COVID-19) Crisis: A Checklist”[2] for a detailed discussion of these issues. Most stock-for-stock transactions will contain certain reciprocal provisions, including representations and interim operating covenants. In considering whether to make COVID-specific revisions to these provisions, a party should either be prepared to accept the same terms for itself, or justify why reciprocity is not appropriate. Negotiations on these points may also be complicated by situations where the parties’ operating results and/or stock prices have not been similarly impacted by the crisis.

Diligence. The target’s diligence of the buyer in a cash merger is typically limited to assessing the buyer’s ability to perform its obligations under the transaction agreements. However, because the target’s stockholders will receive the buyer’s stock in a stock-for-stock merger, the target is more likely to comprehensively diligence the buyer. The mutual diligence effort in a stock-for-stock merger may lengthen the timeline, and increase the complexity and expense of the transaction.

Buyer Stockholder Approval. The buyer’s stockholders may be required to approve certain stock-for-stock mergers, e.g., if the buyer has to amend its charter to authorize the issuance of additional securities to be issued in the merger, if the buyer is one of the merging parties or if required by securities exchange listing rules because the transaction represents a change of control of the buyer or requires the issuance of securities representing twenty percent or more of the buyer’s outstanding common stock or voting power. The requirement to obtain buyer stockholder approval may reduce closing certainty, lengthen the timeline, and increase the complexity and expense of the transaction.

Mixed cash-stock deals. Some parties may consider mergers in which the consideration consists of a mix of cash and stock. While the use of stock may make it easier to finance and close the transaction, the use of stock will also introduce the valuation and other issues discussed in this Client Alert.

Scrutiny. As noted above, the parties to a business combination transaction undertaken in the current environment should expect the deal terms and business rationale to be placed under a microscope. As a result of the uneven M&A activity during the pandemic, every new deal that is announced receives significant attention. The parties should anticipate close scrutiny of the transaction, particularly by stockholder activists and plaintiffs’ firms, and develop their deal announcement and communications plans accordingly.

__________________________

[1]   The March 2020 merger agreement between Provident Financial Services, Inc. and SB One Bancorp provides a current example of a walk-away right. The agreement provides for a fixed exchange ratio. However, SB One may terminate the agreement if the value of Provident Financial’s stock drops (i) by over 20% between signing and the date the last regulatory approval for the transactions is obtained and (ii) by more than the drop in the average of the NASDAQ Bank Index closing prices over the same period less 20%. If SB One exercises this termination right, Provident Financial has the option to increase the merger consideration, in cash, by the amount necessary to cause either of these conditions not to be met. As a result, SB One stockholders are assured that the dollar value of the merger consideration they receive will not fall below a minimum amount.

[2]   Originally published March 18, 2020 and available at https://www.gibsondunn.com/ma-amid-the-corona-virus-covid-19-crisis-a-checklist/; updated version available at https://advance.lexis.com/api/permalink/930c7ac9-3d37-4ff9-82dd-39e19a994dce/?context=1000522.


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

Gibson Dunn’s lawyers regularly counsel strategic and private equity buyers and sellers on the legal issues raised by this pandemic in the M&A context. Please also feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Mergers and Acquisitions or Private Equity practice groups, or the authors:

Stephen I. Glover – Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com)

Eduardo Gallardo – New York, New York (+1 212.351.3847, egallardo@gibsondunn.com)

Alisa Babitz – Washington, D.C. (+1 202-887-3720, ababitz@gibsondunn.com)

Marina Szteinbok – New York, New York (+1 212-351-4075, mszteinbok@gibsondunn.com)

Ann-Marie Harrelson – Washington, D.C. (+1 202-887-3683, aharrelson@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 22, 2020 |
Kristin Linsley and Saee Muzumdar Recognized by LMG Americas Women in Business 2020

At the Euromoney Legal Media Group Women in Business Law Awards, San Francisco partner Kristin Linsley was recognized as Best in Cyber Security and New York partner Saee Muzumdar was recognized as a Corporate Rising Star. The awards recognize “leading women for their contributions to the practice of business law.” The awards were held on September 17, 2020. Kristin Linsley specializes in complex business and appellate litigation across a spectrum of areas, including water and energy law, cybersecurity and technology law, international and transnational law, data and privacy, and complex financial litigation.  She has defended clients in high-stakes litigation involving financial issues arising from the mortgage crisis, commercial/contract disputes between companies, securities fraud and RICO violations, technology, telecommunications, and privacy issues, consumer class actions, intellectual property, and defense and aerospace-related issues. Saee Muzumdar is a corporate transactional lawyer whose practice includes representing both strategic companies and private equity clients (including their portfolio companies) in connection with all aspects of their domestic and cross-border M&A activities and general corporate counseling. She has significant experience with acquisitions and divestitures of public and private entities (including both negotiated transactions and contested takeovers), venture capital investments, proxy contests, tender and exchange offers, recapitalizations, leveraged buyouts, spinoffs, carveouts, joint ventures and other complex corporate transactions.

September 22, 2020 |
Thirteen Gibson Dunn Partners Recognized in Expert Guides’ Women in Business Law

Expert Guides has named 13 Gibson Dunn partners to its 2020 Guide to the World’s Leading Women in Business Law, which recognizes top female legal practitioners advising on business law. Selection to this guide is determined by a survey of fellow legal practitioners. The Gibson Dunn partners included in the guide are Hong Kong partners Kelly Austin and Patricia Tan Openshaw, London partners Anna Howell and Penny Madden, Los Angeles partners Jennifer Bellah Maguire, Catherine Conway, Ruth Fisher and Amy Forbes, New York partners Barbara Becker, Lauren Elliot and Jane Love, San Francisco partner Mary Murphy and Washington, D.C. partner Judith Alison Lee. The guide was published on September 7, 2020.

September 21, 2020 |
Temporary German COVID-19 Insolvency Regime Extended in Modified Form

Click for PDF When the COVID 19 pandemic first hit European shores in early spring 2020, the German legislator was quick to introduce wide-reaching legislative reforms to protect the German business world from unwanted consequences of an economy struggling with unprecedented upheaval, the lock-down and the ensuing social strain.[1] One key element of the overall legal reform in March 2020 was the temporary derogation from the regular mandatory German-law requirement to file for insolvency immediately whenever a company is either illiquid (Zahlungsunfähigkeit) or over-indebted (Überschuldung). This derogation has now been extended in time for over-indebted companies, but restricted in scope for illiquid companies. I.  The Temporary Insolvency Law Reform in March 2020 At the time the German Act on the Temporary Suspension of the Insolvency Filing Obligation and Liability Limitation of Corporate Body in cases of Insolvency caused by the COVID-19 Pandemic (“Gesetz zur vorübergehenden Aussetzung der Insolvenzantragspflicht und zur Begrenzung der Organhaftung bei einer durch die COVID-19-Pandemie bedingten Insolvenz - COVInsAG)[2] was introduced in March 2020, it was felt that the strict insolvency filing requirement that obliges management to file for insolvency without undue delay, but in any event no later than three weeks after such insolvency reason first occurs, would (i) place undue time pressures on companies to file for insolvency in situations where this short time period did not even allow management to canvass its financial or restructuring options or access to newly introduced state funding or other financing sources, (ii) result in a wave of insolvencies of otherwise healthy entities based purely on the traumatic impact of the pandemic and (iii) result in unwanted distortions of the market by failing to differentiate appropriately between businesses facing merely temporary cash-flow problems and genuinely moribund companies with long-standing challenges or issues. In a nutshell and without going into all details, the interim reform of the German Insolvency Code (Insolvenzordnung, InsO) via the COVInsAG introduced a temporary suspension of the mandatory insolvency filing requirement until September 30, 2020 for both the insolvency reasons of illiquidity (Zahlungsunfähigkeit) and of over-indebtedness (Überschuldung) by way of a strong legal assumption that any such insolvency was caused by the pandemic if (i) the company in question was not yet illiquid on December 31, 2019 and (ii) could show that it would (still or again) be in a position to pay all of its liabilities when due on and after September 30, 2020. This temporary exemption from having to file for insolvency was flanked by a number of other legislative tweaks to the Insolvency Code that privileged and protected a company’s continued trading during such time window against management liability risks and/or later contestation rights of the insolvency administrator in case the temporary crisis in the spring and summer of 2020 would ultimately result in a later insolvency, after all. Access to new financing was similarly privileged in this time window when the company could show that it traded under the protection of the COVID 19 exemption from the regular insolvency filing requirement. Finally, the COVInsAG also contained a clause that allowed an extension of this protective time window beyond September 30, 2020 up to the maximum point of March 31, 2021 by way of separate legislative act. II.  The Modified Extension Adopted on September 17, 2020 While an extension of the temporary suspension of the filing requirement was consistently deemed likely by insolvency experts and in political cycles, Germany has since moved beyond the initial lock-down and has mostly opened up the country for trading again. It has also become apparent that, in particular, a continued blanket derogation from the mandatory filing requirement for companies facing severe cash-flow problems to the point of illiquidity (i) would often only delay the inevitable and (ii) create an unwanted cluster of many insolvency proceedings which are ultimately all filed for at the same time when the suspension comes to an end, rather than a steady and progressive cleansing of the market by gradually removing companies that have failed to recover from the pandemic in a reasonably short period of time. As a consequence, Germany has chosen not simply to extend the current provisions in unchanged form, but rather has significantly modified the wording of the COVInsAG to address the above concerns.

  1. Over-Indebtedness
In particular, as of October 1, 2020 and until December 31, 2020, a continued derogation from the immediate obligation to file for insolvency henceforth only applies to companies which otherwise would only file for insolvency due to over-indebtedness (Überschuldung) but which are not also illiquid. Such companies remain protected from having to file for insolvency based on the above-described rules until December 31, 2020, if (i) they were not already illiquid by December 31, 2019 and will not be illiquid after September 30, 2020 and thereafter. Unlike illiquid companies, it was felt that companies which are over-indebted, i.e. (i) whose assets based on specific insolvency-driven valuation rules are not sufficient to cover their liabilities and (ii) which do not currently have a positive continuation prognosis (positive Fortführungsprognose), deserve a further grace period during which they may address their underlying structural issues, provided they do not enter illiquidity during this time window. This extension until year end for over-indebted companies also addresses the often-voiced concerns that the uncertain future effects of the pandemic on a company’s medium-term prospects currently do not allow for a meaningful continuation prognosis which by general consensus has to cover the liquidity situation over the next 12 to 24 months.
  1. Illiquidity
This new restriction of the interim derogation from the filing requirement to over-indebtedness only, in turn, means that companies that cannot pay their liabilities when they fall due on September 30, 2020 (and beyond) and, therefore, are illiquid under German insolvency law terms, may no longer justify such financial distress by claiming it is caused by the pandemic. Instead, they will now be obliged to file for insolvency based on illiquidity once the initial protection accorded to them by the March 2020 rules runs out at the end of September 30, 2020. With it being mid-September 2020 already, this will give the management of any entity facing serious current cash-flow problems only another two weeks to either remedy such cash flow problems and restore full solvency or file for insolvency on or shortly after October 1, 2020 due to their illiquidity at that point in time.
  1. Consequential Issues
The new, changed wording of the COVInsAG consequently restricts the other privileges connected with the temporary exemption from the filing requirement, i.e. that companies are permitted to keep trading during the extended time-window with certain protections against subsequent insolvency contestation rights, personal liability derogations or privileges and simplified access to new external or internal restructuring financing or loans, only to over-indebted companies. For them, these additional rules, which they may have already become accustomed to in the period between March 2020 and September 30, 2020, are simply extended until December 31, 2020. III.  Immediate Outlook This law reform is of utmost importance for the management and the shareholders of any German entities that are currently in significant financial distress. The ongoing, periodic monitoring of their own financial position will need to determine in an extremely short time-frame whether or not the respective company is either illiquid or over-indebted as of September 30, 2020. If necessary such analysis should be firmed up by involving external advice or restructuring experts. If the company is found to be over-indebted but not illiquid, the focus of any future turn-around must be December 31, 2020, i.e. the continued applicability of the COVInsAG rules may continue to provide some respite until then. If the company is found to be illiquid, the remaining time until September 30, 2020 must be used productively to either restore future liquidity via external or internal funding in the shortness of the available time or the filing for insolvency in early October 2020 becomes inevitable and should be prepared. Managing directors of illiquid companies that do not file for insolvency without undue delay, but continue trading regardless of the insolvency reason, will again face the twin risks of personal civil and criminal liability based on a delayed or omitted filing. They and their trading partners and creditors, furthermore, face the full power of the far-reaching array of insolvency contestation rights (Insolvenzanfechtungsrechte) for a subsequent insolvency administrator of any measures now taken outside of the protective force of the COVInsAG interim rules. _________________________________   [1]  In this context, see our earlier general COVID 19 alerts under: https://www.gibsondunn.com/whatever-it-takes-german-parliament-passes-far-reaching-legal-measures-in-response-to-the-covid-19-pandemic/ as well as under: https://www.gibsondunn.com/european-and-german-programs-counteracting-liquidity-shortfalls-and-relaxations-in-german-insolvency-law/.   [2]  In this context, again see: https://www.gibsondunn.com/whatever-it-takes-german-parliament-passes-far-reaching-legal-measures-in-response-to-the-covid-19-pandemic/, under section II.2, as well as with further analysis in this regard https://www.gibsondunn.com/european-and-german-programs-counteracting-liquidity-shortfalls-and-relaxations-in-german-insolvency-law/. __________________________________ The following Gibson Dunn lawyers have prepared this client update: Lutz Englisch, Birgit Friedl, Marcus Geiss. Gibson Dunn’s lawyers in the two German offices in Munich and Frankfurt are available to assist you in addressing any questions you may have regarding the issues discussed in this update. For further information, please feel free to contact the Gibson Dunn lawyer with whom you usually work, or the three authors: Lutz Englisch (+49 89 189 33 150, lenglisch@gibsondunn.com) Birgit Friedl (+49 89 189 33 122, bfriedl@gibsondunn.com) Marcus Geiss (+49 89 189 33 115, mgeiss@gibsondunn.com) © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 18, 2020 |
Gibson Dunn Ranked in ALB’s M&A Rankings 2020

Asian Legal Business has ranked Gibson Dunn as a Notable Firm for the Hong Kong and Singapore: International categories in its 2020 M&A Rankings, which recognizes the best firms in Asia for M&A work. The rankings were published on September 15, 2020. Gibson Dunn’s Mergers and Acquisitions Practice Group is an international leader in mergers, acquisitions, divestitures, spin-offs, proxy contests and joint ventures.  Our M&A capabilities are worldwide.  Gibson Dunn’s combination of U.S.-based lawyers and network of offices in financial centers abroad allows us to handle the most complex cross-border deals effectively and efficiently.

September 9, 2020 |
Webcast: Raising Capital in the Current Environment IV: Five Things to Know for Your Debt Offerings

The past several months have seen record volumes of debt issuance at historically low interest rates. At the same time, the COVID-19 pandemic has led to unforeseen challenges and novel practices for issuers, underwriters and their advisors working on these transactions. This webcast will discuss key legal, financial and logistical issues that are affecting debt offerings, as well as best practices for raising capital in the current environment. Please join our panel as they discuss recent developments in investment-grade and high-yield debt offerings, including market trends and disclosure considerations, as well as our expectations for the months ahead. View Slides (PDF)



PANELISTS: Boris Dolgonos is a partner in the New York office of Gibson, Dunn & Crutcher and a member of the Capital Markets and Securities Regulation & Corporate Governance Practice Groups. Mr. Dolgonos has more than 20 years of experience advising issuers and underwriters in a wide range of equity and debt financing transactions, including initial public offerings, high-yield and investment-grade debt offerings, leveraged buyouts, cross-border securities offerings, and private placements. Mr. Dolgonos has represented public and private companies, investment banks and other financial institutions and sovereign entities in transactions across North and South America, Europe, Asia and Africa. He has experience in many industries, including metals and mining, biotechnology, industrials, aviation, hospitality, media and telecommunications, financial services, technology, and retail. Doug Rayburn is a partner in the Dallas and Houston offices of Gibson, Dunn & Crutcher and a member of the firm’s Capital Markets, Energy & Infrastructure, Mergers & Acquisitions, Global Finance, Private Equity and Securities Regulation & Corporate Governance Practice Groups. His principal areas of concentration are securities offerings, mergers and acquisitions and general corporate matters. He has represented issuers and underwriters in over 200 public offerings and private placements, including initial public offerings, high-yield offerings, investment-grade and convertible note offerings, offerings by MLPs, and offerings of preferred and hybrid securities. Additionally, Mr. Rayburn represents purchasers and sellers in connection with mergers and acquisitions involving both public and private companies, including private equity investments and joint ventures. His practice also encompasses corporate governance and other general corporate concerns. Robyn E. Zolman is a partner in the Denver office of Gibson, Dunn & Crutcher and a member of the firm’s Capital Markets, Securities Regulation & Corporate Governance and Energy Practice Groups. Her practice is concentrated in securities regulation and capital markets transactions. Ms. Zolman represents clients in connection with public and private offerings of equity and debt securities, tender offers, exchange offers, consent solicitations and corporate restructurings. She also advises clients regarding securities regulation and disclosure issues and corporate governance matters, including Securities and Exchange Commission reporting requirements, stock exchange listing standards, director independence, board practices and operations, and insider trading compliance. She provides disclosure counsel to clients in a number of industries, including energy, telecommunications, homebuilding, consumer products, life sciences and biotechnology.
MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 0.5 credit hour, of which 0.5 credit hour may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact CLE@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 0.5 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.

September 8, 2020 |
Gibson Dunn Named Among 2020 Top Commercial Law Firms in Germany

The German weekly FOCUS recognized Gibson Dunn’s Frankfurt and Munich offices in its annual special issue, “Law.” The firm is recommended as “Top-Wirtschaftskanzlei 2020” [top commercial law firm] in the Compliance, Corporate Law, and Mergers & Acquisitions categories. The feature was published on September 5, 2020.

August 26, 2020 |
Webcast: Raising Capital in the Current Environment III: SPACs

Please join members of Gibson Dunn’s Capital Markets and Mergers and Acquisitions Practice Groups as they provide both practical advice and information about the latest legal developments regarding SPACs. Specifically, the panelists will discuss:

  • IPO Market Overview
  • IPO Considerations and Trends
  • Business Combinations –
    • Target Perspective
    • SPAC Perspective
  • London Listed SPACs
View Slides (PDF)

PANELISTS: Evan M. D’Amico is a corporate partner in the Washington, D.C. office of Gibson, Dunn & Crutcher, where his practice focuses primarily on mergers and acquisitions. Mr. D’Amico advises companies, private equity firms, boards of directors and special committees in connection with a wide variety of complex corporate matters, including mergers and acquisitions, asset sales, leveraged buyouts, spin-offs and joint ventures. He also has experience advising issuers, borrowers, underwriters and lenders in connection with financing transactions and public and private offerings of debt and equity securities. Matthew B. Dubeck is a partner in the Los Angeles office of Gibson, Dunn & Crutcher, where he practices in the firm’s Private Equity, Mergers and Acquisitions and Securities Regulation and Corporate Governance Practice Groups. He advises private equity firms, companies and investment banks across a wide range of industries, focusing on public and private merger transactions, stock and asset sales and joint ventures and strategic partnerships. Mr. Dubeck has particular expertise and experience in the use of transactional liability insurance, such as representation and warranty, tax and litigation risk insurance, to reallocate risk and to consummate transactions more efficiently on superior terms, particularly in the private equity and real estate industries. Christopher Haynes is an English qualified corporate partner in the London office of Gibson, Dunn and Crutcher. Chris has extensive experience in equity capital markets transactions and mergers and acquisitions including advising corporates, investment banks and selling shareholders on initial public offerings (including dual track processes), rights issues and other equity offerings as well as on public takeovers, private company M&A and joint ventures. He also advises on corporate and securities law and regulation. Stewart McDowell is a partner in the San Francisco office of Gibson, Dunn & Crutcher. She is a member of the firm’s Corporate Transactions Practice Group, Co-Chair of the Capital Markets Practice Group. Ms. McDowell’s practice involves the representation of business organizations as to capital markets transactions, mergers and acquisitions, SEC reporting, corporate governance and general corporate matters. She has significant experience representing both underwriters and issuers in a broad range of both debt and equity securities offerings. She also represents both buyers and sellers in connection with U.S. and cross-border mergers, acquisitions and strategic investments. Gerry Spedale is a partner in the Houston office of Gibson, Dunn & Crutcher.  He has a broad corporate practice, advising on mergers and acquisitions, joint ventures, capital markets transactions and corporate governance. He has extensive experience advising public companies, private companies, investment banks and private equity groups actively engaging or investing in the energy industry. His over 20 years of experience covers a broad range of the energy industry, including upstream, midstream, downstream, oilfield services and utilities.
MCLE 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 1.0 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 CLE@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.

August 20, 2020 |
13 Gibson Dunn Partners Named Lawyers of the Year

Best Lawyers® named 13 Gibson Dunn partners as the 2021 Lawyer of the Year in their respective practice areas and cities: Frederick Brown – San Francisco – Trademark Law Lawyer of the Year, Jessica Brown – Denver – Employment Law – Management Lawyer of the Year, Christopher Dillon – San Jose – Corporate Law Lawyer of the Year, Baruch Fellner – Washington, D.C. – Litigation – Labor and Employment Lawyer of the Year, Stewart McDowell – San Francisco – Banking and Finance Law Lawyer of the Year, Peter Modlin – San Francisco – Litigation – Environmental Lawyer of the Year, Kenneth Parker – Orange County – Litigation – Patent Lawyer of the Year, Doug Rayburn – Dallas – Securities/Capital Markets Law Lawyer of the Year, Douglas Smith – San Francisco – Corporate Governance Law Lawyer of the Year, Beau Stark – Denver – Mergers and Acquisitions Law Lawyer of the Year, Daniel Swanson – Los Angeles – Antitrust Law Lawyer of the Year, Jeffrey Thomas – Orange County – Litigation – Antitrust Lawyer of the Year and Robyn Zolman – Denver – Securities/Capital Markets Law Lawyer of the Year. The lawyers that were selected received particularly high ratings in Best Lawyers’ survey by earning a high level of respect among their peers for their abilities, professionalism and integrity. Only one lawyer in each legal community is selected as the Lawyer of the Year for each practice area.  The list was published in August 20, 2020.

August 12, 2020 |
Who’s Who Legal 2020 Asset Recovery, Energy, and Product Liability Defence Guides Recognize Eight Gibson Dunn Partners

Eight Gibson Dunn partners were recognized in Who’s Who Legal Asset Recovery 2020, Energy 2020, and Product Liability Defence 2020 guides. Dubai partner Graham Lovett was recommended in Asset Recovery. Houston partners Michael P. Darden, Tull Florey and Hillary Holmes, London partner Anna Howell, Singapore partner Brad Roach, and Washington, D.C. partner William Scherman were recommended in Energy. New York partner Daniel Thomasch was recommended in Product Liability Defence. The Product Liability Defence guide was published on June 17, 2020; the Asset Recovery guide was published on August 3, 2020; and the Energy guide was published on August 6, 2020.

August 4, 2020 |
2020 Mid-Year Sanctions and Export Controls Update

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The ongoing coronavirus has caused governments and populations to rethink how to conduct social interactions and in turn how to conduct business on a global scale. Despite the ongoing global public health crisis, the United States Government’s efforts to use its economic leverage to conduct foreign policy continues unabated. Indeed, throughout the first half of 2020, the United States continued to tighten the screws on Iran and Venezuela and has not shied away from using its economic arsenal in its escalating trade war with China.

As the global pandemic has deepened, there have been calls from some quarters, including from UN Secretary General António Guterres and UN High Commissioner for Human Rights Michelle Bachelet, for a temporary easing of sanctions—on humanitarian and public health grounds—against countries especially vulnerable to the spread of COVID-19, including Iran and Venezuela. U.S. officials have so far declined that invitation, citing the broad humanitarian exceptions already incorporated into U.S. sanctions measures. Underscoring the point, the United States Department of the Treasury's Office of Foreign Assets Control (“OFAC”) in April 2020 issued a fact sheet compiling all of the existing authorizations and exemptions for humanitarian trade and other assistance with respect to each comprehensively sanctioned jurisdiction, including Iran. This suggests that, for now at least, OFAC views its existing exemptions and authorizations as sufficient to meet the current public health emergency and has no intention or appetite for otherwise easing sanctions.

The pandemic has only further highlighted U.S.-China tensions and, unsurprisingly, the United States has continued to use sanctions and export controls not only to apply pressure in the escalating trade war but in response to China’s human rights abuses in Hong Kong and against the country’s Uyghur minority.

More broadly, the U.S. administration and OFAC have taken several measures to remind the world that compliance with economic sanctions remains of paramount importance despite the global upheaval. Even in the midst of the pandemic-induced chaos, OFAC still found time to issue an entirely new sanctions program addressing the humanitarian situation in Mali and has continued to take additional measures targeting Syria and North Korea. OFAC and BIS designations have continued apace, and the State Department has even gotten into the game by designating an increasing number of individuals as “Corrupt Actors” and “Human Rights Violators.” Taking a warning shot across the bow of the shipping industry, in May 2020, OFAC issued the latest in a series of industry advisories addressing deceptive practices in global maritime transportation, building upon previously published guidance relating to North Korea’s, Syria’s, and Iran’s illicit shipping practices. The advisory stresses that 90 percent of global trade involves maritime transportation, and that, even during a massive international public health crisis, participants must remain vigilant.

I. Major U.S. Program Developments

A. Iran

During the first half of 2020, the United States continued to increase sanctions pressure on the regime in Tehran while also seeking to enable the flow of humanitarian goods and services to the Iranian people to alleviate the suffering due to COVID-19. Notably, amid a spike in tensions between Washington and Tehran following the January 2020 killing of Iranian General Qassem Soleimani in a U.S. airstrike, the Trump Administration imposed secondary sanctions on some of the few remaining sectors of the Iranian economy not already subject to U.S. restrictive measures. Meanwhile, as Iran grappled with one of the first severe outbreaks of COVID-19, OFAC leveraged its existing authorities to facilitate the provision of aid to the Iranian people, including by opening a new Swiss channel for humanitarian trade and authorizing certain transactions to flow through Iran’s central bank.

On January 10, 2020, President Trump issued Executive Order 13902, which authorizes OFAC to designate entities operating in the construction, mining, manufacturing, or textiles sectors of the Iranian economy, as well as any other sector of the Iranian economy targeted by the U.S. Secretary of the Treasury. The order also authorizes the imposition of secondary sanctions against any non-U.S. person or company that knowingly engages in a significant transaction involving one of those targeted sectors. Following the expiration of a 90-day wind-down period on June 5, 2020, OFAC published guidance indicating how the agency expects to define those four sectors, as well as what types of dealings in goods and services are potentially sanctionable. For example, in light of the COVID-19 pandemic, OFAC clarified that the new manufacturing sanctions do not target persons or companies in Iran manufacturing medicines, medical devices, or products used for sanitation, hygiene, medical care, medical safety, and manufacturing safety (e.g., soap, hand sanitizer, ventilators, respirators, personal hygiene products, diapers, infant and childcare items, personal protective equipment, and manufacturing safety systems), solely for use within Iran and not for export abroad.

Additionally, consistent with longstanding U.S. policy in favor of legitimate humanitarian trade with sanctioned jurisdictions, the United States during the past six months also implemented several measures designed to facilitate Iran’s response to the coronavirus pandemic.

OFAC, building on a framework announced in October 2019 under which foreign governments and foreign financial institutions may establish approved payment mechanisms for humanitarian exports to Iran, in February 2020 announced that the first such payment channel has become operational. Developed in cooperation with the Swiss government, the Swiss Humanitarian Trade Arrangement is a voluntary mechanism under which OFAC will provide written confirmation, or “comfort letters,” to persons domiciled in Switzerland (including entities owned or controlled by U.S. persons), affirming that sales to Iran of food, agricultural commodities, medicine, and medical devices are not exposed to U.S. sanctions. To obtain these comfort letters, exporters must submit to stringent due diligence and reporting requirements to ensure that humanitarian exports are not improperly diverted to sanctioned parties. Given those exacting requirements, however, the number of transactions processed through the new Swiss payment channel so far remains relatively small.

In February 2020, OFAC issued Iran General License 8, which authorizes certain humanitarian transactions involving the Central Bank of Iran (“CBI”). Entities designated under OFAC’s counterterrorism authorities, including as of last year the CBI, are not only subject to the broad sanctions restrictions typically imposed on SDNs, but also may not participate in humanitarian trade with Iran—a category of activity generally exempt from sanctions restrictions. General License 8 therefore creates an exception under which both U.S. persons and non-U.S. persons are authorized to engage in certain transactions with the CBI involving sales to Iran of food, agricultural commodities, medicine, and medical devices. Notably, that exception is specific to the CBI and does not extend to transactions involving any other Iranian financial institution sanctioned under a U.S. counterterrorism authority, such as Executive Order 13224.

Moreover, as part of its “maximum pressure” campaign, the Trump administration has continued to tighten sanctions on Iranian transactions and activities that do not raise humanitarian concerns. In May 2020, the U.S. Department of State announced that, subject to a 60-day wind-down period that expires on July 27, 2020, the United States is ending sanctions waivers that have allowed non-U.S. persons to engage in certain activities involving Iran’s civil nuclear program. The United States in May and June also designated a steady stream of Iranian targets, including military front companies, senior law enforcement officials, ship captains, and metals producers. With a U.S. presidential election looming in November 2020, such Iran-related designations will likely continue apace throughout the months ahead.

B. Venezuela

Despite presiding over a collapsing economy, a deepening public health crisis, and the exodus of several million of its citizens, the regime of President Nicolás Maduro presently controls nearly all levers of power within Venezuela, including the country’s courts and armed forces. Expanding on earlier sanctions measures, the Trump administration during the first half of 2020 deployed an array of tools to deny the Maduro regime the resources and support necessary to sustain its hold on power—from indicting several of Venezuela’s top leaders to aggressively targeting virtually all dealings with Venezuela’s crucial oil sector.

In March 2020, the U.S. Department of Justice announced criminal indictments against President Maduro and 14 other high-level officials, including Venezuela’s chief justice and defense minister. The indictments allege a wide range of criminal conduct by Venezuela’s senior leadership, including overseeing a cartel that imported significant quantities of cocaine into the United States, corruption, money laundering, and sanctions evasion. While not formally a sanctions action, the announcement was notable because the United States, as a matter of policy, does not charge sitting heads of state—a restriction that was determined not to apply because the United States and nearly 60 other countries do not recognize Maduro as Venezuela’s rightful leader. In addition to constricting the officials’ ability to travel overseas for fear of being arrested and extradited, the indictments also potentially dim the prospects for a negotiated settlement to Venezuela’s political crisis if, upon ceding power, President Maduro and his top lieutenants face the prospect of being jailed in New York.

In addition to leveraging the criminal justice system, the Trump administration over the past six months repeatedly sanctioned (or threatened to sanction) non-U.S. persons for playing even an indirect role in bringing Venezuelan oil to market.

In February and March 2020, OFAC designated two subsidiaries of the Russian state-controlled oil giant Rosneft for brokering the sale and transport of Venezuelan crude—prompting Rosneft to announce shortly afterward that it will cease all operations in Venezuela and sell its Venezuelan assets to an unnamed company wholly owned by the Kremlin. However, this shift does not necessarily mean that Russia is abandoning its alliance with the Maduro regime or even its involvement in Venezuela’s oil industry. Rather, the transaction appears designed to protect Rosneft—the centerpiece of Russia’s oil sector—from the imposition of deeper U.S. sanctions by walling off all Venezuela-related dealings inside a special purpose entity that is perhaps less vulnerable to U.S. sanctions pressure than a large, publicly traded company.

In April 2020, OFAC further restricted dealings with Venezuela’s oil sector by narrowing one of the few remaining authorizations for U.S. companies to engage in dealings with the state-owned oil company Petróleos de Venezuela, S.A. (“PdVSA”). Since the United States imposed sanctions on PdVSA in January 2019, OFAC has issued, and repeatedly extended, a general license authorizing five named U.S. oil and oil field services companies to engage in all transactions and activities ordinarily incident and necessary to operations in Venezuela involving PdVSA and its various subsidiaries. This authorization was designed to enable specific empresas mixtas, which are joint ventures between large multinational energy companies and PdVSA, to continue operating.

The latest version of that license, issued on April 21, 2020, is more limited in scope—authorizing, until December 1, 2020, just certain “essential” activities involving those five companies’ joint ventures, including activities ordinarily incident and necessary to protecting the safety of personnel, preserving assets, and participating in shareholder and board meetings. OFAC now expressly excludes from the authorization a number of key activities, including (1) drilling, lifting, processing, purchasing, selling, or transporting Venezuelan-origin petroleum and petroleum products; (2) repairs or improvements to Venezuelan energy infrastructure; and (3) the payment of dividends to PdVSA entities. Moreover, the license for the first time provides for—but does not require—the wind down of the five companies’ dealings with PdVSA. By effectively prohibiting U.S. firms from extracting and selling Venezuelan-origin petroleum, this policy shift calls into question the continuing viability of the empresas mixtas more generally—at least after December 1, 2020. Though the general license could be renewed once more, if the five U.S. companies named in the license—and their non-U.S. peers, including a number of leading European energy firms with similar ventures—were ultimately to depart Venezuela, the United States stands to lose a foothold in an OPEC member state with enormous proven oil reserves.

Finally, reflecting the breadth of the Trump administration’s efforts to disrupt the Venezuela oil trade, OFAC in June 2020 repeatedly designated shipping companies and tankers for lifting Venezuelan crude. While these companies and their vessels were eventually de-listed following enhancements to their sanctions compliance programs and pledges to cease involvement with Venezuela’s oil sector for so long as the Maduro regime remains in power, these actions—coupled with reports of imminent plans by OFAC to designate dozens more vessels—have caused maritime companies to re-evaluate their exposure to Venezuela. Indeed, ship owners, managers and operators, flag registries, port operators, insurance companies, and financial institutions are now effectively on notice that, absent authorization from OFAC, any involvement in transporting Venezuelan oil is now highly risky.

C. Syria

As the almost decade-old conflict in Syria persists, the U.S. Government has continued to use economic sanctions as a means to pressure the Assad regime as well as other actors in the region who continue to commit human rights abuses against the Syrian civilian population. On June 17, 2020 the Caesar Syria Civilian Protection Act of 2019 (“Caesar Act” or the “Act”) went into effect (180 days since its signing by President Trump as part of the 2020 National Defense Authorization Act). The Caesar Act, named after the Syrian defector known as “Caesar” who smuggled out photographs of torture occurring under the Assad regime, was implemented by Congress to, in the words of Secretary Pompeo, “promote accountability for brutal acts against the Syrian people by the Assad regime and its foreign enablers.” The Act requires the President, at the 180-day mark, to take certain actions, including with respect to the Act’s sanctions provisions. The provisions strengthen secondary sanctions with respect to Syria by requiring the President to enact certain sanctions against foreign persons found to be acting in support of the Government of Syria or other sanctioned individuals or groups operating in Syria. Specifically, Congress has required the President to sanction foreign individuals and entities who knowingly:

  • provide financial, material, or technological support to: (i) the Government of Syria or a senior official; (ii) foreign military or paramilitary forces operating in Syria on behalf of the Syrian, Russian, or Iranian governments; or (iii) foreign persons already sanctioned under the United States’ Syria sanctions program;
  • sell or provide “significant” goods, services, or any other support that “significantly facilitates” the Syrian Government’s natural gas or petroleum production;
  • sell or provide aircraft or aircraft parts to foreign persons or forces operating in areas controlled by the Syrian government or otherwise associated with the Syrian government, or provides goods to services to any such foreign person;
  • provide “significant” construction or engineering services to the Syrian government.

Additionally, the Act requires the Treasury Secretary to determine, by June 17, 2020, whether the Central Bank of Syria (“CBS”) constitutes an institution of primary money laundering concern under the USA PATRIOT ACT, a law enacted passed in 2001 to strengthen U.S. measures to prevent, detect, and prosecute international money laundering and terrorist financing. A primary money laundering concern designation would require U.S. banks that deal with the CBS to take certain information gathering and record-keeping measures and, more significantly, could result in U.S. banks’ being prohibited from opening or maintaining correspondent or payable-through accounts that involve the CBS. However, as of date of this writing no such determination appears to have been made.

Also on June 17, 2020, the U.S. Treasury and State Departments designated 39 individuals and entities under the Caesar Act and Executive Order 13894 and one month later, on July 31, 2020, another 14 individuals and entities were designated under the same authorities. On June 5, 2020, OFAC promulgated new regulations implementing EO 13894 under 31 C.F.R. part 569.  Interestingly, Syrian first lady Asma al-Assad and Assad’s adult son, Hafez al-Assad, were designated for the first time under this new authority. Syrian President Bashar al-Assad and other Syrian military officials were also named, but had previously been designated under authorities such as EO 13573 and EO 13582, which together provided for the designation of senior Syrian government officials and, more broadly, the Government of Syria. As we previously discussed in a client alert and last year’s update, EO 13894 was initially enacted in October 2019 in order address Turkey’s aggression in northern Syria, rather than members of the Assad regime itself.

D. North Korea

During the first half of 2020, the United States continued to mount pressure on the government of North Korea through the issuance of two separate sanctions advisories targeting the country’s illicit activities in the cyber and maritime sectors, amending and intensifying the North Korea Sanctions Regulations (“NKSR”), and bringing indictments against individuals for evading U.S. sanctions for the purpose of supporting the despotic regime’s nuclear program.

On April 15, the U.S. Departments of State, the Treasury, and Homeland Security, and the Federal Bureau of Investigation (“FBI”) issued an advisory on the North Korean Cyber Threat and on measures that the U.S. Government encourages industry and individuals to take to protect themselves from cyber-enabled malicious activity. The advisory notes that North Korea has increasingly relied upon cybercrime as a means to generate revenue in the face of mounting international sanctions. According to a UN sanctions committee expert report, North Korea has attempted to steal as much as U.S. $2 billion through illicit cyber activities.

According to the advisory, cyberattacks sponsored by North Korean state-run organizations—including ransomware, spear phishing, and extortion campaigns—have targeted U.S. and international financial institutions, critical infrastructure, government and military networks, private industry, and individuals. Notable cyber incidents attributed to state-sponsored actors in North Korea include: the hacking of Sony Pictures in 2014, the theft of over $80 million from Bangladesh Bank in 2016, and the WannaCry 2.0 ransomware attacks in 2017.

The purpose of the advisory is to put industry and individuals on notice of the threat, to encourage commercial actors to adopt technical and behavioral measures to enhance their cybersecurity, and to encourage communication between industry and relevant U.S. Government agencies—including the Cybersecurity and Infrastructure Security Agency (“CISA”) and the FBI Cyber Division.

Among the measures companies are encouraged to take is to implement appropriate anti-money laundering/countering the financing of terrorism/counter-proliferation financing compliance standards and programs, such as those published by the Financial Action Task Force or required, in the United States, under the Bank Secrecy Act. U.S. enforcement agencies, including FinCEN, are particularly concerned about U.S. financial institutions’ involvement in digital currency platforms that provide anonymous payment and account services without transaction monitoring, suspicious activity reporting or customer due diligence.

Separately, on April 10, 2020, OFAC issued amendments to the NKSR, found at 31 C.F.R. part 510. These amendments followed Congressional legislation focused on applying further pressure to the isolated regime’s stagnant economy, implementing provisions of the North Korea Sanctions and Policy Enhancement Act of 2016 (“NKSPEA”) (as amended by the Countering America’s Adversaries Through Sanctions Act (“CAATSA”) and the National Defense Authorization Act for Fiscal Year 2020 (“2020 NDAA”). The amendments made several changes to the NKSR, including: implementing secondary sanctions for certain transactions; adding potential sanctions restricting the use of correspondent accounts for non-U.S. financial institutions that have provided significant services to SDNs; prohibiting non-U.S. subsidiaries of U.S. financial institutions from transacting with the government of North Korea or any SDN designated under the NKSR; and revising the definitions of “significant transactions” and “luxury goods.” Due to the rather limited size of the North Korean economy, these changes may not have a very large practical effect; however, these changes serve to remind the international community of the risks involved when dealing with North Korea.

These risks were made even more apparent when, on May 28, 2020, DOJ unsealed an indictment charging 28 North Korean and 5 Chinese individuals, acting on behalf of North Korea’s Foreign Trade Bank, for facilitating over $2.5 billion in illegal payments to support North Korea’s nuclear program. Though the prosecution is still in its early stages, the indictment is yet another reminder that U.S. enforcement agencies will continue to hold individuals and entities accountable—at times criminally accountable—for sanctions violations.

Rounding out the first half of the year, on July 16, 2020, OFAC announced that it had entered into a settlement agreement with UAE-based Essentra FZE Company Limited for violating the NKSR by exporting cigarette filters to North Korea using deceptive practices, including the use of front companies in China and elsewhere, and receiving payment into its accounts at a foreign branch of a U.S. bank. Significantly, OFAC found that Essentra FZE violated 31 C.F.R. § 510.212 by “causing” the U.S. bank to export financial services or engage in transactions involving North Korea. This enforcement action is reminiscent of OFAC”s 2017 settlement with CSE TransTel Pte. Ltd. (“TransTel”), a wholly owned subsidiary of CSE Global Limited (“CSE Global”). As we described in our 2017 Sanctions Year-End Update, OFAC in the CSE Global case appeared to expand its jurisdiction to cases in which non-U.S. parties “cause” U.S. entities (like financial institutions) to violate their sanctions obligations.

II. New Developments

A. China

Against the backdrop of the U.S.-China trade war, the United States has taken several sanctions measures in recent months targeting China’s aggression in its Xinjian region and in Hong Kong. In a volatile political season, there is significant pressure in the U.S. Congress to take steps to deter China’s alleged human rights abuses in its provinces, though it remains to be seen whether these sanctions measures will have any measurable economic impact. Moreover, recent weeks and months have seen a marked deterioration in the rhetoric used by the Trump administration to describe China’s actions, and the Chinese government has taken retaliatory measures that so far have been deemed largely symbolic. China experts report these events as a “turning point” in the U.S.-China relationship and as a downward “ideological spiral” and new “cold war.”

1. Human Rights & Forced Labor Concerns Regarding the Xinjiang Uyghur Autonomous Region

In June and July, the government took several measures aimed at confronting and punishing China’s alleged human rights abuses in the Xinjiang region. On June 17, 2020, the President signed the Uyghur Human Rights Policy Act, which condemns actions taken by the government of China with respect to Turkic Muslims and other Muslim minority groups in the Xinjiang Uyghur Autonomous Region (“XUAR”). The Act requires the President to submit a report to Congress within 180 days that identifies foreign persons, including Chinese government officials, who are responsible for gross violations of human rights in Xinjiang, including, as identified in the legislation, torture, arbitrary detention, abduction, and the operation of internment and forced labor camps. The Act requires the imposition of blocking sanctions and a visa ban on persons identified in the report.

Shortly after passage of the Act, the U.S. Departments of State, Treasury, Commerce, and Homeland Security issued the Xinjiang Supply Chain Business Advisory, a detailed guidance document for industry highlighting risks related to doing business with or connected to forced labor practices in Xinjiang and elsewhere in China. The Advisory states that businesses and individuals engaged in specified industries may face reputational or legal risks if their activities involve support for or acquisition of goods from commercial and governmental actors involved in illicit labor practices. The following activities were noted:

  • Selling or providing biometric devices, cameras, computers, items with surveillance capabilities, microchips and microprocessors, tracking technology, or related equipment, software, and technology; and
  • Involvement in joint ventures with PRC government officials and departments, or Chinese companies whose intellectual property has been known to aid the development or deployment of mass surveillance systems.

The Advisory recommends that businesses with supply chain links to Xinjiang assess their legal, economic, and reputational risks and take appropriate steps to implement reasonable human rights due diligence. The document provides many resources and links to internationally-recognized standards for conducting supply chain due diligence and establishing related corporate responsibility policies and procedures.

Ratcheting Up Designations

On July 9, OFAC designated the Xinjian Public Security Bureau and four current and former senior officials of the Chinese Communist Party (“CCP”) under authority delegated pursuant to the Global Magnitsky Act. The State Department announced complementary visa restrictions on three of the designated CCP officials. On July 31, the U.S. designated the Xinjiang Production and Construction Corps (“XPCC”), a paramilitary group associated with the CCP, as well as the XPCC’s former Political Commissar and Deputy Party Secretary and Commander, also pursuant to the Global Magnitsky Act. We discuss the designation of other entities using U.S. export control authorities in Section IV.G, supra.

In response to the July 9 designations, on July 13, China announced “corresponding sanctions” against four U.S. officials and the U.S. Congressional-Executive Commission on China, an independent U.S. Government agency created by statute in 2001. Though these sanctions have widely been described as “symbolic,” it could portend further retaliatory action by China in the future.

2. Hong Kong

The U.S. Government has taken several measures in early 2020 in response to China’s crackdown on ongoing protests in Hong Kong, opposing China’s proposed legislation that would impose serious criminal penalties on activities deemed to constitute separatism, subversion or collusion with a foreign government.

On May 28, 2020, U.S. Secretary of State Michael Pompeo reported to Congress that Hong Kong no longer warrants preferential treatment under U.S. law as it no longer maintains a “high degree of autonomy” from mainland China. The “de-certification” was announced in conjunction with the State Department’s annual report on the status of Hong Kong required under the United States-Hong Kong Policy Act of 1992, as amended by the Hong Kong Human Rights and Democracy Act of 2019. On July 14, 2020, President Trump issued an Executive Order formally revoking Hong Kong’s special trading status. The effects of this de-certification and revocation are discussed further below in Section IV.F, supra.

The State Department also announced visa restrictions on current and former members of the CCP believed to be responsible for “undermining Hong Kong’s high degree of autonomy,” as guaranteed by the 1984 Joint Declaration signed by Great Britain and Hong Kong and governing the terms of the transfer of Hong Kong back to Chinese sovereignty. Under the Joint Declaration, Hong Kong was to retain unchanged its internal economic, political, and legal institutions through the transfer, effective July 1, 1997, for a period of fifty years until 2047.

Hong Kong Autonomy Act authorizes additional sanctions

After Beijing officials enacted the national security law on an accelerated basis, the U.S. Congress responded with legislation that would authorize the U.S. Government to impose sanctions on foreign persons determined to have materially contributed to the failure of China to meet its obligations under the Joint Declaration, or its implementation in Hong Kong’s Basic Law, establishing the rights and freedoms particular to Hong Kong. President Trump signed the Hong Kong Autonomy Act on July 14, 2020.

The legislation requires the Secretaries of State and the Treasury to submit a report to Congress within 90 days of enactment identifying persons who have materially contributed to China’s actions in apparent violation of the Joint Declaration or the Basic Law. Blocking sanctions and visa restrictions are required within one year of the report. The Secretaries of State and the Treasury are also required to report to Congress if they have determined that any foreign financial institutions have knowingly conducted a significant transaction with a person identified under the Act. Sanctions for financial institutions include asset freezes, bans on banking or correspondent account transactions with U.S. financial institutions, and sanctions on individual officers, among other restrictions.

B. Select Designations

1. SDN List: Shanghai Saint Logistics Limited

On May 19, 2020, OFAC designated the China-based Shanghai Saint Logistics Limited (“Shanghai Saint Logistics”) for acting as a general sales agent for Iranian commercial airline Mahan Air, an entity sanctioned by OFAC under counterterrorism authorities in October 2011 and by the State Department under antiproliferation authorities in December 2019.

According to the U.S. Government, Mahan Air has, for years, transported terrorists and lethal cargo throughout the Middle East in support of Iran’s Islamic Revolutionary Guard Corps (“IRGC”) and the Assad regime in Syria. Mahan Air has also supported the Maduro regime by recently chartering flights to Venezuela for Iranian technicians and technical equipment (containing China-sourced materials).

As we pointed out in our 2019 Year-End Sanctions Update, OFAC’s July 2019 advisory warned non-U.S. persons that they could face designation or secondary sanctions penalties for dealing with Mahan Air. And the year before, U.S. Secretary of the Treasury Steve Mnuchin warned the aviation industry to “sever all ties and distance themselves immediately from this airline.” OFAC has backed up these warnings with action. In the past two years, OFAC has systematically targeted the non-U.S. actors supporting Mahan Air.

Shanghai Saint Logistics joins six other general sales agents (“GSAs”) that have already been blacklisted by OFAC for dealing with Mahan Air. A GSA is an agent providing services on behalf of an airline, typically under the airline’s brand. These services can include sales, marketing, freight handling, administrative services, and financial services. The now seven GSAs sanctioned for supporting Mahan Air span the globe, and include entities based in the United Arab Emirates, Malaysia, and Thailand.

Unsurprisingly, the designation of Shanghai Saint Logistics has not been received well by the government the People’s Republic of China (“PRC”). The PRC has called the designation “illegal” and has asked that the U.S. Government “change course and correct its mistake.” As a PRC Foreign Ministry spokesperson put it, “China stands consistently against U.S. unilateral sanctions and so-called long-arm jurisdiction.”

2. Cuba Restricted List: FINCIMEX and Travel Companies

Consistent with President Trump’s mandate to “identify the entities or subentities . . . that are under the control of, or act for or on behalf of, the Cuban military, intelligence, or security services or personnel,” the State Department has maintained a List of Restricted Entities and Subentities Associated with Cuba (the “Cuba Restricted List”) since November 2017. As we covered in our November 16, 2017 client alert, OFAC generally prohibits U.S. persons and entities from engaging in direct financial transactions with those entities and subentities on the Cuba Restricted List. BIS also has a general policy of denying applications to export or reexport items for use by such listed entities and subentities.

On June 12, 2020, the State Department added seven Cuban military-owned subentities—most operating in Cuba’s tourism industry—to the Cuba Restricted List: (1) a financial services company (FINCIMEX); (2) three hotels (Hotel Marqués de Cardenas de Montehermoso, Hotel Regis, Playa Paraíso Hotel); (3) two diving centers (Varadero, Gaviota Las Molas); and (4) a marine park for tourists (Cayo Naranjo dolphinarium). In announcing the additions, Secretary of State Pompeo stated that the profits generated by these seven subentities were being used to oppress the Cuban people and fund interference in Venezuela. A State Department senior official apparently characterized the additions as a “birthday present to Raul Castro” who turned 89 the day prior.

The listing of FINCIMEX, which handles remittances to Cuba and processes foreign-issued credit cards, is notable. FINCIMEX is the exclusive Cuban representative of Western Union, the vendor of choice for thousands of Americans who send money to their Cuban relatives. A Western Union spokesperson stated that, despite the FINCIMEX listing, “business and services from the U.S. to Cuba are operating as usual and [are] in compliance with U.S. law and regulations.” At this stage, it remains to be seen to what degree remittances to Cuba will be affected in practice. At the very least, this development is consistent with the Trump administration’s recent attempts to tighten remittance-related allowances, such as imposing $1,000 per quarter cap on remittances to Cuba as of September 2019. For more on these remittance-related restrictions, see our 2019 Year-End Sanctions Update.

3. Section 7031(c) Designations: Corrupt Actors and Human Rights Violators

Pursuant to Section 7031(c) of the Further Consolidated Appropriations Act of 2020, “[o]fficials of foreign governments and their immediate family members about whom the Secretary of State has credible information have been involved in significant corruption . . . or a gross violation of human rights [are] ineligible for entry into the United States.” Section 7031(c) designations can be made public or kept private by the State Department. A variation of this authority has existed in annual State-Department appropriations legislation since 2008. However, the Trump administration was the first to implement it when it publicly designated an allegedly corrupt former Albanian prosecutor under Section 7031(c) in February 2018.

Since then, the Trump administration has not been shy about adding to the Section 7031(c) list. Currently, more than 150 individuals (including immediate family members) from over thirty countries have been publicly designated. Thirty of these individuals were designated in the first three months of 2020. They include, for example: (1) thirteen former military personnel from El Salvador allegedly involved in the killing of six Jesuit priests and two others on November 16, 1989 on the campus of Central American University; (2) IRGC Commander Hassan Shahvapour, whose military units killed as many as 148 Iranian protestors in November 2019; and (3) Roberto Sandoval Castañeda, a former governor of the Mexican state of Nayarit, who misappropriated state assets and received bribes from narcotics trafficking organizations. Gibson Dunn will continue to monitor the use of Section 7031(c) designations, as well as other human-rights-based tools of foreign policy available to the President such as the Global Magnitsky sanctions.

III. Other U.S. Developments

A. International Criminal Court

As we have previously noted, the Trump administration has deployed sanctions in unprecedented ways and directed their force at surprising targets. On June 11, the President, unilaterally and without coordination with the United States’ European partners, issued an Executive Order authorizing sanctions against foreign persons determined to have engaged in any effort by the International Criminal Court (“ICC”) to investigate, arrest, detain, or prosecute United States or any U.S. ally personnel without the consent of the United States or that ally. Previously, on March 5, the ICC announced that it would authorize its chief prosecutor to open an investigation into alleged war crimes committed in Afghanistan, including any that may have been committed by U.S. personnel. The Executive Order refers to this decision and reiterates that the United States is not a party to the Rome Statute and has not consented to ICC jurisdiction. To date, no designations have been made under the order.

This action is somewhat reminiscent of the quickly-implemented, and just as quickly removed, sanctions against Turkey in October 2019—the first time that sanctions had been used to target government ministries of a NATO-member country. Unlike the October 2019 sanctions against Turkey, however, it is unlikely that this order will be revoked in the near future. The June 11 Executive Order demonstrates the continued willingness of the Trump administration to use sanctions to advance political and policy interests that traditionally have been outside the conventional use of sanctions.

B. New York Department of Financial Services

New York’s Department of Financial Services (“DFS”), the state’s key regulator in the financial industry, continues to bring enforcement actions against banks that have a New York presence for money laundering and sanctions violations. In its first action involving allegations of sanctions violations since its $405 million fine against Unicredit Group in April 2019, on April 20, 2020, DFS announced a $35 million dollar settlement with the Industrial Bank of Korea (“IBK”) for its failure to maintain adequate Bank Secrecy Act and anti-money laundering (“AML”) compliance programs. Among the compliance failures, DFS noted that IBK failed to detect a money laundering scheme that involved circumventing unspecified sanctions laws, with almost $1 billion clearing through New York banks.

Later that month DFS announced a $220 million settlement with Bank HaPoalim for knowingly facilitating clients’ tax evasion, and in July the regulator brought a $150 million action against Deutsche Bank for its failure to flag suspicious activities involving Jeffrey Espstein’s accounts as well as its failure to adequately monitor the activities of its clients Danske Estonia and FBME Bank, despite known risks associated with both banks. These actions, together with the appointment of a new DFS General Counsel with extensive background in AML and sanctions compliance, indicate that the state regulator will continue to devote significant resources to sanctions and AML enforcement; financial institutions with a New York presence should take heed that OFAC is far from being the only agency monitoring this space.

IV. Export Controls

Despite operating under work-from-home orders due to COVID-19 and a number of significant items still remaining on their to-do list, the staff at the U.S. Department of Commerce’s Bureau of Industry and Security (“BIS”) has already had an extraordinarily busy year administering U.S. export controls on dual-use goods, software, and technology. BIS is continuing to evaluate how to identify and control exports of “emerging and foundational technologies,” as required by the Export Control Reform Act of 2018, with anticipated controls on emerging technologies expected any day and new proposals for foundational technologies reportedly in the pipeline as well. In the meantime, BIS has imposed a number of significant new controls on trade with China and Hong Kong and has suggested that more may be on the way. Alongside these developments, BIS has continued the use of its powerful Entity List designation tool to effectively ban U.S. exports to entities implicated by the Executive Branch’s interagency End-User Review Committee (“ERC”) in certain human rights violations in the XUAR and elsewhere in China.

These developments demonstrate that BIS is continuing to move away from its past as a purely technical agency and towards a much more dynamic future in which its authorities are used for foreign policy and national security objectives, not unlike OFAC. In some respects this is because the collateral impact of an SDN designation on a large company, such as Huawei, is too significant and disruptive to the global economy, and the more limited impact on being added to the Entity or Unverified Lists is more palatable. As such, as the trade war with China heats up and the potential for more designations of even more economically consequential actors becomes a reality, the administration (and the next one) will likely continue to rely on these “lesser” restrictions in place of adding these too-big-to-sanction entities to the SDN blacklist.

A. 0Y521 Series Classification for Geospatial SW

On January 3, BIS announced that it would be imposing new export controls on certain types of artificial intelligence software specially designed to automate the analysis of geospatial imagery in response to emergent national security concerns related to the newly covered software. Covered software includes products that employ artificial intelligence to analyze satellite imagery and identify user-selected objects. As a result of the new controls, a license from BIS is now required to export the geospatial imagery software to all countries, except Canada, or to transfer the software to foreign nationals. The only exception to this license requirement is for software transferred by or to a department or agency of the U.S. Government.

Implementing new export controls can often be a lengthy process, sometimes requiring international coordination. However, to implement this new license requirement, BIS deployed a rarely used tool for temporarily controlling the export of emerging technologies—the 0Y521 Export Controls Classification Number (“ECCN”). This special ECCN category allows BIS to impose export restrictions on previously uncontrolled items that have “significant military or intelligence advantage” or when there are “foreign policy reasons” supporting restrictions on its export. Although these controls would only last one year, items subjected to these controls can be moved to a more permanent ECCN before the expiration of the classification.

These controls on covered geospatial imagery software will last least until January 2021, and the United States will work with its allies over the course of 2020 to impose permanent, multilateral controls on this software. As noted above, we are also expecting BIS to publish a suite of new controls on “emerging technologies” in the near future. BIS has also indicated that it hopes to soon publish an Advanced Notice of Proposed Rulemaking on “foundational” technologies.

B. Expansion of Military End Use/User Rule

In response to U.S. Government concerns about significant overlap between the development of China’s military and commercial sectors, BIS announced a range of regulatory changes on April 28. The most significant of these changes was the expansion of U.S. controls on exports of items to military end users or for military end uses. Specifically, the new rule, which was implemented on June 29, strengthens the controls on exports to China, Russia, and Venezuela by:

  • Expanding the definition of “military end uses” for which exports must be authorized;
  • Adding a new license requirement for exports to Chinese “military end users”;
  • Expanding the list of products to which these license requirements apply; and
  • Broadening the reporting requirement for exports to China, Russia, and Venezuela.

1. Expanding Military End Uses Subject to Control

Exporters of certain goods, software, or technology that are subject to the Export Administration Regulations (“EAR”) previously required a license from BIS to provide those items to China, Russia, or Venezuela if the exporters knew or had reason to know that the items were intended, entirely or in part, for a “military end use” in those countries. This licensing requirement is separate from the EAR’s item-based licensing requirements that otherwise identify which items require export licenses when exported to specific countries and which are based on a range of national security and foreign relations policies. Under the separate, military end use and end user license requirement, “military end use” was defined to include the “use,” “development,” or “production” of certain military items. An export was considered to be for the “use” of a military item if the export is for the operation, installation, maintenance, repair, overhaul and refurbishing of the military item. The exported item had to perform all six functions in order to be considered a “use” item subject to the military end use restriction.

The new rule expands the definition of “military end use” in two important ways. Where the prior formulation only captures items exported for the purpose of using, developing, or producing military items, the revised rule also captures items that merely “support or contribute to” those functions. The revised rule also effectively broadens the definition of “use.” Rather than requiring that an item perform all six previously listed functions, an item that supports or contributes to any one of those functions will now be subject to the military end use license requirement. For example, a repair part for a military item that might not have required a license under the previous formulation (perhaps because it was not also required for the military item’s installation) would be subject to the updated license requirement.

2. Restricting Exports to Chinese Military End Users

Under the prior regulations, exports to military end users in Russia and Venezuela were subject to a specific license requirement. The new rule now also require licenses for exports of covered items to Chinese military end users.

Military end users covered by this license requirement not only include national armed services, police, and intelligence services, but also include “any person or entity whose actions or functions are intended to support ‘military end uses.’” Taken together with the newly broadened definition of “military end uses,” this restriction may apply to a significant number of private entities in China, even those that are engaged largely in civilian activities. For example, a manufacturing company that has an unrelated contract with a military entity could be considered a “military end user” subject to these strict licensing requirements. Given that applications for BIS licenses to export covered items for military end uses or end users face a presumption of denial, this restriction could have a significant impact on commerce with large swaths of the Chinese economy, where the U.S. Government has indicated its concerns about military-civilian collaboration in Chinese industry.

3. Expanding the List of Covered Items

The updated rule also expands the category of goods, software, or technology that require a license for military end use or end user exports. The previous military end use/end user license requirement applied to a relatively limited set of items specifically described in a supplement to the rule. The revised rule expands the scope of the item categories already listed and adds many new categories of covered items—including goods, technology, and software relating to materials processing, electronics, telecommunications, information security, sensors and lasers, and propulsion.

Many of the new items were previously subject to some of the EAR’s most permissive controls and did not generally require a license for export to China, Russia, or Venezuela. For example, mass market encryption software (ECCN 5D992)—a category which includes many types of software that incorporate or call on common encryption functionality—were not previously subject to the military end use restrictions but now are subject to the new controls.

4. Broadening the Reporting Requirement

BIS is also now requiring exporters to report more often and to provide more data on items provided to China, Russia, or Venezuela.

Under the previous rules, exporters were not required to provide Electronic Export Information (“EEI”) for shipments valued under $2,500. Exporters also were not required to provide the ECCN for shipments of items that were only controlled for export because of antiterrorism concerns—the most permissive and most frequently applied category of control on the EAR’s list of items controlled for export.

Under the new rules, there is no value threshold. EEI is generally required for all shipments to China, Russia, or Venezuela of items described on the Commerce Control List (CCL) regardless of value (i.e., all items except those classified EAR 99). Moreover, exporters are required to provide the ECCNs for all items exported to China, Russia, or Venezuela, regardless of the reason for control.

In announcing this change, U.S. Commerce Secretary Wilbur Ross noted that “[c]ertain entities in China, Russia, and Venezuela have sought to circumvent America’s export controls, and undermine American interests in general.” Secretary Ross vowed that the United States would “remain vigilant to ensure U.S. technology does not get into the wrong hands.” This amendment to the EEI reporting requirements—along with the other new licensing requirements—is designed to ensure that BIS and other U.S. Government trade enforcement agencies have increased visibility into shipments to jurisdictions of significant concern.

C. Removal of License Exception for Civilian End Use

On June 29, BIS also removed License Exception Civil End Users (“CIV”) from Part 740 of the EAR. This exception previously allowed eligible items controlled only for National Security (NS) reasons to be exported or reexported without a license for civil end users and civil end uses in countries included in Country Group D:1, excluding North Korea. NS controls are BIS’s second most frequently applied type of control, applying to a wide range of items listed in all categories of the CCL. Country Group D:1 identifies countries of national security concern for which the Commerce Department will review proposed exports for potential contribution to the destination country’s military capability. D:1 countries include China, Russia, Ukraine, and Venezuela, among others.

By removing License Exception CIV, the Commerce Department now requires a license for the export of items subject to the EAR and controlled for NS reasons to D:1 countries. As with the expansion of the military end use/end user license requirements described above, the Commerce Department has stated that the reason for the removal of License Exception CIV is the increasing integration of civilian and military technological development pursued by countries identified in Country Group D:1, making it difficult for exporters or the U.S. Government to be sufficiently assured that U.S.-origin items exported for apparent civil end uses will not actually also be used to enhance the military capacity contrary to U.S. national security interests.

D. Proposed Amendment of License Exception APR

BIS also proposed to amend the EAR’s License Exception Additional Permissive Reexports (“APR”), which currently allows the unlicensed reexport (the export of a U.S.-origin item from one non-U.S. country to another non-U.S. country) of an item subject to the EAR from trusted allies with similar export control regimes (i.e., listed in Country Group A:1, and Hong Kong) to countries presenting national security concerns (i.e., Country Group D:1, except North Korea). To be eligible for the exception, the reexport must also be consistent with the export licensing policy of the reexporting country and the item must be subject to only a subset of other controls (i.e., controlled only for antiterrorism, national security, or regional security reasons), among other limitations. The reexporting countries identified in Country Group A:1 include those countries that are participants with the United States in the Wassenaar Arrangement, a multilateral consortium that develops export controls on conventional weapons and dual-use items and underlies much of the U.S. export control regime. BIS’s proposed amendment would remove this portion of the license exception.

The Commerce Department explained that it has proposed this amendment because of concerns regarding variations in how the United States and its international partners, including those in Country Group A:1, perceive the threat caused by the policy of civil-military technological integration pursued by D:1 countries. Due to these alleged disparities, reexports under License Exception APR have occurred that reportedly would not have been licensed by BIS if the export had taken place directly from the United States.

This proposed rule change echoes recent changes affecting the scope of investment reviews by the U.S. Committee on Foreign Investment in the United States (“CFIUS”), by which the United States has similarly sought to incentivize foreign allies to harmonize their national security-related measures with those of the United States. In the new CFIUS rules implemented in February and previously described here, the Committee will require “excepted foreign states” to ensure their national security-based foreign investment review process meets requirements established by CFIUS in order to retain their excepted status.

E. Huawei Direct Product Rule

In addition to the broad new restrictions on Chinese trade described above, the United States has also focused specifically on restricting trade with Huawei Technologies Co. Ltd. (“Huawei”)—one of the world’s largest technology companies—on the basis of concerns about espionage and national security risks that U.S. officials allege its products may present. Among other U.S. Government initiatives to dissuade U.S. allies from partnering with Huawei and other Chinese telecommunications providers in the development and deployment of 5G networks, BIS has designated Huawei and over one hundred of its affiliates to the Entity List, which has significantly limited Huawei’s ability to source many products directly from the United States and the non-U.S. affiliates of many U.S. companies.

On May 15, BIS announced a new rule to further restrict Huawei’s access to U.S. technology. The rule amends the “Direct Product Rule” and the BIS Entity List to restrict Huawei’s ability to share its semiconductor designs or rely on foreign foundries to manufacture semiconductors using U.S. software and technology.

Although Huawei’s Entity List designation had already effectively cut off Huawei’s access to exports of most U.S.-origin products and technology, BIS has claimed that Huawei has responded to the designations by moving more of its supply chain outside the United States. Huawei and many of the foreign chip manufacturers that Huawei uses, however, still depend on U.S. equipment, software, and technology to design and produce Huawei chipsets.

BIS’s action expands one of the bases on which the U.S. can claim jurisdiction over items produced outside of the United States. Generally, under the EAR, the U.S. claims jurisdiction over items that (1) are U.S. origin; (2) foreign-made items that are being exported from the U.S., (3) foreign-made items that incorporate more than a minimal amount of controlled U.S.-origin content, and (4) foreign-made “direct products” of certain controlled U.S.-origin software and technology. Under the fourth basis of jurisdiction, also known as the Direct Product Rule, foreign-made items are subject to EAR controls if they are the direct product of certain U.S.-origin technology or software or are the direct product of a plant or major component of a plant located outside the U.S., where the plant or major component of a plant itself is a direct product of certain U.S.-origin software and technology. Items that are subject to EAR controls may require BIS licensing depending on the export classification of the item and its destination, the end use to which the item is being put, and the end user receiving it. Depending on the licensing policy BIS applies to particular exports, BIS can effect an embargo on the export of items subject to the EAR to particular countries, end uses, and end users.

BIS’s new rule allows for the application of a tailored version of the Direct Product Rule to parties identified on its Entity List, with a bespoke list of controlled software and technology commonly used by foreign manufacturers to design and manufacture telecommunications and other kinds of integrated circuits for Huawei. The rule imposes a control on foreign-produced items that are a direct product of an expanded subset of specific technology or software described by certain specified ECCNs and foreign-produced items that are the direct product of a plant or major component of a plant located outside the U.S. where the plant or major component is a direct product of the same expanded subset of U.S.-origin technology or software.

Specifically, the rule will make the following non-U.S.-origin items subject to the restrictions of U.S. export controls:

  • Items, such as chip designs, that Huawei and its affiliates on the Entity List produce by using certain software or technology that is subject to the EAR; and
  • Items, such as chipsets made by manufacturers from Huawei-provided design specifications, if those manufacturers are using semiconductor manufacturing equipment that itself is a direct product of certain software or technology subject to the EAR.

Combined with Huawei’s Entity List designation, this new rule will significantly restrict Huawei’s ability to export its semiconductor designs as well as to receive semiconductors from its foreign manufacturers. It will also curtail the ability of Huawei to receive semiconductors from the non-U.S. subsidiaries of U.S. companies that may have previously been eligible for export to Huawei without a license because they were produced from software and technology that would not have triggered export licensing through the normal operation of the Direct Product Rule. Taken together, these changes mean that BIS can now block the sale of many semiconductors manufactured by a number of non-U.S.-based manufacturers that Huawei uses across its telecom equipment and smartphone business lines.

F. Revoking Hong Kong’s Status under U.S. Export Controls

In response to China’s Hong Kong National Security Law—which the Trump administration considers an encroachment on Hong Kong’s special status—President Trump announced on May 29 that the U.S. would reevaluate its export controls imposed on Hong Kong to revoke any preferential treatment given the territory over mainland China. A month later, following statements by Secretaries Pompeo and Ross, BIS announced that it would be suspending license exceptions that treated Hong Kong differently than mainland China.  The agency has not yet made any other adjustments to the treatment of Hong Kong-bound exports or to license exceptions that apply equally to Hong Kong and mainland China—although an Executive Order announced on July 14 will likely require further leveling of treatment for exports to Hong Kong and mainland China

As a result of the license exception suspension enacted on June 30, license exceptions that previously permitted unlicensed exports, reexports, or transfers to or within Hong Kong, but not to mainland China, no longer authorizes exports to Hong Kong.  Such exports will now require specific authorization from BIS.  For example, exports to Hong Kong of software and technology related to telecommunications equipment that would have previously been authorized under License Exception – Technology and Software under Restriction (“TSR”) may now require a specific license. Deemed exports (i.e., the transfer of technology or source code to a foreign person in the U.S.) may continue under affected licenses until August 28.

Other license exceptions affected (but not necessarily unavailable) may include those pertaining to replacement of parts and equipment (“RPL”), aircraft, vessels, and spacecraft (“AVS”), gifts (“GFT”), and baggage (“BAG”).  Importantly the suspension of these license exceptions would not impact products that are not subject to the EAR (e.g., by virtue of their place of development or delivery only through the cloud), are specifically authorized by a BIS-issued license, or are authorized by a license exception that applies equally to both Hong Kong and mainland China.

G. Human Rights-Based Entity List Designations

As we highlighted in our 2019 Year End Review, the ERC, which is chaired by BIS, has been exceptionally active over the past several years. While the ERC, which is composed of representatives of Departments of Commerce, State, Defense, Energy and, where appropriate, the Treasury, has always had the power to designate companies and other organizations for acting counter to U.S. national security and foreign policy interests, these interests historically have been focused on regional stability, counterproliferation, and anti-terrorism concerns and violators of U.S. sanctions and export controls. Beginning in October last year, however, the ERC added human rights to this list of concerns, particularly as they relate to human rights violations occurring in the XUAR and other regions of China directed Uyghurs, Kazakhs, and other members of Muslim minority groups in China.

On October 9, 2019, the ERC placed the XUAR People's Government Public Security Bureau, eighteen of its subordinates, and an additional eight businesses on its Entity List, thereby restricting their access to American exports. On June 5, 2020, BIS placed eight additional businesses and one governmental institute on the Entity List on the explicit basis of their human rights violations. Those added to the Entity List are largely surveillance or security companies, including certain artificial intelligence start-ups. Most recently, on July 22, BIS designated eleven additional entities. Nine appear to be in the apparel, accessories, and manufacturing sectors and were designated due to the ERC’s finding that were using forced labor. Two other entities were added for their involvement in conducting genetic analyses used to further the repression of Muslim minority groups in the XUAR.

As a result of these designations, almost all exports of items subject to the EAR require BIS’s prior review and authorization and most are subject to a policy presumption of denial.


The following Gibson Dunn lawyers assisted in preparing this client update: Judith Alison Lee, Adam Smith, Stephanie Connor, Chris Timura, Jesse Melman, R.L. Pratt, Scott Toussaint, Samantha Sewall and Audi Syarief.

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

United States: Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com) Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, rkirk@gibsondunn.com) Jose W. Fernandez – New York (+1 212-351-2376, jfernandez@gibsondunn.com) Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com) Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com) Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, sconnor@gibsondunn.com) Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com) Ben K. Belair – Washington, D.C. (+1 202-887-3743, bbelair@gibsondunn.com) Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com) Laura R. Cole – Washington, D.C. (+1 202-887-3787, lcole@gibsondunn.com) Jesse Melman - New York (+1 212-351-2683, jmelman@gibsondunn.com) R.L. Pratt – Washington, D.C. (+1 202-887-3785, rpratt@gibsondunn.com) Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com) Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com) Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com) Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)

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