Client Alert Archives

On April 21, 2023, the Financial Stability Oversight Council (“FSOC”) proposed several changes to how the agency would designate nonbank financial companies as systemically important financial institutions (“SIFIs”), thereby subjecting them to supervision by the Federal Reserve and additional regulations. In the first of two proposed “interpretive guidance“ documents, FSOC would “revise and update” its 2019 Interpretive Guidance on several fronts, with the expressed goal of eliminating “hurdles” to FSOC’s ability to designate nonbank financial companies as systemically important. In the second proposed interpretive guidance document, FSOC sets forth an “analytic framework” that it would employ when assessing a company’s “potential risk or threat to U.S. financial stability,” and accordingly whether to designate the company as systemically important. FSOC has also issued factsheets for the first and second proposed interpretive guidances.

These new documents (together, the “Proposed Guidance”), if finalized, would implement several key changes to FSOC’s current Interpretive Guidance. Under the current Guidance, adopted in 2019, FSOC employed an “activities-based approach” to assess risk and would designate individual entities as SIFIs only as a “last resort.” The Proposed Guidance would eliminate any requirement to use an activities-based approach before designating individual entities. The Proposed Guidance would also remove any obligation that FSOC consider a company’s likelihood of material financial distress before designating that company. Finally, the Proposed Guidance eliminates any requirement that FSOC conduct a cost-benefit analysis before designating companies as SIFIs. These changes would expand FSOC’s ability to designate nonbank financial companies as SIFIs, and thus to subject them to additional regulation.

Below, we provide background information on FSOC’s designation process; Gibson Dunn’s challenge to FSOC’s designation of MetLife; the key changes that the Proposed Guidance would implement; the likely implications of those changes; and, finally, the steps to be taken now by concerned parties.

I. Background of FSOC’s Designation Process

Title I of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) established FSOC and gave it the power to designate a nonbank financial company as a SIFI, meaning that FSOC has determined that material financial distress at the company, or the company’s nature, scope, size, scale, concentration, interconnectedness, or mix of activities, could pose a threat to U.S. financial stability. 12 U.S.C. § 5323(a)(1). This designation imposes on the designated nonbank financial company Federal Reserve examination, supervision, and enforcement authority, as well as enhanced prudential standards—including heightened capital and liquidity requirements, leverage limits, resolution planning, concentration limits, and stress testing and early remediation requirements. Id.

In 2012, FSOC promulgated guidance describing the manner in which the agency would make designation determinations. This guidance provided, for example, that FSOC would assess the company’s vulnerability to material financial distress before addressing the effect of that potential distress, and that the agency would assess the company’s threat to U.S. financial stability. See Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies, 77 Fed. Reg. 21,637, 21,653 (Apr. 11, 2012).

In FSOC’s thirteen years of existence, the agency has designated four nonbank financial companies as SIFIs: American International Group, Inc.; General Electric Capital Corporation; Prudential Financial, Inc.; and MetLife, Inc. Only MetLife challenged its designation.

Represented by Gibson Dunn, MetLife brought suit in federal district court, which court ruled that FSOC’s designation of MetLife was arbitrary and capricious and ordered FSOC to rescind the designation. See MetLife, Inc. v. Fin. Stability Oversight Council, 177 F. Supp. 3d 219 (D.D.C. 2016). The district court first held that FSOC had violated its own rules by failing to consider whether MetLife was vulnerable to material financial distress, and whether hypothetical distress at MetLife would pose a threat to U.S. financial stability. Id. at 233–39. The district court also held that FSOC’s designation decision was arbitrary and capricious because it failed to consider the costs of designating MetLife. Id. at 239–42. FSOC appealed the decision to the D.C. Circuit, but then voluntarily dismissed its appeal. See MetLife, Inc. v. Fin. Stability Oversight Council, No. 16-5086, 2018 WL 1052618, at *1 (D.C. Cir. Jan. 23, 2018). On remand, the district court denied a motion to vacate the portion of its opinion that held FSOC was required to perform a cost-benefit analysis. See Order, MetLife, Inc. v. Fin. Stability Oversight Council, No. 1:15-cv-00045-RMC, Dkt. 129 (D.D.C. Feb. 28, 2018).

By 2018, FSOC had rescinded all of its prior designations. Then, in 2019, FSOC amended its regulations, adopting many of the positions that MetLife had presented in the litigation. See Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies, 84 Fed. Reg. 71,740 (Dec. 30, 2019). In particular, the agency adopted an activities-based approach to assessing potential risks to U.S. financial stability, which focuses on working with other federal and state financial regulators to identify and regulate particularly risky activities, and considers designating individual companies to be a last-resort option. FSOC also committed to performing cost-benefit analyses during its designation decisions, and to assessing the likelihood that the entity would actually experience material financial distress.

II. FSOC’s Proposed Guidance Changes

FSOC’s new Proposed Guidance would disavow many of the changes that FSOC made in its 2019 Interpretive Guidance in response to the MetLife decision. As noted above, three changes in the Proposed Guidance would prove especially important.

First, FSOC’s Proposed Guidance would abandon its activities-based approach to preventing material financial distress in the U.S. economy. Under that approach, FSOC monitors the economy and works with federal and state financial regulators to identify particular activities that could pose a risk to U.S. financial stability in certain contexts. Once they identify a risky activity, FSOC works with those regulatory bodies to address the identified potential risk, and considers designating a particular company to be a last resort. This approach enables regulators to promulgate consistent and predictable rules that govern a particular market as a whole, rather than singling out certain entities for unique treatment. The Proposed Guidance, however, would drop that approach in favor of more aggressively designating individual firms based on “non-exhaustive” risk factors contained in the new “analytic framework,” including leverage, liquidity risk and maturity mismatch, interconnections, operational risks, complexity or opacity, inadequate risk management, concentration, and destabilizing activities.

Second, the Proposed Guidance would eliminate any requirement that FSOC consider a company’s likelihood of material financial distress before designating that company as a SIFI. The Proposed Guidance suggests that inquiring into the likelihood of material financial distress is neither “required [n]or appropriate” because such distress can be difficult to recognize or predict. Accordingly, when evaluating future designations, FSOC would “presuppos[e]” that a company is experiencing material financial distress—irrespective “of the likelihood” of such distress in the real world—and assess the impact that this hypothetical distress might have on the broader economy.

Third, the Proposed Guidance would eliminate any requirement that FSOC conduct a cost-benefit analysis before designating a nonbank financial company as a SIFI, despite the district court’s ruling in MetLife that failure to conduct that analysis was arbitrary and capricious and violated the Supreme Court’s ruling in Michigan v. EPA, 576 U.S. 743 (2015), which had held that when a statute allows an agency to regulate when “appropriate,” the agency must consider the costs of its regulation. The Proposed Guidance posits that weighing the increased costs from regulatory burdens against the potential benefits of designation is not “useful or appropriate,” given difficulties in assessing costs and the “potentially enormous” benefits of designation in averting financial crises. It portrays its loss in the district court as having no legal significance on this point. See FSOC, Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies at 16 n.16 (Apr. 21, 2023).

III. Implications of the Proposed Guidance

The goal of the Proposed Guidance is to broaden—and accelerate—FSOC’s ability to identify and designate certain nonbank financial companies as SIFIs, and thus to subject them to additional and potentially onerous supervision, examination, and regulation. The retreat from an activities-based approach would also limit companies’ ability to know in advance what activities would risk designation, and thus to plan their future behavior. Recent statements by financial regulators suggest that the targets of FSOC’s proposed approach may include traditional nonbank financial companies (for instance, insurers, hedge funds, open-end funds, and money-market funds), along with more recent market entrants (such as stablecoin issuers and other FinTechs engaged in financial activities, including nonbank peer-to-peer payments companies).

The Proposed Guidance may be vulnerable to many of the same objections that prevailed in the MetLife litigation. For example, footnote 16 of the Proposed Guidance asserts that FSOC need not conduct any cost-benefit analysis because MetLife was wrongly decided and has no “preclusive effect.” But, as noted above, the district court rejected the government’s attempt, after it had dismissed its appeal, to vacate the cost-benefit portion of the court’s opinion. Moreover, the district court had explained that its cost-benefit decision was compelled by the Supreme Court’s decision in Michigan v. EPA. See MetLife, 177 F. Supp. 3d at 240 (citing Michigan, 576 U.S. at 752). FSOC remains bound by the Supreme Court’s Michigan decision and any designation that ignores cost-benefits considerations will be vulnerable to the same argument on which Gibson Dunn prevailed in MetLife.

Similarly, the district court held that the text of the Dodd-Frank Act itself mandates an inquiry into a company’s likelihood of material financial distress, see MetLife, 177 F. Supp. 3d at 241 (citing 12 U.S.C. § 5323(a)(2)(K))—the same inquiry that the Proposed Guidance now seeks to discard.

IV. Next Steps

FSOC’s Proposed Guidance is subject to public notice and comment for 60 days following publication of the Proposed Guidance in the Federal Register. Incisive comments may have an effect on the substance of the final documents, and may also form the basis for any future court challenges to FSOC’s final guidance and to any nonbank financial company’s potential designation.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Administrative Law and Regulatory, Financial Institutions, or FinTech and Digital Assets practice groups, or the following authors:

Eugene Scalia – Washington, D.C. (+1 202-955-8673, escalia@gibsondunn.com)
Ashlie Beringer – Palo Alto (+1 650-849-5327, aberinger@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
Amir C. Tayrani – Washington, D.C. (+1 202.887.3692, atayrani@gibsondunn.com)
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)
Jason J. Cabral – New York (+1 212-351-6267, jcabral@gibsondunn.com)
Lochlan F. Shelfer – Washington, D.C. (+1 202-887-3641, lshelfer@gibsondunn.com)

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

On April 6, 2023, President Biden signed an executive order entitled “Modernizing Regulatory Review” (the “Order”). The Order makes a number of significant changes to the process by which the White House Office of Information and Regulatory Affairs (“OIRA”) reviews significant regulatory measures. Under executive orders issued by previous presidents, all “significant regulatory actions” are subject to OIRA review, and agencies must perform a cost-benefit analysis of the action before it is undertaken. President Biden’s new Order narrows the definition of what constitutes a “significant regulatory action,” including by doubling the monetary threshold of annual effects on the national economy (raising it from $100 million to $200 million) and adjusting the threshold based on changes in Gross Domestic Product going forward.

The Order also directs the White House Office of Management and Budget (“OMB”) to propose revisions to OMB Circular A-4, which is the primary guidance document governing how executive branch agencies conduct cost-benefit analyses. On April 6, OMB issued its proposed revisions. They include changes to –

lower discount rates that convert future costs and benefits into current dollars;
provide greater weight to the distributional effects of a regulatory action; and
encourage the assessment of even highly uncertain effects of regulatory action.

If finalized, OMB’s proposed revisions would represent the most significant change to how agencies conduct cost-benefit analysis since Circular A-4 was first issued in 2003. In combination with the changes effected by the Order, OMB’s proposal would likely lead to more and faster regulatory action, by, for instance, reducing OIRA oversight and relieving agencies of their obligation to prepare cost benefit analyses for certain regulatory measures. Similarly, many of OMB’s changes could result in agencies more frequently concluding that a regulatory measure is cost-justified. For example, because the costs of new regulations are often incurred in the near-term, while the benefits often accumulate more gradually over longer periods of time, the lower discount rates OMB proposes may mean that agencies will be more likely to find that the benefits of a regulatory action outweigh its costs. This is particularly true for regulations that address longer term phenomena, such as climate change, which is an example OMB discusses in its proposal.

OMB’s proposed changes could also lead to greater litigation vulnerability for certain regulatory measures. In particular, a court may be more likely to find an action arbitrary and capricious if it is based on highly uncertain benefit assessments that are identified by commenters during the notice and comment process. Some of OMB’s revisions to how costs and benefits are weighed could create opportunities for commenters to challenge agencies’ analyses.

By its terms, the Order only applies to “executive departments and agencies.” Independent agencies, such as the FTC, SEC, and FCC, are apparently not covered. That makes sense because they are not subject to the regulatory review process that President Biden’s Order is modifying. Independent agencies will thus be largely unaffected by many of the changes the Order is introducing. However, in some instances, independent agencies voluntarily follow the guidance set forth in Circular A-4, or otherwise interact with OIRA regarding cost-benefit analyses, as in connection with the Congressional Review Act. To the extent independent agencies follow the guidance in Circular A-4, their regulatory analyses may therefore be affected by the proposed changes.

Interested parties have until June 6 to submit comments on OMB’s proposed changes to Circular A-4.

Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Administrative Law and Regulatory Practice or Public Policy groups, or the following authors in Washington, D.C.:

Eugene Scalia (+202-955-8210, escalia@gibsondunn.com)

Helgi Walker (+202-887-3599, hwalker@gibsondunn.com)

Michael Bopp (+202-955-8256, mbopp@gibsondunn.com)

Blake Lanning (+202-887-3794, blanning@gibsondunn.com)

We are pleased to provide you with Gibson Dunn’s Accounting Firm Quarterly Update for Q4 2022. The Update is available in .pdf format at the below link, and addresses news on the following topics that we hope are of interest to you:

PCAOB Announces New Enforcement Director
PCAOB Advisory Group Meeting Suggests Topics of Regulatory Interest
PCAOB Releases 2022 Annual Report
PCAOB and U.S. Senators Raise Questions About Crypto “Proof of Reserves” Reports
PCAOB Sued as Unconstitutional by John Doe Plaintiff
SEC Files Petition for Certiorari in SEC v. Jarkesy
CPAB Brings Rare Enforcement Action Against U.S. Firm
House Signals More SEC Oversight
Ninth Circuit and Ohio Supreme Court Issue Rulings of Interest on Employment Arbitration Agreements and Ransomware Attack Insurance
NLRB Issues Decision on Enforceability of Severance Agreement Provisions
SDNY Criminal Motion Alleges Conflict in Representing Both Company and Employee
Other Recent SEC and PCAOB Regulatory Developments

Read More

Accounting Firm Advisory and Defense Group:

James J. Farrell – Co-Chair, New York (+1 212-351-5326, jfarrell@gibsondunn.com)

Ron Hauben – Co-Chair, New York (+1 212-351-6293, rhauben@gibsondunn.com)

Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, mloseman@gibsondunn.com)

Michael Scanlon – Co-Chair, Washington, D.C.(+1 202-887-3668, mscanlon@gibsondunn.com)

The New York City Department of Consumer and Worker Protection, or DCWP, released final rules on April 6 regarding the city’s Local Law 144 and announced that it would begin enforcement on July 5.

Local Law 144 restricts employers and employment agencies from using an automated employment decision tool in hiring and promotion decisions unless it has been the subject of a bias audit by an “independent auditor” no more than one year prior to use. The law also imposes certain posting and notice requirements to applicants and employees subject to the use of AEDTs.

The DCWP is vested with the authority to amend the Rules of the City of New York under the New York City Charter and New York City Administrative Code. As detailed below, the DCWP’s final rules make a number of noteworthy changes and attempt to clarify the law.

1. The rules attempt to clarify the scope of covered AEDTs.

Local Law 144 defines an AEDT as:

Any computational process, derived from machine learning, statistical modeling, data analytics, or artificial intelligence, that issues simplified output, including a score, classification, or recommendation, that is used to substantially assist or replace discretionary decision making for making employment decisions that impact natural persons.

The final rules seek to clarify two of the key phrases within this definition.

The final rules define “machine learning, statistical modeling, data analytics, or artificial intelligence” as a group of mathematical, computer-based techniques:

That generate a prediction, e.g., an assessment of a candidate’s fit or likelihood of success, or a classification, e.g., categorizing applicants based on skill sets or aptitude; and

For which a computer identifies, at least in part, the inputs and their relative importance and, if applicable, other parameters to improve the model’s predictive accuracy.

The phrase “to substantially assist or replace discretionary decision making” is defined as:

To rely solely on a simplified output (score, tag, classification, ranking, etc.), with no other factors considered; or
To use a simplified output as one of a set of criteria where the simplified output is weighted more than any other criterion in the set; or
To use a simplified output to overrule conclusions derived from other factors including human decision-making.

Notably, this definition appears to permit employers to use the AEDT without conducting a bias audit where an AEDT’s output falls outside the specified circumstances.

Local Law 144 provides several examples of tools outside the scope of covered AEDT, i.e., calculators, junk email filters and spreadsheets. The final rules, however, do not provide any further examples.

Read More

Reproduced with permission. Originally published by Law360, New York (April 19, 2023).

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

Harris M. Mufson – Co-Chair, Whistleblower Team, New York (+1 212-351-3805, hmufson@gibsondunn.com)

Danielle J. Moss – New York (+1 212-351-6338, dmoss@gibsondunn.com)

Emily Maxim Lamm – Washington, D.C. (+1 202-955-8255, elamm@gibsondunn.com)

The Biden administration has been steadily evolving its views of national security risks and priorities—and what measures the executive branch will take to mitigate those risks. Last fall’s National Security Strategy called out critical technology and cybersecurity as key national security concerns. This focus sharpened with the release of the National Cybersecurity Strategy last month. And, most recently, the administration has submitted a $3.1 billion budget request for the Cybersecurity and Infrastructure Security Agency (CISA), a 22 percent increase from its request last year, to implement that strategy and fund other initiatives. While strategy is not policy, and budget proposals are not appropriations, these are strong signals of the shifting winds of the administration regarding the tools and incentives the administration will deploy to mitigate cybersecurity risks.

After years of relying on largely voluntary standards to encourage companies to harden their cybersecurity defenses, interspersed with incentives including funding and grants, the administration has definitively taken the position that it does not think companies have done enough. Accordingly, the new cybersecurity strategy calls for a heavier hand. Should the strategy be implemented, companies can expect to see direct liability, new regulations, and lawsuits from the federal government itself for companies that fail to make secure products, do not adopt minimum security measures, or misrepresent the actions they have taken. These new measures come as the administration is increasingly focused on strategic competition with China.

Below, we highlight the four main tools that companies should know about that the Biden Administration has vowed to use to secure critical infrastructure and industry from cyber threats.

1. Direct liability for software vendors. First, the Biden administration says that software companies and vendors should be directly liable for failing to adopt “reasonable” security measures into the programs used to power critical infrastructure and other areas. The administration said it has been unhappy with voluntary efforts to increase software security, which have made progress but has been inconsistent across industries. And, because the administration believes that software vendors and companies that control data are in the best position to address this liability, it said that they should bear responsibility for failing to adopt those reasonable measures and not their end users and infrastructure providers who will be impacted by those failures directly.

“We’re all walking around with unsafe technology. So we have to change the incentives,” CISA Director Jen Easterly told a House subcommittee recently as she sought funding for the federal government’s efforts. “We may need to look at certain liability for whether manufacturers have duty of care to be able to protect those consumers.”

The legislation the administration is contemplating to implement this liability would prohibit software terms of service from disclaiming all liability for security flaws, even if the flaw is from open-source software that has been integrated into the commercial project, and would also impose higher standards of care in high-risk areas.

2. New rulemaking and legislation to fill in regulatory gaps. Second, in addition to legislation on direct liability, the administration is planning new rulemaking and other legislation to close gaps in existing law that impose minimum security standards in a host of industries. In particular, cloud-based services are not all covered by existing regulations despite being integrated into systems across industries. These new regulations should be “performance-based,” the administration said, and modeled after voluntary frameworks from the National Institute of Standards and Technology (NIST) and CISA.

This comes in the wake of other rulemaking for such standards in the oil and gas pipeline, aviation, rail, and water sectors. And other legislative efforts have also advanced security measures, such as the Cyber Incident Reporting for Critical Infrastructure Act of 2022 (CIRCIA) that requires critical infrastructure providers to notify federal authorities about cybersecurity incidents. The administration is advancing rulemaking to implement CIRCIA as well, with CISA in the lead.

The administration seeks to pair these new requirements with new funding and financial incentives to speed compliance. While some companies can absorb these costs, others have low margins that make this difficult. Thus, in those areas, the administration is encouraging regulators to tilt incentives to reduce these costs, such as through favorable tax and rate-setting arrangements. Such arrangements would be on top of the funding that the government is already pouring into this area through the CHIPS and Science Act, the Inflation Reduction Act, and the Bipartisan Infrastructure Law. Further, the administration said it is exploring a government-backed support for the cyber insurance market to protect it in the event of a catastrophic event.

3. Government to lead the way—including as a plaintiff. Third, in all of these areas, the administration also signaled that it will itself set the bar for private industry to follow, such as by updating its own technology and through procurement processes to test new cybersecurity requirements, and will update its own technology using standards that it wants private industry to adopt as well. For example, the administration is prioritizing cryptography upgrades to public computer networks to be resistant to quantum-based efforts to compromise those networks. This is not just to secure the government’s own networks but also to set the bar that it expects the private sector to follow.

The administration has also signaled it will increase regulatory harmonization, make it easier for companies reporting an incident to connect with the appropriate officials quickly, modernize federal technology, and engage in research and development efforts. Given the increasing patchwork of notification requirements and various government equities in cyber incidents, such harmonization is critical to reducing the regulatory burden on companies—particularly during the high operational tempo of cyber incident response.

The federal government has indicated that it will continue to bring actions to enforce cybersecurity commitments. For example, the Department of Justice has already used the False Claims Act to pursue companies that allegedly misrepresent cybersecurity commitments in their federal contracts. And the Department of Justice has also launched a new nationwide “disruptive technology strike force” with the Commerce Department to coordinate efforts to respond to threats to critical infrastructure.

4. Shifting focus from criminal groups to state actors. Finally, the administration has signaled that the central threat that it has built its strategy around is from state actors. While criminal groups using ransomware to extract groups are still addressed by the administration’s strategy, it is the governments of China, Russia, Iran, and North Korea where the strategy is focused. The administration has highlighted the efforts of those state actors, and in particular China, to carry out cyber attacks and compromise vulnerable infrastructure. In an echo of the National Security Strategy, the cybersecurity strategy highlights that China “now presents the broadest, most active, and most persistent threat.” And also without naming China, the strategy notes that domestic networks should reduce their dependence “on critical foreign products and services from untrusted suppliers,” pointing to the longstanding controversy over China-based companies that supply hardware and equipment for U.S. computer networks.

The administration’s cybersecurity strategy further highlights the administration’s increased cross-border efforts to coordinate cybersecurity efforts with Australia, the United Kingdom and other European countries, India, Japan, and others.

In sum, the key takeaways for private industry in the administration’s cybersecurity strategy, as reinforced by budget priorities, are that companies in an ever-wider set of industries will not only be tempted into compliance with new funding or cajoled from the bully pulpit to increase their cybersecurity measures, but will also have to contend with a more forceful response from government that will expect them to meet security standards and promises—and face liability if they fail to do so. This increased enforcement may also be complicated by multiple agencies pursuing the same actions, resulting in the potential for companies having to deal with overlapping and uncoordinated inquiries. And with the increasing focus on state actors in place of cybercriminals, the strategy shows less of a focus on private ransomware issues and an increasing national security response that may serve as a prioritization filter. While the strategic objectives outlined in the cyber strategy and backed by the budget proposal will require significant executive action prior to coming into effect, companies should prepare now to meet the shifting approach towards increased cybersecurity requirements and liability.

The following Gibson Dunn lawyers assisted in preparing this alert: Alexander Southwell, Stephenie Gosnell Handler, and Eric Hornbeck.

Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the firm’s Privacy, Cybersecurity & Data Innovation practice group:

United States
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, aberinger@gibsondunn.com)
Jane C. Horvath – Co-Chair, PCDI Practice, Washington, D.C. (+1 202-955-8505, jhorvath@gibsondunn.com)
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, asouthwell@gibsondunn.com)
Matthew Benjamin – New York (+1 212-351-4079, mbenjamin@gibsondunn.com)
Ryan T. Bergsieker – Denver (+1 303-298-5774, rbergsieker@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Gustav W. Eyler – Washington, D.C. (+1 202-955-8610, geyler@gibsondunn.com)
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, cgaedt-sheckter@gibsondunn.com)
Svetlana S. Gans – Washington, D.C. (+1 202-955-8657, sgans@gibsondunn.com)
Lauren R. Goldman – New York (+1 212-351-2375, lgoldman@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Kristin A. Linsley – San Francisco (+1 415-393-8395, klinsley@gibsondunn.com)
Vivek Mohan – Palo Alto (+1 650-849-5345, vmohan@gibsondunn.com)
Karl G. Nelson – Dallas (+1 214-698-3203, knelson@gibsondunn.com)
Rosemarie T. Ring – San Francisco (+1 415-393-8247, rring@gibsondunn.com)
Ashley Rogers – Dallas (+1 214-698-3316, arogers@gibsondunn.com)
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com)
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com)
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, mwong@gibsondunn.com)
Debra Wong Yang – Los Angeles (+1 213-229-7472, dwongyang@gibsondunn.com)

Europe
Ahmed Baladi – Co-Chair, PCDI Practice, Paris (+33 (0) 1 56 43 13 00, abaladi@gibsondunn.com)
Kai Gesing – Munich (+49 89 189 33-180, kgesing@gibsondunn.com)
Joel Harrison – London (+44(0) 20 7071 4289, jharrison@gibsondunn.com)
Vera Lukic – Paris (+33 (0) 1 56 43 13 00, vlukic@gibsondunn.com)

Asia
Connell O’Neill – Hong Kong (+852 2214 3812, coneill@gibsondunn.com)
Jai S. Pathak – Singapore (+65 6507 3683, jpathak@gibsondunn.com)

Decided April 14, 2023

Axon Enterprise, Inc. v. FTC (No. 21-86), SEC v. Cochran (No. 21-1239)

The Supreme Court held today in two related cases that federal district courts have jurisdiction to resolve certain challenges to the structure or existence of the Federal Trade Commission (“FTC”) and Securities and Exchange Commission (“SEC”), rejecting the argument that litigants can raise such challenges only on review of a final agency action before the court of appeals.

Background: Federal district courts have jurisdiction to hear “civil actions arising under the Constitution.” 28 U.S.C. § 1331. Federal courts of appeals also have jurisdiction to review certain agency actions, including final orders of the FTC and SEC. 15 U.S.C. §§ 45, 78y(a)(1).

Axon Enterprise, a company that was subject to an FTC enforcement action, and Michelle Cochran, a certified public accountant who was subject to an SEC enforcement action, each sued the respective agency in federal district court while their enforcement actions were pending. Axon and Cochran argued that the agencies’ basic structure and operations were unconstitutional and the pending enforcement actions were unlawful.

The district courts in both cases dismissed the complaints, holding that the specialized judicial-review provisions in the FTC Act and Exchange Act deprived them of jurisdiction by funneling review of final agency orders to the federal courts of appeals. The Fifth and Ninth Circuits reached different conclusions on that issue—the Ninth Circuit affirmed the dismissal for lack of jurisdiction, but the en banc Fifth Circuit reasoned that structural constitutional challenges to an agency’s jurisdiction were not the sort of claims Congress meant to funnel to the courts of appeals through the statutory review scheme.

Issue: Whether, by giving the courts of appeals jurisdiction to review final agency orders of the FTC and SEC, Congress stripped federal district courts of jurisdiction to hear constitutional challenges to the agencies’ structure or existence.

Court’s Holding:

Federal district courts have jurisdiction under 28 U.S.C. § 1331 to hear cases raising structural challenges to the FTC or SEC.

“[T]he review schemes set out in the Exchange Act and the FTC Act do not displace district court jurisdiction over Axon’s and Cochran’s far-reaching constitutional claims.”

Justice Kagan, writing for the Court

Gibson Dunn submitted an amicus brief on behalf of Raymond J. Lucia, Sr., George R. Jarkesy, Jr., and Christopher M. Gibson, in support of respondent in No. 21-1239: Michelle Cochran

What It Means:

Today’s decision allows people and businesses subjected to FTC and SEC (and potentially other) administrative enforcement actions to promptly raise certain structural challenges in court, without having to first complete long and costly agency proceedings (which often settle before a final order). As the Court recognized, permitting suits to proceed in federal district court allows regulated parties to vindicate the “here-and-now injury” of being subjected to unconstitutional administrative processes.
The Court’s holding likely implicates other agencies subject to similar review provisions, such as the Consumer Financial Protection Bureau.
More generally, the Court’s decision confirms that Congress’s establishment of special administrative review procedures does not necessarily require a claim to be channeled through that administrative process when: (1) doing so would preclude meaningful judicial review, (2) the claim is collateral to the administrative-review provisions, and (3) the claim is beyond the agency’s expertise to adjudicate.
The Court focused its holding on structural constitutional claims and did not specifically address whether other types of claims—fact-specific constitutional due-process claims, for example—may be raised directly in federal court or must instead proceed through the administrative-review process first.
The decision will likely keep pressure on the SEC to file contested claims in district court, providing regulated entities challenging SEC actions with greater procedural rights and protections than are available in administrative proceedings.
Today’s decision—issued with no dissent—reflects the current Court’s strong interest in reining in excesses of the administrative state by reinforcing constitutional limitations on the structure, composition, and operation of administrative agencies.

The Court’s opinion is available here.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:

Appellate and Constitutional Law Practice

Allyson N. Ho +1 214.698.3233 aho@gibsondunn.com	Thomas H. Dupree Jr. +1 202.955.8547 tdupree@gibsondunn.com	Julian W. Poon +1 213.229.7758 jpoon@gibsondunn.com
Lucas C. Townsend +1 202.887.3731 ltownsend@gibsondunn.com	Bradley J. Hamburger +1 213.229.7658 bhamburger@gibsondunn.com	Brad G. Hubbard +1 214.698.3326 bhubbard@gibsondunn.com

Related Practice: Administrative Law and Regulatory Practice

Eugene Scalia
+1 202-955-8210
escalia@gibsondunn.com

Helgi C. Walker
+1 202.887.3599
hwalker@gibsondunn.com

Related Practice: Antitrust and Competition

Rachel S. Brass
+1 415.393.8293
rbrass@gibsondunn.com

Stephen Weissman
+1 202.955.8678
sweissman@gibsondunn.com

Related Practice: Securities Enforcement

Richard W. Grime
+1 202.955.8219
rgrime@gibsondunn.com

Mark K. Schonfeld
+1 212.351.2433
mschonfeld@gibsondunn.com

David Woodcock
+1 214.698.3211
dwoodcock@gibsondunn.com

Related Practice: Litigation

Reed Brodsky
+1 212.351.5334
rbrodsky@gibsondunn.com

Theane Evangelis
+1 213.229.7726
tevangelis@gibsondunn.com

Veronica S. Moyé
+1 214.698.3320
vmoye@gibsondunn.com

In an April 13, 2023 webcast, the CHIPS Program Office (“CPO”) at the Department of Commerce provided a deep dive on the Financial Information requirements for funding applications and pre-applications. We have provided a fulsome discussion of CHIPS Act funding in our previous alerts here and here. The key takeaway from this most recent discussion is that applicants need to prepare thorough financial statements both for their pre-applications and even more so for their final applications. The financial analysis needs to give the government confidence that the projects already have solid financial backing and strong future prospects for financial success.

In particular, the CPO addressed the evaluation criteria for Financial Information, the differences—both in form and substance—between Financial Information submitted at the pre-application and application stages, and published resources and templates that can guide the preparation of these materials.

The CPO stressed that this guidance applies only to applicants applying for funding pursuant to its first Notice of Funding Opportunities (“NOFO”).[1] Detailed application instructions for other applicants will be released after the publication of the second and third NOFOs, in late spring and fall 2023, respectively.

I. Evaluation Criteria for Financial Information

As discussed in our previous alert, the CPO will evaluate all applications and pre-applications according to six key criteria: (1) economic and national security objectives; (2) commercial viability; (3) financial strength; (4) technical feasibility and readiness; (5) workforce development; and (6) projects’ broader impacts.[2] During the April 13th webcast, CPO staff emphasized that the Financial Information an applicant provides will be the primary source by which their application’s commercial viability and financial strength will be assessed.[3]

Commercial Viability: To establish a project’s commercial viability, Financial Information should demonstrate:
- a demand for the product;
- the size and diversity of the product’s customer base;
- expected volume and pricing dynamics;
- the stability of key supplies; and
- the project’s ability to counter potential technological obsolescence.

This reinforces a continuing CPO CHIPS Act tenet of deploying CHIPS Act capital to projects that have the optimal path for a combination of commercial success, onshoring of fabrication (particularly for leading nodes), and/or bolstering of sensitive industry verticals such as defense applications.

Financial Strength: Applicants should use their Financial Information submissions to paint a clear picture of their own financial strength, as well as that of their project and their corporate parent (if applicable). Additionally, the CPO stressed that it will prioritize projects that demonstrate meaningful third party financial validation, and thus do not rely solely on CHIPS Act funding, but have secured commitments for concurrent third-party investments, loans and associate guarantees, and/or local or state government incentives.[4]

II. Differences Between Pre-Application and Application Financial Information

At a high level, CPO staff described the difference between pre-application and final application financials as the level of necessary granularity. Because the pre-application’s primary objective is to create a dialogue and opportunity for feedback from the CPO, Financial Information at this stage needs only to provide “sufficient preliminary information on the proposed project(s)” to enable meaningful feedback from the CPO.[5] (CPO staff emphasized, however, that the more detail they receive at the pre-application stage, the better they can evaluate the project’s strengths and weaknesses.)[6] When judging the merits of a final application, on the other hand, applicants’ Financial Information must be extensive and detailed.

In addition to this high-level guidance, the CPO noted specific differences between the materials required to complete the Financial Information portions of the pre-application and the application, listed below:[7]

Pre-Application	Full Application
I. Financial Information Narrative	I. Financial Plan
II. Financial Ownership Structure	II. Sources and Uses of Funds
III. Sources and Uses of Funds	III. Project Cash Flow, Balance Sheet, and Income Statement Projections
IV. Company Financials	IV. Scenario Analyses
V. Summary Financials	V. CHIPS Incentives Request
VI. CHIPS Incentives Request	VI. CHIPS Loan or Loan Guarantee Request

For example, whereas both the pre-application and application require some form of summary narrative, the application specifically requires a financial plan for each proposed project, including narratives on cash flow projections, key equity return and debt service metrics, and sensitivity analyses.

Applicants should be sure to consult the NOFO and the CPO’s Guiding Principles for Full Application Financial Model to ensure that the final application’s Financial Information moves beyond “preliminary information” and provides the level of granularity necessary to obtain funding.

III. Resources and Templates

The CPO has prepared and published a number of resources and templates for the preparation of applications and pre-applications under the first NOFO, including extensive materials on the Financial Information requirements.[8]

One of the most substantial aspects of the Financial Information is the need for a dynamic financial model including variable inputs for key assumptions. This model must be comprehensive, including variables such as funding sources and cash flows to (in the final application) scenario analyses, internal rates of return, and risk and debt service metrics. Companies are free to use their own financial models and plans to satisfy these requirements, but the CPO has also created a Pre-Application Example Financial Model (and accompanying Pre-Application Example Financial Model White Paper) to demonstrate the types of financial data needed at the pre-application stage. As applicants move to the final application stage, they should also consult the Guiding Principles for Full Application Financial Model. These models demonstrate the level of specificity and types of data the CPO expects to see in an application’s Financial Information. CPO staff reiterated, however, that they are merely examples. Depending on an applicant’s unique business needs, additional data fields may be necessary.[9]

While these reference guides are illustrative examples of the financials CPO expects to review, applicants will be required to submit templates for certain parts of their pre-application and application Financial Information. These required templates are:

Pre-Application	Application
Pre-Application Sources and Uses Template	Full Application Offline Template Sources and Uses Full Application Offline Incentives Request

Guidance on how to use these templates can be found in the Pre-Application Instructions and the Sources and Uses of Funds Instructions.

Additional resources and templates can be found at the CHIPS for America Guides and Templates webpage.

IV. How Gibson Dunn Can Assist

Gibson Dunn has an expert team tracking implementation of the CHIPS Act closely, including semiconductor industry subject matter experts and our Public Policy Practice Group professionals. Our team is available to assist eligible clients to secure funds throughout the application process. We also can engage with our extensive contacts at the Department of Commerce and other federal agencies to facilitate dialogue with our clients and discuss the structure of future CHIPS Act programs being developed.

________________________

[1] 5 U.S.C. § 4651(2); U.S. Dep’t of Commerce Nat’l Institute of Standards and Technology Notice of Funding Opportunity, CHIPS Incentives Program—Commercial Fabrication Facilities, https://www.nist.gov/system/files/documents/2023/02/28/CHIPS-Commercial_Fabrication_Facilities_NOFO_0.pdf [hereinafter, NOFO]; Department of Commerce Webcast (Apr. 13, 2023).

[2] NOFO at 58–64.

[3] Department of Commerce Webcast (Apr. 13, 2023).

[4] Id.

[5] Id.

[6] Id.

[7] NOFO at 35–37, 43–47.

[8] CHIPS for America Guides and Templates: CHIPS Incentives Program—Commercial Fabrication Facilities (last accessed Apr. 13, 2023), https://www.nist.gov/chips/guides-and-templates-chips-incentives-program-commercial-fabrication-facilities.

[9] Department of Commerce Webcast (Apr. 13, 2023).

The following Gibson Dunn lawyers prepared this client alert: Ed Batts, Michael Bopp, Roscoe Jones, Jr., Amanda Neely, Danny Smith, and Sean Brennan.*

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Public Policy practice group, or the following authors:

Michael D. Bopp – Co-Chair, Public Policy Group, Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)

Roscoe Jones, Jr. – Co-Chair, Public Policy Group, Washington, D.C. (+1 202-887-3530, rjones@gibsondunn.com)

Ed Batts – Palo Alto (+1 650-849-5392, ebatts@gibsondunn.com)

Amanda H. Neely – Washington, D.C. (+1 202-777-9566, aneely@gibsondunn.com)

Daniel P. Smith* – Washington, D.C. (+1 202-777-9549, dpsmith@gibsondunn.com)

*Daniel P. Smith is of counsel working in the Washington, D.C. office who is admitted only in Illinois and practicing under supervision of members of the District of Columbia Bar under D.C. App. R. 49. Sean J. Brennan is an associate working in the firm’s Washington, D.C. office who currently is admitted to practice only in New York.

The German Government adopted the draft of the 11th amendment to the Act against Restraints on Competition on 5 April 2023. The initial draft had been published by the German Ministry of Economic Affairs and Climate Action on 26 September 2022 (see our earlier client alert of 30 September 2022 here).

The ministry’s initial draft of the 11th amendment to the German Act against Restraints of Competition (“ARC”) (“initial draft bill”) triggered a broad public debate and has been criticized by various stakeholders, including some of the largest business associations. In particular, it has been criticized that the initial draft bill provided for unbalanced and overreaching additional powers for the German Federal Cartel Office’s (“FCO”), including an ultima ratio power to unbundle undertakings. These concerns have partly been addressed in the revised draft bill (“revised draft bill”). In particular the revised draft bill increases the threshold for the new ultima ratio powers compared to the initial draft bill. Still, the revised draft bill marks a substantial shift towards a new era of antitrust law enforcement, with extensive powers of the FCO to intervene in markets, even without a need to establish antitrust law infringements.

The main aspects of the revised draft bill include: (i) a revision of the sector inquiry tool and related interventional powers of the FCO; (ii) the facilitation of disgorgements of economic benefits; and (iii) the implementation of the DMA in the national framework of public and private enforcement.

New intervention powers of the FCO after completion of a sector inquiry

The FCO can conduct a sector inquiry if it suspects that competition in the market under investigation is restricted or distorted, unrelated to a specific competition law infringement. Such a sector inquiry is generally concluded with a report on the competitive conditions on the market under investigation. As of today, the FCO can only impose remedies if it finds that the restraint of competition is based on an infringement of antitrust law.

The revised draft bill gives power to the FCO to intervene on the market on which it was found that competition has been disrupted, even when there is no infringement of antitrust law. This would be an absolute novelty to German antitrust law.
The interventional powers of the FCO require that there is a “substantial and continuing distortion of competition on at least one market which is at least nationwide, on several individual markets or across markets”. This is supposed to clarify that the distortion of competition must have a certain intensity and cannot be only temporary. It marks one of the changes compared to the initial draft bill where a “significant, persistent or repeated distortion of competition” was required. The revised draft bill includes a non-exhaustive list of factors relevant for the assessment of a distortion of competition on the one hand, as well as the continuance of this distortion of competition (continued in the previous three years and is not expected to end in the upcoming two years) on the other hand.
If the FCO determines that there is a substantial and continuing distortion of competition, it can impose behavioral or structural remedies against one or more undertakings, including:
- Granting access to data, interfaces, networks or other facilities;
- Specifications to the business relationships between companies in the markets under review;
- Establishing transparent, non-discriminatory and open norms and standards;
- Requirements for certain types of contracts or contractual arrangements also with regard to the disclosure of information;
- Prohibition of unilateral disclosure of information that favors parallel behavior by companies;
- The organizational separation of corporate or business units; and
- As a ultima ration, the FCO may impose unbundling remedies on companies with a dominant market position and companies with paramount significance for competition across markets according to (the recently introduced) Sec. 19a ARC. In contrast to the initial draft bill, the revised draft bill does not provide for these remedies if a dominant position or paramount significance for competition across markets cannot be established. However, according to the revised draft bill, assets only have to be sold if the sales price is at least 50% of the price determined by an auditor that has been engaged by the FCO. If the actual sales price is below the price determined by the auditor, an additional payment in the amount of half of the difference between the audited value and the actual sales price has to be paid to the selling company from federal funds.

Additional / extended merger control after completion of a sector inquiry

As already provided for in the initial draft bill, the FCO can impose an obligation on specific undertakings to notify any future concentrations even if they do not meet (i.e. fall below) the regular merger control notification thresholds. This notification requirement can be imposed on companies if there are “objectively verifiable indications that future mergers could significantly impede effective competition in Germany in one or more of the economic sectors” specified in the sector inquiry report. A de minimis exception applies to transactions in which the buyer generated turnover with customers in Germany in its last completed financial year of less than EUR 50 million and/or the target of less than EUR 500,000. This “special notification obligation” expires after three years, but it can be extended.

Simplified disgorgement of economic benefits

Pursuant to the existing Sec. 34 ARC, in cases of an infringement of antitrust law, the FCO can order the disgorgement of profits achieved by a company as a result of an antitrust infringement. However, since the legal requirements for such a disgorgement are rather high, this provision has not been applied much in practice in the past.

The revised draft bill aims at facilitating the use of this instrument by the FCO. It holds that the FCO no longer has to prove an intentional or negligent infringement of antitrust law before making use of the disgorgement mechanism of Sec. 34 ARC. Further, the revised draft bills facilitates the establishment of economic benefits associated with antitrust infringements. If a violation of antitrust law is determined, the revised draft bill includes a presumption that the antitrust law infringement has resulted in an economic benefit for the concerned undertaking. The amount of the economic benefit can be estimated by the FCO, and there is even a legal presumption that at least 1% of the national turnover of the concerned company relating to the products and services affected by the antitrust law infringement are subject to disgorgement. A rebuttal of this presumption requires that neither the legal entity directly involved in the infringement nor its group generated a profit in the respective amount during the relevant period. However, the amount to be paid must not exceed 10% of the total turnover of the undertaking in the fiscal year preceding the decision of the authority.

Regarding the time frame in which the FCO can disgorge economic benefits, the revised draft bill retains the current legal status: The disgorgement of economic benefits may be ordered only within a period of up to seven years after the termination of the infringement and for a maximum period of five years. The initial draft bill provided a time period of ten years after the termination of the infringement with an unlimited disgorgement period.

Enforcement of the EU Digital Markets Act (DMA)

As already included in the initial draft bill, the revised draft bill is intended to establish the legal basis for enforcement of the DMA in Germany. The FCO will be able to conduct investigations with regard to violations of the DMA. However, the FCO can only conduct investigations. The results of the investigations shall be forwarded to the European Commission. The FCO has no powers of its own to sanction non-compliance with the DMA.

In addition, private enforcement of the DMA will be facilitated. The civil law enforcement mechanisms are inspired by the enforcement mechanisms of the EC’s cartel damage claim directive. In particular, final decisions of the European Commission finding a violation of the DMA will have binding effect in damages proceedings before German courts.

The revised draft bill does not include any changes compared to the initial draft bill with regard to the provisions relating to the enforcement of the DMA.

Outlook

The revised draft bill has to take another step in the legislative process by passing the German Parliament [Bundestag] and the German Federal Council [Bundesrat]. There also is still no clarity yet as to when the revised draft bill will enter into force, but it is expected to come into force still this year.

As already mentioned in the previous Client Alert (available here), the competent Ministry is already working on a draft 12th amendment of the German Competition Act with a focus on establishing more legal certainty for sustainability cooperation between companies as well as stronger consumer protection.

The following Gibson Dunn lawyers assisted in preparing this client update: Georg Weidenbach, Kai Gesing, Jan Vollkammer, and Elisa Degner.

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

Kai Gesing – Munich (+49 89 189 33 180, kgesing@gibsondunn.com)
Georg Weidenbach – Frankfurt (+49 69 247 411 550, gweidenbach@gibsondunn.com)
Christian Riis-Madsen – Co-Chair, Brussels (+32 2 554 72 05, criis@gibsondunn.com)
Ali Nikpay – Co-Chair, London (+44 (0) 20 7071 4273, anikpay@gibsondunn.com)
Rachel S. Brass – Co-Chair, San Francisco (+1 415-393-8293, rbrass@gibsondunn.com)
Stephen Weissman – Co-Chair, Washington, D.C. (+1 202-955-8678, sweissman@gibsondunn.com)

With the rapid proliferation of artificial intelligence across industries and sectors, state legislatures have taken notice.

In the past few months alone, there has been a flurry of action at the state government level, including Connecticut, Illinois and Texas introducing bills to create government task forces to study AI, Massachusetts proposing an act drafted with ChatGPT to regulate generative AI models and at least four proposed bills governing automated-decision-making tools in employment.

While many of these states are only starting to dip their toes into the regulatory ring in this space, California has been steadily building its foundation for over a year and is positioning itself as a key regulator of AI in employment. Indeed, there have been a number of noteworthy proposals in California focused on automated-decision-making tools.

This article focuses on two of California’s recent proposals — regulations from the California Civil Rights Council and Assembly Bill 331 — and five things employers should know about them.

Read More

Reproduced with permission. Originally published by Law360, New York (April 12, 2023).

Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, cgaedt-sheckter@gibsondunn.com)

Danielle J. Moss – New York (+1 212-351-6338, dmoss@gibsondunn.com)

Emily Maxim Lamm – Washington, D.C. (+1 202-955-8255, elamm@gibsondunn.com)

On March 29, 2023, Iowa’s Governor, Kim Reynolds, signed Senate File 262 into law, making Iowa—somewhat unexpectedly—the sixth state, following California, Virginia, Colorado, Utah and Connecticut, to enact comprehensive data privacy legislation. Meanwhile, the Colorado Office of the Attorney General filed a final draft of the Colorado Privacy Act Rules (“CPA Rules”) with the Colorado Secretary of State’s Office on March 15, 2023. Additionally, on February 3, 2023, the California Privacy Protection Agency (“CPPA”) Board voted to (1) adopt and approve the CPPA’s California Privacy Rights Act (“CPRA”) regulations and (2) invite pre-rulemaking comments from the public on the topics of cybersecurity audits, risk assessments, and automated decision making. Finally, Utah’s Governor, Spencer Cox, signed two bills that regulate social media companies with respect to children’s use of social media platforms into law on March 23, 2023.

Iowa’s Comprehensive Privacy Law

Iowa’s law will become effective on January 1, 2025, and applies to any person conducting business in the state of Iowa, or producing products or services that are targeted to consumers who are residents of the state, and that processes a certain number of Iowa consumers’ personal data during a calendar year, namely:

100,000 Iowa consumers;[1] or
25,000 Iowa consumers, if the person derives over fifty percent of gross revenue from the sale of personal data.[2]

This definition tracks the non-California laws, though does not additionally have the $25 million incremental requirement like Utah. As a result, small businesses that process a large number of Iowa consumers’ data might be covered. Further, like Virginia’s, Colorado’s, Utah’s and Connecticut’s laws, Iowa’s law defines “consumer” as a natural person acting only in an individual or household context, thereby excluding employee and business-to-business (B2B) data from the law’s applicability.[3]

Iowa’s law draws heavily from its predecessors elsewhere as well, and is most similar to, and even more business-friendly in many ways than, Utah’s privacy law. Like Utah’s law, Iowa’s does not grant consumers the right to correct their personal data or opt out of the processing of their personal data for purposes of profiling, and grants consumers the right to opt out of (as opposed to opt in to) the processing of their sensitive personal data.[4] Additionally, Iowa’s law does not explicitly grant consumers the right to opt out of the processing of their personal data for purposes of targeted advertising or cross-context behavioral advertising, making it the only comprehensive state privacy law that does not do so.[5] However, Iowa’s law does specify that a controller that engages in targeted advertising “shall clearly and conspicuously disclose such activity, as well as the manner in which a consumer may exercise the right to opt out of such activity”, suggesting that not including the right to opt out of the processing of personal data for purposes of targeted advertising under consumer data rights may have been a drafting error.[6] Iowa’s law allows controllers 90 days to respond to consumer requests, which period may be extended by an additional 45 days upon notice to the consumer, along with a reason for the extension;[7] by contrast, all of the other state laws require controllers to respond within 45 days and allow them to extend such period by an additional 45 days upon notice and explanation to the consumer. Unlike Utah’s law, and like Virginia’s, Colorado’s, and Connecticut’s laws, Iowa’s affords consumers the right to appeal a controller’s denial of a consumer request.[8] Like Utah’s law, and unlike the others, Iowa’s law does not require controllers respond to opt-out preference signals or conduct data protection assessments. Additionally, Iowa’s law does not require controllers to practice purpose limitation or data minimization.

Iowa’s law grants the state attorney general exclusive enforcement authority, subject to a (longer-than-others) 90-day cure period.[9] The attorney general may seek injunctive relief and civil penalties of up to $7,500 per violation.[10]

Colorado Privacy Act Rules

On March 15, 2023, the Colorado Office of the Attorney General filed a final draft of the CPA Rules, which will be published in the Colorado Register later this month and will go into effect July 1, 2023. The draft regulations – finalized after a review of 137 written comments, five virtual and in-person public input sessions, and a rulemaking hearing – clarify language around consumers’ rights, consent, universal opt-out mechanisms, duties of controllers, and data protection assessments. Below, we’ve highlighted what we believe to be some of the most interesting and potentially impactful rules.

Right to Delete. While the Colorado Privacy Act (the “CPA”) affords Colorado consumers the right to delete personal data concerning them,[11] the CPA Rules clarify that if the controller has obtained personal data concerning the consumer from a source other than the consumer, the controller may comply with a consumer’s deletion request with respect to such personal data by opting the consumer out of the processing of such personal data.[12] This brings Colorado’s rules in line with Virginia’s law, leaving Connecticut as the only state that truly affords consumers the right to delete personal data obtained about them.

Universal Opt-Out Mechanisms. The CPA allows consumers to exercise their right to opt out of certain processing through a universal opt-out mechanism.[13] The CPA Rules specify the required technical specifications for such mechanisms and create standards governing the way that opt-out mechanism requirements must be implemented. Specifically, the CPA Rules indicate that the mechanism must (1) allow consumers to automatically communicate their opt-out choice with multiple controllers; (2) allow consumers to clearly communicate one or more opt-out rights; (3) store, process, and transmit consumers’ personal data using reasonable data security measures; (4) not prevent controllers from determining (a) whether a consumer is a Colorado resident or (b) that the mechanism represents a legitimate request to opt out of the processing of personal data; and (5) not unfairly disadvantage any controller.[14] The CPA Rules also specify that universal opt-out mechanisms may not be the default setting for a tool that comes pre-installed.[15] Additionally, the CPA Rules require the Colorado Department of Law to maintain a public list of universal opt-out mechanisms that have been recognized to meet the foregoing standards, with an initial list to be released no later than January 1, 2024.[16] The Global Privacy Control (GPC), which is recognized by the California Attorney General, is likely to be included on such list. By July 1, 2024, controllers must respond to opt-out requests received through universal opt-out mechanisms included on such list, provided that the controller has had at least six months’ notice of the addition of new mechanisms; the controller may (but is not required to) recognize universal opt-out mechanisms that are not included in such list.[17] Finally, a controller may not interpret the absence of a universal opt-out mechanism after the consumer previously used one as a consent to opt back in.

Loyalty Programs. The CPA Rules contain extensive disclosure requirements for controllers maintaining a “bona fide loyalty program”, which it defines as “a loyalty, rewards, premium feature, discount, or club card program established for the genuine purpose of providing [an offer of superior price, rate, level, quality, or selection of goods or services] to [c]onsumers that voluntarily participate in that program, such that the primary purpose of [p]rocessing [p]ersonal [d]ata through the program is solely to provide [such benefits] to participating [c]onsumers.”[18] Specifically, the CPA Rules require controllers disclose: (1) the categories of personal data collected through the bona fide loyalty program that will be sold or processed for targeted advertising; (2) the categories of third parties that will receive the consumer’s personal data; (3) a list of any bona fide loyalty program partners, and the benefits provided by each such partner; (4) an explanation of why the deletion of personal data makes it impossible to provide a bona fide loyalty program benefit (if the controller claims that is the case); and (5) an explanation of why sensitive data is required for the bona fide loyalty program benefit (if the controller claims that is the case).[19]

Changes to a Privacy Notice. The CPA Rules require controllers to notify consumers of material changes to their privacy notices, and specify that material changes may include changes to: (1) categories of personal data processed; (2) processing purposes; (3) a controller’s identity; (4) the act of sharing personal data with third parties; (5) categories of third parties personal data is shared with; or (6) methods by which consumers can exercise their data rights request.[20]

Purpose Specification, Data Minimization, and Secondary Use. The CPA Rules clarify the CPA’s purpose specification, data minimization, and secondary use provisions.[21] Notably, the CPA Rules require controllers set specific time limits for erasure or conduct a periodic review to ensure compliance with data minimization principles, and specify that biometric identifiers, photographs, audio or voice recordings and any personal data generated from photographs or audio or video recordings should be reviewed at least annually.[22] The CPA Rules require controllers obtain consent before processing personal data for purposes that are not “reasonably necessary to or compatible with specified [p]rocessing purpose(s)”, and enumerate factors that controllers may consider to determine whether the new purpose is “reasonably necessary to or compatible with” the original specified purpose.[23]

Sensitive Data. The CPA prohibits controllers from processing a consumer’s sensitive data without first obtaining consent.[24] Among other clarifications (including that biometric data must be used or intended for identification), the CPA Rules create a new category of sensitive data called sensitive data inferences, which are defined as “inferences made by a [c]ontroller based on [p]ersonal [d]ata, alone or in combination with other data, which indicate an individual’s racial or ethnic origin; religious beliefs; mental or physical health condition or diagnosis; sex life or sexual orientation; or citizenship or citizenship status”, and specify that controllers must obtain consent in order to process sensitive data inferences unless such inferences are (1) from consumers over the age of thirteen, (2) the processing purposes are obvious, (3) such inferences are permanently deleted within 24 hours, (4) such inferences are not transferred, sold, or shared with any processor, affiliates, or third parties, and (5) the personal data and sensitive data inferences are not processed for any purpose other than the express purpose disclosed to the consumer.[25]

Consent. The CPA Rules contain detailed requirements for what constitutes and how to obtain valid consent, as well as a significant discussion of user interface design, choice architecture, and dark patterns.[26] Specifically, consent must be informed, specific, freely given, obtained through clear and affirmative action, and reflect the consumer’s unambiguous agreement, and the CPA Rules provide additional guidance on each of these elements.[27] The CPA Rules require that controllers refresh consent to continue processing sensitive data or personal data for a secondary use that involves profiling in furtherance of decisions that produce legal or similarly significant effects when a consumer has not interacted with the controller in the prior 24 months; however, controllers are not required to refresh consent when the consumer has access and ability to update their opt-out preferences at any time through a user-controlled interface.[28] The CPA Rules indicate that controllers need to obtain consent before January 1, 2024 in order to continue processing sensitive data collected prior to July 1, 2023.[29] The CPA Rules also specify that if a controller has collected personal data prior to July 1, 2023 and the processing purposes change after July 1, 2023 such that it is considered a secondary use, the controller must obtain consent at the time the processing purpose changes.[30]

Data Protection Assessments. The CPA requires controllers to conduct and document a data protection assessment before conducting a processing activity that presents a heightened risk of harm to a consumer.[31] The CPA Rules clarify the scope and requirements of such data protection assessments, making Colorado the first state to provide regulations governing data protection assessments conducted under a comprehensive state privacy law. The CPA Rules specify thirteen topics that must be included in a data protection assessment, including a short summary of the processing activity, the categories of personal data processed, the sources and nature of risks to consumers associated with the processing activity, measures and safeguards the controller will employ to reduce such risks, and a description of how the benefits of the processing outweigh such risks. The CPA Rules indicate that if a controller conducts a data protection assessment for the purpose of complying with another jurisdiction’s law or regulation, such assessment shall satisfy the requirements set forth in the CPA Rules if such assessment is “reasonably similar in scope and effect” to the assessment that would otherwise be conducted pursuant to the CPA Rules.[32] If the assessment is not reasonably similar, a controller may still submit that assessment, along with a supplement that contains any additional information required by Colorado.[33] The CPA Rules also clarify that data protection assessments are required for activities created or generated after July 1, 2023; the requirement is not retroactive.[34]

Profiling. Colorado is also the first state to enact regulations governing profiling in the context of a comprehensive state privacy law. With respect to the right of access, the CPA Rules clarify that “specific pieces of personal data” include profiling decisions, inferences, derivative data, marketing profiles, and other personal data created by the controller that is linked or reasonably linkable to an identified or identifiable individual.[35] With respect to the right to opt out of the processing of personal data for purposes of profiling in furtherance of decisions that produce legal or similarly significant effects, the CPA Rules clarify that a controller may decide not to take action on such a request if the profiling is based on “human involved automated processing” (i.e., “the automated processing of [p]ersonal [d]ata where a human (1) engages in a meaningful consideration of available data used in the [p]rocessing or any output of the [p]rocessing and (2) has the authority to change or influence the outcome of the [p]rocessing”), provided that certain information is provided to the consumer.[36]

California Privacy Rights Act Regulations

On February 3, 2023, the CPPA Board voted to adopt and approve the CPPA’s CPRA regulations promulgated and revised to date, and to direct staff to take all steps necessary to complete the rulemaking process, including the filing of the final rulemaking package with the Office of Administrative Law (“OAL”).[37] On February 14, 2023, the CPPA submitted the rulemaking package to the OAL for final review.[38] The OAL has 30 days from the date of submission to review the proposed regulations; while the 30 days have passed, an update has not explicitly been released. The details of the regulations have been detailed in prior Gibson Dunn alerts.[40]

The Board also voted to invite pre-rulemaking comments from the public on cybersecurity audits, risk assessments, and automated decision making, for which there have not been any regulations drafted.[41] Following the vote, on February 10, 2023, the CPPA issued an Invitation for Preliminary Comments on Proposed Rulemaking on these topics.[42] Interested parties were required to submit comments by 5:00 p.m. PT on Monday, March 27, 2023. A copy of the invitation that was issued is available here.

Utah Social Media Regulation Act

On March 23, 2023, Utah’s Governor, Spencer Cox, signed two bills into law that regulate social media companies with respect to children’s use of social media platforms. Both will take effect on March 1, 2024.

S.B. 152 requires “social media companies”, which it defines as “a person or entity that: (a) provides a social media platform that has at least 5,000,000 account holders worldwide; and (b) is an interactive computer service”, to verify the age of Utah residents seeking to maintain or open an account, obtain parental consent before allowing a Utah resident under the age of 18 to open or maintain an account, and implement specific restrictions for Utah residents under 18.[43] Specifically, S.B. 152 prohibits social media companies from (1) showing minors’ accounts in search results, (2) displaying advertising to minors’ accounts, (3) targeting or suggesting groups, services, products, posts, accounts or users to minors’ accounts or (4) collecting, sharing, or using personal information from minors’ accounts (with certain exceptions).[44] Additionally, S.B. 152 requires social media companies to (1) prohibit minors’ accounts from direct messaging “any other user that is not linked to the [minor’s] account through friending”, (2) limit hours of access (subject to parental or guardian direction), and (3) provide parents with a password or other means of accessing the minor’s account.[45]

H.B. 311 prohibits social media companies from using a practice, design or feature that it knows (or should know through the exercise of reasonable care) causes a Utah resident under the age of 18 to “have an addiction to” the social media platform.[46] H.B. 311 defines “addiction” as “use of a social media platform that: (a) indicates the user’s substantial preoccupation or obsession with, or the user’s substantial difficulty to cease or reduce use of, the social media platform; and (b) causes physical, mental, emotional, developmental, or material harms to the user.”[47]

The laws grant authority to administer and enforce their requirements to the Division of Consumer Protection.[48] S.B. 152 also delegates certain rulemaking authority to the Division of Consumer Protection.[49] Violations of S.B. 152 are punishable by an administrative fine of up to $2,500 for each violation, subject to a 30-day cure period.[50] Violations of H.B. 311 are punishable by (1) a civil penalty of $250,000 for each practice, design, or feature shown to have caused addiction and (2) a civil penalty of up to $2,500 for each Utah minor account holder who is shown to have been exposed to such practice, design or feature.[51] Additionally, the laws provide for private rights of action and specify that the person who brings action is entitled to (a) an award of reasonable attorney fees and court costs and (b) an amount equal to the greater of (i) $2,500 per violation or (ii) actual damages for financial, physical, and emotional harm incurred by the person bringing the action.[52]

In a previous client alert, we discuss the California Age-Appropriate Design Code Act, which is also aimed at protecting the wellbeing, data, and privacy of children under the age of 18 using online platforms. However, Utah’s laws go much further. Together, these laws evidence the increased attention children’s privacy is receiving from lawmakers and regulators, as they are more targeted in scope—and incremental—as compared to each state’s previous, comprehensive privacy law.

Other States

State legislative activity regarding data privacy appears to be at an all-time high. Proposed data privacy legislation has passed a legislative chamber in Hawaii, Indiana, Kentucky, Montana, New Hampshire, and Oklahoma. Numerous other states are also actively considering data privacy legislation, with drafting and negotiations at various phases.

We will continue to monitor developments in this area, and are available to discuss these issues as applied to your particular business.

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[1] This is a fairly significant threshold to meet, as it is about 3% of the state’s population.

[2] S.F. 262, 90th Gen. Assemb., Reg. Sess. §§ 2(1), 10 (Iowa 2023).

[3] Id. § 1(7).

[4] See id. § 3.

[5] See id.

[6] See id. § 4(6).

[7] Id. § 3(2)(a).

[8] Id. § 3(3).

[9] Id. §§ 8(1)-(2).

[10] Id. § 8(3).

[11] Colorado Privacy Act (“CPA”), S.B. 21-190, 73rd Gen. Assemb., Reg. Sess., § 6-1-1306(1)(d) (Colo. 2021) (to be codified in Colo. Rev. Stat. Title 6).

[12] Colo. Dep’t of Law, Colorado Privacy Act Rules (“CPA Rules”), to be codified at 4 Colo. Code Regs. § 904-3, r. 4.06(D), available at https://coag.gov/app/uploads/2023/03/FINAL-CLEAN-2023.03.15-Official-CPA-Rules.pdf.

[13] CPA, § 6-1-1306(1)(a)(IV).

[14] CPA Rules, r. 5.06.

[15] Id., r. 5.04(A).

[16] Id., r. 5.07(A).

[17] Id., r. 5.08(A)-(B).

[18] Id., r. 2.02.

[19] Id., r. 6.05(F).

[20] Id., r. 6.04(A).

[21] Id., r. 6.06-.08

[22] Id., r. 6.07(B).

[23] Id., r. 6.08(B)-(C).

[24] CPA, § 6-1-1308(7).

[25] CPA Rules, r. 2.01(A), 6.10(A)-(B).

[26] Id., pt. 7

[27] Id., r. 7.03

[28] Id., r. 7.08(A)-(B).

[29] Id., r. 7.02(B)(1).

[30] Id., r. 7.02(B)(2).

[31] CPA, § 6-1-1309(1).

[32] CPA Rules, r. 8.02(B).

[33] Id.

[34] Id., r. 8.05(F).

[35] Id., r. 4.04(A)(1).

[36] Id., r. 2.02, 9.04(C)

[37] Cal. Priv. Prot. Agency, News & Announcements, CPPA Board Unanimously Votes to Advance Regulations (Feb. 3, 2023), available at https://cppa.ca.gov/announcements/.

[38] Cal. Priv. Prot. Agency, News & Announcements, CPPA Files Proposed Regulations with the Office of Administrative Law (OAL) (Feb. 14, 2023), available at https://cppa.ca.gov/announcements/.

[39] Id.

[40] See, e.g., U.S. Cybersecurity and Data Privacy Outlook and Review – 2023 (January 30, 2023), available at https://www.gibsondunn.com/us-cybersecurity-and-data-privacy-outlook-and-review-2023/#_ednref2; Insights on New California Privacy Law Draft Regulations, Gibson Dunn (June 15, 2022), available at https://www.gibsondunn.com/insights-on-new-california-privacy-law-draft-regulations/.

[41] Cal. Priv. Prot. Agency, News & Announcements, CPPA Board Unanimously Votes to Advance Regulations (Feb. 3, 2023), available at https://cppa.ca.gov/announcements/.

[42] Cal. Priv. Prot. Agency, News & Announcements, CPPA Issues Invitation for Preliminary Comments on Cybersecurity Audits, Risk Assessments, and Automated Decision Making (Feb. 10, 2023), available at https://cppa.ca.gov/announcements/.

[43] S.B. 152, 2023 Gen. Sess., §§ 13-63-101(8), 13-63-102(1),(3) (Utah 2023).

[44] Id., § 13-63-103.

[45] Id., §§ 13-63-103(1), 13-63-104, 13-63-105.

[46] H.B. 311, 2023 Gen. Sess., § 13-63-201(2) (Utah 2023).

[47] Id., § 13-63-101(2).

[48] S.B. 152, § 13-63-202(1); H.B. 311, § 13-63-201(1)(a).

[49] S.B. 152, § 13-63-102(4).

[50] S.B. 152, §§ 13-63-202(3)(a)(i), (4).

[51] H.B. 311, § 13-63-201(3)(a).

[52] S.B. 152, § 13-63-301; H.B. 311, § 13-63-301.

The following Gibson Dunn lawyers assisted in preparing this alert: Cassandra Gaedt-Sheckter, Ryan T. Bergsieker, and Sarah Scharf.

Asia
Connell O’Neill – Hong Kong (+852 2214 3812, coneill@gibsondunn.com)
Jai S. Pathak – Singapore (+65 6507 3683, jpathak@gibsondunn.com)

Since the CHIPS and Science Act (“CHIPS Act”) was enacted into law in August 2022, the Biden Administration has been busy implementing its mandate to “incentivize investment in facilities and equipment in the United States for the fabrication, assembly, testing, advanced packaging, production, or research and development of semiconductors, materials used to manufacture semiconductors, or semiconductor manufacturing equipment.”[1] As discussed in our previous client alert, the administration published the first of three expected Notices of Funding Opportunities (“NOFO”) on February 28, 2023, and the U.S. Department of Commerce (the “Department”) began evaluating pre-applications and applications from leading-edge facilities last month.[2]

In an April 11, 2023 webcast, the CHIPS Program Office (“CPO”) discussed the application process for this first funding opportunity and critical elements of a successful pre-application. This alert highlights key details from that webcast that will assist clients preparing funding pre-applications.

I. Who Can Apply, and When?

The CPO emphasized that currently the pre-application guidance in this alert applies only to covered entities applying for funding under the first NOFO, and it is unclear whether future NOFOs will follow a similar pre-application process.[3] The first NOFO encompasses funding for the principle fabrication aspects of semiconductors: fabrication facilities themselves, as well as assembly, testing, and advanced packaging. The first NOFO covers in general the full spectrum of fabrication technology, including: leading-edge, current-generation, and mature-node facilities, as well as back-end production facilities.[4] In its April 11 webinar, however, the CPO indicated that all potential applicants for CHIPS funding—even those not eligible for funding under the first NOFO—are encouraged to submit a Statement of Interest at this time.[5] These Statements of Interest, which include applicant information and a brief description of the planned application, allow the Department to gauge interest and prepare for the review of applications and pre-applications.[6] Official instructions for submitting a Statement of Interest have been published online.

After filing the Statement of Interest, applicants must wait a minimum of twenty-one days before submitting an application or pre-application for funding.[7] Once this twenty-one day period has passed, potential applicants eligible for funding may submit a pre-application (or application), according to the following schedule:

March 31, 2023: Earliest submission date for applicants for leading-edge project funding to submit an optional pre-application or mandatory full application.
May 1, 2023: Earliest date for applicants for current-generation, mature-node, and back-end project funding to submit an optional pre-application.
June 26, 2023: Earliest date for applicants for current-generation, mature-node, and back-end project funding to submit a mandatory full application.

II. Benefits of Submitting a Pre-Application

The Department of Commerce does not require a pre-application to award CHIPS Act funds under the first NOFO.[8] Submitting a pre-application, however, creates an opportunity for dialogue with the CPO. While this dialogue is useful for all applicants, the CPO has indicated that areas other than leading-edge fabrication—specifically, current-generation, mature-node, and back-end production applicants are especially encouraged to submit a pre-application, presumably as the CPO will need to more closely evaluate the merits of funding current or legacy technology as opposed to cutting-edge nodes.[9]

After reviewing a pre-application, the Department will provide potential applicants with a written assessment of the pre-application’s strengths and weaknesses, along with recommendations for improvement. This written assessment will include a “recommendation for next steps,” ranging from submitting a revised pre-application or full application to not submitting any further application materials.[10] Moreover, the CPO will use the pre-application to assess the project’s likely level of review under the National Environmental Policy Act (“NEPA”), allowing applicants to avoid delays down the line.[11]

For current-generation, mature-node, and back-end production applicants, the Department has indicated that the choice to submit a pre-application—or not—will not affect the timeline of the full application’s review.[12] The Department will initially screen applications and pre-applications for eligibility in order of receipt. The subsequent comprehensive review order, however, will be determined based on the program priorities discussed in Section IV of this alert. The Department has thus far been reluctant to provide any estimated turnaround time for applications until it has a clearer picture of the volume of potential applications.[13]

III. Elements of the Pre-Application

The pre-application consists of six main sections, including a mix of narrative responses, data uploads, and web form responses. The form of the pre-application largely mirrors that of the final application, to allow the Department to provide as thorough of an assessment of the application’s strengths and weaknesses as possible.[14] Guides and templates for these pre-application elements are available on the CHIPS for America website.

Cover Page: The pre-application’s cover page is created by populating a number of required fields in a web-based form on the CHIPS Incentives Program Application Portal. These fields include the applicant’s organization and a descriptive name for the project, as well as whether the applicant is part of a consortium.[15]As part of this cover page, applicants must indicate whether they have registered for an account with the federal government’s System for Award Management (“SAM.gov”). CPO staff advised that all potential applicants apply for an account on SAM.gov as soon as possible to avoid delays and to receive a Unique Entity Identifier number, which should be included on the cover page when possible.[16]The pre-application cover page should also, if applicable, provide information about any other entities with which the applicant anticipates partnering for purposes of their project. Such partners may include, but are not limited to, customers, suppliers, investors, bankers, or advisors. The Department has emphasized that, so long as these partners are meaningfully involved in the proposed project, applicants should be as inclusive as possible when listing potential partners in their cover page.[17]

Project Plan

The Project Plan provides a space for applicants to describe each project expected to be included in the future full application and explain how these projects satisfy the evaluation criteria discussed in Section IV of this alert. The Project Plan should consist of:[18]

Description of Projects: Applicants must provide a detailed description of the proposed project(s) for each facility included in the application.This description should include, among other things: the products that each facility produces or will produce, these products’ end market application, the top ten customers for each major product, and key suppliers.

Estimated Project Timeline: This timeline should include an estimated schedule for capital expenditures, key construction and operations milestones, and an estimate of when the applicant may be ready to submit the full application.

Applicant Profile: Applicants should identify their headquarters, primary officers, ownership, main business lines, countries of operation, and, if applicable, the identity of any corporate parent.

Consortium Description (if applicable): If applying as one participating entity in a larger consortium, an applicant must identify all individual entities that are members of the consortium, along with the role of each entity and the governance structure of the consortium.

Cluster Profile: Applicants should describe how their project(s) will attract supplier, workforce, and other related investments.

CHIPS Incentive Justification: A narrative summary should describe how CHIPS Act funding will incentive investments in facilities and equipment in the U.S. that would not occur in the absence of this funding.

Summary Narrative Addressing the Evaluation Criteria: This narrative response should address each evaluation criteria discussed in Section IV and indicate how the proposed project would support these program priorities.

Financial Information

The Financial Information section of the pre-application aims to ascertain the financial strength of the applicant (including any parent entities) and the project, as well as the existence of any third-party investments and the reasonableness of the CHIPS Act funding request.

The Financial Information submission should include:

Summary Financials for Each Project: For each project described in the pre-application, applicants must submit the expected revenues, costs, and cashflows for the project, including key income statements, cash flow statements, and balance sheet information.[19]
The Department has created an example financial model that can guide applicants’ submissions for these summary financials.[20]

Company Financials: Applicants must provide audited financial statements, key performance metrics, and details on leverage and related debt coverage for both the applicant and, if relevant, its corporate parent.

Facility Ownership Structure: Though not relevant in all cases, the Department has indicated that a detailed ownership map will generally be helpful for their review.[21]

Sources and Uses of Funds: Working from a template, applicants must describe the proposed project’s costs—including capital investment, operating losses and cash outflows, and workforce development costs—as well as a detailed description of project capital sources. When calculating project capital sources, applicants should factor in the estimated value the benefit is expected to be eligible to receive from the Investment Tax Credit, if applicable, and other state and local tax incentives.[22]

CHIPS Incentives Request: Applicants must submit a summary of requested dollar amounts for CHIPS Direct Funding.

Environmental Questionnaire

Companies may not have complete information regarding potential environmental impacts of their proposals at the pre-application stage. However, applicants should provide as thorough responses as possible to the environmental questionnaire in order to prevent delays at later stages.

In particular, the CPO has emphasized that comprehensive pre-application questionnaires enable its Environmental Division to more effectively assess an applicant’s likely level of NEPA review. The CPO Office has indicated that it plans to work with applicants and their third-party contractors to facilitate the environmental review under NEPA, including working with applicants at the pre-application stage to ensure that all required environmental information is collected as early as possible.[23] Specifically, they noted they will provide resources such as webinars, templates, and consultation in preparing for environmental reviews.[24]

Workforce Development Information

As a key program priority of the CHIPS Act, applicants must provide detailed information about their planned efforts to recruit, train, and retain a “diverse and skilled” set of workers.[25] In addition to forward-looking goals, the CPO stressed its interest in understanding any early actions applicants have already taken to support workforce development efforts.[26]

This workforce development section must provide an estimated number of jobs that an applicant’s projects will create, proposed strategy to meet these workforce needs, proposed training and education strategies, and an applicant’s strategy to comply with the Good Jobs Principles published by the Departments of Commerce and Labor.

In its April 11 webcast, the CPO repeatedly stressed its focus on creating “opportunities to reflect America’s diversity.”[27] Therefore, all submissions should include proposed equity strategies to promote the hiring and retention of employees from historically underserved communities.

The Department has also emphasized the importance of strategic partnerships to help attract talent, increase awareness of employment opportunities within a community, provide wraparound support for employees, and retain and grow a company’s workforce.[28] These partners may include community-based organizations, labor unions, educational institutions, and local housing organizations. Applicants cannot merely gesture to these community groups: the CPO indicated that applicants must secure commitments from these strategic partners and are expected to engage with them on an ongoing basis.[29]

Applicants seeking more than $150 million in direct funding will be required at the final application stage to provide a plan for how they will provide childcare for their workers. Although it is encouraged if possible, applicants are not required to submit this childcare plan at the pre-application stage.[30]

Attestation and Submission

After a pre-application is submitted through the CHIPS Incentives Program Application Portal, the CPO will send an email confirming receipt of the application. Once the pre-application has been screened for eligibility, the Department will begin a comprehensive review of the application and may reach out to the applicant for additional information or for clarification before providing its written assessment and next steps.

IV. Confidentiality

Some elements of the pre-application may require applicants to reveal trade secrets or other confidential business information. The CHIPS Act expressly provides that “any information derived from records or necessary information disclosed by a covered entity to the Secretary” with respect to CHIPS funding is exempt from disclosure under the Freedom of Information Act (“FOIA”) and “shall not be made public.”[31] Applicants’ trade secrets and privileged commercial or financial information is also protected from disclosure by FOIA.[32] Additionally, CPO staff emphasized that the Office is in the process of “instituting robust protocols, technology solutions, and organizational practices” to keep applicants’ data safe. They noted that application materials will only be available to federal officials and contractors on a need-to-know basis.[33]

To ensure that all confidential business information is properly protected from disclosure, the Department provides detailed instructions for marking this information in Section III(C)(2) of the NOFO.[34]

V. Project Evaluation Criteria

All applications and pre-applications for funding under the first NOFO are evaluated based on their ability to satisfy six main criteria, based on CHIPS program priorities. These criteria are:

Economic & National Security Objectives

Because “[a]dvancing U.S. economic and national security is the principal objective of the CHIPS Incentives Program,”[35] the Department has indicated that projects’ ability to support these goals will receive the greatest weight in its review.[36] Strong applications must therefore explain how their projects will support U.S. economic and national security by, for example, mitigating against supply chain shocks associated with the current geographic concentration of semiconductor manufacturers or meeting the government’s need for safe and secure chips for modern defense systems.

Moreover, because the CHIPS Act aims to support the “next wave of U.S.-based production” of semiconductors, the Department will consider “the extent to which the applicant makes credible commitments of ongoing private investment” in the United States as part of its economic security analysis.[37]

Projects that remain vulnerable to cybersecurity risks or supply chain disruption may pose risks to U.S. national security. Therefore, applicants should address their risk management strategies designed to avoid supply chain exploitation, loss of intellectual property, and data security.[38]

Commercial Viability

The Department of Commerce has indicated that projects funded under the CHIPS Act should eventually be capable of “providing reliable cash flows that are sufficient to maintain continuity of operations and continued investment as necessary in the facility.”[39] Applications and pre-applications should therefore demonstrate a reasonable market environment and demand—including an assessment of the size and diversity of the expected customer base—for the types of semiconductor technology the projects will produce.

In its April 11 webcast, CPO staff indicated that evidence of existing customer demand can be particularly persuasive.[40] However, applications should address the commercial viability for the “entire estimated useful life” of the project, including by addressing any technology obsolescence risk.[41]

Financial Strength

As discussed in Section III, the Department will assess any application on the financial strength not just of the applicant, but also of its corporate parent and key intermediate entities.

When assessing the financial strength of any given project, the Department will consider all alternative sources of financing that an applicant has pursued, including through private equity and external debt financing. CPO staff indicated that applicants that have minimized the size of their CHIPS funding request by pursuing alternative funding sources will generally be preferred.[42]

Technical Feasibility & Readiness

The CHIPS Act’s success depends, in part, on the timely and effective construction and operation of funded facilities. Therefore, applicants must demonstrate not only that their projects are technically feasible, but also that the applicant has a clear project execution plan including construction and operational deadlines. Applicants who can demonstrate, for example, existing infrastructure and contractual arrangements for their projects may be more successful in securing funding.

Workforce Development

As discussed in Section III, a key priority of the CHIPS Act is the development of a highly skilled and diverse workforce, including both the construction workforce necessary to complete funded projects and the semiconductor workforce that will ultimately operate these facilities. Applicants must detail their plans to recruit, train, and retain these construction and facility workers on an equitable basis and in line with the Good Jobs Principles.

The Department of Commerce has published a detailed Workforce Development Planning Guide to assist applicants in developing these strategies.

Broader Impacts of the Project

The Department of Commerce has emphasized its interest in funding projects that will contribute to “community vitality” by supporting small businesses, engaging in appropriate environmental stewardship, and more.[43] Applicants should demonstrate that they will maximize benefits to taxpayers by supporting a wide variety of tangential impacts, such as:

Commitments to future investment in the U.S. semiconductor industry;

Support for CHIPS research and development programs;

Creating inclusive opportunities for businesses, including small businesses and minority-owned, women-owned, and veteran-owned businesses;

Demonstrated climate and environmental responsibility;

Community investments, including affordable housing, education, and transportation opportunities; and

Use of domestic manufacturing and raw materials in construction and operation of projects.

VI. How Gibson Dunn Can Assist

Gibson Dunn has an expert team tracking implementation of the CHIPS Act closely, including semiconductor industry subject matter experts and public policy professionals. Our team is available to assist eligible clients to secure funds throughout the CHIPS Act application process, including the pre-application process. We also can engage with our extensive political-appointee and career officials contacts at the Department of Commerce and other federal agencies to facilitate dialogue with our clients and discuss the structure of future CHIPS Act programs being developed.

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[1]      Pub. Law No. 117–167 Sec. 102(a) (funding the authorization of the semiconductor incentive program established under the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021 (15 U.S.C. §§ 4652, 4654, 4656, Pub. Law No. 116-283)).

[2]      5 U.S.C. § 4651(2); U.S. Dep’t of Commerce Nat’l Institute of Standards and Technology Notice of Funding Opportunity, CHIPS Incentives Program—Commercial Fabrication Facilities, https://www.nist.gov/system/files/documents/2023/02/28/CHIPS-Commercial_Fabrication_Facilities_NOFO_0.pdf [hereinafter, NOFO].

[3]      Department of Commerce Webcast (Apr. 11, 2023). During this webcast, the CPO reiterated that two additional NOFOs are expected to be published in the coming months: one focused on material suppliers and equipment manufactures in late spring 2023 and one for the construction of semiconductor research and development facilities in fall 2023. Id.

[4]      NOFO at 5.

[5]      Id.

[6]      NOFO at 11.

[7]      Id. at 1.

[8]      NOFO at 11.

[9]      Department of Commerce Webcast (Apr. 11, 2023).

[10]    Id.

[11]    NOFO at 11.

[12]    Department of Commerce Webcast (Apr. 11, 2023).

[13]    Id.

[14]    See NOFO at 38–39. The full application submission is made up of the following components, which include information captured in large part in the pre-application: Cover Page, Covered Incentive, Description of Project(s), Applicant Profile, Alignment with Economic and National Security Objectives, Commercial Strategy, Financial Information, Project Technical Feasibility, Organization Information, Workforce Development Plan, Broader Impacts, and Standard Forms.

[15]    CHIPS for America Guide: Instruction for Pre-Application Forms and Templates (Mar. 27, 2023), https://www.nist.gov/system/files/documents/2023/03/27/Pre-App-Instruction-Guide.pdf.

[16]    Department of Commerce Webcast (Apr. 11, 2023).

[17]    Id.

[18]    NOFO at 34–35.

[19]    NOFO at 36.

[20]    CHIPS for America Guides and Templates (last accessed Apr. 11, 2023), https://www.nist.gov/document/chips-nofo-commercial-fabrication-facilities-pre-application-sources-and-uses-template. The Department of Commerce published a white paper explaining the financial models contained within this example, available at: https://www.nist.gov/system/files/documents/2023/03/31/Pre-App-Financial-Model-White-Paper.pdf.

[21]    Department of Commerce Webcast (Apr. 11, 2023).

[22]    NOFO at 36.

[23]    Id.

[24]    Department of Commerce Webcast (Apr. 11, 2023).

[25]    NOFO at 37.

[26]    Department of Commerce Webcast (Apr. 11, 2023).

[27]    Id.

[28]    Id.

[29]    Id.

[30]    Id.

[31]    See 15 U.S.C. § 4652(a)(6)(G).

[32]    See 15 U.S.C. § 4652(a)(6)(G).

[33] Department of Commerce Webcast (Apr. 11, 2023).

[34]    NOFO at 30–31.

[35]    NOFO at 13.

[36]    Department of Commerce Webcast (Apr. 11, 2023).

[37]    NOFO at 14.

[38]    Id. at 15.

[39]    Id. at 16.

[40]    Department of Commerce Webcast (Apr. 11, 2023).

[41]    NOFO at 17.

[42]    Department of Commerce Webcast (Apr. 11, 2023).

[43]    Id.

The following Gibson Dunn lawyers prepared this client alert: Ed Batts, Michael Bopp, Roscoe Jones, Jr., Amanda Neely, Danny Smith, and Sean Brennan.*

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Public Policy practice group, or the following authors:

Michael D. Bopp – Co-Chair, Public Policy Group, Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)

Roscoe Jones, Jr. – Co-Chair, Public Policy Group, Washington, D.C. (+1 202-887-3530, rjones@gibsondunn.com)

Ed Batts – Palo Alto (+1 650-849-5392, ebatts@gibsondunn.com)

Amanda H. Neely – Washington, D.C. (+1 202-777-9566, aneely@gibsondunn.com)

Daniel P. Smith – Washington, D.C. (+1 202-777-9549, dpsmith@gibsondunn.com)

*Sean J. Brennan is an associate working in the firm’s Washington, D.C. office who currently is admitted to practice only in New York.

© 2023 Gibson, Dunn & Crutcher LLP

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

On March 23, 2023, the Federal Trade Commission (“FTC”) issued a Notice of Proposed Rulemaking (“NPRM”) to significantly expand legal requirements for sellers that use negative option offers.[1] Negative option offers allow a seller to interpret a consumer’s silence or inaction as acceptance of an offer and include prenotification and continuity plans, automatic renewal plans, and free trial offers that convert into automatic renewal plans unless canceled before the end of the trial period. The NPRM was published in the Federal Register on April 24, 2023, and the comment deadline is June 23, 2023.

The FTC’s stated objective is to create enforceable performance-based requirements for all negative option offers across all media pertaining to: misrepresentations, disclosures, consents, and cancellation methods.[2] But the proposed Rule would extend beyond the offer’s negative option features to “any material fact related to the [offer’s] underlying good or service.”[3] Consequently, negative option sellers could face substantial civil penalties for violations of the proposed Rule for any allegedly deceptive facet of the broader consumer transaction.

The proposed Rule could be finalized by the end of the year. Companies should consider how this Rule might impact their business and consider submitting a comment to the NPRM addressing: (i) the prevalence of the alleged deceptive and unfair conduct relating to negative option features; (ii) empirical evidence concerning compliance costs, and the degree to which they would outweigh anticipated benefits; (iii) negative consequences to consumers that might arise from the Rule; and (iv) potential exemptions to the rules, including for industries subject to billing and notice requirements under separate federal or state legal regimes, such as the telecommunications or energy industries.

The Proposed Rule Would Significantly Broaden Requirements and Risks For Sellers Using Negative Option Features.

The proposed Rule would replace regulations that apply only to prenotification negative option plans for physical goods with more expansive requirements that would be applicable to all media containing any type of negative option feature. The proposed Rule would also incorporate negative option rules contained in other laws and regulations, such as the Restore Online Shoppers’ Confidence Act (“ROSCA”) and the Telemarketing Sales Rule (“TSR”) to “establish a comprehensive scheme for regulation of negative option marketing in a single rule… — [a] one-stop regulatory shop[.]”[4] The FTC asserts that the existing ROSCA and TSR rules are insufficient to protect consumers and serve as a deterrence because misrepresentations concerning negative options continue to be prevalent in the marketplace.[5]

The proposed requirements include the following:

Disclosures of Material Terms: Sellers must disclose clearly and conspicuously all material terms related to both the negative option feature and the underlying good or service prior to collecting billing information from the consumer. Material terms include: (i) the nature and amount of charges to be imposed, including any future increases or recurring payments; (ii) deadline(s) for a consumer to affirmatively object to charges; (iii) the date(s) charges will be submitted for payment; and (iv) information on how to cancel a negative option feature.[6]
Broad Prohibition on Misrepresentations: Sellers must not misrepresent, expressly or by implication, any material fact related to the transaction, including the negative option feature, or those related to the underlying good or service.[7]
Easy Cancellation Methods: Sellers must provide consumers with a cancellation method that is at least as easy as the method used to initiate the negative option feature. For instance, if consumers enter into a negative option feature on a seller’s website, they should be able to cancel the negative option feature through the same or an easier process on the seller’s website. If a consumer consented to the feature in-person, the seller must offer a simple cancellation option by phone and/or on its website in addition to, where practical, a similar in-person cancellation method. Sellers cannot require consumers who signed up via their website to call a phone number in order to cancel their negative option agreement.[8]
Consent to Negative Option Feature: Sellers must obtain consumers’ express, informed consent to a negative option feature separately from any other part of a transaction and prior to charging them. Sellers cannot obtain simultaneous consent to charges for an instant purchase and to accept a negative option feature. Sellers must retain records of these consents for three years, or one year after the negative option ends, whichever is longer.[9]
Requirement for Immediate Cancellation Upon Consumer Request: Sellers must immediately cancel the negative option feature upon request from a consumer, unless the seller obtains the consumer’s unambiguous affirmative consent to receive a save prior to cancellation. Sellers cannot present additional and alternative offers during a cancellation attempt, unless a consumer first expressly consents to receive information about offers. Sellers must retain records of these consents for three years, or one year after the negative option ends, whichever is longer.[10]
Annual Reminders: At least annually, sellers must send consumers reminders describing the product or service, the frequency and amount of charges, and the means to cancel. This provision does not apply to negative option agreements involving the delivery of physical goods.[11]

Noncompliance with any of these requirements would be considered an unfair or deceptive practice in violation of Sections 5 and 19 of the FTC Act, subject to civil penalties, currently up to $50,120 per day for ongoing violations.[12]

Former Commissioner Christine Wilson wrote a five-page dissent stating that the proposed Rule went “far beyond practices for which the rulemaking record supports a prevalence of unfair or deceptive practices.”[13] Among other problems, Commissioner Wilson noted that the proposed Rule “is not confined to negative option marketing” and “covers any misrepresentation made about the underlying good or service sold with a negative option feature,” notwithstanding that the Commission did not include and seek comments about such general misrepresentations in its Advance Notice of Proposed Rulemaking.[14] Because the proposed Rule would allow the FTC to invoke Section 19 of the FTC Act to obtain civil penalties or consumer redress, she explained, marketers could be liable for civil penalties for product-efficacy claims “even if the negative option terms are clearly described, informed consent is obtained, and cancellation is simple.”[15]

Commissioner Wilson also stated that the breadth of the proposed Rule would evade the Supreme Court’s decision limiting the FTC’s authority to seek disgorgement in cases enforcing the general prohibition on unfair or deceptive practices in Section 5 of the FTC Act.[16] In addition, she said that the breadth of the proposed Rule is inconsistent with the FTC’s cases under ROSCA, and “will treat marketers differently for purposes of potential Section 5 violations, depending on whether they sell products or services with or without negative option features.”[17] We anticipate that there will be a significant number of comments submitted that raise similar arguments, potentially among others, in opposition to the proposed rulemaking, and if the rulemaking is finalized, similar legal challenges are likely to be raised in courts.

Gibson Dunn attorneys are closely monitoring these developments and available to discuss these issues as applied to your particular business and assist in preparing a public comment for submission on this proposed Rule.

_________________________

[1] Negative Option Rule NPRM, Fed. Trade Comm’n (Mar. 23, 2023). The Commission voted 3-1, along party lines, to publish the NPRM. Chair Khan and Commissioners Slaughter and Bedoya released a joint statement in support of the proposed Rule. See Joint Statement, Fed. Trade Comm’n (Mar. 23, 2023). Former Commissioner Wilson dissented. See Dissenting Statement of Commissioner Christine S. Wilson, Fed. Trade Comm’n (Mar. 23, 2023).

[2] Id. at 3.

[3] Id. at 77-78 (the proposed Rule’s requirements pertaining to misrepresentations and disclosures).

[4] Id. at 42.

[5] Id. at 10-12.

[6] Id. at 77-78.

[7] Id. at 77.

[8] Id. at 80-81.

[9] Id. at 78-80.

[10] Id. at 81.

[11] Id. at 82.

[12] FTC Publishes Inflation-Adjusted Civil Penalty Amounts for 2023, Fed. Trade Comm’n (Jan. 6, 2023).

[13] Dissenting Statement of Commissioner Christine S. Wilson, pg. 1, Fed. Trade Comm’n (Mar. 23, 2023).

[14] Id. at 2.

[15] Id.

[16] Id. at 2, 5; see also AMG Capital Mgmt., LLC v. FTC, 141 S. Ct. 1341 (2021).

[17] Id. at 5.

The following Gibson Dunn lawyers prepared this client alert:

Svetlana S. Gans – Washington, D.C. (+1 202-955-8657, sgans@gibsondunn.com)
Ella Alves Capone – Washington, D.C. (+1 202-887-3511, ecapone@gibsondunn.com)
Victoria Granda – Washington, D.C. (+1 202.955.8249, vgranda@gibsondunn.com)
Natalie Hausknecht – Denver, CO (+1 303.298.5783, nhausknecht@gibsondunn.com)

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of Gibson Dunn’s Privacy, Cybersecurity and Data Innovation, Public Policy, and Administrative Law and Regulatory teams.

Privacy, Cybersecurity and Data Innovation Group:
S. Ashlie Beringer – Palo Alto (+1 650-849-5327, aberinger@gibsondunn.com)
Jane C. Horvath – Washington, D.C. (+1 202-955-8505, jhorvath@gibsondunn.com)
Alexander H. Southwell – New York (+1 212-351-3981, asouthwell@gibsondunn.com)

Public Policy Group:
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)
Roscoe Jones, Jr. – Washington, D.C. (+1 202-887-3530, rjones@gibsondunn.com)

Administrative Law and Regulatory Group:
Eugene Scalia – Washington, D.C. (+1 202-955-8543, escalia@gibsondunn.com)
Helgi C. Walker – Washington, D.C. (+1 202-887-3599, hwalker@gibsondunn.com)

On April 4, 2023, the IRS and Treasury issued Notice 2023-29 (the “Notice”) (here), which provides eagerly awaited guidance for developers and investors seeking to qualify energy projects for the energy community bonus credit available under sections 45, 45Y, 48, and 48E.[1] Following the passage of the Inflation Reduction Act of 2022 (the “IRA”),[2] each of these sections provides for a “bonus” credit for certain facilities that are located in an “energy community.” The Notice includes rules for determining (i) what constitutes an “energy community” and (ii) whether a qualified facility, energy project, or any energy storage technology is “located” or “placed in service” within an energy community. The IRS and Treasury ultimately expect to issue regulations addressing these issues, but, until regulations are proposed, taxpayers may rely on the rules described in the Notice.

On April 7, 2023, Treasury and the IRS made material amendments to the Notice as discussed below.

In connection with the release of the Notice, the Interagency Working Group on Coal and Power Plant Communities and Economic Revitalization also released a searchable mapping tool to help identify areas that may be eligible for the energy community bonus credit. The mapping tool is a general aid and reflects only certain categories of energy communities (and, in the case of Statistical Area energy communities (discussed below), is not yet complete). The mapping tool may not be relied upon by taxpayers.

Background

A bonus credit is available to energy community projects (“EC Projects”) under sections 45 and 45Y (the “PTC”) and sections 48 and 48E (the “ITC”), each of which is explained briefly below. For PTC projects, the maximum bonus credit available to EC Projects is 10 percent, and for ITC projects, the maximum bonus credit is 10 percentage points.[3]

Under current law, the PTC is claimed in respect of the production of electricity from qualified energy resources (e.g., wind, solar) at a qualified facility during the 10-year period beginning on the date on which the project was placed in service. For zero-emission energy projects that begin construction after 2024, the IRA will transition to a new PTC under section 45Y, which is based on a technology-neutral framework.

The current ITC is claimable in respect of the basis of certain energy property (e.g., wind, solar, and energy storage property). Like the PTC, for zero-emission energy projects that begin construction after 2024, the IRA will transition to a new technology-neutral ITC under section 48E.

Definition of “Energy Community”

The Notice provides clarification and guidance related to three location-based categories of energy communities described in the IRA: (i) the Brownfield Site category, (ii) the Statistical Area category, and (iii) the Coal Closure category.

Brownfield Site Category

The Notice defines a Brownfield Site as “real property, the expansion, redevelopment, or reuse of which may be complicated by the presence or potential presence of a hazardous substance, pollutant, or contaminant” or real property that is “mine-scarred land.”[4]

Helpfully, the Notice includes a safe harbor that provides that a site will be a Brownfield Site for purposes of the Notice if that site meets at least one of the following conditions:

the site was previously assessed through federal, state, territory, or federally recognized Indian tribal brownfield resources as meeting the definition of a brownfield site under 42 U.S.C. § 9601(39)(A);[5]
an ASTM E1903 Phase II Environmental Site Assessment has been completed with respect to the site, and assessment confirms the presence on the site of a hazardous substance, pollutant or contaminant; or
for projects with a nameplate capacity of not greater than 5MW (AC), an ASTM E1527 Phase I Environmental Site Assessment has been completed with respect to the site.

However, a site otherwise within one of these prongs is excluded from the safe harbor (and the Brownfield Site category) if it falls within a category of property in 42. U.S.C. § 9601(39)(B) (e.g., such site is already under remediation, on the Superfund National Priorities List, or previously permitted for hazardous waste disposal or treatment).

Statistical Area Category

This category includes a metropolitan statistical area (an “MSA”) or a non-MSA that (i) has (or had at any time after December 31, 2009) 0.17 percent or greater direct employment (the “Fossil Fuel Employment Test”) or 25 percent or greater local tax revenue (the “Fossil Fuel Tax Revenue Test”) related to the extraction, processing, transport, or storage of coal, oil, or natural gas and (ii) has an unemployment rate at or above the national average unemployment rate for the previous year (as determined by the IRS) (the “Unemployment Rate Test”).

The Fossil Fuel Employment Test is calculated by dividing (i) the number of people employed in certain industries identified by certain NAICS codes,[6] by (ii) the total number of people employed in that area. The Unemployment Rate Test is calculated by dividing (i) the total number of unemployed individuals within the MSA or non-MSA by (ii) the total labor force in that MSA or non-MSA, as applicable. Annual unemployment rates are generally released in April of the following calendar year. The Notice also provides detailed definitions for MSAs (which the Notice defines by reference to Office of Management and Budget standards that generally are static for 10 years and were last updated in 2018) and non-MSAs.[7]

The Notice does not provide a methodology for calculating the Fossil Fuel Tax Revenue Test and invites comments to address possible data sources, revenue categories, and procedures to determine whether a MSA or non-MSA qualifies through the Fossil Fuel Tax Revenue Test, noting the potential difficulty of applying the test in light of the substantial number of taxing jurisdictions and absence of a centralized information repository.

The Notice includes an appendix listing all MSAs and non-MSA (by county) that satisfy the Fossil Fuel Employment Test (here). The IRS and Treasury intend to issue in May of each year a list identifying the MSAs and non-MSAs that qualify under the Statistical Area category for the twelve-month period starting in that May and continuing through April of the following year.

Coal Closure Category

This category is defined as a census tract (or a census tract directly adjoining such census tract) in which either (i) a coal mine has closed after December 31, 1999 or (ii) a coal-fired electric generating unit has been retired after December 31, 2009.

The Notice includes an appendix listing all census tracts that are included in the Coal Closure category (here). The Notice makes clear that census tracts are directly adjoining if their boundaries touch at any single point.

A coal mine is treated as having closed if it is a surface or underground mine that has ever had for any period of time, since December 31, 1999, a mine status listed as abandoned or abandoned and sealed (in a list maintained by the Mine Safety and Health Administration).

A coal-fired electric generating unit is treated as having been retired if it has been classified as retired at any time since December 31, 2009 in certain inventories maintained by the U.S. Energy Information Administration and if, at the time of being listed as retired, the generating unit was characterized (under rules set forth in the Notice) as a coal-fired electric generating unit by the U.S. Energy Information Administration. The retirement of a single coal-fired electric generating unit at a plant with multiple units would cause the retired unit’s entire census tract to be a Coal Closure category tract.

Closed coal mines and retired coal-fired electric generating units are excluded from this category if they have irregular location information; however, taxpayers may work with the Mine Safety and Health Administration and the U.S. Energy Information Administration to correct irregular location information.

Beginning Construction and Location Requirements for an “Energy Community”

To qualify for the energy community bonus credit, a PTC project must be “located in” an energy community and an ITC project must be “placed in service” within an energy community. For PTC purposes, the general rule is that a qualified facility must be located in an energy community each year that a PTC is claimed in respect of that facility. For ITC purposes, however, the determination of whether a project is placed in service within an energy community generally is required to be made as of the date the project is placed in service.

The rules described in the preceding paragraph (particularly with respect to the PTC, which is claimed over a multi-year period) could present practical difficulties for the development and financing of projects, usually a capital intensive and multi-year process that relies upon the accuracy of forecasted credit availability, in particular for projects in Statistical Area energy communities (for which status is redetermined annually under the Unemployment Rate Test). Fortunately, the Notice provides a taxpayer-friendly rule that, if a project is located in an energy community on the date that construction begins, that location will, in the case of PTC projects, be deemed an energy community for the entire 10-year credit period and, in the case of ITC projects, be deemed an energy community on the date the project is placed in service.

Update: On Friday, April 7, 2023, Treasury and the IRS amended the Notice to provide that the foregoing taxpayer-friendly rule would apply only to projects that begin construction on or after January 1, 2023.

The determination as to whether construction has begun is made pursuant to well-established guidance (including Notice 2013-29 and its further clarifications and extensions). Nevertheless, there are various practical aspects of the application of this existing guidance to the “energy community” determination that could benefit from further clarification, including the following:

- Given that Notice 2013-29 and its progeny allow for construction to be treated as having begun in a particular year based on off-site physical work of a significant nature or based on incurring a certain percentage of the costs of a project in that year, it would be good to receive confirmation that the relevant year for making these determinations is nonetheless the year when that physical work of a significant nature was done or those expenditures were incurred. In particular, these rules may place further pressure on a particular area of uncertainty that pre-dates the IRA – the extent to which off-site work has been identified and properly associated with a specific project (and location) at the time the off-site work begins.
- Moreover, it would be helpful to receive express confirmation whether the continuity requirements under the existing guidance, which generally require a facility to be placed in service within a certain number of years (i.e., after the year when the relevant activities (or spending) that would otherwise satisfy the “begun construction” requirement under the guidance occurred) in order for construction to actually be deemed to have begun in such year, apply for purposes of determining a project’s eligibility for the “energy community” begun construction rule.
- Finally, given that construction of some projects that potentially qualify for the “energy community” bonus began before publication of the Notice, it would be helpful for the IRS and Treasury to permit taxpayers to apply the begun construction rule using either the year in which construction first began (under Notice 2013-29 and subsequent guidance) or the first taxable year ending after the date of the Notice in which additional physical work is completed (or additional costs are incurred) that independently would satisfy the requirements of Notice 2013-29 and subsequent guidance.

Update: On Friday, April 7, 2023, Treasury and the IRS amended the Notice to provide that the Notice’s special beginning-of-construction rule would apply only to projects that begin construction on or after January 1, 2023. Limiting application of this special rule to projects that begin construction after 2022 is unusually restrictive and may require taxpayers to attempt to “re-commence” construction in energy communities where construction may have already properly begun in order to benefit from the certainty provided by the begun construction rule. Moreover, it seems particularly inequitable to discriminate against projects that began construction in 2022 on or after the date President Biden signed the IRA into law (i.e., August 16, 2022).

In addition to rules specifying when the “energy community” determination is made, the Notice explains which portion of the project needs to be within an “energy community.” A project with “nameplate capacity” is, in general, treated as located in or placed in service within an energy community if 50 percent or more of the project’s nameplate capacity is in an area that qualifies as an energy community. If a project does not have a nameplate capacity, then that project is, in general, treated as located in or placed in service within an energy community if 50 percent or more of the project’s square footage is in an energy community.

However, the Notice also provides a special taxpayer-friendly rule for offshore energy facilities (such as offshore wind farms) that have nameplate capacity but no energy-generating units located in a census tract, an MSA, or non-MSA (which is likely). For these facilities, the entire nameplate capacity of the facility is attributed to the land-based equipment that conditions energy generated by the facility for transmission, distribution, and use. Effectively, this rule provides that taxpayers can gain access to the energy community bonus credit for an offshore facility by locating the power conditioning equipment for that facility in an onshore energy community. Importantly, and what appears to be a trap for the unwary, this guidance takes into account only the power conditioning equipment (e.g., a substation) that is closest to the point of interconnection when testing whether an offshore facility is located in an energy community. Accordingly, if an offshore facility has power conditioning equipment in multiple locations, and if the power conditioning equipment that is closest to the point of interconnection is not located in an energy community, then the offshore facility would not qualify for the energy community bonus credit (even if other power conditioning equipment is located in an energy community). Developers of offshore wind projects will want to be mindful of these rules when determining the location of power-conditioning equipment.[8]

Effective Date

Taxpayers may rely on the rules set forth in Notice 2023-29 until the issuance of the proposed regulations. The proposed regulations are expected to apply to taxable years ending after April 4, 2023.

_________________________

[1] All section references are to the Internal Revenue Code of 1986, as amended.

[2] As was the case with the so-called Tax Cuts and Jobs Act, the Senate’s reconciliation rules prevented Senators from changing the Act’s name, and the formal name of the so-called Inflation Reduction Act is actually “An Act to provide for reconciliation pursuant to title II of S. Con. Res. 14.”

[3] Like the base PTC and ITC themselves, the bonus credit also is reduced by 80 percent for certain projects that do not meet prevailing wage or apprenticeship requirements.

[4] The terms are defined by reference to the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (42 U.S.C. § 9601(39)).

[5] Potential site lists may be found under the category of Brownfields Properties on the EPA’s Cleanups in My Community webpage or on similar webpages maintained by states, territories, or for federally recognized Indian tribes. See https://java.epa.gov/acrespub/stvrp/.

[6] These codes are the 2017 North American Industry Classification System codes 211 (Oil and Gas Extraction), 2121 (Coal Mining), 213111 (Drilling Oil and Gas Wells), 213112 (Support Activities for Oil and Gas Operations), 213113 (Support Activities for Coal Mining), 32411 (Petroleum Refineries), 4861 (Pipeline Transportation of Crude Oil), and 4862 (Pipeline Transportation of Natural Gas), each as listed in the annual County Files of the County Business Patterns published by the Census Bureau.

[7] The Notice includes an appendix listing all relevant MSAs and non-MSAs (here) that are used for all purposes of the Notice.

[8] It also would be helpful for the IRS and Treasury to confirm that the relevant measurement date for purposes of determining whether power conditioning equipment is located in an energy community is the date on which construction on the corresponding offshore facility began (and not the date on which construction on the power conditioning equipment began).

This alert was prepared by Josiah Bethards, Emily Brooks, Mike Cannon, Matt Donnelly, and Simon Moskovitz.

Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Tax or Power and Renewables practice groups, or the following authors:

Tax Group:
Michael Q. Cannon – Dallas (+1 214-698-3232, mcannon@gibsondunn.com)
Matt Donnelly – Washington, D.C. (+1 202-887-3567, mjdonnelly@gibsondunn.com)
Josiah Bethards – Dallas (+1 214-698-3354, jbethards@gibsondunn.com)
Emily Risher Brooks – Dallas (+1 214-698-3104, ebrooks@gibsondunn.com)
Simon Moskovitz – Washington, D.C. (+1 202-777-9532 , smoskovitz@gibsondunn.com)

Power and Renewables Group:
Peter J. Hanlon – New York (+1 212-351-2425, phanlon@gibsondunn.com)
Nicholas H. Politan, Jr. – New York (+1 212-351-2616, npolitan@gibsondunn.com)

As information trickles out about how the government will implement an outbound investment review program or “reverse CFIUS,” Gibson Dunn attorneys Stephenie Gosnell Handler, Annie Motto, and Chris Mullen say the program should be narrowly tailored to critical technologies used in national security.

Late last year, Congress directed the Treasury Department to submit a report explaining what resources would be needed to establish and implement an outbound investment review program, the so-called “reverse CFIUS.”

CFIUS (the Committee of Foreign Direct Investment in the United States) has authority to review the national security implications associated with certain foreign investments in or acquisitions of US businesses.

In contrast, a “reverse CFIUS” mechanism is expected to give the US government authority to screen and monitor outbound investment from the United States to “countries of concern”—most notably China—in order to review the flow of US capital that would directly support the use of critical technologies by China’s military or civil sector.

Recently released reports from two federal agencies on this topic, the Biden administration’s proposed fiscal year 2024 budget, recent statements by the Secretary of Commerce, and research by non-governmental groups highlight key aspects of what are expected to define any potential regime.

Regardless of what the regime ultimately looks like, there is broad consensus that a successful outbound investment review program should be grounded in clear policy objectives and narrowly tailored to critical technologies implicating national security. To that end, proposals for interim outbound investment review measures should be focused on finding the right regime to balance national security concerns without unnecessarily stifling innovation.

Read More

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

Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@gibsondunn.com)

Annie Motto – New York (+1 212-351-3803, amotto@gibsondunn.com)

Chris R. Mullen – Washington, D.C. (+1 202-955-8250, cmullen@gibsondunn.com)

As we wrap up the first quarter of 2023, Gibson Dunn’s Media, Entertainment and Technology Practice Group highlights some of the notable rulings, developments, deals, and trends since the start of 2022 that will inform the industry in years to come.

A. Music and Television Litigation

AMC Successfully Defends Lawsuit From Creators and Producers of The Walking Dead Series Yet Again

In 2020, AMC Film Holdings, LLC, AMC Network Entertainment, LLC, and AMC Networks Inc. (“AMC”) won a phase-one trial on all contract interpretation issues raised by certain creators and producers of The Walking Dead in the multi-hundred-million-dollar lawsuit brought by Robert Kirkman, David Alpert, Charles Eglee, Glen Mazzara, and Gale Anne Hurd.[1] The plaintiffs alleged that AMC breached their agreements by failing to properly account to them for backend compensation they were allegedly due in connection with the series The Walking Dead, Fear The Walking Dead, and Talking Dead. Following that trial, which was resolved entirely in favor of AMC, the court ordered the case to proceed on the merits “based on the contract interpretations so decided in th[at] trial.”[2]

Following amended complaints, two demurrers, and additional discovery, in April 2022, AMC successfully won summary adjudication on the plaintiffs’ remaining “big ticket” claims for breach of the implied covenant and fair dealing and inducing breach of contract. The court found there were no triable issues of material fact concerning AMC’s alleged lack of good faith in setting its Modified Adjusted Gross Receipts definition and the contested imputed license fee for AMC’s broadcast of The Walking Dead and Fear The Walking Dead on its own services.[3] The court further concluded that, because agents cannot be liable for interference with the contracts of their principals, and because AMC Film Holdings LLC’s employees were acting as agents for their company, there was no triable issue of material fact as to whether AMC Networks Inc. induced AMC Film Holdings LLC to breach its contracts with Plaintiffs.[4]

Following the court’s ruling, the parties agreed to resolve the remaining breach of profit participation audit claims in arbitration. As a result, in January 2023, the plaintiffs dismissed their remaining claims with prejudice.[5] [Disclosure: Gibson Dunn represents AMC in this action.]

Katy Perry Prevails in Long-Running Copyright Dispute Over Song “Dark Horse”

On March 10, 2022, the Ninth Circuit ruled for Katy Perry in a long-running copyright dispute involving her song “Dark Horse” and a Christian hip-hop song called “Joyful Noise.” The suit began in 2014, when the creators of Joyful Noise sued Perry and other Defendants associated with the production of “Dark Horse,” alleging that an eight-note ostinato from “Dark Horse” copied key elements of an eight-note ostinato in “Joyful Noise.”[6] At a month-long trial, the Plaintiffs relied on the testimony of an expert musicologist, who testified that the Joyful Noise ostinato had several “elements” that Perry’s song copied—including “length,” “rhythm,” “melodic content,” and “the timbre or the quality and color of the sound.”[7] On September 11, 2019, a Los Angeles jury found for the Plaintiffs, concluding that “Dark Hose” infringed their copyright and awarding them $2.8 million in damages.[8] But on March 16, 2020, the district court granted the Defendants’ post-trial motion for judgment notwithstanding the verdict, holding that: (1) none of the individual “elements” Plaintiffs’ expert identified were copyrightable; (2) even when considered as a whole, the ostinato used a pitch combination that was “not a particularly unique or rare combination,” and nothing else about the ostinato rendered it “so exceptionally original as to warrant protection”; and (3) in any event, the Dark Horse ostinato used different “pitches, … keys, tempos, harmonies, and rhythms” than the Joyful Noise ostinato, so there was no actionable copying.[9]

Last year, the Ninth Circuit affirmed the trial court’s decision—holding in a published opinion that the fact that two ostinatos share basic similarities like “employ[ing] the pitch progression 3-3-3-3-2-2 played in a completely flat rhythm” is insufficient to state a copyright claim.[10] The Ninth Circuit concluded that “allowing a copyright over this material would essentially amount to allowing an improper monopoly over two-note pitch sequences or even the minor scale itself, especially in light of the limited number of expressive choices available when it comes to an eight-note repeated musical figure.”[11] This ruling brings the eight-year litigation to an end.

Ninth Circuit Taylor Swift Dismissal Leaves Open Questions About Copyrighting Lyrical Concepts

Last year also saw the resolution of a long-running copyright suit alleging that Taylor Swift’s hit song “Shake It Off” illegally copied from an earlier work. But unlike Perry’s definitive victory in the “Dark Horse” case, the resolution of the “Shake It Off” ligation leaves open questions about whether certain lyrical concepts—like references to “player hating”—are copyrightable.

In Hall v. Swift, the Plaintiffs—songwriters Sean Hall and Nathan Butler—alleged that Swift and others stole the central lyrics of their song, “Playas Gon’ Play” [“Playas they gonna play / And haters, they gonna hate”] and using these lyrics in the chorus of “Shake It Off” [“Cause the players gonna play, play, play, play, play/ And the haters gonna hate, hate, hate, hate, hate”].[12] On February 13, 2018, the district court granted Defendants’ motion to dismiss Plaintiffs’ claim, finding that the complaint did not show originality in the pertinent portions of Plaintiffs’ work, as American popular culture had been “heavily steeped in the concepts of players, haters, and player haters” in 2001 when Plaintiffs’ song was written.[13] But Swift and the other Defendants were not as successful on appeal; on December 5, 2019, the Ninth Circuit reversed the dismissal, finding in a brief, unpublished decision that the Plaintiffs’ complaint did enough to “plausibly allege[] originality” to survive a motion to dismiss.[14]

On December 9, 2021, Defendants once again moved to dismiss Plaintiffs claims. But this time the district court denied the Defendants’ motion, finding that “even though there are some noticeable differences between the works, there are also significant similarities in word usage and sequence/structure…Although Defendants’ experts strongly refute the implication that there are substantial similarities, the Court is not inclined to overly credit their opinions here.”[15] The ruling set the stage for a highly contentious jury trial in late 2022 with potential ramifications on future music copyright decisions.[16] But on December 12, 2022, weeks before the trial to determine whether Plaintiffs’ lyrics were copyright protectable, a judge dismissed the matter after a joint request by Plaintiffs and Defendants, which provided no details regarding the apparent settlement.[17]

Live Nation Faces Investigation

In November 2022, the U.S. Department of Justice (“DOJ”) opened an investigation into Live Nation Entertainment and its wholly owned subsidiary Ticketmaster for purported antitrust violations by the concert promotion and ticket sales company.[18] Live Nation Entertainment was formed in 2010 as a result of the merger between Ticketmaster Entertainment, a ticket sales distribution company, and Live Nation, an events promoter and venue operator.[19] News of the investigation followed issues that arose during the presale of Taylor Swift’s highly anticipated Eras Tour, which prompted the filing of a federal class action lawsuit in California.[20] Results of the DOJ’s investigation are expected to be released by the end of the year. [Disclosure: Gibson Dunn represented Ticketmaster Entertainment in the merger.]

B. Copyright Litigation

Supreme Court Hears Arguments on Andy Warhol Fair Use Case

On October 20, 2022 the Supreme Court heard oral argument on a highly anticipated fair use case concerning Andy Warhol’s famous Prince Series.[21] The case focuses on photographer Lynn Goldsmith’s claim that the Prince Series inappropriately copied her 1981 portrait of Prince.[22] Warhol’s Prince Series indisputably uses Goldsmith’s photo, but the Warhol Foundation has argued that Warhol’s use of the photo is protected “fair use” because Warhol used various coloring and shading techniques to create new, transformative works that conveyed a different message than the original picture. The Second Circuit disagreed, holding that “the imposition of another artist’s style on [a] primary work” was insufficient to qualify for fair use protection.[23]

At the Supreme Court, oral argument focused on the first factor of the multi-factor fair use test—assessing the “purpose and character of the use” of the copyrighted work and whether the new work is “transformative.”[24] Roman Martinez, on behalf of the Warhol Foundation, argued that any analysis of whether a work is transformative must consider the artist’s meaning and message of the work.[25] Martinez argued that Warhol’s depiction of Prince commented on the musician’s rise to fame and status as a “celebrity icon,” in contrast to Goldsmith’s “vulnerable” portrait of Prince.[26] A majority of the Justices pushed Martinez to define how much a work’s meaning would have to diverge from the original in order to be transformative; Justice Kagan asked whether a movie adaptation of a book would be transformative enough to support a fair use defense, to which Martinez responded that a change in form would not inherently change the meaning or message of the secondary work.[27]

Lisa Blatt, arguing on behalf of Goldsmith, countered that the Warhol Foundation’s emphasis on new meaning was “too easy to manipulate,” and that secondary works would always provide an opportunity to argue new meaning.[28] Yaira Dubin, arguing for the U.S. in support of Goldsmith, emphasized that a secondary work should not be entitled to fair use protection unless its use of the earlier work was necessary, as in the case of parody or commentary.[29] Dubin noted that the Warhol Foundation had not shown that Warhol’s use of Goldsmith’s portrait—as opposed to any other image of Prince—was necessary to create his work.[30]

The Supreme Court’s ruling is expected in the next few months. This will be the Court’s first fair use ruling in art since Campbell v. Acuff-Rose Music, Inc. in 1994, and it should have significant ramifications on whether and to what degree artists can use prior works in their own creations.[31]

Ninth Circuit Rejects Three-Year Limit to Copyright Infringement Damages

On July 14, 2022, the Ninth Circuit held that application of the “discovery rule” can allow a copyright plaintiff to recover damages occurring more than three years prior to suit, potentially exposing defendants to damages awards for infringements that occurred decades ago.[32] Affirming the lower court’s denial of a motion to dismiss, the Ninth Circuit held that Starz Entertainment could sue MGM Domestic Television Distribution for damages for alleged infringement that occurred well before the three-year limitations period.[33]

Starz brought the case in 2020, alleging that it had entered into two licensing deals with MGM that gave Starz the exclusive right to distribute certain MGM films and TV series, each for a specified license window, in the United States for certain specified formats.[34] According to Starz, MGM breached these agreements and infringed Starz’s alleged copyrights by licensing certain of the titles to other outlets during Starz’s window of exclusivity.[35] Although Starz brought suit in 2020, many of MGM’s purported violations of Starz’s exclusivity rights were alleged to have occurred years earlier.[36] MGM moved to dismiss all of Starz’s copyright claims that were alleged to have occurred more than three years before Starz filed its lawsuit, arguing that the plain language of the Copyright Act as interpreted by the Supreme Court in Petrella v. Metro-Goldwyn-Mayer, Inc. (2014) allowed a plaintiff to “gain retrospective relief only three years back from the time of suit” and that “[no] recovery may be had for infringement in earlier years.”[37] Because Starz’s licenses in the films and TV series at issue in MGM’s motion to dismiss had already expired and any purported claims for damages were barred by the Copyright Act’s three-year limit on retrospective relief, MGM argued that there was no relief the court could grant.[38] The district court denied MGM’s motion to dismiss, finding that Starz could seek damages outside of the three-year lookback period if its claims were timely under the discovery rule, an issue that the court declined to adjudicate at the pleadings stage.[39]

The district court certified its ruling for an interlocutory appeal, and the Ninth Circuit took up the case—recognizing that language in Petrella appeared to limit recovery on copyright claims to just three years before the filing of the lawsuit regardless of when they were discovered.[40] Courts, including the Second Circuit, which was the first appellate court to consider the issue, held that Petrella’s interpretation of the plain language of the Copyright Act did bar a copyright plaintiff from recovering damages that occurred more than three years before the plaintiff brought suit.[41] The Second Circuit, in particular, recognized that the discovery rule continues to apply and that the rule may render timely some claims that would otherwise be barred.[42] Regardless, even with the application of the discovery rule, a plaintiff’s recovery of monetary damages must be limited to three-years prior to suit under Petrella’s interpretation of the Copyright Act.[43]

The Ninth Circuit, however, rejected the Second Circuit’s approach, asserting that because Petrella arose in a factual context where the discovery rule was not at issue, Petrella cannot be read to curtail the discovery rule in any way.[44] Concluding that Petrella “did not change any law in the Ninth Circuit pertaining to the discovery rule,” the Ninth Circuit held that its prior discovery rule cases remained good law—and that, under those cases, Starz could recover damages for otherwise time-barred infringement if it could not reasonably have discovered that infringement earlier.[45] The Ninth Circuit thus held that Petrella did not impose any separate “damages bar” on copyright claims that would otherwise be viable under the discovery rule, thereby creating a significant circuit split between it and the Second Circuit.[46] [Disclosure: Gibson Dunn represents the defendants in this action.]

Northern District of California Holds Digital Service Provider’s Reliance on Content Providers’ Contractual Representations Can Preclude Willful Infringement

On March 21, 2022, the Northern District of California held, on summary judgment, that Apple’s alleged infringement of musical compositions through the iTunes Store was not willful because Apple reasonably relied on the contractual representations of its content providers.[47] The plaintiffs, heirs of famous Hollywood composers, brought three separate actions against Apple alleging it willfully infringed the plaintiffs’ copyrights in 101 musical compositions embodied in over 1,200 sound recordings sold in the iTunes Store.[48] The sound recordings at issue were delivered to Apple by digital distributors, co-defendants in these actions, who represented and warranted they had all necessary authorizations to license the sound recordings and underlying musical compositions to Apple.[49] The plaintiffs also filed numerous other actions against other major digital distributors which were settled. The cases against Apple were consolidated for summary judgment purposes before the Honorable William H. Orrick III in the Northern District of California.[50] The parties filed cross-motions on whether Apple’s alleged infringement was willful such that the plaintiffs could be entitled to enhanced damages under the Copyright Act.[51] The court denied the plaintiffs’ motion and, in a reversal of the court’s prior tentative, granted Apple’s motion.[52] Reflecting one of the rare instances in which courts grant summary judgment on willfulness damages—a notoriously fact-dependent inquiry—the decision also marks the first time a court has held on summary judgment that a digital service provider’s reliance on contractual representations from its content providers can preclude a finding of willful infringement. [Disclosure: Gibson Dunn represented Apple in these actions.]

Central District of California Holds Dance Moves Are Not Copyrightable

On August 24, 2022, the Central District of California held that Epic Games did not violate a dancer’s copyright when it created a Fortnite dance that used choreography from the dancer’s performance.[53] In issuing its decision, the court found that dance moves, by themselves, were not subject to copyright protection.[54] The case began when celebrity choreographer Kyle Hanagami brought copyright infringement and unfair competition claims against Epic Games, the creators of the online game Fortnite. Hanagami alleged that Epic copied choreography used in a 2017 Hanagami video when it created an animated dance for players to perform within the game.[55] Epic Games filed a motion to dismiss all claims, which was granted by the district court.[56]

Although the court determined that the Fortnite dance contained some “steps” that were identical to the “steps” used in Hanagami’s dance, it concluded that the limited number of dance steps used in the game were not protected by copyright.[57] The court drew on guidance from the U.S. Copyright Office and the Copyright Act’s legislative history to suggest that choreographic works do not include simple steps or routines.[58] While accepting that Hanagami’s full five-minute video is copyrightable, the court held that the particular “steps” at issue in the Fornite dance were not protectable. Hanagami’s appeal to the Ninth Circuit is pending.

Only Known Errors on a Copyright Registration Can Be Penalized

On February 24, 2022, the Supreme Court issued an opinion offering new guidance on when works are properly “registered” with the Copyright Office—a key (but often overlooked) issue in copyright infringement suits.[59] In Unicolors Inc. v. H&M Hennes & Mauritz, the Court held that a copyright holder cannot be penalized for legal errors in its copyright registration unless it knew about the errors.

The underlying case began when Unicolors sued H&M for allegedly infringing several of Unicolors’s fabric designs.[60] After a jury found in Unicolors’s favor at trial, H&M asked the trial court to grant it a judgment as a matter of law, arguing that Unicolors’s copyright registration for the designs was invalid. More specifically, H&M said that Unicolors filed for registration of 31 separate designs in a single registration, but the Copyright Office’s regulations require that each design be included in a separate registration unless they were all published as a single unit.[61] Because the fabric designs were indisputably distributed separately (and thus not published as part of the same unit), H&M argued that Unicolors had violated the Copyright Office’s regulations and its registration was invalid. But the District Court denied H&M’s motion, holding that a registration could not be invalidated under the Copyright Act unless the copyright holder knew of the inaccuracy in the registration application—and finding that Unicolors did not know of the single unit of publication requirement when it applied for registration.[62] The Ninth Circuit disagreed, concluding that a registration applicant’s factual errors can be excused if the applicant does not know about them, but that a legal error—such as failure to follow the single publication regulation—cannot be excused based on the applicant’s lack of knowledge.[63]

The Supreme Court reversed the Ninth Circuit, holding that a registration applicant’s lack of knowledge of a legal requirement is a valid excuse for the applicant’s violation of a registration requirement. Holding that “[l]ack of knowledge of either fact or law can excuse an inaccuracy in a copyright registration,” the Court decided that Unicolors’s violation of the single publication regulation could be excused by the fact that it did not know about the regulation—saving Unicolors’s copyright registration.[64]

Ninth Circuit Finds Vietnamese Music Streamer Subject to Personal Jurisdiction in U.S. Copyright Suit

On July 21, 2022, the Ninth Circuit decided Lang Van, Inc. v. VNG Corporation.[65] In 2014, Plaintiff Lang Van, a music distributor specializing in Vietnamese music, filed a copyright infringement suit against VNG, a Vietnam-based company that runs a music website and app, Zing MP3, that VNG makes available in the U.S.[66] Lang Van brought claims for copyright infringement, alleging that VNG made Lang Van’s copyrighted music available on Zing without compensating Lang Van.[67] VNG moved to dismiss the suit for lack of personal jurisdiction on the basis that it is based in Vietnam and primarily serves a Vietnam audience.[68]

The district court agreed with VNG and dismissed the lawsuit.[69] On appeal, the Ninth Circuit vacated the district court ruling, finding that the district court failed to apply the Ninth Circuit’s “purposeful direction” test.[70] The Ninth Circuit remanded to the district court for jurisdictional discovery.[71]

On remand, VNG renewed its motion to dismiss arguing lack of personal jurisdiction, and the district court granted the motion.[72] This time, the Ninth Circuit reversed and remanded.[73] The court found that jurisdiction was reasonable given VNG’s contacts with the United States, specifically that VNG purposefully targeted American companies and their intellectual property and targeted the U.S. market by making its app available in English and on app stores in the United States.[74] The court also found that VNG contracted with U.S. businesses in connection with Zing MP3, and that it did not attempt to geoblock Lang Van’s content to Vietnam only.[75] Finally, the court rejected VNG’s forum non conveniens argument, finding that venue was proper in California, not in Vietnam, as the underlying dispute involved infringing activities in the United States.[76]

Tenth Circuit Affirms Constitutionality of DMCA’s Anti-Circumvention and Anti-Trafficking Provisions

On December 6, 2022, the D.C. Circuit decided Green v. United States Department of Justice.[77] Green, a lawsuit brought by the Electronic Frontier Foundation (“EFF”), challenged the Digital Millennium Copyright Act’s (DMCA) anti-circumvention and anti-trafficking provisions on First Amendment grounds.[78] The anti-circumvention provision prohibits the circumvention of any encryptions—or technological measures that control access to a protected work—that the copyright holder does not allow, and the anti-trafficking provision prohibits any person from manufacturing or offering to the public any technology designed to circumvent such technological measures.[79] The EFF challenged the provisions on three grounds: the provisions are facially overbroad First Amendment violations; unconstitutional prior restraints; and First Amendment violations as applied to the Plaintiffs.[80] The district court dismissed the first two challenges, but ruled that the as-applied challenge was properly pled.[81]

Three months later, the Plaintiffs filed a motion for preliminary injunction.[82] Relying on the “likelihood of success on the merits” element, Judge Sullivan held that both plaintiffs were likely to fail on the merits.[83] Plaintiffs appealed.

On appeal, the D.C. Circuit affirmed the district court’s decision.[84] Writing for the majority, Judge Tatel first held that one of the plaintiffs, Green, lacked standing because there was no credible threat of prosecution against him.[85] Green planned to publish a book on how to circumvent technological protection measures and believed that the book would likely violate the provisions. But during oral arguments, the government conceded that it would be “legal for Green to publish his book even if the book includes enough code to allow someone to piece together a circumvention technology.”[86] Next, the court held that the DMCA’s provisions do not target the “expressive content of computer code, but rather the act of circumvention and the provision of circumvention-enabling tools.”[87] Citing to City of Austin v. Reagan National Advertising of Austin, LLC,[88] the court held that reading computer code to determine if it is technology-circumventing is content neutral, just like reading a sign to determine whether it advertises products located near the sign (which was permissible) or not (which was prohibited) is content-neutral.[89] In both cases, the substantive message of the sign or code was irrelevant, and reading the sign or code was only required to determine whether its function was prohibited.[90] The court remanded the case back to the district court for further proceedings consistent with the opinion.[91]

Comic Artist Sues Image-Generating AI Companies for Copyright Infringement

On January 13, 2023, artist Sarah Andersen filed a class action lawsuit in the Northern District of California against Stability AI, MidJourney Inc., and DeviantArt Inc.[92] Each of these companies utilizes an AI program created by Stability AI called Stable Diffusion that creates visuals based on users’ text prompts.[93] Stable Diffusion works by scraping five billion public images on the internet and training the AI to diffuse these public images into newly generated images.[94] The process works by taking a training image, reducing it to a field of random noise, and then reversing the process to recreate the training image. With enough training, the AI program can generate and combine different images to create new images responsive to users’ text prompts.[95]

Ms. Andersen is a cartoonist and an illustrator of a semiautobiographical comic strip called “Sarah’s Scribbles.”[96] In October of 2023, Ms. Andersen received, via Twitter, an image generated by an AI that attempted to copy her art style.[97] This sparked her class action lawsuit against Stability AI, MidJourney Inc., and DeviantArt Inc.[98]

The lawsuit alleges violations of the DMCA, direct copyright infringement, and right of publicity violations, among other claims.[99] With respect to direct copyright infringement, Andersen alleged that the method Defendants used to train their AI to generate images violated her and the Class’s copyrights in their original works.[100] Programs like Stable Diffusion work by scraping the internet for images and training their AI to recreate the images.[101] Andersen’s direct copyright claim argues that, while Stability AI had access to their images, it did not have the rights to download, store, and distribute copies of their works for use in training.[102] Stability Diffusion also works by pulling images that it trained on and combining them with other images.[103] Andersen claims that by using her images to combine with others or to satisfy a prompt, Stability Diffusion violates her copyright.[104]

With respect to her DMCA claim in particular, Andersen alleged that defendants violated the DMCA by “removing copyright management information (‘CMI’) from the Works and/or causing their respective AI Image Products to omit CMI from their output images.”[105] In essence, Andersen asserts that because these programs recreate copyrighted images without recreating the CMI, they run afoul of the DMCA.[106] This case has the potential to answer a key question that has emerged alongside widespread AI use: What, if any, copyright liability do AI companies and users face?

C. Right of Publicity Litigation

Melendez v. Sirius XM Radio, Inc.: Illustrating the Copyright Act’s Preemption of State Right of Publicity Claims

On October 4, 2022, the Second Circuit affirmed the district court’s grant of Defendant Sirius XM’s motion to dismiss Plaintiff John Melendez’s right of publicity claims, holding that Melendez’s claims were preempted by the Copyright Act.[107] Melendez was a writer and on-air contributor for the Howard Stern Show until 2004.[108] Two years after Melendez left the show, Sirius XM acquired a license to air new episodes and rebroadcast complete and partial archived episodes of the program, excerpts of which Sirius XM uses in its online and on-air advertisements to promote the show.[109] Melendez claimed that the advertisements featuring his voice violated his right of publicity under California common and statutory law because his name and likeness had been exploited for Sirius XM’s commercial gain without his permission.[110] Sirius XM moved to dismiss Melendez’s claims with prejudice, arguing that they were preempted by the Copyright Act, and the district court agreed because the claims were “effectively claims for the wrongful rebroadcasting of copyrightable sound recordings” and any amendment would be futile.[111]

The Second Circuit agreed that Melendez’s claims were preempted by the Copyright Act, based on its application of a two-pronged test that asks whether (1) the plaintiff’s claim concerns a work coming within the scope of copyrightable subject matter, and (2) the right asserted is equivalent to any exclusive right granted under the Copyright Act.[112] The Second Circuit held that both prongs were satisfied, and thus affirmed the district court’s dismissal of Melendez’s claims with prejudice.[113]

As to the first prong, the Second Circuit rejected Melendez’s argument that his vocal attributes, not the underlying sound recordings in which they were embodied, were the proper focus of his claims.[114] According to the Second Circuit, Melendez’s claims focused on the alleged unauthorized distribution and republication of archived sound recordings of the show, which are copyrightable works under the Copyright Act.[115] Melendez did not allege that Sirius XM used his name or likeness apart from rebroadcasting excerpts from archival episodes that contained Melendez’s voice.[116] Nor did Melendez allege that Sirius XM “usurped” his identity to sell a product or service that bore no connection to Melendez.[117] As a result, the court concluded that the subject matter of the litigation was segments of copyrightable works, and not Melendez’s name or likeness.[118]

As to the second prong, the Second Circuit held that Melendez’s common and statutory law claims “are aimed at stopping the reproduction of copyrightable works that embody [Melendez’s] identity—the excerpts of the archival episodes of the HS Show—not the independent use of his identity to sell unrelated goods or services without his permission.”[119] Although Melendez’s statutory claim included the extra element of commercial purpose, the court concluded the claim is not qualitatively different from a copyright infringement claim since commercial interests have always played an enormous role in copyright law.[120] Because both prongs were satisfied, and Melendez failed to identify any additional allegations he could plead to overcome preemption, the Second Circuit affirmed the dismissal of Melendez’s right of publicity claims with prejudice.[121]

Emerging Right of Publicity Issues Implicating NFTs

In the wake of the Supreme Court’s decision in NCAA v. Alston,[122] student-athletes have sought to cash in on NIL deals in a variety of markets, including the NFT space. The NIL-NFT nexus has produced two broad categories of deals.[123] In the first category of deals, a college athlete sells NFTs that are linked to what are essentially digital trading cards featuring that athlete’s name, image, or likeness.[124] In the second category of deals, so-called “NIL collectives”—which tend to consist primarily of alumni boosters and businesses, and which operate independently of any university—pool money together to help student-athletes leverage NIL opportunities.[125] In some cases, a NIL collective may launch an NFT collection that features a school mascot or other iconography but not any particular athlete’s name, image, or likeness.[126] In such cases, the proceeds from the sale of the NFT collection are then distributed among current student athletes affiliated with the school.[127]

A recent non-NCAA case, Notorious B.I.G. LLC v. Yes. Snowboards, demonstrates that courts’ level of understanding of the concept of NFTs may dictate whether a right of publicity claim implicating an allegedly infringing NFT is preempted by the Copyright Act.[128] In that case, Plaintiff—an LLC that controls the IP rights that belonged to the estate of rapper Christopher Wallace, professionally known as “Notorious B.I.G.” or “Biggie”—alleged that Defendant’s sale of artwork (e.g., posters and prints) and merchandise (e.g., shower curtains and snowboards) bearing Wallace’s likeness infringed Plaintiff’s right of publicity.[129] Plaintiff sought a preliminary injunction.[130] In ruling on Plaintiff’s preliminary injunction motion, the court held that the claims involving the sale of the artwork were preempted by the Copyright Act, while the claims involving the merchandise were not.[131] The Defendant also sold Biggie NFTs, which the court categorized as “artwork” rather than “merchandise,” because “an NFT is a digital representation of the underlying asset, i.e., the photographs at issue.”[132] As a result, the court “assumed that the NFTs fall within the subject matter of the Copyright Act.”[133] Of course, technically speaking, an NFT is a transferrable certificate of ownership attached to an asset, which can be digital or tangible; it is not a “digital representation” of an underlying asset.[134] Thus, one could perhaps persuasively argue that the NFTs at issue in the Notorious B.I.G. case should have been categorized as “merchandise,” thereby allowing the associated claims to evade preemption.

D. First Amendment Litigation

Supreme Court Hears Jack Daniel’s / Dog Toy Case

On March 22, 2023, the Supreme Court heard oral argument in a trademark dispute between whiskey manufacturer Jack Daniel’s and dog toy manufacturer VIP Products. The case centers around VIP Products’ “Bad Spaniels Silly Squeaker”—a dog toy resembling a bottle of Jack Daniel’s Old No. 7 Black Label Tennessee Whiskey with “light-hearted, dog-related alterations.”[135] Jack Daniel’s sued VIP Products for trademark infringement and dilution. The U.S. Court for the District of Arizona ruled in favor of Jack Daniel’s, finding a likelihood that consumers would be confused between the “Bad Spaniels” toy and authentic Jack Daniel’s products, and ruling that VIP Products could no longer manufacture the toy. In 2020, the U.S. Court of Appeals for the Ninth Circuit reversed the district court decision and ruled in favor of VIP Products. As to the claim by Jack Daniel’s of trademark infringement, the Ninth Circuit held that the district court should have applied the test articulated by the U.S. Court of Appeals for the Second Circuit in Rogers v. Grimaldi, 875 F.2d 994 (2d Cir. 1989), which protects “expressive works” from claims of trademark infringement unless the trademark holder can establish that the alleged infringer’s use of the mark in question is either “(1) not artistically relevant to the underlying work or (2) explicitly misleads consumers as to the source or content of the work.”[136] The Ninth Circuit concluded that the Rogers test should apply to the “Bad Spaniels” toy because it “communicate[d] a humorous message . . . by juxtaposing the irreverent representation of the trademark with the idealized image created by the mark’s owner.”[137] And as to the claim by Jack Daniel’s of trademark dilution, the Ninth Circuit found that VIP Products’ use of the Jack Daniel’s mark was “noncommercial” because it was “used to convey a humorous message,” and so the First Amendment protected VIP from trademark dilution liability.[138] The Ninth Circuit remanded for the district court to apply the Rogers test in evaluating the trademark infringement claim by Jack Daniel’s.[139] On remand, the district court applied the Rogers test and granted summary judgment to VIP Products, finding that Jack Daniel’s could not satisfy either Rogers prong and that therefore “the Bad Spaniels Toy is entitled to First Amendment protection and [the] claim [by Jack Daniel’s] for trademark infringement must fail.”[140] The Ninth Circuit summarily affirmed.[141]

Jack Daniel’s filed a petition for a writ of certiorari with the U.S. Supreme Court. The Court granted certiorari and held oral argument on March 23, 2023. A decision is expected by summer 2023.

Palin Argues New York Times v. Sullivan Is Obsolete in Appeal Over Defamation Suit

The U.S. Court of Appeals for the Second Circuit is currently considering an appeal from a February 2022 ruling from the U.S. District Court of the Southern District of New York against former Alaska Governor Sarah Palin in her libel suit against The New York Times. The dispute between Palin and the newspaper arose from a June 2017 editorial published by The New York Times that, Palin argued, defamed her by linking the 2011 shooting of former U.S. Representative Gabby Giffords to a political advertisement issued by SarahPAC, a political action committee associated with former Governor Palin.[142] Palin filed a defamation suit in the Southern District of New York against The New York Times, later amending her suit to add the paper’s then-opinion editor, James Bennet, as a defendant. [143]

The district court originally granted The New York Times’s motion to dismiss in August 2017 after holding an evidentiary hearing at which the parties examined witnesses.[144] The Second Circuit reversed that ruling in August 2019 and held that Palin could plausibly plead a claim for defamation that would survive a motion to dismiss.[145] The case proceeded to a jury trial in February 2022. At the close of the jury trial and while the jury was in deliberations, the district court granted The New York Times’s motion for judgment as a matter of law under Federal Rule of Civil Procedure 50. In evaluating Palin’s libel claim, the court found that under both federal constitutional law as articulated by the U.S. Supreme Court in the seminal New York Times v. Sullivan decision, as well as under New York state statutory law, Palin could only establish liability if she could show that Bennet and The New York Times acted with “actual malice”—that the newspaper published the editorial in question “with knowledge that it was false or with reckless disregard of whether it was false or not.”[146] The district court found that Palin had failed to do so at trial: Palin had adduced no evidence at trial, the district court held, that a jury could rely on to find that Bennet or The New York Times had known or recklessly disregarded the possibility that the statements at issue were false. The district court ruled that Palin had not offered any evidence undermining Bennet’s trial testimony that he did not know or recklessly disregard the possibility that those statements were false. And the district court concluded that other evidence, including the process by which the editorial was written and revised, Bennet’s post-publication correspondence with other Times employees, and his expression of regret and attempt to apologize to Palin, “weighs heavily and uniformly against finding” that Bennet or the Times knew the statements at issue were false or recklessly disregarded the possibility that they might be false.[147]

After the district court issued judgment as a matter of law in favor of Bennet and the Times under Rule 50, the jury also returned a verdict in favor of the defendants.

Palin has since appealed the district court’s decision and the jury verdict to the Second Circuit. Among other things, Palin has argued to the Second Circuit that the actual malice standard articulated in New York Times v. Sullivan “is obsolete in the modern speech landscape.”[148] Gibson, Dunn & Crutcher filed an amicus brief in support of Bennet and The New York Times on behalf of the Reporters Committee for Freedom of the Press and a coalition of 52 other media organizations, explaining in detail why “[t]he actual malice standard remains as vital today as it was in 1964.”[149]

E. Trademark Litigation

Federal Circuit Finds for “TRUMP TOO SMALL” Trademark

In February 2022, the Federal Circuit reversed a decision from the U.S. Patent and Trademark Office (USPTO) Trademark Trial and Appeal Board (TTAB), holding the TTAB had violated the First Amendment when it refused to register the trademark “TRUMP TOO SMALL.”[150] In In re Elster, the Federal Circuit reviewed the TTAB’s refusal to grant Steve Elster a trademark for shirts bearing the phrase “TRUMP TOO SMALL”—an acknowledged criticism of former President Donald Trump.[151] The TTAB found that Elster’s proposed trademark was proscribed under section 2(c) of the Lanham Act, which prohibits granting a trademark that “[c]onsists of or comprises a name, portrait, or signature identifying a particular living individual except by his written consent.”[152]

Reversing the decision, the Federal Circuit held that, as applied to Elster’s trademark, “section 2(c) involves content-based discrimination that is not justified by either a compelling or substantial government interest.”[153] The court found that the First Amendment interests in the dispute “are undoubtedly substantial” because “the First Amendment ‘has its fullest and most urgent application’ to speech concerning public officials”—here, former President Trump.[154] Analyzing the government’s interests under both privacy and publicity torts, the Federal Circuit found that “the government does not have a privacy or publicity interest in restricting speech critical of government officials or public figures in the trademark context.”[155]

Notably, the Federal Circuit did not decide whether the statute was unconstitutional, noting that Elster had only challenged the statute as applied to his trademark application.[156] The court did state, however, that “section 2(c) raises concerns regarding overbreadth” and “reserve[d] the overbreadth issue for another day.”[157]

Federal Circuit Reverses Coca-Cola’s Win Over India-Registered Trademarks

On June 29, 2022, the U.S. Court of Appeals for the Federal Circuit rejected Coca-Cola’s bid to cancel two trademarks owned by Meenaxi Enterprise, Inc. for Meenaxi’s products Thums Up cola and Limca lemon-lime soda.[158] The USPTO TTAB had previously granted Coca-Cola’s application to cancel Meenaxi’s marks.[159] The Federal Circuit reversed and held that Coca-Cola did not establish lost sales or reputational injury from Meenaxi’s sale of the two beverages.[160]

In 1993, Coca-Cola purchased Parle (Exports), the maker of Thums Up cola and Limca lemon-lime soda, two “well known” soft drinks in India.[161] Coca-Cola does not directly sell either beverage in the United States, although its products are imported and sold in the United States by third parties.[162] Since 2008, Meenaxi has been selling its own Thums Up and Limca soda products to Indian grocers in the United States.[163] Meenaxi registered marks for its soda drinks in the United States in 2012.[164] In 2016, Coca-Cola brought a claim under § 14(3) of the Lanham Act to cancel Meenaxi’s registrations, arguing that Meenaxi’s marks misrepresented the source of those products.[165] The TTAB found that Coca-Cola was entitled to bring a claim against Meenaxi under the Lanham Act because Coca-Cola held an interest falling with the zone of interests protected by the Lanham Act and could show an injury proximately caused by a violation of the Act.[166] Specifically, the Board found that Coca-Cola had an interest falling within the zone of interests protected by the Lanham Act because Coca-Cola’s India-registered Thums Up and Limca marks “are well known in India” and “the reputation of [the marks] would extend to the United States, at least among the significant population of Indian-American consumers” because the marks “likely would be familiar to much of the substantial Indian-American population in the United States.”[167] The Board also found that Coca-Cola could show an injury proximately caused by a violation of the Act because Meenaxi’s use of the marks in question “could cause a harm ‘stemming from the upset expectations of consumers’” and that Meenaxi had used its registrations to block importation of Coca-Cola’s Thums Up and Limca beverages by third parties into the United States .[168]

The Federal Circuit reversed the TTAB decision, finding that Coca-Cola could not show that it was harmed by Meenaxi’s use of the marks at issue in the United States and therefore could not bring a cancellation claim under the Lanham Act against Meenaxi.[169] Coca-Cola could not show lost sales in the United States because it did not sell the products under its India-registered marks in the United States and could not rely on sales generated by third parties, who are not authorized U.S. distributors.[170] The Federal Circuit also held that Coca-Cola could not show any reputational injury arising from Meenaxi’s use of the marks at issue in the United States because Coca-Cola had not established the reputation of its India-registered marks within the Indian-American community in the United States.[171] The Federal Circuit explained that the TTAB’s decision below “appear[ed] to rest in part on an assumption that Indian Americans would necessarily be aware of the marks’ reputations in India,” but Coca-Cola had provided “no basis to assume that an American of Indian descent is aware of brands in India.”[172] Instead, the Federal Circuit observed, the Board’s conclusion “relie[d] at least in part on stereotyped speculation.”[173]

District Court Grants Starz, Lions Gate, and 50 Cent Motion to Dismiss Under Rogers Test Over “BMF” Trademark

On June 17, 2022, the District Judge Fred Slaughter of the U.S. District Court for the Central District of California ruled in favor of Starz Entertainment, Lions Gate Entertainment, and Curtis Jackson, also known as 50 Cent, in a dispute involving the use of the acronym “BMF” in reference to the television series “BMF: Black Mafia Family.”[174] Plaintiff Byron Belin, the registered owner of a mark for “BMF” used to market and promote media services, including the production of television programming, sued Starz, Lions Gate, and Jackson, alleging that the defendants’ use of the term “BMF” constituted trademark infringement, unfair competition, and false designation of origin under the Lanham Act.[175]

The court held that because the “BMF: Black Mafia Family” series was “an expressive work,” the “Rogers test” of Rogers v. Grimaldi, 875 F.2d 994 (2d Cir. 1989) applied to its use of “BMF.”[176] Under the Rogers test, Belin was required to show either that (1) defendants’ use of the BMF mark is not “artistically relevant” to the underlying work or (2) the defendants’ use of the BMF mark is “explicitly misleading” as to the source of the work.[177] The court found that the defendants’ use of the BMF mark to abbreviate the show’s title “Black Mafia Family” was “the centerpiece of the [Series]” and clearly qualified as artistically relevant.[178] Likewise, the court found “no explicit statements or claims suggesting” Belin’s involvement in the series that would be misleading to consumers.[179] Accordingly, the court granted the defendants’ motion to dismiss Belin’s claim.

Hermes Wins Trademark Trial Over “Metabirkin” NFTs

On February 8, 2023, a federal jury in Manhattan found designer Mason Rothschild liable for trademark infringement, trademark dilution, and cybersquatting for his promotion and sale of non-fungible tokens (“NFTs”) Rothschild referred to as “MetaBirkins.”[180] Hermes International filed the lawsuit in 2022, claiming Rothschild’s NFTs infringe its trademarks protecting its Birkin handbags, which sell for as much as $200,000, and that Rothschild has interfered with Hermes’s ability to market its products online.[181] Rothschild, who sold 100 of the MetaBirkins in 2021 for $450 each, argued that the First Amendment protected his right to produce and market his art, regardless of the fact that it emulates Hermes’s trademarked Birkin handbags. Rothschild moved to dismiss Hermes’s claims in March 2022, arguing that the use of the term “MetaBirkin” was protected expression under the U.S. Court of Appeals for the Second Circuit’s seminal case Rogers v. Grimaldi, 875 F.2d 994 (2d Cir. 1989), which held that use of a famous trademark (in that case, a trademark composed of a celebrity name) in connection with a work of art does not infringe trademark rights so long as (1) the name is “minimally artistically relevant” to the product, and (2) the use does not “explicitly mislead” as to content, authorship, sponsorship, or endorsement.[182] The district court denied Rothschild’s motion to dismiss, holding that the Rogers test should apply but leaving for the jury to decide whether Rothschild’s use of the term “MetaBirkin” qualified as artistically relevant or had explicitly misled consumers.[183] The case proceeded to a jury trial. The jury ruled in favor of Hermes, awarding Hermes $110,000 in profit and resale commissions Rothschild received from selling the MetaBirkins, and $23,000 in damages for cybersquatting.[184] On March 3, 2023, Hermes moved for a permanent injunction against Rothschild, claiming that Rothschild continues to promote NFTs that resemble Hermes’s Birkin handbags, despite the jury verdict.[185] On March 14, 2023, Rothschild moved for judgment as a matter of law in his favor or for a new trial, arguing that the jury had not properly been instructed on, and did not properly apply, the Second Circuit’s Rogers test.[186]

Cult Gaia Trademark Appeal Underscores High Bar for Trade Dress Protection in Fashion

In 2017, Cult Gaia filed an application in the United States Patent and Trademark Office (USPTO) to register company founder Jasmin Larian’s bamboo “Ark Bag” design as trade dress. Three years later, the USPTO Examiner issued a final decision rejecting the trademark application. Last year, the U.S. Patent and Trademark Office’s Trademark Trial and Appeal Board (TTAB) affirmed the Examiner’s refusal to register the handbag design in a 51-page precedential opinion, providing detailed analysis to support its ultimate conclusion that the design is either too generic or not distinctive enough to warrant trademark protection—despite the significant media attention that had been garnered by the design.[187]

In its discussion of genericness, TTAB relied on evidence that “handbags embodying the proposed mark are so common in the industry,” ultimately concluding that “such product design is not capable of indicating source and that [Larian’s] proposed mark is at best a minor variation thereof.”[188] TTAB also affirmed the refusal on non-distinctiveness grounds, noting the “record does not support a finding that consumers perceive the design … as an indicator of source.”[189]

Despite the vast amount of social media coverage of the bag, there were multiple third-party handbags available both before and after Cult Gaia’s bag came onto the market. Further, Cult Gaia tagged the bag “CULT GAIA” in its social media posts, thereby indicating the brand name was still necessary to connect the design to the brand. This decision highlights the high bar to clear in order to achieve a trade dress registration, including the need to achieve true distinctiveness in order to do so.

TTAB Refuses to Protect Curse Words

Erik Brunetti, founder of streetwear brand “FUCT,” was the respondent in the 2019 U.S. Supreme Court decision, Iancu v. Brunetti, 204 L. Ed. 2d 714, 139 S. Ct. 2294 (2019), where Justice Kagan held in Brunetti’s favor that the Lanham Act’s bar on the registration of “immoral” or “scandalous” trademarks discriminates on the basis of viewpoint and thus violates the First Amendment.[190]

Two years after his successful appeal to the Supreme Court, Brunetti has lost a related appeal before the Trademark Trial and Appeal Board, which refused to let the streetwear designer register the F-word as a trademark.[191] The decision sheds light on how the recent Supreme Court decision interacts with existing trademark law.

In explaining its refusal to trademark the term, the Board explained that the F-word “is commonly used on the types of goods as to which applicant wants exclusive rights to the term.”[192] Because the F-word “expresses well-recognized familiar sentiments and the relevant consumers are accustomed to seeing it in widespread use,” the Board found that “it does not create the commercial impression of a source indicator, and does not function as a trademark to distinguish Applicant’s goods and services in commerce and indicate their source.”[193] For these reasons, the Board affirmed the refusal to register the F-word for failure to function as a mark under the Trademark Act.

TikTok Inc. and ByteDance Ltd. Defeat $350 Million Trademark Infringement Lawsuit From London-Based Video-Editing Company

On March 9, 2023, a federal jury in Los Angeles agreed with TikTok Inc. and ByteDance Ltd. that TikTok’s “Stitch” video-editing tool does not infringe any trademarks belonging to Stitch Editing Ltd., a London-based video-editing house.[194] TikTok’s Stitch tool allows users to combine up to five seconds of another user’s video with their own video. Stitch Editing claimed that TikTok’s use of the word “stitch” infringed Stitch Editing’s registered service mark in “Stitch Editing” and unregistered service mark in “Stitch,” and sought $350 million in compensatory damages for the alleged infringement.[195] Stitch Editing also sought punitive damages on its claim for unfair competition under California common law. TikTok responded that Stitch Editing did not have any rights in the asserted marks, and that TikTok’s use of “stitch” was unlikely to cause any consumer confusion and constitutes fair use.

Before trial, TikTok persuaded the district court to exclude Stitch Editing’s damages expert’s opinion that the company was entitled to $50 million in corrective advertising,[196] and to preclude Stitch Editing from seeking any damages for alleged infringement occurring outside the United States.[197] TikTok also convinced the district court to trifurcate the trial, so that Stitch Editing’s claim for more than $200 million in disgorgement damages would be tried by the court and that its claim for punitive damages would be tried only if the jury found liability and actual damages.[198] And at trial, TikTok persuaded the jury that its use of “stitch” was unlikely to cause any consumer confusion, that Stitch Editing did not have any common law rights in “stitch,” and that Stitch Editing was not entitled to any actual or punitive damages.[199] [Disclosure: Gibson Dunn represents TikTok Inc. and ByteDance Ltd. in this action.]

F. Legislation and Regulation

California Enacts Statute Limiting Evidentiary Use of Rap Lyrics in Criminal Cases

A first-of-its kind state statute, California’s “Decriminalizing Artistic Expression Act,” seeks to limit the ways in which forms of creative expression, most notably rap lyrics, can be used for evidentiary purposes in criminal cases.[200] California Governor Gavin Newsom signed the bill, AB 2799, into law in September 2022 following its unanimous passage by the California Senate and Assembly.[201] The Act, which defines “creative expression” broadly, requires courts to consider specified factors in balancing the probative value of the “creative expression” evidence against the substantial danger of undue prejudice.[202] The Act creates a presumption that the “creative expression” evidence is of “minimal” probative value unless it was “created near in time to charged crime or crimes, bears a sufficient level of similarity to the charged crime or crimes, or includes factual detail not otherwise publicly available.”[203] In analyzing undue prejudice, courts must now also consider among other factors outlined by California’s evidence code, the possibility that the jury will treat the “creative expression” as evidence of the defendant’s “propensity for violence or general criminal disposition,” as well as the possibility it will “inject racial bias into the proceedings.”[204] In making this determination, California courts will be required to consider any additional relevant evidence offered by the parties as to the genre of creative expression at issue, as well as any experimental or social science research on how the introduction of a particular type of expression can introduce racial bias into the proceeding.[205]

A California appeals court already cited the Act in overturning the murder conviction of Travon Rashan Venable Sr., ruling in part that the use of a rap video during Venable’s trial violated the Act.[206] The California law has been praised by federal lawmakers who introduced similar federal legislation—Restoring Artistic Protection—this summer.[207]

Generative AI Updates

With OpenAI’s ChatGPT and DALL-E, generative AI—or algorithms that can be used to create new text, images, code, or other content—has garnered significant attention in recent months, including among copyright lawyers. Broadly speaking, generative AI raises novel copyright questions both with respect to the inputs—e.g., whether owners of copyrighted works used to train an AI have any legal claim over the model or the content it creates—and the outputs—e.g., whether content created by generative AI is copyrightable and, if so, by whom.

Inputs. On January 13, 2023, a proposed class action lawsuit was filed in the Northern District of California against Stability AI, Midjourney, and DeviantArt, creators of AI art tool Stable Diffusion, on behalf of artists alleging their works were downloaded and used without consent to create the LAION data set that powers Stable Diffusion.[208] In January 2023, Getty Images announced it had “commenced legal proceedings in the High Court of Justice in London” against Stability AI, on the basis that “Stability AI unlawfully copied and processed millions of images” whose copyright is owned or represented by Getty Images.[209] And on February 3, 2023, Getty Images filed suit against Stability AI in the District of Delaware, asserting claims under the Copyright Act, the Lanham Act, and Delaware trademark and unfair competition laws.[210] Similar lawsuits have been filed over other generative AI tools. For example, in November 2022, a proposed class action lawsuit on behalf of GitHub users was filed in the Northern District of California against GitHub, Microsoft, and OpenAI, alleging the defendants violated the terms of open-source licenses under which many GitHub users posted code used to train the GitHub Copilot tool. The U.S. Copyright Office has said it “is developing registration guidance for works created in part using material generated by artificial intelligence technology.”[211]

Outputs. In February, the U.S. Copyright Office finalized its refusal to uphold a copyright registration for a graphic novel containing elements created through generative AI.[212] Kristina Kashtanova initially applied for and obtained copyright registration for her graphic novel Zarya of the Dawn in September 2022, without disclosing her use of artificial intelligence. After the Copyright Office became aware of statements Ms. Kashtanova had made on social media indicating she had created the comic book using Midjourney artificial intelligence, it notified her that it intended to cancel the registration. Ms. Kashtanova’s response letter argued that she had authored the work using Midjourney only as an assistive tool or, alternatively, that her creative selection, coordination, and arrangement of the text and images was copyrightable as a compilation. Citing its policy not to register copyright “if it determines that a human being did not create the work,” the Copyright Office concluded that material generated by artificial intelligence technology was not copyrightable; it agreed to issue a new registration covering the selection and arrangement but explicitly excluding “artwork generated by artificial intelligence.”[213] The Copyright Office’s position is poised to be tested in the courts in another case. Computer scientist Stephen Thaler filed suit against the Copyright Office in 2022, asking the United States District Court for the District of Columbia to overturn the Copyright Office’s decision denying copyright to a visual artwork, “A Recent Entrance to Paradise,” made autonomously by his Creativity Machine AI system and stating that only creative works made by humans are entitled to copyright protection.[214] The parties’ cross-motions for summary judgment will be fully briefed in April 2023.

Copyright Claims Board Updates

The Copyright Claims Board (CCB), a three-member tribunal established by the Copyright Alternative in Small-Claims Enforcement (CASE) Act of 2020, was launched on June 16, 2022. The CCB serves as a voluntary alternative to federal court and was designed to offer a cheaper and more efficient path to resolving copyright disputes involving claims for no more than $30,000.[215] After the claimant files a compliant claim with the CCB and serves the respondent, the respondent has 60 days in which to opt out of CCB review, leaving the claimant with the option to bring suit in federal court.[216] The CCB—which conducts all hearings remotely through video conference—is intended to be accessible to unrepresented litigants (though parties may be represented by counsel if they choose) and to minimize the burdens of discovery. The CCB’s jurisdiction is limited to claims of copyright infringement, claims seeking declarations of non-infringement, and claims of “misrepresentation” in take-down notices or counter notices sent under the Digital Millennium Copyright Act.

Since the CCB began accepting cases in 2022, over 375 cases have been filed.[217] Early analysis indicates that the vast majority of claims filed were infringement claims, with claims over pictorial, graphic, and sculptural works representing the largest segment, followed by claims involving motion picture and audiovisual works and literary works.[218]

On February 28, 2023, the CCB issued its first decision, in a case referred to the Board by the United States District Court for the Northern District of California with the consent of the parties.[219] The claimant, David Oppenheimer, a professional photographer, discovered that an aerial photograph he took of the Ronald V. Dellums Federal Building and U.S. Courthouse in Oakland, California appeared on the website of attorney Douglas Prutton, to illustrate a “Where We Work” subpage. Prutton admitted that he used the image without permission but asserted affirmative defenses of fair use and unclean hands. The CCB rejected both defenses. With respect to fair use, the CCB held that Prutton’s use on his website promoting his law firm was commercial and not transformative, Oppenheimer’s photograph was creative, Prutton used the entire photograph, and, although Oppenheimer admitted he had never sold or licensed the photo at issue, Oppenheimer had at least some minimal licensing history such that cognizable market harm was presumed to exist and had not been refuted by Prutton. The CCB also rejected Prutton’s unclean hands defense based on his contention that Oppenheimer was a copyright troll whose primary revenue stream from his photographs is litigation, rather than sales or licensing; it held that being a litigious copyright holder was not a basis for an unclean hands defense. Ultimately, the CCB awarded $1000 in statutory damages, near the bottom of the permissible range. Like all CCB decisions, the Oppenheimer decision is public, but is not precedential.

G. Media, Entertainment, and Technology Deals

Private Equity and Hollywood

Despite market uncertainty, private equity investments in Hollywood proved the show must go on. In January 2022 alone, there were multiple major private equity funded content acquisition deals announced,[220] including Candle Media’s acquisition of Faraway Road Productions, the creators of Fauda,[221] and private equity giant Apollo’s $760 million investment in Legendary Entertainment, which produced the film Dune.[222]

The boom in deal-making activity came as private equity firms looked to cash in on highly desirable IP and fund the creation of new content by investing in production companies, financing content acquisition vehicles, and purchasing soundstages and physical studios.[223] Co-founder and co-CEO of Candle Media, Kevin Mayer, explained that “[w]e have a thesis, and that thesis is content, community and commerce. We feel that high-quality content with high-quality creators at the right brands create great connections in social media with large audiences.”[224] In May 2022, Candle Media announced its acquisition of Spanish-language production powerhouse Exile Content Studio, which creates content for more than 550 million Spanish speakers globally,[225] and in July 2022, Exile Content Studio announced its majority investment in Lil’ Heroes NFT Franchise.[226]

Candle Media initially acquired Reese Witherspoon’s Hello Sunshine, a deal reported to be worth $900 million,[227] and Moonbug Entertainment, the company behind CoComelon.[228] [Disclosure: Gibson Dunn advised Kevin Mayer in the formation of Candle Media and subsequently represented Candle Media in its acquisition of Hello Sunshine, its acquisition of Faraway Road Productions, its acquisition of Exile Content Studios, and the investment in Lil’ Heroes.]

The golden age of streaming created new opportunities for private equity firms looking to invest in the content-creation business. Shamrock Capital Partner, Andy Howard, noted that “[u]nlike TV or cable, today’s streaming platforms do not have slots or limitations on how much content they can hold. Therefore, content is king, and especially premium content.”[229]

In July 2022, Peter Chernin launched The North Road Company, a global, multi-genre studio, backed by up to $800 million in financing from Apollo and Providence Equity Partners.[230] The North Road Company owns Chernin Entertainment, Words + Pictures, and ventures in other production companies such as the U.S. assets of Red Arrow Studios.[231] [Disclosure: Gibson Dunn represented affiliates of Chernin Entertainment in the formation of The North Road Company and subsequently represented The North Road in its acquisition of Red Arrow Studios International, Inc., its acquisition of Words + Pictures, the investment by Providence Equity Partners of up to $500 million in equity in North Road, and the provision by Apollo of $300 million in debt financing.]

With the demand for more premium content comes the need for real estate to house production of these new projects. To meet the need, many private equity firms invested in the acquisition, construction, and expansion of soundstages.[232] In June 2022, Silver Lake invested $500 million in Shadowbox Studios, a production facility company with stages in Atlanta, London, and Los Angeles.[233]

Private Equity Conglomerate Acquires Nielsen Holdings

Gibson Dunn represented Elliott Investment Management, which together with a consortium of other investors, including Brookfield, acquired Nielsen Holdings plc for $16 billion, the second largest leveraged buyout in 2022.[234]

Sony Music Publishing Signs Deal With Muddy Waters’s Estate

Sony Music Publishing agreed to administer the estate of McKinley “Muddy Waters” Morganfield, known as the father of Chicago blues and an influential figure in rock & roll.[235] Chairman and CEO, Jon Platt, stated that “[Sony] look[s] forward to partnering with the Muddy Waters Estate on exciting new ways to invigorate the catalogue.”[236]

Music Catalog Acquisitions

The market for music catalogue acquisitions—which includes master recordings, music publishing, and other trademark and IP—continued to boom in 2022, with companies like Primary Wave, Warner, Hipgnosis, Concord, and Universal announcing major acquisitions.[237] Catalog acquisitions have become extremely lucrative revenue streams for investors, who are able to capitalize on numerous opportunities to use the songs in licensing deals, film and television, and advertisements. Some highlights from the past year include:

Warner Chappell Acquires David Bowie’s Music Catalog

On January 3, 2022, Warner Chappell Music, a subsidiary of Warner Music Group, announced its acquisition of the global music publishing rights to David Bowie’s song catalogue from his estate after months of negotiations.[238] The acquisition closed for a price upwards of $250 million.[239] The catalogue includes songs from Bowie’s 26 studio albums, including the posthumous studio album release, “Toy.”[240]

Universal Music Acquires Sting’s and Neil Diamond’s Music Catalogs

On February 10, 2022, Universal Music Publishing Group (UMPG) announced its agreement to acquire Sting’s entire song catalog for a price north of $300 million.[241] The agreement marks one of biggest acquisitions by UMPG and continues its acquisition record that started when it acquired Bob Dylan’s songwriting catalog in 2020.[242] Just a few weeks later, on February 28, 2022, UMPG announced it had acquired Neil Diamond’s song catalog and the rights to all of his master recordings, including any future recordings from Diamond.[243] The price of the deal was not disclosed.[244]

Hipgnosis Acquires Leonard Cohen’s and Justin Timberlake’s Song Catalogs

On March 5, 2022, Hipgnosis Song Management announced its acquisition of the song catalog of Leonard Cohen through his estate.[245] Cohen was one of the most influential song writers of the past several decades and was inducted into both the Songwriters Hall of Fame and the Rock & Rock Hall of Fame.[246] The agreement included the rights to all 278 songs and derivatives written by Cohen, including “Hallelujah.”[247] Hipgnosis also acquired Cohen’s royalty interests from his Stranger Music catalog and the entirety of his copyright interests and share of royalties in the Old Ideas catalog.[248] The price of the deal was not disclosed.[249]

On May 26, 2022, Hipgnosis announced its acquisition of Justin Timberlake’s copyright interests in his song catalog and his authored musical compositions.[250] The price of the deal was not disclosed, although unnamed sources believe it to be valued “just above $100 million.”[251] The deal does not include rights to any future Timberlake works.[252]

Influence Media Partners Acquire Future’s Song Publishing Catalog

On September 20, 2022, Influence Media Partners, an entertainment investment company, announced its acquisition of the music publishing catalog of Future.[253] The catalog includes 612 songs, including collaborations with Drake, The Weeknd, and Kendrick Lamar.[254] The agreement represents an eight-figure acquisition, although the terms of the deal are not disclosed.[255]

Concord Acquires Music Catalog of Genesis Band Members Phil Collins, Mike Rutherford, and Tony Banks

On September 29, 2022, Concord announced its acquisition of the publishing and recorded music catalogs of Tony Banks, Phil Collins, and Mike Rutherford, including the master recordings and publishing catalogs from their years in the band Genesis.[256] Although the terms of the deal are undisclosed, sources close to the deal have valued it at north of $300 million.[257]

_____________________________

[1] Kirkman v. AMC Film Holdings LLC, No. BC672124, 2020 WL 4364279 (Cal. Super. Ct. July 22, 2020).

[2] Id. at *32.

[3] Ruling on Defendants’ Motion for Summary Adjudication at 5, Kirkman v. AMC Film Holdings LLC, No. BC672124 (Cal. Super. Ct. Apr. 6, 2022).

[4] Id. at 12, 15.

[5] Plaintiffs’ Notice of Dismissal at 2, Kirkman v. AMC Film Holdings LLC, No. BC672124 (Cal. Super. Ct. Jan. 9, 2023).

[6] Gray v. Perry, 2020 WL 1275221, at *1 (C.D. Cal. Mar. 16, 2020).

[7] Id. at *5.

[8] Id. at *1.

[9] Id. at *10-*12.

[10] Gray v. Perry, 28 F. 4th 87, 102.

[11] Id.

[12] Hall v. Swift, No. CV 17-6882-MWF (ASx) (C.D. Cal. Sept. 18, 2017).

[13] Id. at ECF 30.

[14] Hall v. Swift, 786 F. App’x 711, 712 (9th Cir. 2019).

[15] Hall v. Swift, 2021 WL 6104160, at *4-*5 (C.D. Cal. Dec. 9, 2021).

[16] Id. at 1.

[17] Ben Sisario, Lawsuit Over Lyrics in Taylor Swift’s ‘Shake it Off’ is Dismissed, The New York Times (2022), https://www.nytimes.com/2022/12/12/arts/music/taylor-swift-shake-it-off-lawsuit.html (last visited Mar 3, 2023).

[18] David McCabe & Ben Sisario, Justice Dept. Is Said to Investigate Ticketmaster’s Parent Company, N.Y. Times (Jan. 24, 2023), https://www.nytimes.com/2022/11/18/technology/live-nation-ticketmaster-investigation-taylor-swift.html; see also Caitlin Huston, Live Nation President Says DOJ Investigation Could Have “Chilling Impact” on Settlements, The Hollywood Reporter (Mar. 8, 2023, 12:24 PM), https://www.hollywoodreporter.com/business/business-news/live-nation-doj-investigation-could-have-chilling-effect-1235346117/.

[19] Ben Sisario, Justice Dept. Clears Ticketmaster Deal, N.Y. Times (Jan. 25, 2010), https://www.nytimes.com/2010/01/26/business/26ticket.html.

[20] Sterioff v. Live Nation Ent., Inc. and Ticketmaster LLC, No. 2:22-cv-09230-GW-GJS (C.D. Cal. filed Dec. 20, 2022).

[21] Transcript of Oral Argument, Andy Warhol Foundation for Visual Arts, Inc. v. Goldsmith, No. 21-869 (U.S., argued Oct. 12, 2022).

[22] Andy Warhol Foundation for Visual Arts, Inc. v. Goldsmith, 11 F.4th 26, 32 (2d Cir. 2021).

[23] Id. at 42.

[24] Id. at 37.

[25] Transcript of Oral Argument at 11-12, Andy Warhol Foundation for Visual Arts, Inc. v. Goldsmith.

[26] Id. at 21, 101.

[27] Id. at 15.

[28] Id.

[29] Id. at 68.

[30] Id. at 99.

[31] Campbell v. Acuff-Rose Music, Inc., 510 U.S. 569 (1994).

[32] Starz Entertainment, LLC v. MGM Domestic Television Distribution, LLC, 39 F.4th 1236 (9th Cir. 2022).

[33] Id.

[34] Id. at 1239.

[35] Id. at 1238–1239.

[36] Id.

[37] Id. at 1239; Petrella v. Metro-Goldwyn-Mayer, Inc., 572 U.S. 663, 677 (2014).

[38] Starz, 39 F.4th at 1239.

[39] Id.

[40] Id. at 1241.

[41] Id. at 1243.

[42] Id.

[43] Id. at 1240.

[44] Id. at 1244.

[45] Id. at 1247.

[46] Id.

[47] SA Music LLC v. Apple, Inc., 592 F. Supp. 3d 869, 877 (N.D. Cal. 2022).

[48] Id.

[49] Id. at 886.

[50] Id. at 879.

[51] Id. at 880-81.

[52] Id. at 877.

[53] Hanagami v. Epic Games Inc., 2022 WL 4007874 (C.D. Cal. Aug. 24, 2022).

[54] Id. at *5.

[55] Id. at *1.

[56] Id. at *2.

[57] Id. at *4.

[58] Id.

[59] Unicolors, Inc. v. H&M Hennes & Mauritz L.P., 142 S. Ct. 941, 945 (2022)

[60] Id.

[61] Id.

[62] Id. at 946.

[63] Id.at 945.

[64] Id.

[65] 40 F.4th 1034 (9th Cir. 2022).

[66] Lang Van, Inc. v. VNG Corp., No. SACV 14-0100 AG (RNBx), 2014 WL 12585661, at *1 (C.D. Cal. Oct. 8, 2014), vacated, 669 F. App’x 479 (9th Cir. 2016).

[67] Id.

[68] Id.

[69] Id.

[70] Lang Van, Inc. v. VNG Corp., 669 F. App’x 479, 480 (9th Cir. 2016).

[71] Id.

[72] Lang Van, Inc. v. VNG Corp., No. SACV 14-100 AG (JDEx), 2019 WL 8107873, at *1 (C.D. Cal. Nov. 21, 2019), rev’d and remanded, 40 F.4th 1034 (9th Cir. 2022).

[73] 40 F. 4th at 1043.

[74] Id. at 1041-43.

[75] Id. at 1041-42.

[76] Id. at 1043.

[77] 54 F.4th 738 (D.C. Cir. 2022).

[78] Id. at 741.

[79] 17 U.S.C. § 1201(a), §§ 1203-04.

[80] Green v. U.S. Dep’t of Just., 392 F. Supp. 3d 68, 79 (D.D.C. 2019).

[81] Id. at 100.

[82] Green v. U.S. Dep’t of Just., No. 16-1492 (EGS) (July 15, 2021).

[83] Id. at *14, 18.

[84] See Green, 54 F.4th at 747.

[85] Id. at 744.

[86] Id.

[87] Id. at 745.

[88] 142 S. Ct. 1464 (2022).

[89] See Green, 54 F.4th at 745.

[90] Id. at 746.

[91] Id. at 747.

[92] Andersen v. Stability AI Ltd., No. 3:23-cv-00201 (N. D. Cal. filed Jan. 13, 2023).

[93] James Vincent, Anyone can use this AI art generator — that’s the risk, The Verge (Sep. 15, 2022, 5:30 AM), https://www.theverge.com/2022/9/15/23340673/ai-image-generation-stable-diffusion-explained-ethics-copyright-data.

[94] Id.

[95] See Vincent, supra note 77.

[96] Sarah Andersen, The Alt-Right Manipulated My Comic. Then A.I. Claimed it., N.Y. Times (Dec. 31, 2023), https://www.nytimes.com/2022/12/31/opinion/sarah-andersen-how-algorithim-took-my-work.html.

[97] Id.

[98] Id.

[99] Complaint at 30-42, Andersen, No. 3:23-cv-00201.

[100] Id. at 30-32.

[101] Id. at 5.

[102] Id. at 31.

[103] Id. at 20.

[104] Id. at 31.

[105] Id. at 10.

[106] Id. at 33-34.

[107] Melendez v. Sirius XM Radio, Inc., 50 F.4th 294 (2d Cir. 2022).

[108] Id. at 297.

[109] Id.

[110] Id. at 298.

[111] Id.

[112] Id. at 301.

[113] Id. at 308-309.

[114] Id. at 304.

[115] Id.

[116] Id.

[117] Id. (“The challenged advertisements are for that same [Howard Stern Show]—not for a separate product or show on which Melendez has never performed or with which he otherwise has no connection.”).

[118] Id. at 307.

[119] Id. at 308.

[120] Id.

[121] Id. at 309.

[122] 141 S.Ct. 2141 (2021).

[123] Jeremy Crabtree, What are NFTs and why are they becoming a big part of NIL deals?, ON3OS (Apr. 6, 2022), https://www.on3.com/nil/news/what-are-nfts-and-why-are-they-becoming-a-big-part-of-nil-deals/.

[124] Jesse Haynes, How Brands And College Athletes Can Navigate Name, Image And Likeness Marketing, Forbes (Oct. 6, 2022, 8:15 AM), https://www.forbes.com/sites/forbescommunicationscouncil/2022/10/06/how-brands-and-college-athletes-can-navigate-name-image-and-likeness-marketing/?sh=11e521d214dd.

[125] Ross Dellenger, The Other Side of the NIL Collective, College Sports’ Fast-Rising Game Changer, Sports Illustrated (Aug. 10, 2022), https://www.si.com/college/2022/08/10/nil-collectives-boosters-football-tennessee-daily-cover.

[126] Crabtree, supra note 107.

[127] Id.

[128] No. LACV1901946JAKKSX, 2022 WL 2784808 (C.D. Cal. June 3, 2022).

[129] Id. at 2

[130] Id.

[131] Id. at 6.

[132] Id. at 5.

[133] Id.

[134] Elizabeth Ferrill, Soniya Shah and Michael Young, Demystifying NFTs and intellectual property: what you need to know, Reuters (May 10, 2022, 9:19 AM), https://www.reuters.com/legal/legalindustry/demystifying-nfts-intellectual-property-what-you-need-know-2022-05-10/.

[135] VIP Prod. LLC v. Jack Daniel’s Properties, Inc., 953 F.3d 1170, 1172 (9th Cir. 2020).

[136] Id. at 1174 (internal quotation marks omitted).

[137] Id. at 1175 (internal quotation marks and citation omitted).

[138] Id. at 1176.

[139] Id. at 1175-76.

[140] VIP Prod. LLC v. Jack Daniel’s Properties Inc., 2021 WL 5710730, at *6 (D. Ariz. Oct. 8, 2021), aff’d, No. 21-16969, 2022 WL 1654040 (9th Cir. Mar. 18, 2022), cert. granted, 214 L. Ed. 2d 271, 143 S. Ct. 476 (2022).

[141] VIP Prod. LLC v. Jack Daniel’s Properties, Inc., No. 21-16969, 2022 WL 1654040, at *1 (9th Cir. Mar. 18, 2022), cert. granted, 143 S. Ct. 476 (2022).

[142] Palin v. New York Times Co., 588 F. Supp. 3d 375, 380 (S.D.N.Y.), reconsideration denied, 604 F. Supp. 3d 208 (S.D.N.Y. 2022).

[143] Id. at 381.

[144] Palin v. New York Times Co., 264 F. Supp. 3d 527 (S.D.N.Y. 2017).

[145] Palin v. New York Times Co., 940 F.3d 804 (2d Cir. 2019).

[146] 588 F. Supp. 3d at 399 (quoting New York Times Co. v. Sullivan, 376 U.S. 254, 280 (1964)).

[147] Id. at 410.

[148] Brief of Petitioner-Appellant at 33, Palin v. New York Times Co., No. 22-558 (2nd Cir. Sept. 19, 2022).

[149] Brief of Amici Curiae the Reporters Committee for Freedom of the Press and 52 Media Organizations in Support of Appellees at 10, Palin v. New York Times Co., No. 22-558 (2nd Cir. Dec. 15, 2022).

[150] In re Elster, 26 F.4th 1328, 1339 (Fed. Cir. 2022).

[151] Id. at 1330.

[152] Id. at 1331.

[153] Id.

[154] Id. at 1334.

[155] Id. at 1339.

[156] Id.

[157] Id.

[158] Meenaxi Enter., Inc. v. Coca-Cola Co., 38 F.4th 1067 (Fed. Cir. 2022).

[159] Coca-Cola Co. v. Meenaxi Enter. Inc., 2021 U.S.P.Q.2d 709 (T.T.A.B. 2021).

[160] Meenaxi, 38 F.4th at 1069.

[161] Id.

[162] Id.

[163] Id.

[164] Id.

[165] Id.

[166] Id.

[167] Id.

[168] Id.

[169] Id.

[170] Id.

[171] Id.

[172] Id.

[173] Id.

[174] Belin v. Starz Ent., LLC, No. CV 21-09586-FWS-PLA, 2022 WL 2192999 (C.D. Cal. June 17, 2022).

[175] Id. at *1.

[176] Id. at *6.

[177] Id.

[178] Id.

[179] Id. at *7.

[180] Hermes Int’l v. Rothschild, No. 22-cv-384 (JSR), Dkt. 144 (S.D.N.Y Feb. 8, 2023).

[181] Id. Dkt. 1.

[182] Id. Dkt. 50.

[183] Id.

[184] Id. Dkt. 144.

[185] Id. Dkt. 170.

[186] Id. Dkt. 172.

[187] Id. at 51 (“The refusal to register Applicant’s proposed mark is affirmed on both grounds.”).

[188] Id. at 37.

[189] Id. at 51. (“Overall, this record does not support a finding that consumers perceive the design of Applicant’s handbag as an indicator of source. Based on a consideration of the all the evidence in the record, we find that Applicant has failed to establish that its handbag design embodying the proposed mark has acquired distinctiveness within the meaning of Section 2(f) of the Trademark Act.”).

[190] Iancu v. Brunetti, 204 L. Ed. 2d 714, 139 S. Ct. 2294 (2019).

[191] In re Erik Brunetti, Serial No. 88308426, 88308434, 88308451 and 88310900 (August 22, 2022), available at https://assets.law360news.com/1523000/1523717/88310900_33.pdf.

[192] Id. at 43.

[193] Id. at 46.

[194] Stitch Editing Ltd. v. TikTok Inc., 2:21-cv-06636-SB-SK, Dkt. 518 (C.D. Cal. Mar. 9, 2023).

[195] Stitch Editing Ltd. v. TikTok Inc., 2:21-cv-06636-SB-SK, Dkt. 379 at 14, 20 (C.D. Cal. Jan. 26, 2023).

[196] Id. at 20.

[197] Stitch Editing Ltd. v. TikTok Inc., 2:21-cv-06636-SB-SK, Dkt. 465 (C.D. Cal. Feb. 28, 2023).

[198] Stitch Editing Ltd. v. TikTok Inc., 2:21-cv-06636-SB-SK, Dkt. 334 at 2 (C.D. Cal. Jan. 10, 2023).

[199] Stitch Editing Ltd. v. TikTok Inc., 2:21-cv-06636-SB-SK, Dkt. 518 (C.D. Cal. Mar. 9, 2023).

[200] In May 2022, the New York State Senate passed Senate Bill S7527, a law that seeks to “limit the admissibility of evidence of a defendant’s ‘creative or artistic expression’ against such defendant in a criminal proceeding” and requires prosecutors to “overcome the presumption of inadmissibility” by showing that the work is “literal, rather than figurative or fictional.” 2022 NY Senate-Assembly Bill S7527, A8681. The legislation has been pending in the New York State Assembly since June 2022.

[201] August Brown, Gov. Newsom signs bill restricting the use of rap lyrics in criminal trials, Los Angeles Times (Sept. 30, 2022), https://www.latimes.com/entertainment-arts/music/story/2022-09-30/rap-lyrics-bill-governor-newsom-decriminalizing-artistic-expression-act.

[202] Evidence Code, Section 352.2.

[203] Id.

[204] Id.

[205] Id.

[206] Deena Zaru, Court Overturns California man’s murder conviction, citing state’s new ‘rap lyrics’ law, ABCNews (Mar. 2, 2023), https://abcnews.go.com/US/court-overturns-california-mans-murder-conviction-citing-states/story?id=97523648.

[207] Ethan Shanfeld, California Restricts Use of Rap Lyrics in Criminal Trials After Gov. Newsom Signs Bill, Variety (Sept. 30, 2022), https://variety.com/2022/music/news/rap-lyrics-cant-be-used-evidence-newsom-california-new-bill-1235389803/?sub_action=logged_in.

[208] Andersen v. Stability AI Ltd., Case No. 3:23-cv-00201, ECF No. 1 (N.D. Cal. 2023).

[209] Getty Images Statement (Jan. 17, 2023), https://newsroom.gettyimages.com/en/getty-images/getty-images-statement.

[210] Getty Images (US), Inc. v. Stability AI, Inc., Case No. 1:23-cv-00135, ECF No. 1 (D. Del. 2023).

[211] Franklin Graves, U.S. Copyright Office Clarifies Limits of Copyright for AI-Generated Works, IPWatchdog (Feb. 23, 2023), https://ipwatchdog.com/2023/02/23/u-s-copyright-office-clarifies-limits-copyright-ai-generated-works/id=157023/.

[212] Letter from U.S. Copyright Office re: Zarya of the Dawn (Feb. 21, 2023), https://copyright.gov/docs/zarya-of-the-dawn.pdf.

[213] Id. (quoting U.S. Copyright Office, Compendium of U.S. Copyright Office Practices § 313.2 (3d ed. 2021)).

[214] Thaler v. Perlmutter, Case No. 1:22-cv-01564, ECF No. 1 (D.D.C. 2022).

[215] About the Copyright Claims Board, U.S. Copyright Office, https://ccb.gov/about/.

[216] Claimant Information, U.S. Copyright Office, https://ccb.gov/claimant/index.html.

[217] Jonathan Bailey, The Copyright Claims Board Decides its First Case, PlagiarismToday (Mar. 2, 2023), https://www.plagiarismtoday.com/2023/03/02/the-copyright-claims-board-decides-its-first-case/.

[218] Terrica Carrington, Copyright Office Activities in 2022: A Year in Review, Copyright Alliance (Jan. 10, 2023), https://copyrightalliance.org/copyright-office-2022/.

[219] Oppenheimer v. Prutton, Dkt. No. 22-CCV-0045 (CCB Feb. 28, 2023), https://dockets.ccb.gov/document/download/2220.

[220] Heidi Chung, Hollywood Investment Frenzy in Production Companies, Variety (Jan. 18, 2023, 2:18 PM), https://variety.com/vip/hollywood-investment-frenzy-in-production-companies-1235493888/.

[221] Elsa Keslassy, Candle Media Confirms Acquisition of ‘Fauda’ Production Banner Faraway Road Productions, Variety (Jan. 12, 2022, 4:43 AM), https://variety.com/2022/tv/global/candle-media-fauda-faraway-road-productions-1235152160/.

[222] Etan Vlessing, Legendary Sells $760M Minority Stake to Apollo, The Hollywood Reporter (Jan. 31, 2022, 1:15 PM), https://www.hollywoodreporter.com/business/business-news/legendary-760m-minority-stake-to-apollo-1235084468/.

[223] Alex Weprin, Why Hollywood Is Private Equity’s New Money Machine, The Hollywood Reporter (Jan. 18, 2022, 5:30 AM), https://www.hollywoodreporter.com/business/business-news/private-equity-hollywood-1235076358/.

[224] Id.

[225] Caitlin Huston, Candle Media Acquires Spanish-Language Studio Exile Content, The Hollywood Reporter (May 24, 2022, 6:31 AM), https://www.hollywoodreporter.com/business/business-news/candle-media-acquires-spanish-language-studio-exile-content-1235152960/.

[226] Anna Marie de la Fuente, Candle Media’s Exile Content Studio Snags Majority Share in Lil Heroes NFT Franchise, Variety (July 21, 2022, 6:30 AM), https://variety.com/2022/tv/global/candle-media-exile-content-lil-heroes-1235326984/.

[227] Benjamin Mullin & Miriam Gottfried, Reese Witherspoon’s Hello Sunshine to Be Sold to Media Company Backed by Blackstone, Wall St. J. (Aug. 2, 2021, 10:30 AM), https://www.wsj.com/articles/reese-witherspoons-hello-sunshine-to-be-sold-to-media-company-backed-by-blackstone-11627914600.

[228] Todd Spangler, Inside the $3 Billion Deal for Kid’s Content Player Moonbug, Owner of CoComelon, Variety (Dec. 3, 2021, 10:00 AM), https://variety.com/2021/biz/news/moonbug-acquisition-disney-tom-staggs-kevin-mayer-1235124553/.

[229] Alex Weprin & Winston Cho, Private Equity Money Picks Hollywood as Smart Bet Even in Downtown, The Hollywood Reporter (July 15, 2022, 5:30 AM), https://www.hollywoodreporter.com/business/business-news/private-equity-money-hollywood-as-smart-bet-even-in-downturn-1235180961/.

[230] Alex Weprin, Peter Chernin Launching $1B+ Content Studio Rollup The North Road Company, The Hollywood Reporter (July 6, 2022, 5:00 AM), https://www.hollywoodreporter.com/business/business-news/peter-chernin-north-road-company-1235175542/.

[231] Elaine Low, Claire Atkinson & Madeline Berg, 16 Top Private Equity Firms Making Bets on Entertainment, From Apollo to Redbird, as Media Dealmaking Continues Amid Market Uncertainty, Business Insider (Dec. 26, 2022, 8:04 AM), https://www.businessinsider.com/top-private-equity-players-investing-hollywood-2022-7.

[232] Winston Cho, Television Center in Hollywood to get $600M Soundstage Redevelopment, The Hollywood Reporter (Sept. 29, 2022, 5:00 AM), https://www.hollywoodreporter.com/business/business-news/television-center-in-hollywood-soundstage-redevelopment-1235229403/.

[233] Josh Wilson, Silicon Valley-Based Silver Lake to Invest $500 Million to Expand Shadowbox Studios, Forbes (June 30, 2022, 11:59 AM), https://www.forbes.com/sites/joshwilson/2022/06/30/silicon-valley-based-silver-lake-to-invest-500-million-to-expand-shadowbox-studios/?sh=4ae13ad3548e.

[234] Nielsen, Nielsen Announces Closing of Transaction with Evergreen- and Brookfield-led Consortium, Nielsen (October 11, 2022), https://www.nielsen.com/news-center/2022/nielsen-announces-closing-of-transaction-with-evergreen-and-brookfield-led-consortium/.

[235] Andrea Paine, Sony Music Publishing Signs a Global Deal with Muddy Wasters Estate, Music Week (Oct. 13, 2022), https://www.musicweek.com/publishing/read/sony-music-publishing-signs-global-deal-with-muddy-waters-estate/086739.

[236] Id.

[237] Id.

[238] Jem Aswad, David Bowie’s Estate Sells His Publishing Catalog to Warner Chappell, Variety (January 3, 2022), https://variety.com/2022/music/news/david-bowie-publishing-catalog-acquired-warner-chappell-1235145941/.

[239] Id.

[240] Id.

[241] Murray Stassen, Sting Sells Song Catalog to Universal for $300M+, Music Business Worldwide (February 10, 2022), https://www.musicbusinessworldwide.com/sting-sells-song-catalog-to-universal-for-300m/.

[242] Id.

[243] K.J. Yossman, Neil Diamond Sells Song Catalog, Master Recordings to Universal Music Group, Variety (February 28, 2022), https://variety.com/2022/music/news/neil-diamond-universal-music-1235191641/

[244] Id.

[245] Jem Aswad, Leonard Cohen Song Catalog Acquired By Hipgnosis, Variety (March 5, 2022), https://variety.com/2022/music/news/leonard-cohen-hipgnosis-1235196842/

[246] Id.

[247] Id.

[248] Id.

[249] Id.

[250] Jem Aswad, Justin Timberlake Sells Song Catalog to Hipgnosis for “Just Above” $100 Million, Variety (May 26, 2022), https://variety.com/2022/music/news/justin-timberlake-sells-song-catalog-hipgnosis-1235277907/.

[251] Id.

[252] Id.

[253] Ed Christman, Future Sells Song Publishing Catalog to Influence Media Partners: ‘An Artist of the Ages’, Billboard (September 20, 2022), https://www.billboard.com/pro/future-publishing-catalog-influence-media-partners/.

[254] Id.

[255] Id.

[256] Murray Stassen, Phil Collins, Mike Rutherford, and Tony Banks of Genesis Sell Rights to Concord in $300M Deal, Music Business Worldwide (September 29, 2022), https://www.musicbusinessworldwide.com/phil-collins-mike-rutherford-and-tony-banks-of-genesis-sell-rights-to-concord-in-300m-deal12/.

[257] Id.

The following Gibson Dunn lawyers assisted in the preparation of this client update: Brian Ascher, Ilissa Samplin, Jillian London, Connor Sullivan, Dan Nowicki, Shaun Mathur, Marissa Mulligan, Amanda Bello, Zach Montgomery, Jordan Rose, Lexie Perloff-Giles, Cate Harding, Dillon Westfall, Maya Halthore, Elise Widerlite, Peter Jacobs, Sara Greaves, Mary Otoo, Minnie Che, Mona Mosavi, Beshoy Shokralla, and Rameez Anwar.*

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or the following leaders and members of the firm’s Media, Entertainment & Technology Practice Group:

Media, Entertainment and Technology Group:
Scott A. Edelman – Co-Chair, Los Angeles (+1 310-557-8061, sedelman@gibsondunn.com)
Kevin Masuda – Co-Chair, Los Angeles (+1 213-229-7872, kmasuda@gibsondunn.com)
Benyamin S. Ross – Co-Chair, Los Angeles (+1 213-229-7048, bross@gibsondunn.com)
Orin Snyder – New York (+1 212-351-2400, osnyder@gibsondunn.com)
Brian C. Ascher – New York (+1 212-351-3989, bascher@gibsondunn.com)
Ilissa Samplin – Los Angeles (+1 213-229-7354, isamplin@gibsondunn.com)
Jillian London – Los Angeles (+1 213-229-7671, jlondon@gibsondunn.com)

*Sara Greaves, Peter Jacobs, Mona Mosavi, Mary Otoo, Jordan Rose and Beshoy Shokralla are associates working in the firm’s New York or Los Angeles offices who are not yet admitted to practice law.

Gibson Dunn’s summary of director education opportunities has been updated as of April 2023. A copy is available at this link. Boards of Directors of public companies find this a useful resource as they look for high quality education opportunities.

This quarter’s update includes a number of new opportunities as well as updates to the programs offered by organizations that have been included in our prior summaries.

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The following Gibson Dunn attorneys assisted in preparing this update: Hillary Holmes, Lori Zyskowski, Ronald Mueller, and Elizabeth Ising. Thank you to associates Mason Gauch and To Nhu Huynh from our Houston office for their assistance with this quarter’s update.

On March 15, 2023, in an opinion following a lawsuit brought by former stockholders of Mindbody, Inc. (Mindbody) arising out of the 2019 take-private acquisition of Mindbody by Vista Equity Partners (Vista),[1] Delaware Chancellor Kathaleen McCormick found that (1) the former CEO of Mindbody, Richard Stollmeyer, violated his fiduciary duties under Revlon by “tilt[ing] the sale process in Vista’s favor for personal reasons,” (2) Stollmeyer violated his duty of disclosure by “fail[ing] to disclose the full extent of his involvement with Vista, which was a material omission,” and (3) Vista aided and abetted Stollmeyer’s breach of his duty of disclosure by “failing to correct the proxy materials to include a full and fair description of its own interactions with Stollmeyer.” Chancellor McCormick awarded damages equal to $1 per share, plus interest and costs, and held that both Stollmeyer and Vista were jointly and severally liable for the damages.

This case provides several lessons for public company boards and potential private equity buyers in reinforcing the importance of designing and following fair and open sale processes, crafting honest and fulsome proxy disclosures, and being prudent with written communications.

Background

As the Court put it, Stollmeyer had “idiosyncratic reasons” for pursuing a sale of Mindbody that did not align with Mindbody stockholders’ interests. Specifically, Stollmeyer wanted to (1) sell fast, (2) sell to a “good home” for “his company” and management team, (3) obtain near-term liquidity and a potential large post-closing equity upside and (4) enter into a lucrative post-closing employment arrangement.

Before initiating any formal sale process, Stollmeyer twice indicated to Vista that he was considering putting Mindbody up for sale – including at Vista’s annual summit of its portfolio company executives, during which Stollmeyer texted a colleague that Vista “really love me and I love them.” In both instances, Stollmeyer failed to inform the Board of his overtures. Vista subsequently made an oral expression of interest to Stollmeyer to acquire Mindbody in October 2018, after which Vista swiftly kicked off its internal diligence processes to prepare a formal bid. Meanwhile, the Court found that Stollmeyer slow-walked the Mindbody Board by waiting eight days to inform the Board of the proposal to give Vista an edge over other potential bidders.

After learning of Vista’s expression of interest in an acquisition, the Board appointed an independent transaction committee to evaluate the transaction, but the Court found that Stollmeyer’s conflicts of interests once again infected the process. Stollmeyer knew that Mindbody’s largest stockholder, Institutional Venture Partners (IVP), similarly desired a near-term exit, and as a result Stollmeyer pushed for IVP’s representative on the Board, Eric Liaw to chair the transaction committee. In turn Liaw, as chair of the committee, pushed to engage the investment bank that connected Stollmeyer to Vista.

Once the formal sales process was initiated, Stollmeyer continued to back-channel with Vista throughout November and early December 2018, giving it a competitive advantage over other potential bidders. It was not until December 15 that Vista and the other financial sponsors received access to a Mindbody data room, but by that time Vista already had completed its internal diligence and its investment committee already had approved the Vista deal team to pursue an acquisition. On December 18, just three days after the data room opened, Vista submitted a formal bid to acquire Mindbody for $35 per share. Although the transaction committee’s financial advisor prompted Hellman & Friedman (H&F), the last remaining potential competitive bidder, to make a bid, H&F lamented internally that it needed more time and never submitted a bid. On December 20, Vista made a “best and final offer” to acquire Mindbody for $36.50 – a premium of approximately 68% based on Mindbody’s December 21 closing stock price – and the merger agreement signed on December 23, 2018.

Legal Analysis

Under Delaware’s seminal Revlon[2] line of cases, once a company’s board of directors decides to put the company up for sale, the board must focus on obtaining the best price reasonably available. When these so-called “Revlon duties” are implicated, directors, as fiduciaries, face enhanced scrutiny of their actions during the sale process. Enhanced scrutiny does not apply, however, if the transaction was “approved by a fully informed, uncoerced majority of the disinterested stockholders,”[3] in which case the more deferential business judgment rule applies. Here, the Court found that Stollmeyer was liable under a “paradigmatic Revlon claim” and could not escape enhanced scrutiny due to false and misleading disclosures in Mindbody’s proxy statement.

Applying Revlon to Stollmeyer’s action in the sale process, the Court concluded that the decision-making process was not adequate because Stollmeyer was clearly conflicted and “tilted the playing field in Vista’s favor” in multiple ways. The Court further found that Stollmeyer’s conduct during the sale process was not reasonable and constituted a breach of his fiduciary duties, concluding that “without Stollmeyer’s help, Vista would not have gotten [Mindbody] for $36.50 per share.” Stollmeyer also did not inform the Board of his conflicts and took steps to deprive the Board of the information needed to employ a reasonable decision-making process. Thus, Stollmeyer could not rely on the Board’s actions to support the reasonableness of the sale process.

Further, the Court found that Stollmeyer and Vista kept Mindbody’s stockholders as uninformed of their back-channel end-run around the Board’s formal sale process as the Board had been. The Court focused the fact that the preliminary proxy statement omitted mention of Stollmeyer’s two preliminary meetings with Vista, Vista’s verbal expression of interest to Stollmeyer on October 15, 2018, and Stollmeyer’s tip to Vista that Mindbody would be running a formal sale process before the sale process began. Although Mindbody filed supplemental disclosures that disclosed the early meetings with Vista and Vista’s expression of interest, the Court found the disclosures were “sterilized” at best and outright false at worst. For example, the proxy statement noted that it was “typical” for Stollmeyer to present to potential investors, but the Court found that Stollmeyer had not indicated to any other investors that he wanted to pursue a sale of Mindbody before the initiation of the formal sale process. Notably, the supplemental disclosures still did not disclose that Stollmeyer had tipped Vista. As such, the disclosures amounted to a “false narrative,” that Stollmeyer and Vista met casually before the sale process and that Vista only learned of the formal sale process through the same channels as all other potential bidders.

In finding that Vista knowingly aided and abetted Stollmeyer’s breach of his duty to disclose, the Court noted that Vista had negotiated for the right to review and comment on any Mindbody proxy materials and that Vista had the obligation to inform Mindbody of any material misstatements or omissions in the proxy materials it became aware of. Yet, the Court found that Vista reviewed multiple versions of the preliminary proxy statement and the supplemental disclosures and approved the language despite the disclosures being misleading and incomplete.

The Court also found that Vista knew the omissions and misstatements were material and took active steps to obscure the tilted nature of the sale process. An early draft of Vista’s investment committee deck noted that Vista had been informed of Mindbody’s sale process in “late October,” but the final deck adjusted the date to November 30 – when the transaction committee’s financial advisor formally reached out to Vista. Between the drafts, a senior member of the Vista deal team texted the drafter of the deck stating, “don’t tell them about process.” Similarly, an earlier draft of the investment committee deck noted that Stollmeyer informed Vista at the August 2018 meeting that he wanted to put Mindbody up for sale, but the final version of the deck simply stated that Stollmeyer met with a Vista representative.

To remedy these breaches, the Court awarded damages to the stockholder plaintiffs equal to $1 per share based on what Vista would have been willing to pay had a fair process been conducted. The Court focused on the fact that Vista deal team members took bets on what the deal price would be, and two of Vista’s most informed deal team members bet the deal price would be $37.50. Thus, the Court found, “the evidence demonstrates that Vista would have paid $37.50 had Stollmeyer not corrupted the process.”

Lessons Learned

1) Designing and following a fair and open sale process is critical for both public company fiduciaries and potential buyers. The Court’s decision reinforces the importance of boards and their transaction committees having ultimate control over a sale process and insisting on full transparency on interactions with potential bidders. And although the Court did not find Vista liable for aiding and abetting Stollmeyer’s Revlon violations because plaintiffs failed to timely raise such a claim, the Court nonetheless faulted Vista for participating in the scheme to end-run the sale process. Accordingly, private equity bidders should be mindful of following the established procedures in a sale process and be proactive in ensuring that the parties they are negotiating with have been authorized to do so and are reporting back to the full board or transaction committee.

2) Parties must be cognizant of avoiding pitfalls where the interests of management, large insider stockholders and the remaining disinterested stockholders may diverge. A related concern is that the interests of incumbent management and other stockholders who will have a continuing interest in the post-transaction company inherently will diverge from the interests of disinterested stockholders who are being cashed out in the transaction. This is particularly relevant to private equity bidders in take-private transactions, which often involve post-closing leadership roles for incumbent management and require large stockholders, including incumbent management, to “roll-over” a portion of their equity stake into the post-closing privately held company. To the extent possible, private equity bidders generally should avoid discussing post-closing roles and compensation with management at least until a purchase price has been agreed with the target board. And although not specifically raised in the Mindbody case, in transactions involving equity rollovers by management directors or other stockholders with board representation, both target boards and private equity bidders should also ensure that a committee of disinterested directors with its own advisors is established to negotiate and approve the transaction, with a majority of disinterested stockholders also potentially approving the transaction depending on the facts and circumstances.

3) Proxy disclosures should not omit or obscure any material communications between a target and potential buyer. Even though a proxy statement is sent by a target company to its stockholders, a private equity buyer in a take-private acquisition will generally have the obligation to ensure that the disclosures in the proxy statement regarding the material communications and interactions between the buyer and the target company or its management are truthful and accurate, and may face liability if it fails do so.

4) Potential private equity buyers should be mindful of internal price deliberations, which may become the basis for a future damages calculation, and other internal communications, which may become the basis for potentially embarrassing or damaging disclosure. Just as public company target boards are consistently reminded to be careful with written communications and to assume that all written communications will be discovered as part of litigation, private equity bidders should be careful with any written record they create, including emails, text messages, internal presentations and other written materials. In finding that Vista was liable for aiding and abetting Stollmeyer’s disclosure violations, the Court relied in large part on this written record, including Vista’s after-the-fact attempts to cleanse the record through later drafts of documents.

__________________________

[1] In re Mindbody, Inc. Stockholder Litigation, C.A. No. 2019-0442-KSJM, memo. op. (Del. Ch. Mar. 15, 2023).

[2] Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).

[3] Corwin v. KKR Fin. Holdings, LLC, 125 A.3d 304, 305–06 (Del. 2015).

The following Gibson Dunn lawyers prepared this client alert: Quinton C. Farrar, Colin B. Davis, and Brennan Halloran.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Mergers and Acquisitions, Private Equity, or Securities Regulation and Corporate Governance practice groups, or the following practice leaders and members:

Private Equity Group:
Richard J. Birns – New York (+1 212-351-4032, rbirns@gibsondunn.com)
Quinton C. Farrar – New York (+1 212-351-2661, qfarrar@gibsondunn.com)
Ari Lanin – Los Angeles (+1 310-552-8581, alanin@gibsondunn.com)
Michael Piazza – Houston (+1 346-718-6670, mpiazza@gibsondunn.com)
Steven R. Shoemate – New York (+1 212-351-3879, sshoemate@gibsondunn.com)

Mergers and Acquisitions Group / Transactions:
Robert B. Little – Dallas (+1 214-698-3260, rlittle@gibsondunn.com)
Saee Muzumdar – New York (+1 212-351-3966, smuzumdar@gibsondunn.com)

Mergers and Acquisitions Group / Litigation:
Colin B. Davis – Orange County (+1 949-451-3993, cdavis@gibsondunn.com)
Brian M. Lutz – San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com)

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
James J. Moloney – Orange County (+1 949-451-4343, jmoloney@gibsondunn.com)
Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com)

On March 30, 2023, the United States—along with over twenty international partners—adopted a nonbinding Code of Conduct outlining its commitment to use export control tools to address serious human rights concerns. Specifically, the Subscribing States[1] to the Code of Conduct will work together to target “the export of dual-use goods or technologies to end-users that could misuse them for the purposes of serious violations or abuses of human rights,” with a particular focus on the misuse of surveillance tools.[2] For the United States, this effort includes amendments to the Export Administration Regulations (“EAR”) that expressly make “protecting human rights worldwide” a basis for designation to the Entity List.[3]

As the Departments of State and Commerce have acknowledged, this Export Controls and Human Rights Initiative (“ECHRI”) Code of Conduct is yet another example of the U.S.’s continued efforts “to put human rights at the center of [its] foreign policy.”[4] In fact, although the Code of Conduct makes the United States’ focus on the intersection of export controls and human rights more explicit, in reality it builds on existing agency practice in recent years.

Between these existing practices and the Code of Conduct’s focus on collaboration with civil society, academia, and the international community, however, this may suggest even more robust enforcement and creative uses of regulatory authority in the coming years. To ensure continued compliance, companies engaged in the export of sensitive technologies will need to think creatively about integrating human rights evaluations into their existing trade due diligence processes.

I. ECHRI Code of Conduct’s Key Commitments

This recent Code of Conduct is the result of more than a year of work by the Export Controls and Human Rights Initiative, a multilateral effort initially created by the United States, Australia, Denmark, and Norway in December 2021.[5] In addition to ECHRI’s founding members, the following states committed to the Code of Conduct at the time of its publication: Albania, Bulgaria, Canada, Croatia, Czechia, Ecuador, Estonia, Finland, France, Germany, Japan, Kosovo, Latvia, The Netherlands, New Zealand, North Macedonia, Republic of Korea, Slovakia, Spain, and the United Kingdom.[6]

Although a non-binding document, the ECHRI Code of Conduct outlines a number of political commitments designed to ensure the effective application of export controls to protect human rights internationally. These include commitments of each Subscribing State to:

Make efforts to ensure that domestic legal, regulatory, policy and enforcement tools are updated to control the export of dual-use goods or technologies to end-users that could misuse them for the purposes of serious violations or abuses of human rights;
Engage with the private sector, academia, researchers, technologists, and members of civil society (including those from vulnerable groups) for consultations concerning these issues and concerning effective implementation of export control measures;
Share information regarding threats and risks associated with such tools and technologies with other Subscribing States on an ongoing basis;
Share, develop, and implement best practices among Subscribing States to control exports of dual-use goods and technologies to state and non-state actors that pose an unacceptable risk of human rights violations or abuses;
Consult with industry and promote non-state actors’ implementation of human rights due diligence policies and procedures in line with the UN Guiding Principles on Business and Human Rights or other complementing international instruments, and share information with industry to facilitate due diligence practices;
Aim to improve the capacity of States that have not subscribed to the Code of Conduct, and encourage other States to join or act consistent with the Code of Conduct.

In addition to these substantive goals, the Code of Conduct establishes procedural commitments for Subscribing States. Most significantly, these include ongoing meetings of Subscribing States designed to further develop the Code of Conduct by sharing information and creating mechanisms for the resolution of policy questions.

Notably, these multilateral efforts to coordinate export control strategies follow the international community’s unprecedented coordination on trade controls in response to the war in Ukraine, which we have discussed further in past client alerts. In fact, there is significant crossover between the current membership of the ECHRI Code of Conduct and those states that have worked in coordination on implementing Russia-related sanctions and export controls. For example, many states who have adopted the Code of Conduct are also members of the coalition that has adopted a price cap on the maritime transport of Russian-origin oil, as discussed further in our client alert on the subject. Similarly, most Code of Conduct states are exempted from the Department of Commerce’s Russia/Belarus Foreign Direct Product Rules because they have implemented “substantially similar export controls on Russia and Belarus” as the U.S.[7] As coordination among these states on a wide range of trade issues continues to increase, we can expect robust collaboration on implementation of the Code of Conduct.

Moreover, the Code of Conduct emphasizes the goal of increased adoption by other states by highlighting that the Code “does not specifically mention any of the multilateral export control regimes, such as the Wassenaar Arrangement.” Instead, the Code of Conduct is explicitly left open for any participant in the Summit for Democracy to join, regardless of their ratification of other multilateral regimes. Not only would broad future adoption increase the Code’s efficacy, but by tying membership to participation in the Summit for Democracy, the Code of Conduct reinforces a shared commitment to the democratic values central to human rights.

II. U.S. Implementation: The Entity List

Since 1997, the U.S. Department of Commerce—specifically its Bureau of Industry & Security (“BIS”)—has maintained an “Entity List“ of foreign persons subject to heightened license requirements for the export, reexport, or in-country transfer of specified items. As the first step toward implementing the ECHRI Code of Conduct, BIS published a final rule on March 30 confirming human rights concerns as a valid basis for designation to the Entity List.[8]

Initially, inclusion on the Entity List was limited primarily to foreign persons presenting risk of involvement in the proliferation of weapons of mass destruction (“WMDs”).[9] Over time, however, grounds for inclusion expanded to include any foreign persons “reasonably believed to be involved, or to pose a significant risk of being or becoming involved, in activities contrary to the national security or foreign policy interests of the United States.”[10]

Despite this potentially broad language, designations to the Entity List, historically, were relatively infrequent and narrowly focused on issues such as the proliferation of conventional weapons and WMDs, support for terrorism, and violations of U.S. sanctions and export controls. Though not explicitly linked to human rights, even these narrow grounds for designation demonstrate a U.S. focus on serious humanitarian and human rights violations arising out of U.S. exports. This focus has only increased in recent years, as BIS has dramatically increased the rate of designations—including some designations explicitly based on involvement in human rights abuses.

For example, beginning in 2019, BIS began designating a number of Chinese entities “implicated in human rights violations and abuses” against the Uyghurs and other ethnic minorities in the Xinjiang Uyghur Autonomous Region (the “XUAR”) of China.[11] Likewise, in 2021, BIS designated eight Burmese entities in response to human rights violations that occurred following the country’s February 2021 military coup.[12]

In light of this enforcement history, BIS’s recent final rule merely “confirm[s]” that the “protection of human rights worldwide” is a U.S. foreign policy objective sufficient to justify designation to the Entity List.[13] Although it does not represent a change in understanding, this amendment is likely to signal an increased use of export controls to target human rights violators, especially with respect to technologies involved in “enabling campaigns of repression and other human rights abuses.”[14]

In a statement accompanying publication of this rule, Assistant Secretary of Commerce for Export Enforcement Matthew S. Axelrod warned that “Export Enforcement will continue to work vigorously to identify those who use U.S. technology to abuse human rights and will use all law enforcement tools at our disposal to hold them accountable.”[15] This robust enforcement appears to already be in motion: concurrent with the publication of its amendment to the EAR, BIS designated eleven entities to its Entity List for their involvement in human rights abuses. These newly listed entities ranged from the Nicaraguan National Police and Burmese military contractors to Chinese companies implicated in surveillance and repression in the XUAR.[16]

III. The Continued Convergence of Human Rights & Export Controls

The Entity List is one of numerous trade control mechanisms the U.S. Government has used in recent years to address the intersection of international trade and human rights violations. Looking ahead, we can expect the Department of Commerce to deploy the following additional tools and sources of authority to implement the Code of Conduct.

a. Item-Based Controls

BIS most prominently introduced the concept of human rights into item-based crime control and detection (“CC”) controls in 2020. Specifically, in July 2020, BIS requested public comments regarding potential additional or modified controls on several items that may be used to assist human rights violations abroad, including facial recognition devices and other biometric systems, non-lethal visual disruption lasers, and long-range acoustic devices.[17] In its request for comments, BIS noted that these items could be used in mass surveillance, censorship, privacy violations, or other human rights abuses.[18]

Although BIS has not yet implemented additional CC controls pursuant to the comments received, in October 2020, BIS amended its CC controls to reflect a human rights-focused licensing policy.[19] Pursuant to this amendment, for items controlled for CC reasons, license applications are generally treated favorably “unless there is civil disorder in the country or region or unless there is a risk that the items will be used to violate or abuse human rights,” a restriction that is expressly designed “to deter human rights violations and abuses, distance the United States from such violations and abuses, and avoid contributing to civil disorder in a country or region.”[20]

In light of the ECHRI Code of Conduct commitment to “control the export of dual-use goods or technologies to end-users that could misuse them for the purposes of serious violations or abuses of human rights,” we may see additional controls on these surveillance systems and technologies.[21]

b. End-Use Based Controls

Another area with significant human rights implications is the end-use prohibitions of the EAR. Under Section 1754(d) of the Export Control Reform Act of 2018 (“ECRA”), the Department of Commerce is directed to require a license for U.S. persons to engage in specific “activities” in connection with nuclear explosive devices, missiles, chemical or biological weapons, whole plants for chemical weapons precursors, and foreign maritime nuclear projects—even without any export, reexport, or in-country transfer of items subject to the EAR.

BIS has increasingly used this specific export controls authority in recent years. In January 2021, BIS expanded this authority to control U.S. person activities in connection with military intelligence end-use, citing to a general authority provided in the ECRA.[22] “Military intelligence end-use” involves U.S. person support provided to the intelligence or reconnaissance organization of the armed services or national guard of Burma, China, Cuba, Iran, North Korea, Russia, Syria, or Venezuela. While this control is primarily focused on foreign military intelligence efforts, as such efforts are often inextricably intertwined with political repression and human rights issues, this control can be expected to take an increasingly important approach as a tool to uphold the U.S. position on human rights. Thus, as U.S. policies shift, we may also start seeing expansions to the list of foreign governments that are subject to the military intelligence end-use and end-user controls.

Further, in October 2022, BIS announced an unprecedented expansion of this authority in controlling U.S. person support for items used to produce certain advanced semiconductors and supercomputers in China.[23] According to BIS, because “China’s military-civil fusion effort makes it more difficult to tell which items are made for restricted end uses,” U.S. person support for advanced semiconductors and supercomputers “necessary for military programs of concern” would require a license even if the precise end-use could not be determined.[24] Similar types of controls with a human rights angle may be on the horizon—whether for additional items such as surveillance systems or for additional foreign governments other than China.

IV. Engagement with Civil Society, Academia, and the Private Sector

The ECHRI Code of Conduct emphasizes Subscribing States’ commitment to engage with civil society, academia, and the private sector on various issues relating to the implementation of effective human rights-focused export controls. If other areas of trade controls focused on human rights are any indication, these sectors can be expected to play a large role in driving enforcement priorities at the intersection of human rights and export controls.

The Code of Conduct appears to envision a two-way relationship between the government and civil society, academia, and the private sector: On one hand, states commit to facilitate due diligence and work with industry groups to promote human rights compliance. On the other hand, these other sectors can provide consultations on issues of human rights and the effective implementation of export controls. In the latter scenario, civil society and academia, in particular, may play a critical role in fact-gathering and presenting allegations of human rights violations to the U.S. government.

In fact, civil society and academia already play this role in the context of other human rights-focused trade restrictions, from sanctions to customs law. For example, the U.S. nonprofit Human Rights First coordinates a coalition of over 300 civil society organizations to facilitate the production of dossiers to share with the U.S. Government to promote the designation of specific human rights violators pursuant to the Global Magnitsky Sanctions program.[25] And, in the realm of customs law, the U.S. government has been particularly responsive to reports from civil society and academia in enforcing the Uyghur Forced Labor Prevention Act (“UFLPA”), discussed in our previous client alerts. Just this past December, for example, the U.K.’s Sheffield Hallam University published a report alleging that major automotive manufacturers had used components made with forced labor in the XUAR.[26] Shortly thereafter, U.S. Customs and Border Protection began detaining shipments from numerous automotive manufacturers pursuant to the UFLPA.

In addition to human rights-focused organizations, technological organizations and industry groups may prove critical to the implementation of the Code of Conduct. The Code’s commitments specifically envision engagement with “technologists” to advise on the effective implementation of export control measures. These specialists will be able to provide BIS with the information to determine which dual-use technologies pose risks of serious human rights abuses.

V. Effective Integration of Human Rights and Trade Compliance

With increasing overlap between human rights standards and trade compliance obligations—as evinced by the Code of Conduct—companies throughout the world must think critically about how to integrate human rights and trade practices to ensure compliance in this dynamic regulatory landscape. Companies should coordinate both internally and externally to identify opportunities to make their compliance programs more human rights-focused. Referring to existing U.S. guidance and international frameworks can also help them strengthen contractual relationships and due diligence practices to better protect human rights.

a. Internal Stakeholder Mapping

To integrate corporate efforts on human rights and trade compliance, a company should first identify the team of internal stakeholders who can provide visibility into the company’s various activities. Open communication among these departments will be critical to maintaining compliance, especially as human rights concerns continue to converge with trade obligations. Accordingly, having a clear understanding of relevant stakeholders and their perspectives is an important first step.

For example, members of a company’s logistics or legal team may have access to the most up-to-date information on a particular shipment and its end-users. A member of the environmental, social, and governance (“ESG”) or public relations team, however, may be most up-to-date on human rights issues dominating the news cycle—and, therefore, government enforcement priorities. Likewise, engineering or product teams may be best equipped to assess whether any individual product—particularly in the technology sectors—may have an unintended dual use that could be exploited to violate human rights, such as integration into surveillance efforts by foreign governments. Regular communication across these groups will allow companies to foresee reputational and commercial risks posed by exporting dual-use products to entities at risk of designation.

b. Industry and Civil Society Coordination

Just as the United States will coordinate with other Subscribing States to share information and strengthen programs, companies should prioritize opportunities to coordinate among industry groups and even with civil society to develop best practices.

Since advanced goods and technologies will be a primary target of the export controls the ECHRI Code of Conduct envisions, companies producing technology with the potential to be used for repression, surveillance, or other human rights abuses should collaborate to develop due diligence and risk assessment programs scoped to the specific concerns of their industry. For example, industry groups representing companies exporting facial recognition technology—which poses a high risk of use for surveillance—can develop technology-specific export due diligence best practices that can be implemented by all of their members.

Companies should also engage with civil society to learn about evolving human rights concerns. As discussed above, the U.S. government has indicated its intention to collaborate with civil society and academia in implementing human rights-focused export controls, and reports from these organizations are likely to drive U.S. enforcement priorities. By actively engaging with civil society, companies position themselves to stay ahead of the enforcement curve by developing early awareness and risk mitigation protocols before, for example, a counterparty is added to the Entity List.

c. Contracting for Human Rights Compliance

Even after determining it is permissible to export goods to a particular entity, companies should identify opportunities to obtain legal and reputational protections through their contracts.

Companies can use contractual provisions not only to obtain access to additional information about counterparties (and their business associates) but also to secure protection in the event a counterparty is later found to be involved in human rights violations. Such provisions are even more essential in the context of distributors or channels partners, where companies may be relying on the partner to conduct diligence on the ultimate end-users. With the potential decreased visibility into these sales, partner contracts should go beyond standard compliance representations to ensure companies have a strong legal basis to investigate and remediate any issues that may arise.

These contractual protections include provisions that allow companies to obtain information from their partners, such as audit rights, or that require partners to proactively disclose information regarding end-users. Effective contracting will also provide for consequences for non-compliance, including termination and indemnification. Companies may also incorporate structural mechanisms to mitigate risk, including by expressly limiting the territorial scope of its partners.

Companies can also streamline the contracting process by grouping third parties into categories based on a human rights risk profile or by the type of contractual relationship. This process allows for category-specific risk assessments and contract templates, while also allowing companies to consider what contracting incentives can be used to motivate categories of counterparties to support their human rights and trade compliance efforts.

d. Existing Guidance & Human Rights Frameworks

Although the ECHRI Code of Conduct reflects a strengthened commitment to use export controls to address human rights concerns, existing frameworks continue to provide helpful guidance on corporate due diligence and risk assessments. Indeed, the Code of Conduct expressly encourages the private sector to conduct due diligence in line with “the UN Guiding Principles on Business and Human Rights or other complementing international instruments.”[27]

In the United States, the U.S. government has already provided specific guidance on how to implement the UN Guiding Principles for certain transactions covered by the ECHRI Code of Conduct. In September 2020, for example, the U.S. State Department published Guidance on Implementing the UN Guiding Principles for Transactions Linked to Foreign Government End-Users for Products or Services with Surveillance Capabilities in recognition of the fact that certain products or services with surveillance capabilities can be misused to violate or abuse human rights when exported to public or private end-users who do not respect basic freedoms and the rule of law.[28]

The State Department’s guidance identifies due diligence concerns and potential red flags to consider at various steps when transacting with government end-users, along with suggested safeguards to detect and halt abuse. In fact, the guidance provides a number of recommended contractual safeguards, in line with our guidance above.[29] While this guidance is primarily focused on government end-users, it also covers transactions with non-state actors in high-risk jurisdictions where governmental or quasi-governmental entities may be undisclosed end-users. Lastly, the guidance’s appendices provide helpful resources for further compliance guidance, from human rights frameworks and reports to examples of foreign laws suggesting the possible misuse of surveillance-related exports.[30]

The ECHRI Code of Conduct expresses a commitment to use export controls to address a wide range of entities—not just government end-users. However, given the Code of Conduct’s focus on “surveillance tools and other technologies . . . that can lead to serious violations of human rights,” the U.S. State Department’s 2020 guidance provides a baseline understanding of the U.S. government’s expectations for due diligence and risk mitigation when exporting goods or technologies with surveillance capabilities.[31]

Additionally, for exports destined for China—and especially the XUAR—companies should consult the Xinjiang Supply Chain Business Advisory issued by the Departments of State, Treasury, Commerce, and Homeland Security.[32] This advisory outlines specific risks and concerns about due diligence related to the export of goods or technology that could be used for surveillance in the XUAR.

While other governments will adopt their own guidance and related measures, we assess that many countries will look to the U.S. model as they develop their domestic authorities.

VI. Conclusion

The Biden administration has made clear that it will continue to use an aggressive, yet multilateral, approach to enforce human rights around the world, and the ECHRI Code of Conduct appears to be another example of this priority. By integrating their human rights and trade compliance efforts, however, companies can protect themselves from risk in this area.

As human rights concerns increasingly motivate export controls, open communication among internal stakeholders and with civil society will be key to preventing human rights-related export violations. Companies should think critically about every step of their contracting processes to maximize legal and reputational protection, particularly when working with distributors or channels partners. Existing U.S. guidance and international human rights instruments can help companies throughout the world address these and other due diligence issues as they update policies and procedures to ensure effective compliance.

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[1] At the time of the Code of Conduct’s publication, the following countries comprise the Subscribing States: Albania, Australia, Bulgaria, Canada, Costa Rica, Croatia, Czechia, Denmark, Ecuador, Estonia, Finland, France, Germany, Japan, Kosovo, Latvia, The Netherlands, New Zealand, North Macedonia, Norway, Republic of Korea, Slovakia, Spain, the United Kingdom, and the United States.

[2] Code of Conduct for Enhancing Export Controls of Goods and Technology That Could Be Misused and Lead to Serious Violations or Abuses of Human Rights, U.S. Dep’t of State, https://www.state.gov/wp-content/uploads/2023/03/230303-Updated-ECHRI-Code-of-Conduct-FINAL.pdf (hereafter “Code of Conduct”).

[3] Additions to the Entity List; Amendment to Confirm Basis for Adding Certain Entities to the Entity List Includes Foreign Policy Interest of Protection of Human Rights Worldwide, 88 Fed. Reg. 18,983 (Mar. 30, 2023) (revising 15 C.F.R. § 744.11 to explicitly add involvement in activities that are contrary to the “foreign policy interest of the protection of human rights throughout the world” as a basis for designation to the Department of Commerce’s Entity List)

[4] Press Release, Export Controls and Human Rights Initiative Code of Conduct Released at Summit for Democracy, U.S. Dep’t of State (Mar. 30, 2023), https://www.state.gov/export-controls-and-human-rights-initiative-code-of-conduct-released-at-the-summit-for-democracy/; Press Release, Biden Administration and International Partners Release Export Controls and Human Rights Initiative Code of Conduct, U.S. Dep’t of Commerce (Mar. 30, 2023), https://www.bis.doc.gov/index.php/documents/about-bis/newsroom/press-releases/3257-2023-03-30-bis-press-release-echri-code-of-conduct/file.

[5] Joint Statement on the Export Controls and Human Rights Initiative, U.S. Dept. of State (Dec. 10, 2021), https://www.whitehouse.gov/briefing-room/statements-releases/2021/12/10/joint-statement-on-the-export-controls-and-human-rights-initiative/.

[6] Press Release, Export Controls and Human Rights Initiative Code of Conduct Released at Summit for Democracy, U.S. DEP’T OF STATE (Mar. 30, 2023), https://www.state.gov/export-controls-and-human-rights-initiative-code-of-conduct-released-at-the-summit-for-democracy/.

[7] Additions to the List of Countries Excluded From Certain License Requirements Under the Export Administration Regulations (EAR), 87 Fed. Reg. 21,554 (Apr. 12, 2022); see 15 C.F.R. Part 746, Supplement No. 3.

[8] Press Release, Commerce Adds Eleven to Entity List for Human Rights Abuses and Reaffirms Protection of Human Rights as Critical U.S. Foreign Policy Objective, Bureau of Indus. and Sec’y (Mar. 30, 2023), https://www.bis.doc.gov/index.php/documents/about-bis/newsroom/press-releases/3256-2023-03-30-bis-press-release-human-rights-entity-list-additions/file.

[9] Entity List, Bureau of Indus. and Sec’y (last accessed Apr. 2, 2023), https://www.bis.doc.gov/index.php/policy-guidance/lists-of-parties-of-concern/entity-list.

[10] 15 C.F.R. § 744.16 (2022).

[11] See, e.g., Addition of Certain Entities to the Entity List, 84 Fed. Reg. 54,002 (Oct. 9, 2019).

[12] See Addition of Entities to the Entity List, 86 Fed. Reg. 13,179 (Mar. 8, 2021); see also Addition of Certain Entities to the Entity List; Correction of Existing Entry on the Entity List, 86 Fed. Reg. 35,389 (July 6, 2021).

[13] Additions to the Entity List; Amendment to Confirm Basis for Adding Certain Entities to the Entity List Includes Foreign Policy Interest of Protection of Human Rights Worldwide, 88 Fed. Reg. 18,983 (Mar. 30, 2023) (emphasis added).

[14] Press Release, Commerce Adds Eleven to Entity List for Human Rights Abuses and Reaffirms Protection of Human Rights as Critical U.S. Foreign Policy Objective, Bureau of Indus. and Sec’y (Mar. 30, 2023), https://www.bis.doc.gov/index.php/documents/about-bis/newsroom/press-releases/3256-2023-03-30-bis-press-release-human-rights-entity-list-additions/file.

[15] Id.

[16] Additions to the Entity List, supra note 13.

[17] Advanced Surveillance Systems and Other Items of Human Rights Concern, 85 Fed. Reg. 43,532 (July 17, 2020).

[18] Id. at 43,533.

[19] Amendment to Licensing Policy for Items Controlled for Crime Control Reasons, 85 Fed. Reg. 63,007 (Oct. 6, 2022).

[20] Id. at 63,009.

[21] Code of Conduct, supra note 2.

[22] Expansion of Certain End-Use and End-User Controls and Controls on Specific Activities of U.S. Persons, 86 Fed. Reg. 4,865 (Jan. 15, 2021); see 15 C.F.R. § 744.22.

[23] Implementation of Additional Export Controls: Certain Advanced Computing and Semiconductor Manufacturing Items; Supercomputer and Semiconductor End Use; Entity List Modification, 87 Fed. Reg. 62,186 (Oct. 13, 2022); see 15 C.F.R. § 744.6.

[24] Implementation of Additional Export Controls: Certain Advanced Computing and Semiconductor Manufacturing Items; Supercomputer and Semiconductor End Use; Entity List Modification, 87 Fed. Reg. 62,186, 62,187 (Oct. 13, 2022)

[25] Global Magnitstky and Targeted Sanctions, Human Rights First (last accessed Apr. 2, 2023), https://humanrightsfirst.org/efforts/global-magnitsky-targeted-sanctions/.

[26] Driving Force: Automotive Supply Chains and Forced Labor in the Uyghur Region, Sheffield Hallam Univ. Helena Kennedy Centre for Int’l Justice (Dec. 2022), https://acrobat.adobe.com/link/track?uri=urn%3Aaaid%3Ascds%3AUS%3A69ce4867-d7e7-4a6a-a98b-6c8350ceb714&viewer%21megaVerb=group-discover.

[27] Code of Conduct, supra note 2.

[28] Guidance on Implementing the UN Guiding Principles for Transactions Linked to Foreign Government End-Users for Products or Services with Surveillance Capabilities, U.S. Dept. of State (Sep. 30, 2020), https://www.state.gov/wp-content/uploads/2020/10/DRL-Industry-Guidance-Project-FINAL-1-pager-508-1.pdf. As this document explains, these products and services can violate a host of fundamental rights that are protected by the Universal Declaration of Human Rights and the International Covenant on Civil and Political Rights, such as the right to be free from arbitrary or unlawful interference with privacy. See id. at 3.

[29] Id. at 11.

[30] Id. at 14–19.

[31] Code of Conduct, supra note 2.

[32] Xinjiang Supply Chain Business Advisory (Jul. 2, 2020, updated Jul. 13, 2021), U.S. Dept. of Treasury, https://www.state.gov/wp-content/uploads/2021/07/Xinjiang-Business-Advisory-13July2021-1.pdf

The following Gibson Dunn lawyers prepared this client alert: Sean Brennan*, Christopher Timura, Claire Yi, Anna Searcey, Stephenie Gosnell Handler, Adam M. Smith, Chris Mullen, Maria Banda, and Annie Motto.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or the following members and leaders 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)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Annie Motto – Washington, D.C. (+1 212-351-3803, amotto@gibsondunn.com)
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, cmullen@gibsondunn.com)
Sarah L. Pongrace – New York (+1 212-351-3972, spongrace@gibsondunn.com)
Anna Searcey – Washington, D.C. (+1 202-887-3655, asearcey@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)
Claire Yi – Washington, D.C. (+1 202-887-3644, cyi@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)

Asia
Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com)
David A. Wolber – Hong Kong (+852 2214 3764, dwolber@gibsondunn.com)
Qi Yue – Hong Kong – (+852 2214 3731, qyue@gibsondunn.com)
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)

Europe
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Susy Bullock – London (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris – London (+44 (0) 207 071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly – London (+44 (0) 20 7071 4205, sharber-kelly@gibsondunn.com)
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, mkirschner@gibsondunn.com)
Penny Madden – London (+44 (0) 20 7071 4226, pmadden@gibsondunn.com)
Irene Polieri – London (+44 (0) 20 7071 4199, ipolieri@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Nikita Malevanny – Munich (+49 89 189 33 160, nmalevanny@gibsondunn.com)

*Sean Brennan is an associate working in the firm’s Washington, D.C. offices who currently is admitted to practice only in New York.

We are pleased to provide you with Gibson Dunn’s ESG monthly updates for March 2023. This month our update covers the following key developments. Please click on the blue links below for further details.

International
1. PRI releases new report on stewardship practices across investment managers
  The United Nations Principles for Responsible Investment (“PRI”) released a report on stewardship practices amongst their investment manager signatories on March 17, 2023, resulting from the PRI’s analysis of responses from 1,858 investment managers. As part of the report, the PRI has identified a number of key areas for development which include: (i) the development of detailed, public responsible investment policies, (ii) broader coverage across assets under management, asset classes and ESG issues, (iii) clear accountability and governance for implementing responsible investment, (iv) expansion of client reporting, including quantitative analysis relating to ESG performance, and (v) robust implementation of the recommendations of the Task Force on Climate-Related Financial Disclosures.
2. IASB initiates project to consider climate-related risks in financial statements and proposes amendments to classification requirements for financial assets with ESG features
  The International Accounting Standards Board (“IASB”) launched a project on March 20, 2023 aimed at exploring whether and how companies can provide better information about climate-related risks in their financial statements. In undertaking the project, the IASB will research the cause of stakeholders’ concerns in respect of: (i) the inconsistent application of the International Financial Reporting Standards’ Accounting Standards in relation to climate-related risks, and (ii) the disclosure of insufficient information in financial statements about climate-related risks. The project will include a consideration of the work of the International Sustainability Standards Board in respect of financial statements to ensure that any proposals are complementary to that work.
  
  Separately, on March 21, 2023, the IASB also published an Exposure Draft proposing amendments to IFRS 9 (Financial Instruments) and related requirements in IFRS 7 (Financial Instruments: Disclosures) to include clarifications in respect of the assessment of contractual cash flow characteristics in financial assets containing ESG features. Comments on the Exposure Draft are to be received by July 19, 2023.
3. TNFD releases fourth and final beta framework
  On March 28, 2023, the Taskforce on Nature-related Financial Disclosures (“TNFD”) released its fourth and final beta framework for nature-related risk management and disclosure for market participants to identify, assess, respond to, and disclose their nature-related issues. In this final beta draft, the TNFD has outlined its approach to disclosure metrics proposing a three-tiered approach as to disclosure metrics for nature-related issues: (i) core global disclosure metrics (that cover all sectors), (ii) core sector-specific disclosure metrics, and (iii) additional disclosure metrics (that can be used more flexibly). The TNFD is expected to release its final recommendations in September 2023.
4. APLMA, LMA and LSTA publish two guidance documents on green, social and sustainability-linked loans
  On March 3, 2023, the Asia Pacific Loan Market Association (“APLMA”), the Loan Market Association (“LMA”) and the Loan Syndications and Trading Association (“LSTA”) announced the joint publication of two new ESG guidance documents to support the development of green, social and sustainability-linked loans. The first of these documents entitled “Guidance for Green, Social, and Sustainability-Linked Loans External Reviews“ is intended to provide best practice guidance on the professional and ethical standards for the external review process, which is recommended in certain circumstances by the Green Loan Principles, the Social Loan Principles or the Sustainability-Linked Loan Principles, in connection with entering into green, social, or sustainability-linked loans respectively. The second guidance document entitled “Guidance on Social Loan Principles“ is designed to sit alongside the Social Loan Principles and is intended to provide greater clarity for market participants with regards to the requirements of the Social Loan Principles.
United Kingdom
1. UK government publishes an updated green finance strategy and a strategic framework for international climate and nature action
  On March 30, 2023, the UK government published: (i) its revised green finance strategy (the “Strategy”), which is an update to its earlier 2019 predecessor, and (ii) its 2030 Strategic Framework For International Climate And Nature Action (the “Framework”), which sets out the direction for the UK’s integrated approach to international action on nature and climate up to 2030. Both the Strategy and the Framework are important cogs in a series of mechanisms aimed at furthering the UK’s goal to become the world’s first “net-zero financial centre”.
  
  The Strategy showcases the UK government’s focus on five key objectives: (i) the growth of the UK’s financial services sector, (ii) investment in the green economy, (iii) financial stability to manage risks from climate change and nature loss, (iv) incorporation and adaptation of nature and climate into the government’s green finance policy framework, and (v) alignment of global financial flows with climate and nature objectives.
  
  On the other hand, the Framework sets out three key global goals to ensure that the UK delivers internationally on its climate and nature goals: (i) keeping the 1.5^°C target within reach by halving global emissions, (ii) building resilience to current and future climate impacts, and (iii) halting and reversing global nature loss. It proposes to do so by focussing on six local objectives: (i) a transition to clean technologies and sustainable practices, (ii) building resilience and adapting to climate impacts, (iii) increasing protection, conservation and restoration of nature, (iv) the strengthening of international agreements and cooperation to accelerate the delivery of climate and nature commitments, (v) alignment of global financial flows with a net zero future, and (vi) shifting trade and investment rules and patters to support the transition to a climate and nature positive future.
2. UK Treasury publishes a consultation paper on a potential regime for ESG ratings providers
  On March 30, 2023, the UK Treasury published a consultation paper on a potential regulatory regime for ESG ratings providers. In the consultation paper, the Treasury outlines that the proposed regime would broadly seek to establish a framework whereby any assessment (excluding raw ESG data collection) regarding one or more ESG factors, whether or not it is labelled as such, provided to a UK user in relation to a number of specified investments, would be deemed to be a restricted activity in the UK. Consequently, such restricted activity could only be carried out if the relevant person (individual or corporate) is either authorised by the appropriate regulator or exempt from the authorisation requirement. The consultation paper itself seeks market participants’ views on a range of issues, such as whether there should be fewer requirements for smaller providers and the scope of the regulatory regime. The consultation will close on 30 June 2023.
3. FCA outlines areas for improvement for ESG benchmarks
  On March 20, 2023, the UK’s Financial Conduct Authority (“FCA”) announced that it had completed a preliminary review on ESG benchmarks and reported that the overall quality of ESG-related disclosures made by benchmark administrators was poor. At the same time, the FCA announced that it had sent a further letter to benchmark administrators outlining the key issues it had identified, which included: (i) lack of sufficient detail on the relevant ESG factors considered in benchmark methodologies, (ii) lack of accessibility and clarity of the underlying methodologies for ESG data and rating products, and (iii) ESG benchmark administrators not fully implementing all ESG disclosure requirements.
4. UK Treasury Committee raises concerns on consumer cost of the FCA’s proposed ESG designation criteria and the FCA publishes update on its proposals
  Following the UK’s Financial Conduct Authority’s (“FCA”) a consultation paper in October 2022 proposing new criteria that a UK investment fund would need to meet to describe itself as “sustainable” (or similar), on March 9, 2023 the Treasury Committee raised concerns with the FCA that consumers who have invested in investment funds guilty of greenwashing may have to pay to move their investments into other ‘sustainable’ funds. As a result, the Treasury Committee has called for the FCA to conduct a more detailed cost-benefit analysis of its proposals and provide an assessment of the risks to both consumers and the funds industry. The FCA subsequently published an update on its proposals on March 29, 2023, confirming that the regime would be aimed primarily at protecting consumers, that there will be flexibility as to the labelling restrictions, and that it will seek international coherence with other regimes. The FCA’s full Policy Statement on the topic is expected to be published in Q3 of 2023.
Europe
1. EU Commission proposes reforms of the EU electricity market design to boost renewables
  On March 14, 2023, the European Commission announced a proposal for a European Union (“EU”) Regulation to reform the EU’s electricity market which envisages revisions to several pieces of key EU electricity legislation, notably the Electricity Regulation, the Electricity Directive, and the REMIT Regulation. The key proposals include the introduction of: (i) measures to incentivise more stable longer term contracts with non-fossil power production, (ii) more clean flexible solutions to compete with gas, such as demand response and storage, and (iii) a wider choice of consumer contracts and clearer information about them to allow consumers to lock in secure, long-term prices to avoid excessive risks and volatility (while retaining the flexibility for consumers to enter into dynamic pricing contracts to take advantage of price variability to use electricity when it is cheaper).
2. EU Commission proposes the Net Zero Industry Act
  On March 16, 2023, the European Commission proposed the Net Zero Industry Act, which aims to simplify the regulatory framework for the manufacturing of technologies (or key components of technologies) which are key to achieve climate neutrality. The Act supports in particular eight strategic net zero technologies: (i) solar photovoltaic and solar thermal technologies, (ii) onshore wind and offshore renewable energy, (iii) batteries and storage, (iv) heat pumps and geothermal energy, (v) electrolysers and fuel cells, (vi) biogas/biomethane, (vii) carbon capture and storage, and (viii) grid technologies (which also include electric vehicles’ smart and fast charging). Other net zero technologies are also supported by the measures in the proposed Act, to a different degree, including sustainable alternative fuels technologies, advanced technologies to produce energy from nuclear processes with minimal waste from the fuel cycle, small modular reactors and related best-in-class fuels. The proposed Act now needs to be discussed and agreed by the European Parliament and the Council of the European Union before its adoption and entry into force.
3. EU Commission proposes a directive on “green claims”
  The European Commission proposed the Green Claims Directive on March 22, 2023, which would have a significant impact on businesses making “green claims” for their products in the European Union. A “green claim” under the directive may include any message or representation in any form that states or implies a positive or no environmental impact for a product, service, or organisation. The directive, among others, provides for strict rules for evidence supporting any such green claims made by companies, mandates third-party verification for green claims, and requires businesses to provide consumers with information on such claims, either in a physical form or via weblink or QR code.
4. European Parliament and European Council reach a deal on cleaner maritime fuels
  On March 23, 2023, the European Parliament and the European Council reached a provisional agreement to establish a fuel standard for ships to steer the European Union (“EU”) maritime sector towards the uptake of renewable and low-carbon fuels and decarbonisation. This agreement is part of the EU’s “Fit for 55” target of reducing net greenhouse gas emissions by at least 55% by 2030. The proposed legislation requires that the greenhouse gas intensity of fuels is lowered over time (below the 2020 levels of 91.16 grams of CO2 per MJ), initially by 2% as of 2025, increasing incrementally and reaching up to 80% reduction as of 2050.
United States
1. Biden vetoes anti-ESG investment legislation
  The president of the United States Joe Biden issued the first veto of his presidency on March 20, 2023, rejecting legislation that sought to void the Department of Labor’s rule allowing fiduciaries to consider ESG factors when choosing retirement investments. This ESG legislation, which took effect on January 30, 2023, was finalised in November of last year, following an executive order signed by President Biden in May 2021 that directed federal agencies to consider policies to protect against the threats of climate-related financial risk. The rule has been subject to significant debate, with opponents arguing that it will hurt retirement savings but the Department of Labor has emphasised that the rule permits, but does not mandate, fiduciaries to consider these factors.
2. West Virginia House of Delegates passes bill targeting ESG shareholder votes
  On March 28, 2023, the governor of West Virginia, Jim Justice, signed legislation that targets shareholder votes (on behalf of the state’s investment boards) that factor in ESG principles. The West Virginia House Bill 2862 seeks to designate “environmental, social, corporate governance, or other similarly oriented considerations” as factors that should not be considered in shareholder votes cast by the state’s Investment Management Board or the fund managers it entrusts with casting such votes, unless such ESG factors directly and materially affect the financial risk or financial returns of the relevant investments. This is expected to impact decisions on investments of over USD $4 billion as the West Virginia Investment Management Board is tasked with investing assets for the retirement systems of deputy sheriffs, emergency management services, judges, municipal police officers, firefighters, public employees, state police officers and teachers within the state.
3. Proxy Preview publishes 2023 report on ESG shareholder proposals
  On March 7, 2023, As You Sow, the Sustainable Investments Institute, and Proxy Impact, published the Proxy Preview 2023 report, containing information on hundreds of shareholder proposals, including environmental, corporate political spending, human rights, diversity, sustainable governance issues and others. Key takeaways from the report regarding 2023 developments are: (i) a continued increase in climate change shareholder proposals, and (ii) a significant expansion of shareholder proposals on reproductive health, in response to the United States Supreme Court’s decision from June 2022 that is prompting a wave of restrictions across the United States. Proxy Preview also reports a surge in proposals pressing companies to commit (or re-commit) to international standards that protect the right to organise unions, notes that corporate political influence proposals are evenly split among lobbying, election spending and values congruency, and predicts (based on early indications) that anti-ESG resolutions, which increased in numbers last year, will expand further.
4. COSO releases new supplemental guidance on internal control over sustainability reporting
  On March 30, 2023, the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) released supplemental guidance for organisations on improving internal control over sustainability reporting (“ICSR”). The supplemental guidance uses the globally recognised COSO Internal Control Integrated Framework as its basis and includes the following notable aspects: (i) references to the role of the internal audit function in sustainability reporting in the scope of the guidance, reflecting their integral part of ICSR, (ii) key themes to consider as organisations continue their journeys toward establishing and maintaining an effective system of internal control over financial and sustainable business information, and (iii) insights from companies with a particular ICSR focus to help more firmly establish ICSR practice within the internal audit profession.
APAC
1. Japan announces timeline for introducing sustainability disclosure standards
  Japan announced on March 2, 2023 that it plans to introduce its own sustainability disclosure standards based on the International Sustainability Standards Board (“ISSB”) framework ahead of the 2025-2026 financial year. The timeline for this was announced following a meeting between the ISSB and the Sustainability Standards Board of Japan and includes a proposed initial draft of the standards to be tabled by March 31, 2024 and final form standards to be issued by March 31, 2025. It is expected that the standards will be voluntary initially, with mandatory requirements to follow at a later date (which is yet to be decided).
2. Malaysia’s stock exchange plans to introduce a sustainability reporting platform in April
  Bursa Malaysia announced on March 22, 2023 that it is set to launch a sustainability reporting platform in April, in conjunction with the London Stock Exchange. The platform is expected to serve as a repository where both listed entities and small-to-medium enterprises can calculate their supply chain carbon emission impact and disclose common ESG data in accordance with established global standards, such as those of the Task Force on Climate-Related Financial Disclosures. The announcement follows last year’s memorandum of understanding between Bursa Malaysia and the London Stock Exchange, which seeks to improve collaboration between the two exchanges, in particular in relation to ESG educational initiatives, implementation of supply chain finance and corporate ESG reporting solutions.
3. South Korea reduces 2030 emission reduction targets for industrial sector
  On March 21, 2023, the South Korean Presidential Commission on Carbon Neutrality and Green Growth announced via a press release from the Korean Ministry of Environment that it has decided to cut South Korea’s 2030 targets for reducing gas emissions (compared to its 2018 levels) in the industrial sector by 3.1% from the 14.5% set in late 2021 to 11.4%. The announcement also notes that South Korea is committed to maintaining its national goal of cutting emissions by 40% of 2018 levels and the gap created by this reduction is expected to be filled by switching more energy sources to renewables and making more reductions overseas. The Commission has backed its proposal noting that it has been necessitated “in light of realistic domestic conditions including raw material supply and technology prospects.”

Please let us know if there are topics that you would be interested in seeing covered in future editions of the monthly update.

Warmest regards,

Susy Bullock
Elizabeth Ising
Perlette M. Jura
Ronald Kirk
Michael K. Murphy
Selina S. Sagayam

Chairs, Environmental, Social and Governance Practice Group, Gibson Dunn & Crutcher LLP

The following Gibson Dunn lawyers prepared this client update: Selina Sagayam, Elizabeth Ising, David Woodcock, Patricia Tan Openshaw, Sarah Leiper-Jennings, and Grace Chong.

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

Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Perlette M. Jura – Los Angeles (+1 213-229-7121, pjura@gibsondunn.com)
Ronald Kirk – Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, mmurphy@gibsondunn.com)
Patricia Tan Openshaw – Hong Kong (+852 2214-3868, popenshaw@gibsondunn.com)
Selina S. Sagayam – London (+44 (0) 20 7071 4263, ssagayam@gibsondunn.com)
David Woodcock – Dallas (+1 214-698-3211, dwoodcock@gibsondunn.com)

On March 27, 2023, the U.S. Department of Justice and U.S. Federal Trade Commission (together, the “Agencies”) hosted international and state antitrust enforcers for panel discussions on current and emerging enforcement trends. Agency leaders Assistant Attorney General (“AAG”) Jonathan Kanter and FTC Chair Lina M. Khan used the Summit to showcase their efforts to update the antitrust laws and expand their enforcement efforts in the “modern economy.”

Three key themes emerged from the Summit:

The Agencies believe case law based on economic theory developed in the 1970s must be updated, especially to account for application to modern economic structures.
To set new precedent, the Agencies must aggressively challenge and litigate cases, even if they lose at trial.
As part of their broader effort to expand enforcement, the Agencies are attempting to reinvigorate seldom-used enforcement tools, such as the Robinson-Patman Act and criminal enforcement of Sherman Act Section 2.

The Agencies are expected to bring merger challenges and conduct cases under novel theories of harm to develop new precedent.

During the Summit, federal, state, and international enforcers discussed their efforts to ensure competition in the “new” economy (which they described as being media and technology markets characterized by innovation, network effects, and so-called platform-based business models). Enforcers specifically celebrated the formation of technology and AI task forces, updated enforcement guidelines to reflect novel theories of harm, and recent enforcement actions against technology firms they consider dominant.

During these discussions, Agency leadership announced their intent to push courts to update judicial precedent by aggressively bringing enforcement actions under novel or seldom-used theories of harm. Chair Khan and AAG Kanter expressed concern that “stale” antitrust doctrine has been under-deterring anticompetitive conduct in the “new” and “old” economies alike and announced that aggressive test cases—even if they result in trial losses—were needed. Throughout panel presentations, Agency leadership specifically committed to bringing test cases challenging mergers and alleged monopolistic conduct.

Mergers and Acquisitions: John Newman, Deputy Director of the FTC’s Bureau of Competition, indicated that the FTC would continue to aggressively challenge acquisitions in what it views to be nascent digital markets. Newman specifically cited the FTC’s challenge to Meta’s acquisition of Within as a “success” in that the FTC persuaded the court that its market definition and theory of harm were valid, despite ultimately losing on the merits.

Monopolization: Deputy Assistant Attorney General Hetal Doshi indicated that DOJ would continue to criminally prosecute alleged monopolization and agreements to allocate labor markets. Doshi announced that DOJ was working to establish “indicia of criminality” that would elevate monopolization from a civil to a criminal offense and that DOJ would bring test cases to develop these indicia as appropriate. Chair Khan announced the FTC was focused on prosecuting “incumbent [technology firms who] resort to anticompetitive tactics to protect their moat and protect their dominance.”

The Agencies are expected to attempt to reinvigorate enforcement efforts under seldomly used statutes.

Agency leadership also recommitted to using every “tool in the toolbox” to protect competition, including the Robinson-Patman Act and Clayton Act Sections 3 and 8. Chair Khan stated that a key pillar of her leadership approach was the continued full “activation” of all antitrust statutes at her disposal. Throughout the panel, the Agencies specifically identified three statutes they intend to enforce more aggressively.

Robinson-Patman Act: The Robinson-Patman Act (RPA), which prohibits price discrimination, was enacted to protect small businesses by preventing larger companies from using their purchasing power to obtain better prices. However, it has been seldom enforced since 1970 due to concerns it harmed consumers by punishing efficient firms. Current Democratic FTC leadership has repeatedly declared the non-enforcement of the RPA was an error, and the FTC has recently launched RPA investigations into multiple industries. Chair Khan also indicated that the FTC’s next challenge under the RPA would be filed in “short order.”

Clayton Act Section 3: Section 3 of the Clayton Act prohibits anticompetitive exclusive dealing arrangements, tying arrangements, and requirements contracts. Chair Khan committed to using Section 3 and Section 5 of the FTC Act to prosecute unfair selling and buying practices and highlighted the FTC’s complaint against two companies (alleging the firms violated Section 3 by paying distributors to block generic pesticide products) as a framework for future enforcement actions.

Clayton Act Section 8: Section 8 of the Clayton Act prohibits interlocking directorates, where a person simultaneously serves as a director or officer of two competing corporations. The law is designed to prevent conflicts of interest and promote fair competition by ensuring that competing companies have independent leadership. AAG Kanter highlighted four recent enforcement actions under Section 8 and committed to enforcing the statute more broadly, especially against private equity firms.

* * *

As the Agencies expand enforcement and bring novel challenges, companies and individuals should be cognizant that district and circuit courts ultimately determine whether conduct violates the antitrust laws and tend to favor adherence to precedent instead of embracing novel and untested theories of liability. As a recent string of Agency defeats at trial demonstrate, parties may ultimately succeed in vindicating their conduct through litigation in federal court.

The following Gibson Dunn lawyers prepared this client alert: Rachel Brass, Jay Srinivasan, Stephen Weissman, Jamie France, Caroline Ziser Smith, Veronica Altabef, Hadhy Ayaz, Logan Billman, Tiffany Mickel*, and Nick Rawlinson.

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

Antitrust and Competition Group:
Jamie E. France – Washington, D.C. (+1 202-955-8218, jfrance@gibsondunn.com)
Jay P. Srinivasan – Los Angeles (+1 213-229-7296, jsrinivasan@gibsondunn.com)
Rachel S. Brass – Co-Chair, San Francisco (+1 415-393-8293, rbrass@gibsondunn.com)
Stephen Weissman – Co-Chair, Washington, D.C. (+1 202-955-8678, sweissman@gibsondunn.com)

Mergers and Acquisitions Group:
Robert B. Little – Co-Chair, Dallas (+1 214-698-3260, rlittle@gibsondunn.com)
Saee Muzumdar – Co-Chair, New York (+1 212-351-3966, smuzumdar@gibsondunn.com)

*Tiffany Mickel is an associate in the Washington, D.C. office admitted only in Maryland and practicing under supervision of members of the District of Columbia Bar under D.C. App. R. 49.