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).

---

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:

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:

1. 100,000 Iowa consumers;[1] or
2. 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.

___________________________

[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.

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)

© 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.

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.

1. 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]

2. 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.

3. 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.

4. 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]

5. 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]

6. 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:

1. 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]

2. 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]

3. 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]

4. 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.

5. 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.

6. 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.

__________________________

[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)

© 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 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:

1. 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]
2. 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
3. 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)

© 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.

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

Reproduced with permission. Published April 10, 2023. Copyright 2023 Bloomberg Industry Group (800-372-1033), http://www.bloombergindustry.com.

---

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)

© 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.

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

1. 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.]

2. 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.

3. 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]

4. 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

1. 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]

2. 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.]

3. 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.]

4. 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.

5. 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]

6. 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]

7. 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]

8. 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

1. 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]

2. 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

1. 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.

2. 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

1. 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]

2. 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]

3. 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.

4. 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]

5. 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.

6. 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.

7. 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

1. 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]

2. 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.

3. 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

1. 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]

2. 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]

3. 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]

4. 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.

© 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.

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.

Read More

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.

© 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 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)

© 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 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:

1. 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;
2. 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;
3. Share information regarding threats and risks associated with such tools and technologies with other Subscribing States on an ongoing basis;
4. 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;
5. 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;
6. 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.

_________________________

[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.

© 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.

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.

1. 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.

2. 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.

3. 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.

4. 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.

5. 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)

© 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 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.

© 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.

Over the last few years, market conditions have changed so dramatically that today, no matter its products or services, every company is also in the environmental business. Prompted by the real-world impacts of climate change, many consumers now demand environmental action from corporations and prefer to buy products marketed as environmentally friendly. Many companies therefore market their products as “net-zero” or “carbon neutral”—and make pledges to be, as a business, “net-zero” by a certain date. In support of these pledges, companies often buy carbon credits from voluntary carbon markets to offset or mitigate their carbon emissions voluntarily.

Voluntary carbon markets present opportunity, but also create financial, regulatory, and litigation risks. Because the voluntary markets are often fragmented, suffer from a lack of transparency and, above all, are not subject to any statutory common standards, there is a lack of trust in the credits issued under these system, which also limits the tradability of the credits.

This quarterly newsletter aggregates the knowledge and experience of Gibson Dunn attorneys around the globe as we help our clients across all sectors navigate the ever-changing landscape of voluntary carbon markets.

* * * *

This Q1 2023 edition of the newsletter explores the question companies must ask when they buy credits on the voluntary carbon market: can we trust that we are getting what we paid for? A recent survey of more than 500 corporate sustainability officers around the world found that 40% of participants did not use carbon offsets because they did trust them, while many companies that do buy carbon credits seek trustworthy credits by only buying from government or certified providers, working with rating agencies, or engaging in their own due diligence.

Read More

---

The following Gibson Dunn lawyers assisted in the preparation of this alert: Susy Bullock, Abbey Hudson, Brad Roach, Lena Sandberg, Jeffrey Steiner, Jonathan Cockfield, Arthur Halliday, Yannis Ioannidis, Alexandra Jones, Mark Tomaier, and Alwyn Chan.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding 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 Environmental, Social and Governance (ESG), Environmental Litigation and Mass Tort, Global Financial Regulatory, or Energy practice groups, or the following authors:

Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)

Environmental Litigation and Mass Tort Group:
Abbey Hudson – Los Angeles (+1 213-229-7954, ahudson@gibsondunn.com)

Global Financial Regulatory Group:
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)

Energy, Regulation and Litigation Group:
Lena Sandberg – Brussels (+32 2 554 72 60, lsandberg@gibsondunn.com)

Oil and Gas Group:
Brad Roach – Singapore (+65 6507 3685, broach@gibsondunn.com)

© 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.

This edition of Gibson Dunn’s Federal Circuit Update summarizes the current status of several petitions pending before the Supreme Court.  We also discuss recent Federal Circuit decisions concerning written description, motivation to combine, and requirements for stipulated judgments of non-infringement based on a district court’s claim construction.

Federal Circuit News

Supreme Court:

On March 27, 2023, the United States Supreme Court heard oral argument in Amgen Inc. v. Sanofi (U.S. No. 21-757) on the issue of enablement under 35 U.S.C. § 112.  During argument, the Court expressed concern with the breadth of Amgen’s genus claims, which potentially cover millions of antibodies, and repeatedly asked petitioner to clarify what Amgen actually invented.  The Court also observed that there appeared to be general agreement between the parties on the enablement legal standard (that a patent must enable a skilled artisan to practice the full scope of the claims without undue experimentation) and questioned what was left for the Court to do.  A more detailed summary of the argument may be found on SCOTUSblog here.

Noteworthy Petitions for a Writ of Certiorari:

There are several new potentially impactful petitions pending before the Supreme Court:

• Thaler v. Vidal (US No. 22-919): “Does the Patent Act categorically restrict the statutory term ‘inventor’ to human beings alone?”  The government waived its right to file a response.

• Nike, Inc. v. Adidas AG et al. (US No. 22-927): “Whether, in inter partes review, the Patent Trial and Appeal Board may raise sua sponte a new ground of unpatentability—including prior art that the petitioner neither cited nor relied upon—and whether the Board may rely on that new ground to reject a patent-holder’s substitute claim as unpatentable.”  Adidas waived its right to file a response.

• Avery Dennison Corp. v. ADASA, Inc. (US No. 22-822): “The question presented is whether [a] claim, by subdividing a serial number into ‘most significant bits’ that are assigned such that they remain identical across RFID tags, constitutes patent-eligible subject matter under 35 U.S.C. § 101.”  After ADASA waived its right to file a response, a response was requested by the Court and is due May 2, 2023.

• Ingenio, Inc. v. Click-to-Call Technologies, LP (US No. 22-873): “1. Whether 35 U.S.C. § 315(e)’s IPR estoppel provision applies only to claims addressed in the final written decision, even if other claims were or could have been raised in the petition.   Whether the Federal Circuit erroneously extended IPR estoppel under 35 U.S.C. § 315(e) to all grounds that reasonably could have been raised in the petition filed before an inter partes review is instituted, even though the text of the statute applies estoppel only to grounds that “reasonably could have [been] raised during that inter partes review.”  After Click-to-Call waived its right to file a response, a response was requested by the Court and is due May 26, 2023.

As we summarized in our January 2023 and February 2023 updates, the Court is considering petitions in Novartis Pharmaceuticals Corp. v. HEC Pharm Co., Ltd. (US No. 22-671) and Arthrex, Inc. v. Smith & Nephew, Inc. (US No. 22-639).  The response in Arthrex is due April 12, 2023.  Novartis will be considered during the Court’s April 14, 2023 conference.  Gibson Dunn partners Thomas G. Hungar, Jacob T. Spencer, Jane M. Love, and Robert Trenchard are counsel for Novartis.  The petitions in Interactive Wearables, LLC v. Polar Electro Oy (US No. 21-1281) and Tropp v. Travel Sentry, Inc. (US No. 22-22) are still pending the views of the Solicitor General.

Upcoming Oral Argument Calendar

The list of upcoming arguments at the Federal Circuit is available on the court’s website.

Key Case Summaries (March 2023)

Regents of the University of Minnesota v. Gilead Sciences, Inc., No. 21-2168 (Fed. Cir. Mar. 6, 2023):  The Patent Trial and Appeal Board (“Board”) determined that UM’s patent directed to phosphoramidate prodrugs of nucleoside derivatives (used to prevent viruses from reproducing or cancerous tumors from growing) was invalid as anticipated by one of Gilead’s patents.  The Board concluded that Gilead’s patent was prior art to UM’s patent, because UM’s patent could not claim priority to its parent applications, which failed to provide sufficient written description support for the challenged claims.

The Federal Circuit (Lourie, J., joined by Dyk and Stoll, JJ.) affirmed.  The Court explained that written description of a broad genus of chemical compounds requires description not only of the outer limits of the genus but also of either a representative number of members of the genus or structural features common to the members of the genus, both with enough precision for a person of skill in the art to visualize or recognize the members of the genus.  The Court reasoned that the various claims in the parent applications created “a maze-like path, each step providing multiple alternative paths” that lead to so many varying options that it is “unclear how many compounds actually fall within the described genera and subgenera.”  The Court therefore agreed with the Board that UM’s parent applications failed to provide adequate written description support for the challenged claims, and thus, Gilead’s patent was anticipatory prior art.

Intel Corp. v. PACT XPP Schweiz AG, No. 22-1037 (Fed. Cir. Mar. 13, 2023):  The Board determined the challenged claim was not unpatentable as obvious over two prior art references (Kabemoto and Bauman).   The Board concluded that prior art did not disclose the recited segment-to-segment limitation in the claim, and that one skilled in the art would not be motivated to combine the two references.

The Federal Circuit (Prost, J., joined by Newman and Hughes, JJ.) reversed and remanded.  The Court concluded that Bauman plainly disclosed the segment-to-segment limitation.  The Court also reversed the Board’s rejection of Intel’s motivation to combine argument, which was that when a known technique has been used to improve one device, a person of ordinary skill in the art would recognize that it would improve similar devices in the same way.  Here, Bauman disclosed that a secondary cache could be used to improve cache coherency, and a person of ordinary skill in the art would have recognized that such a cache would improve similar multiprocessor systems, like the one in Kabemoto, by addressing the same cache coherency problem.

AlterWAN, Inc. v. Amazon.com, Inc., No. 22-1349 (Fed. Cir. Mar. 13, 2023):  After the district court construed two disputed terms, the parties stipulated to judgment of non-infringement so that AlterWAN could appeal the constructions.

The Federal Circuit (Dyk, J., joined by Lourie and Stoll, JJ.) vacated the judgment and remanded to the district court for further proceedings on the basis that the stipulation failed to identify which claims remained at issue, and failed to specify whether the construction of both terms must be correct for Amazon to prevail.  The Court explained that a stipulated judgment of non-infringement based on a district court’s claim construction must specify which claims remain at issue and which constructions affect the issue of infringement.

---

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Federal Circuit.  Please contact the Gibson Dunn lawyer with whom you usually work or the authors of this update:

Blaine H. Evanson – Orange County (+1 949-451-3805, bevanson@gibsondunn.com)
Audrey Yang – Dallas (+1 214-698-3215, ayang@gibsondunn.com)

Please also feel free to contact any of the following practice group co-chairs or any member of the firm’s Appellate and Constitutional Law or Intellectual Property practice groups:

Appellate and Constitutional Law Group:
Thomas H. Dupree Jr. – Washington, D.C. (+1 202-955-8547, tdupree@gibsondunn.com)
Allyson N. Ho – Dallas (+1 214-698-3233, aho@gibsondunn.com)
Julian W. Poon – Los Angeles (+ 213-229-7758, jpoon@gibsondunn.com)

Intellectual Property Group:
Kate Dominguez – New York (+1 212-351-2338, kdominguez@gibsondunn.com)
Y. Ernest Hsin – San Francisco (+1 415-393-8224, ehsin@gibsondunn.com)
Josh Krevitt – New York (+1 212-351-4000, jkrevitt@gibsondunn.com)
Jane M. Love, Ph.D. – New York (+1 212-351-3922, jlove@gibsondunn.com)

© 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.

The Biden Administration has sparked debate over the safety and efficiency of gas stoves. In January, the Consumer Product Safety Commission (CPSC) began exploring the safety of gas stoves based on recent studies related to alleged health effects from indoor air pollutant emissions.[1] Then, in February, the Department of Energy proposed new efficiency standards that would require removing most existing gas stove models from the market.[2] Both agencies are now requesting public input. Members of Congress, state governments, local municipalities, and private plaintiffs also are advancing efforts to investigate and limit the use of “combustible appliances,” including gas stoves.

With gas stoves in approximately 38 percent of American homes, any regulatory restriction on them could have a significant market effect on stove manufacturers, retailers, and the fossil fuel industry. This alert reviews the current status of federal regulatory action and discusses how related investigations and litigation are developing. Interested stakeholders should consider making submissions to the CPSC and Department of Energy, as well as preparing for potential investigations and litigation.

CPSC Actions

In an October meeting, the CPSC unanimously adopted an amendment to obtain public input on potential gas stove hazards.[3] That action stemmed from the CPSC’s focus on studies related to the potential health effects of gas stoves, including one 2022 study that attributed almost 13 percent of childhood asthma in the United States to gas stove use.[4] Under the amendment, CPSC staff was directed to submit “to the Commission a Request for Information (RFI) to seek public input on hazards associated with gas stoves and proposed solutions to those hazards.”

Following adoption of the amendment to issue an RFI, Commissioner Richard L. Trumka Jr. said in an interview that “[a]ny option is on the table” with respect to addressing potential harms from gas stoves. “Products that can’t be made safe can be banned,” he stated.[5] That statement drew a fiery rebuke from certain lawmakers, businesses, and consumers, leading the White House to come out against a gas stove ban,[6] and CPSC Chairman Alexander Hoehn-Saric to remark on January 11, 2023, that he is “not looking to ban gas stoves” and that the CPSC “has no proceeding to do so.”[7]

The RFI ordered in October, however, is still proceeding. Indeed, the CPSC published the RFI on March 7, and the agency requires that all public comments be submitted by May 8, 2023.[8] The RFI “seeks input from the public on chronic chemical hazards from gas ranges” and asks “consumers, manufacturers, government agencies, non-governmental organizations, and researchers” to provide information related to:

• “the scope and scale of potential chronic chemical hazards, exposures, and risks associated with gas range use”;
• “data sources and approaches CPSC should consider when completing an evaluation of chronic chemical hazards, exposures, and risks related to gas range use”; and,
• “potential tradeoffs between different hazards (e.g., chemical, fire, mechanical, or other) associated with the use of gas ranges, electric ranges (including older and newer models), and other large cooking appliances.”[9]

In a statement accompanying the announcement of the RFI, Commissioner Trumka declared it “an important milestone on the road to protecting consumers from potential hazards in their homes—the emissions from gas stoves.”[10] He also expressed an expectation that the “RFI will set records for consumer and scientific participation . . . because right now, more people are aware than ever before of the potential hazards in this space.”[11]

Actions following the CPSC’s issuance of past RFIs suggest that its issuance of the RFI may lead to efforts to restrict gas stoves and other combustible appliances. For example, the CPSC developed stringent carbon monoxide sensor standards in 2015[13] based on findings from a 2014 RFI that requested information on detecting carbon monoxide.[12]  A 2016 CPSC RFI on crib bumpers[14] likewise resulted in a 2020 notice of proposed rulemaking[15] that then was superseded by a 2021 law[16] banning the products.[17]

Given this history, engagement with the RFI is critical for stakeholders seeking to inform any further action that the CPSC may take related to gas stoves. Interested stakeholders can submit information to the CPSC’s RFI by May 8, 2023, including appropriate scientific information, data sources, and analysis regarding potential and comparative risks and benefits of gas stoves and related products. If the RFI results in agency rulemaking, interested stakeholders should submit comments.

Department of Energy Rulemaking

The Department of Energy proposed a rule on February 1, 2023 that would set maximum energy-consumption standards for gas and electric stoves.[18] If adopted, the proposed rule would apply to product classes, including gas stoves, “manufactured in, or imported into, the United States starting on the date three years after the publication of any final rule for this rulemaking.” While not outright banning gas stoves, the proposed rule would effectively ban most models on the market today, as most stoves currently sold could not meet the proposed energy consumption standard. That, in turn, would require redesigning gas stoves—or moving away from gas stoves altogether. Indeed, the Department estimates in the proposed rule that the impact on stove manufacturers would be approximately −$154.8 million to −$150.4 million between 2022 and 2056, with total conversion costs of $183.4 million.[19]

Various individuals and entities have expressed skepticism that the Department’s proposed rule meets the requirements of its authorizing statutes, including that the energy-consumption standard in the proposed rule be “technologically feasible and economically justified and . . . result in a significant conservation of energy.”[20]

The Department requires all public comments to be submitted by April 17, 2023. Issues for potential comment include the scope of the Department’s regulatory authority, the information on which the Department relied in formulating the proposed rule, and the likely effect of the proposed rule on interested stakeholders.

Congressional Actions

Regardless of what final actions federal agencies eventually may take, it already is clear that Congress will engage in the debate over gas stoves’ safety and efficiency.

In December 2022, Senator Cory Booker and Representative Donald Beyer Jr., along with other Congressional signees, wrote a letter to CPSC Chair Hoehn-Saric encouraging the CPSC to “take action to address . . . the risks posed to consumers from indoor air pollution generated by gas stoves.”[21] Similarly, Representative Raja Krishnamoorthi, Chair of the House Subcommittee on Economic and Consumer Policy in the 117th Congress, had requested information from the CPSC about its failure to warn consumers or establish safety standards for indoor air pollution from gas stoves, despite having knowledge of such risks as early as 1986. In the 118th Congress, it is possible that Senate Committees like the Health, Education, Labor and Pensions (HELP) Committee or the Permanent Subcommittee on Investigations might continue to encourage the CPSC to act.

By contrast, other congresspersons have come out against prohibitions on gas stoves.[22] In February 2023, Senate Energy Committee Chairman Joe Manchin and Senator Ted Cruz introduced legislation that would prohibit the use of federal funds by the CPSC “to regulate existing or new gas stoves as a banned hazardous product.”[23] The CPSC would also be prohibited under the proposed law from spending federal funds to impose or enforce product safety standards that would prohibit or substantially increase the price of gas stoves. Representative Debbie Lesko likewise has proposed the “Save Our Gas Stoves Act,” which would prevent finalizing, implementing, or enforcing Department of Energy rulemaking related to gas stoves.[24]

State and Local Actions

Efforts at the federal level may continue to drive action at state and local levels of government. While twenty states have passed laws prohibiting cities from banning natural gas,[25] New York is now poised to ban gas stoves and other fossil-fuel hookups in new buildings as part of an all-electric mandate to help the state meet targets for greenhouse gas reduction.[26] Governor Kathy Hochul proposed the measure as part of the state’s budget, and both chambers of the state assembly have supported it. The proposed measure would phase in a ban with various exemptions and likely take effect sometime between 2025 and 2028.[27]

The proposed new-construction restriction in New York would resemble those enacted by dozens of U.S. municipalities, including New York City, and cities like Berkeley, California, which have already banned gas stoves in new buildings.[28]

Consistent with trends following safety concerns raised about other consumer products, State Attorneys General also may initiate investigations and lawsuits based on potential violations of state law. By way of example, the Washington D.C. Attorney General’s Office filed a lawsuit against a baby food manufacturer in 2021 based on alleged misrepresentations of health and safety standards.[29] New York Attorney General Letitia James also requested information from several baby food manufacturers and took public action against their interests.[31] State Attorneys General may similarly investigate and sue gas stove manufacturers or natural gas providers under various consumer protection laws.

Potential Product Liability Litigation

Just as consumers individually and as classes filed actions alleging injury from products like baby foods[32] and talcum powder,[33] users of gas stoves already have begun to initiate litigation on the basis of alleged concerns raised about gas stove safety. These claims emphasize alleged asthma or other health conditions due to indoor health pollutants.

For example, in one California class action, consumer plaintiffs allege that a manufacturer breached warranties and violated consumer protection and false advertising laws by selling stoves allegedly associated with harmful emissions.[34] Specifically, the plaintiffs claim that, had they known about the risks, they would have paid less for the gas stoves they purchased or not purchased the gas stoves at all. The plaintiffs further allege that the manufacturer chose not to make the gas stoves safer despite having the ability to do so.

It is essential that entities potentially subject to such litigation take steps to prepare for it and address potentially disparate lawsuits with a coordinated approach. Preparatory steps include taking measures to preserve privilege and considering how to manage the potential proliferation of lawsuits in multiple judicial districts.

Conclusion

The debate over the safety of gas stoves is likely only to heat up over the coming year. As both the CPSC and the Department of Energy decide how to proceed with rulemaking or enforcement actions, Congress may investigate and consumer product-liability litigation will commence. Actions at the state and local level also are assured, with State Attorneys General likely to play a role. Gibson Dunn is well prepared to advise and assist clients in responding to, and engaging with, any of these developments.

___________________________

[1] Ari Natter, The US Consumer Product Safety Commission will move to regulate gas stoves as new research links them to childhood asthma, Bloomberg (Jan. 9, 2023, 7:00 AM ET), available at https://www.bloomberg.com/news/articles/2023-01-09/us-safety-agency-to-consider-ban-on-gas-stoves-amid-health-fears?leadSource=uverify%20wall.

[2] Energy Conservation Program: Energy Conservation Standards for Consumer Conventional Cooking Products, 88 Fed. Reg. 6818 (proposed Feb. 1, 2023).

[3] U.S. Consumer Prod. Safety Comm’n, Minutes Of Commission Meeting, Decisional Matter: Fiscal Year 2023 Operating Plan (Oct. 26, 2022).

[4] Eric D. Lebel, Colin J. Finnegan, Zutao Ouyang, & Robert B. Jackson, Methane and NOx Emissions from Natural Gas Stoves, Cooktops, and Ovens in Residential Homes, 56 Env’t Sci. & Tech. 2529 (2022). See also Am. Pub. Health Assoc’n, Gas Stove Emissions Are a Public Health Concern: Exposure to Indoor Nitrogen Dioxide Increases Risk of Illness in Children, Older Adults, and People with Underlying Health Conditions (2022).

[5] Ari Natter, The US Consumer Product Safety Commission will move to regulate gas stoves as new research links them to childhood asthma, Bloomberg (Jan. 9, 2023, 7:00 AM ET), available at https://www.bloomberg.com/news/articles/2023-01-09/us-safety-agency-to-consider-ban-on-gas-stoves-amid-health-fears?leadSource=uverify%20wall.

[6] Hillary Vaughn & Chris Pandolfo, Biden White House says it does not support gas stove ban, Fox Bus. (Jan. 11, 2023, 1:09 PM ET).

[7] Alex Hoehn-Saric (@HoehnSaricCPSC), Twitter (Jan. 11, 2023, 10:46 AM), https://twitter.com/HoehnSaricCPSC/status/1613200634194415616?cxt=HHwWgMC-icDbnuMsAAAA.

[8] Request for Information on Chronic Hazards Associated With Gas Ranges and Proposed Solutions, 88 Fed. Reg. 14150 (proposed Mar. 7, 2023).

[9] Id.

[10] Press Release, U.S. Consumer Prod. Safety Comm’n Comm’r Rich Trumka Jr., CPSC Approves Request for Information on Gas Stove Hazards and Potential Solutions (Mar. 1, 2013).

[11] Id.

[12] Carbon Monoxide/Combustion Sensor Forum and Request for Information, 79 Fed. Reg. 21442 (proposed Apr. 16, 2014).

[13] See Ronald A. Jordan, U.S. Consumer Prod. Safety Comm’n, Report on the Findings from CPSC’s 2014 Carbon Monoxide/Combustion Sensor Forum and Request for Information (Mar. 2015); Letter from Ronald A. Jordan, Mechanical Engineer, U.S. Consumer Prod. Safety Comm’n, to Lorraine McCourt, Project Manager, CSA Group (Sept. 30, 2015).

[14] Request for Information Regarding Crib Bumpers, 81 Fed. Reg. 7765 (proposed Feb. 16, 2016).

[15] Safety Standard for Crib Bumpers/Liners, 85 Fed. Reg. 18878 (proposed Apr. 3, 2020).

[16] Safety Standard for Crib Bumpers/Liners; Withdrawal, 87 Fed. Reg. 44306 (July 26, 2022).

[17] Safe Sleep for Babies Act of 2021, Pub. L. No. 117-126, 136 Stat. 1208.

[18] Energy Conservation Program: Energy Conservation Standards for Consumer Conventional Cooking Products, 88 Fed. Reg. 6818 (proposed Feb. 1, 2023).

[19] The DOE estimates the impact on manufacturers by measuring the change in industry net present value (“INPV”), defined as “the sum of the discounted cash flows to the industry from the base year through the end of the analysis period (2022-2056).” Id. “Using a real discount rate of 9.1 percent, DOE estimates that the INPV for manufacturers of consumer conventional cooking products in the case without new and amended standards is $1,607 million in 2021 dollars. Under the proposed standards, the change in INPV is estimated to range from -9.6 percent to -9.4 percent, which is approximately −$154.8 million to −$150.4 million.” Id.

[20] 42 U.S.C. § 6295(o).

[21] Letter from Sen. Cory A. Booker, Rep. Donald S. Beyer Jr., et al. to Alex Hoehn-Saric, Chair, Consumer Prod. Safety Comm’n (Dec. 21, 2022).

[22] Ronny Jackson (@RonnyJacksonTX), Twitter (Jan. 20, 2023, 10:52 AM); Press Release, Energy & Commerce Chair Rodgers, Energy & Commerce Chair Rodgers’ Statement on Biden Considering Nationwide Gas Stove Ban (Jan. 11, 2023).

[23] Press Release, Sens. Cruz, Manchin Introduce Bipartisan Bill to Stop the Federal Government from Banning Gas Stoves (Feb. 2, 2023).

[24] To prohibit the Secretary of Energy from finalizing, implementing, or enforcing the proposed rule titled “Energy Conservation Program: Energy Conservation Standards for Consumer Conventional Cooking Products,” and for other purpose, H.R.1640, 118th Cong. (2023).

[25] Alex Brown, Natural Gas Bans Are New Front in Effort to Curb Emissions, Pew (Jan. 6, 2022).

[26] Scott Calvert, New York Poised to Ban Gas Stoves in New Buildings as Part of All-Electric Mandate, The Wall Street Journal (Mar. 26, 2023).

[27] Id.

[28] Id.; Ella Nilsen, Cities tried to cut natural gas from new homes. The GOP and gas lobby preemptively quashed their effort, CNN (Feb. 17, 2022), available at https://www.cnn.com/2022/02/17/politics/natural-gas-ban preemptive-laws-gop-climate/index.html.

[29] Press Release, Office of the Attorney General for the District of Columbia, AG Racine Sues Baby Food Company Beech-Nut for Misleading Parents About the Health & Safety of Its Products (Apr. 21, 2021).

[30] Press Release, Letitia James, Attorney General James Leads Coalition Urging FDA to Accelerate Actions to Protect Children From Toxic Metals in Baby Food (Oct. 21, 2021).

[31] Press Release, Letitia James, Attorney General James Probes Toxic Substances Found in Baby Food Sold in New York (Apr. 29, 2021); see also Press Release, Letitia James, Attorney General James Leads Coalition Urging FDA to Accelerate Actions to Protect Children From Toxic Metals in Baby Food (Oct. 21, 2021).

[32] See, e.g., In re Gerber Prods. Co. Heavy Metals Baby Food Litig., No. 1:21-cv-269 (Oct. 17, 2022 E.D. Va.).

[33] See, e.g., In re Johnson & Johnson Talcum Powder Prods. Mktg., Sales Pracs. & Liab. Litig., 903 F.3d 278, 284 (3d Cir. 2018).

[34] Sherzai v. LG Electronics USA, Inc., No. 2:23-cv-00429-TLN-CKD (Mar. 8, 2023 E.D. Cal.).

---

The following Gibson Dunn lawyers prepared this client alert: Michael Bopp, Gustav Eyler, Stacie Fletcher, Rachel Levick, Eugene Scalia, and Kirsten Bleiweiss*.

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 Administrative Law and Regulatory, Environmental Litigation and Mass Tort, FDA and Health Care, or Public Policy practice groups, or the authors:

FDA and Health Care / White Collar Defense and Investigations Groups:
Gustav W. Eyler – Washington, D.C. (+1 202-955-8610, geyler@gibsondunn.com)

Environmental Litigation and Mass Tort Group:
Stacie B. Fletcher – Washington, D.C. (+1 202-887-3627, sfletcher@gibsondunn.com)
Rachel Levick – Washington, D.C. (+1 202-887-3574, rlevick@gibsondunn.com)

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

*Kirsten Bleiweiss is admitted to practice only in Maryland and is practicing under the supervision of members of the District of Columbia Bar under D.C. App. R. 49.

© 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 3, 2023, the Consumer Protection Branch (CPB) of the U.S. Department of Justice (DOJ) issued two new policies: (1) a Voluntary Self-Disclosure Policy for Business Organizations,[1] and (2) a Monitor Selection Policy.[2]  CPB spearheads DOJ efforts to enforce federal laws protecting American consumers’ “health, safety, economic security, and identity integrity,”[3] including through criminal and civil enforcement of the Federal Food, Drug, and Cosmetic Act (FDCA), the Federal Trade Commission Act, the Consumer Product Safety Act, the Controlled Substances Act, and laws administered by the Department of Transportation, among others.  CPB’s new policies reflect key themes from a speech by Deputy Attorney General Lisa Monaco at the American Bar Association’s National Institute on White Collar Crime,[4] and the policies were released in coordination with that speech.

In addition to clarifying CPB’s protocols and expectations in key areas of criminal corporate enforcement, the policies signal a desire to incentivize self-disclosure directly to CPB and to impose independent monitors more frequently.  Below we provide a summary of the key policy changes and clarifications, along with our observations regarding their potential implications.

Voluntary Self-Disclosure Policy

The Voluntary Self-Disclosure Policy for Business Organizations (Self-Disclosure Policy) announced by CPB aligns with broader DOJ efforts to incentivize companies to voluntarily self-disclose potential criminal conduct, fully cooperate with DOJ investigations, and undertake remediation measures.  The Self-Disclosure Policy is similar to DOJ’s Criminal Division Corporate Enforcement Policy (covered in a previous alert here) and the Corporate Voluntary Self-Disclosure Policy for all U.S. Attorney’s Offices.[5]

The Self-Disclosure Policy applies across CPB’s criminal enforcement efforts to protect consumers’ health, safety, economic security, and identity integrity.  The Policy defines economic security and identity integrity matters as “involving data-privacy violations and fraud schemes affecting large numbers of older adults, immigrants, veterans and servicemembers, or other vulnerable victims.”  As for CPB’s health and safety work, the Policy describes enforcement efforts covering “unlawful conduct related to drugs (including prescription and counterfeit drugs), medical devices, food, dietary supplements, and consumer products and vehicles.”  In this category, the Policy emphasizes CPB’s role in the “prosecution and oversight of all criminal matters arising under the [FDCA],” noting that “U.S. Attorney’s Offices must notify and consult with CPB upon opening any criminal investigation involving a possible violation of the FDCA.”  This statement of CPB’s responsibilities in FDCA matters is consistent with recent revisions to the Justice Manual, see JM 4-8.200 and 9-99.000, and reflects continuing significant increases in CPB’s staff and coordination with U.S. Attorney’s Offices.  In the health and safety context, the Self-Disclosure Policy applies not only to potential criminal violations “involving the manufacture, distribution, sale, or marketing of products,” but also to “misconduct involving failures to report to, or misrepresentations to” regulators.

As Arun Rao, the Deputy Assistant Attorney General with oversight of CPB, recently explained, the Self-Disclosure Policy seeks to “encourage corporate self-disclosure by establishing consistent and transparent factors that, if met, will result in substantial rewards.”[6]  But companies will need to carefully consider applicability of the Policy alongside other wide-ranging compliance and reporting assessments required by regulators, with the Policy putting additional pressure on companies to move swiftly in investigating issues of potential regulatory non-compliance.

1. Requirements. To receive credit for voluntary self-disclosure of wrongdoing under the Self-Disclosure Policy, a company must:

• Disclose the conduct “directly” to CPB “prior to an imminent threat of disclosure [in other forums]” or government investigation;
• Make the disclosure within a reasonably prompt time after the company becomes aware of the conduct;
• Have no pre-existing obligation to disclose the conduct pursuant to a prior resolution;
• Preserve, collect, and produce relevant documents or information in a timely manner; and
• Disclose all relevant facts then known to the company concerning the misconduct, including individuals and third parties involved in the misconduct.

The requirement to report “directly” to CPB is significant for companies that manufacture, distribute, or sell regulated products.  The Self-Disclosure Policy specifically makes clear that CPB will not deem it sufficient for a company to report only to a regulator, explaining that “if a company . . . chooses to self-report only to a regulatory agency and not to CPB, the company will not qualify for the benefits of a voluntary self-disclosure. . . .”  By emphasizing “direct” reporting to CPB, the Self-Disclosure Policy also suggests that CPB is seeking to disincentivize forum shopping across DOJ in matters falling within its purview.  That could be a meaningful consideration for companies considering where to report within DOJ.  The Policy also underscores that a company’s communications with regulators about an issue that potentially implicates DOJ enforcement authorities will not necessarily come to DOJ’s attention.  Companies should carefully evaluate whether a regulatory issue may rise to the level of criminal liability in considering whether self-disclosure is beneficial under the Policy.

2. Benefits. Consistent with Deputy Attorney General Monaco’s commitment that—absent aggravating factors—DOJ “will not seek a guilty plea when a company has voluntarily self-disclosed, cooperated, and remediated misconduct,”[7] the Self-Disclosure Policy provides that CPB will not seek a guilty plea from companies that fulfill the Policy’s requirements.  Under the Policy, CPB also will not require an independent compliance monitor for a complying company if, at the time of resolution, the company has implemented and tested an effective compliance program.

These benefits fall short of offering a rebuttable presumption of declination, as in the Criminal Division’s Corporate Enforcement Policy.  But they represent meaningful incentives nevertheless.  The promise not to pursue a guilty plea may be particularly important for life-sciences and consumer-product companies that could face exclusion from federal health care programs or debarment from government contracting if convicted of a crime—even a misdemeanor offense under the FDCA or other consumer-protection laws that do not require DOJ to prove criminal intent.  That promise is notable as well in light of recent political pressure on CPB to secure guilty pleas from companies; indeed, some politicians recently have criticized resolutions that spared companies from exclusion by avoiding guilty pleas.[8]

The Self-Disclosure Policy’s pathway to avoid an independent compliance monitor also is meaningful, especially for highly regulated corporations.  As discussed below, CPB’s establishment of a corporate compliance unit and promulgation of a policy on independent monitors is consistent with broader DOJ developments and suggests a likelihood that CPB will seek to impose monitors in more resolutions.  That development could add a heavy layer of oversight and reporting to corporations that may already be under strict regulatory scrutiny or even a separate monitor imposed by an agency settlement (e.g., a Department of Health and Human Services, Office of Inspector General corporate integrity agreement).  Thus, the opportunity to avoid a CPB-imposed monitor could prove a valuable benefit to corporations considering whether to self-disclose.

3. Exclusions. The Self-Disclosure Policy outlines a list of aggravating factors that may undermine certain benefits of self-disclosure under the Policy.  As explained by Deputy Assistant Attorney General Rao, CPB “considered its unique mission” in “carefully calibrat[ing]” these factors “to address [CPB’s] work in health, safety, and consumer fraud areas.”[9] The factors include consideration of whether:

• The conduct at issue was deeply pervasive throughout the organization;
• Upper management knowingly was involved in the conduct;
• The conduct was intentional or willful and created significant risk of death or serious bodily injury; or
• The conduct intentionally or willfully targeted vulnerable populations.

The Self-Disclosure Policy notes that CPB prosecutors will weigh the existence of any of these  aggravating factors in balancing the goal of encouraging disclosures against the goal of deterring serious offenses (particularly those that pose risks to health or safety).  However, more guidance and assurance to companies may be needed with respect to application of the factors, as they could swallow the policy’s benefits.  Misconduct involving regulated products, for instance, often is subject to criminal prosecution when it is associated with a significant risk of harm to consumers.  As a result, absent further guidance, prosecutors could assert that a wide variety of conduct in violation of the FDCA or other consumer-protection statutes falls outside of the Self-Disclosure Policy’s safe harbor.

CPB has indicated that further guidance might develop if necessary, with Deputy Assistant Attorney General Rao stating that CPB “is open to making adjustments as we move forward.”[10]  Indeed, further guidance would be welcome, as the recent Policy announcement suggests there may be a disincentive to reporting the most serious issues.  Further guidance also could account for the challenges inherent in conducting an early internal assessment of the potential causes and effects of a regulatory issue.  We will continue to monitor and report on developments in this space.  In the meantime, companies must very carefully consider whether the facts of an identified issue could trigger one of the Policy’s aggravating-factor exceptions in evaluating the benefits of self-disclosure.

Monitor Selection Policy

CPB’s new Monitor Selection Policy (“Monitor Policy”) is consistent with Deputy Attorney General Monaco’s September 2022 directive[11] for DOJ components to establish a clear process for monitor selection.[12]  The Monitor Policy generally tracks the Criminal Division’s recently issued Revised Memorandum on Selection of Monitors in Criminal Division Matters.[13]

The Monitor Policy’s issuance signals that CPB is likely to begin seeking monitors in more corporate criminal resolutions.  CPB generally has not required monitors in past resolutions: at most, it has required defendants to retain expert consultants to advise on the design and implementation of required compliance measures.  This practice has been consistent with what CPB typically requires in consent decrees resolving civil actions under the FDCA.  Unlike independent monitors, these experts have not been selected by CPB and they have not reported directly to CPB.  Thus, a potential shift to greater use of monitors in CPB criminal matters is significant, especially—as noted above—for corporations that already are highly regulated or that may face imposition of a monitor by other regulators.

The Monitor Policy also is noteworthy in the prominent role that it assigns to CPB’s Corporate Compliance and Policy Unit, which is a new unit as of last year.  Creation of that Unit—like the Monitor Policy—reflects an increased focus on imposing consistent and meaningful compliance terms in resolutions and then enforcing those terms.[14]

1. Applicability. The Monitor Policy applies to the use of independent compliance monitors in CPB criminal corporate resolutions including guilty pleas, deferred prosecution agreements (DPAs), and non-prosecution agreements (NPAs).  The policy does not apply to civil resolutions.

The Monitor Policy does not provide guidance on when a monitor should be imposed in a particular resolution, but CPB prosecutors are governed by Section 9-28.1700 of the Justice Manual, which outlines ten non-exclusive factors for prosecutors to consider in assessing the need to impose a monitor and identifies two “broad considerations [to] guide prosecutors”: “(1) the potential benefits that employing a monitor may have for the corporation and the public, and (2) whether the costs of a monitor and its impact on the operations of a corporation . . . substantially outweigh the potential benefits of a monitor.”[15]  Section 9-28.1700 of the Justice Manual also provides that, “[i]n general, the Department should favor the imposition of a monitor where there is a demonstrated need for, and clear benefit to be derived from, a monitorship.”  As CPB leadership previously has discussed in public remarks, its prosecutors also are guided by—and seek to remain consistent with—Criminal Division guidance on the need for a monitor.  Such commentary strongly suggests that companies should evaluate their compliance programs in the context of a CPB investigation even outside the self-disclosure process, as the state of their compliance program could well be relevant to an evaluation of the need for outside monitors under DOJ guidance.

2. Monitor Selection Process. The Monitor Policy outlines the process by which CPB will select a monitor when its prosecutors and leadership determine that one is appropriate in a particular case and a resolution provides for appointment of a monitor.

Nomination.  Under the first step in the Monitor Policy process, CPB will ask a corporate defendant to submit a written proposal identifying three candidates, outlining various information pertaining to the candidates’ credentials, and providing certifications that the candidates do not have potential conflicts of interest in performing the work.

Corporate defendants will benefit from crafting thoughtful proposals that address points of concern and interest for CPB, as doing so will more likely lead to selection of a preferred monitor candidate and a quicker selection process.

Evaluation.  Working from a corporation’s proposal of monitor candidates, the Monitor Policy provides that CPB’s Corporate Compliance and Policy Unit will interview each candidate to assess their candidacy based on their general background, education, and training; past experience as the relevant monitor type; degree of objectivity and independence from the company; adequacy and sufficiency of the candidate’s resources; and any other factors the Unit deems relevant.  In matters involving regulated products, corporations can expect that CPB will look for monitors who understand the applicable regulatory landscape and have knowledge of the relevant industry.

Recommendation.  The Monitor Policy next explains that CPB’s Corporate Compliance and Policy Unit will recommend a monitor candidate to a Standing Committee comprised of the Civil Division Deputy Assistant Attorney General with oversight of CPB, the Director of CPB, and the Civil Division’s designated Ethics Official.  Under the Monitor Policy, the Standing Committee will review the Corporate Compliance and Policy Unit’s recommendation and decide whether or not to accept it.  If the Committee accepts the candidate, it will forward the recommendation to the Assistant Attorney General for the Civil Division, who then will pass forward the recommendation to the Offices of the Associate Attorney General and the Deputy Attorney General.  The Office of the Deputy Attorney General has ultimate authority to approve a monitor candidate.

***

The new voluntary-disclosure and monitor-selection policies issued by CPB reflect that office’s continuing focus on corporate criminal enforcement and compliance.  The policies offer both new opportunities and challenges for engaging with CPB.  Gibson Dunn has deep familiarity with CPB and experience in navigating corporate enforcement and compliance policies.  We stand ready to assist clients engaging with the office or the ramifications of its policies.

_________________________

[1] United States Department of Justice, Civil Division – Consumer Protection Branch Voluntary Self Disclosure Policy for Business Organizations (Feb. 2023), available at https://www.justice.gov/file/1571106/download.

[2] United States Department of Justice, Civil Division – Consumer Protection Branch Monitor Selection Policy (Feb. 2023), available at https://www.justice.gov/file/1571111/download.

[3] United States Department of Justice, Civil Division – Consumer Protection Branch, About the Branch, available here.

[4] United States Department of Justice, “Deputy Attorney General Lisa Monaco Delivers Remarks at American Bar Association National Institute on White Collar Crime” (Mar. 2, 2023), available at https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-monaco-delivers-remarks-american-bar-association-national.

[5] United States Attorneys’ Offices Voluntary Self-Disclosure Policy, (Feb. 22, 2023), available at https://www.justice.gov/usao-sdny/press-release/file/1569411/download; United States Department of Justice, Criminal Division Corporate Enforcement and Voluntary Self-Disclosure Policy, JUSTICE MANUAL § 9-28.900, available at https://www.justice.gov/jm/jm-9-28000-principles-federal-prosecution-business-organizations#9-28.900.

[6] Deputy Assistant Attorney General Arun G. Rao, Remarks, “What’s Coming Down the Hill” Symposium, Georgetown Law Center (Mar. 10, 2023).

[7] United States Department of Justice, “Deputy Attorney General Lisa O. Monaco Delivers Remarks on Corporate Criminal Enforcement” (Sep. 15 2022), available at https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-o-monaco-delivers-remarks-corporate-criminal-enforcement.

[8] Letter from Sen. Elizabeth Warren and Sen. Ben Ray Luján to Hon. Merrick Garland (Aug. 11, 2022), available here here.

[9] Deputy Assistant Attorney General Arun G. Rao, Remarks, “What’s Coming Down the Hill” Symposium, Georgetown Law Center (Mar. 10, 2023).

[10] Id.

[11] Memorandum, Dep’t of Justice, Further Revisions to Corporate Criminal Enforcement Policies Following Discussions with Corporate Crime Advisory Group (Sept. 15, 2022), available https://www.justice.gov/opa/speech/file/1535301/download.

[12] United States Department of Justice, Office of the Deputy Attorney General, “Further Revisions to Corporate Criminal Enforcement Policies Following Discussions with Corporate Crime Advisory Group” (Sep. 15, 2022), available at https://www.justice.gov/opa/speech/file/1535301/download; see also Gibson Dunn & Crutcher, “From the Broader Perspective: Deputy Attorney General Announces Additional Revisions to DOJ’s Corporate Criminal Enforcement Policies” (Oct. 3, 202), available at https://www.gibsondunn.com/from-the-broader-perspective-deputy-attorney-general-announces-additional-revisions-to-dojs-corporate-criminal-enforcement-policies/.

[13] United States Department of Justice, Civil Division – Consumer Protection Branch Revised Memorandum on Selection of Monitors in Criminal Division Matters (Feb. 2023), available at  https://www.justice.gov/opa/speech/file/1571916/download.

[14] United States Department of Justice, Civil Division – Consumer Protection, “Recent Highlights” (Apr. 2022), available at https://www.justice.gov/file/1490441/download.

[15] United States Department of Justice, Criminal Division “Use of Independent Compliance Monitors in Corporate Resolutions, JUSTICE MANUAL § 9-28.1700 (2023), available at https://www.justice.gov/jm/jm-9-28000-principles-federal-prosecution-business-organizations#9-28.1700.

---

The following Gibson Dunn lawyers prepared this client alert: Gus Eyler, Nick Hanna, Marian Lee, John Partridge, Jonathan Phillips, Justine Kentla, Wynne Leahy, and Laila Naraghi.

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, the authors, or any of the following leaders and members of the firm’s FDA and Health Care or White Collar Defense and Investigations practice groups:

FDA and Health Care Group:
Gustav W. Eyler – Washington, D.C. (+1 202-955-8610, geyler@gibsondunn.com)
Marian J. Lee – Washington, D.C. (+1 202-887-3732, mjlee@gibsondunn.com)
John D. W. Partridge – Denver (+1 303-298-5931, jpartridge@gibsondunn.com)
Jonathan M. Phillips – Washington, D.C. (+1 202-887-3546, jphillips@gibsondunn.com)

White Collar Defense and Investigations Group:
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
Winston Y. Chan – San Francisco (+1 415-393-8362, wchan@gibsondunn.com)
Daniel P. Chung – Washington, D.C. (+1 202-887-3729, dchung@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Charles J. Stevens – San Francisco (+1 415-393-8391, cstevens@gibsondunn.com)
Patrick F. Stokes – Washington, D.C. (+1 202-955-8504, pstokes@gibsondunn.com)
F. Joseph Warin – Washington, D.C. (+1 202-887-3609, fwarin@gibsondunn.com)
Debra Wong Yang – Los Angeles (+1 213-229-7472, dwongyang@gibsondunn.com)

© 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 February 21, 2023, the National Labor Relations Board (“NLRB” or the “Board”) issued a decision in McLaren Macomb, 372 NLRB No. 58 (2023), regarding the enforceability of confidentiality and non-disparagement provisions in severance agreements for non-supervisory employees, irrespective of union status.  The Board ruled that an employer violates Section 8(a)(1) of the National Labor Relations Act (“NLRA”) by offering a severance agreement to employees that includes confidentiality and non-disparagement terms restricting the exercise of the employees’ NLRA rights.  On March 22, 2023, NLRB General Counsel (“GC”) Jennifer Abruzzo issued a non-binding memorandum[1] expressing her position  on the scope and application of the McLaren Macomb decision, including that it applies retroactively to severance agreements already in effect.  In light of this ruling and the GC’s memorandum, employers should carefully consider whether changes may be required to their severance agreements.

Impacted Severance Agreements

The Board’s decision impacts severance agreements offered to both unionized and non-unionized employees who do not hold supervisory roles.[2]  Under the NLRA, “supervisors” are those employees who exercise authority over other workers, using “independent judgment.”[3]  To “exercise authority” under the NLRA is, by way of example, to hire, transfer, suspend, lay off, recall, promote, discharge, assign, reward, discipline, or direct other employees.[4]

Brief Summary of the McLaren Macomb Case

During the COVID-19 pandemic, a Michigan hospital furloughed unionized employees and offered them confidential release agreements in exchange for a severance payment.  Those agreements prohibited employees from (i) disclosing any part of the severance agreement to anyone other than a spouse or professional advisor, and (ii) making statements to other employees or the general public which could “disparage or harm the image of” the hospital.  The union filed a complaint with the NLRB against the hospital alleging unfair labor practices.  Following a hearing in June 2021, an administrative law judge (“ALJ”) held that the hospital did not violate Section 8(a)(1) merely by offering the severance agreement (with its confidentiality and non-disparagement provisions) to the employees.

The ALJ relied on the NLRB’s 2020 decisions in Baylor University Medical Center (“Baylor”) and IGT d/b/a International Game Technology (“IGT”).  The Baylor and IGT cases had overturned prior precedent that focused on the language of the severance agreement at issue to determine if there was an unlawful infringement on an employee’s NLRA Section 7 rights.[5]  Baylor and IGT instead held that broad confidentiality and non-disparagement provisions were generally permissible absent additional circumstances such as a finding of wrongful termination or an employer harboring animus against Section 7 activity.[6]

The Board — in a three-to-one decision with its sole Republican member dissenting — reversed the ALJ’s decision and overturned Baylor and IGT.  The Board held that both the confidentiality and non-disparagement provisions in the severance agreement unlawfully restricted the employees’ rights under Section 7 of the NLRA.[7]  The Board ruled that an offer of severance in exchange for confidentiality and non-disparagement terms that would have the “reasonable tendency to restrain, coerce, or interfere” with Section 7 rights violates Section 8(a)(1) of the NLRA.

Analysis of Confidentiality Provision

The McLaren Macomb confidentiality provision provided: “The Employee acknowledges that the terms of this Agreement are confidential and agrees not to disclose them to any third person, other than spouse, or as necessary to professional advisors for the purposes of obtaining legal counsel or tax advice, or unless legally compelled to do so by a court or administrative agency of competent jurisdiction.”

While such a provision may seem standard to many employers, the Board majority held that precluding employees from disclosing terms of the severance agreement — including those that may be unlawful — violated employees’ Section 7 rights to assist coworkers and the NLRB.  Specifically, the majority explained that by prohibiting any discussion of the agreement’s terms, employees were in effect prevented from any future discussion of a possible “labor issue, dispute, or term and condition” found in or caused by the agreement.

In addition, the McLaren Macomb non-disclosure clause stated: “At all times hereafter, the Employee promises and agrees not to disclose information, knowledge or materials of a confidential, privileged, or proprietary nature of which the Employee has or had knowledge of, or involvement with, by reason of the Employee’s employment.”

The Board majority held that this language would impermissibly preclude employees from cooperating with NLRB investigations and litigation of unfair labor practices, in violation of the employees’ Section 7 right to participate in the Board’s investigative process.

The Board also provided reasoning that may assist employers as they craft severance agreements going forward.  Specifically, the Board stated that severance agreements should not preclude an employee from “assisting coworkers with workplace issues concerning their employer”—”the heart of protected Section 7 activity.”

Notwithstanding this result in McLaren Macomb, GC Abruzzo’s recent memorandum acknowledges that confidentiality clauses that are “narrowly-tailored to restrict the dissemination of proprietary or trade secret information for a period of time based on legitimate business justifications may be considered lawful” so long as they do not effectively preclude employees from communicating and/or cooperating on workplace issues.

Analysis of Non-Disparagement Provision

The McLaren Macomb non-disparagement section stated: “At all times hereafter, the Employee agrees not to make statements to Employer’s employees or to the general public which could disparage or harm the image of Employer, its parent and affiliated entities and their officers, directors, employees, agents and representatives.”  Notably, the non-disparagement provision at issue did not include a definition of “disparagement” and contained no temporal limitation.  Also absent from the severance agreement was any express statement making clear that nothing in the severance agreement limited employees’ exercise of Section 7 rights.

The Board majority held that the non-disparagement clause unlawfully created “a sweepingly broad bar that has a clear chilling tendency on the exercise of Section 7 rights.”  More specifically, the Board held that the agreement impermissibly infringed on the employees’ Section 7 right to raise complaints about the employer with “their fellow coworkers, the Union, the Board, any other government agency, the media, or almost anyone else.”  Based on what the Board majority characterized as a plain reading of the NLRA, it held that an employer may not infringe on any employee’s critique of “employer policy” as a general matter, so long as it is outside of the “disloyal, reckless, or maliciously untrue” exclusion in the statute.

The Board provided reasoning that may guide employers in revising severance agreements.  Specifically, the Board cautioned against language that would effectively restrict future efforts by a worker “to assist fellow employees.”  Such assistance could include cooperating with an NLRB investigation, which the Board held extends to assistance of both current and former employees.

Again, notwithstanding the Board’s broad holding, according to GC Abruzzo’s recent interpretation of the Board’s decision a “narrowly-tailored, justified, non-disparagement provision that is limited to employee statements about the employer that meet the definition of defamation” may be lawful.

Takeaways

The decision reflects continuing efforts by the current Board not only to reverse recent Trump-era NLRB precedent but also to move aggressively toward expanded union and employee protections.  NLRB General Counsel Abruzzo has criticized the prior Board under President Trump and stated her intention to bring cases capable of reversing the Trump-era doctrinal “shifts [that] include[d] overruling many legal precedents which struck an appropriate balance between the rights of workers and the obligations of unions and employers.”

With this decision, the Board has now prohibited offering severance agreements with broad confidentiality and non-disparagement provisions that may restrict non-supervisory employees’ exercise of their NLRA rights.  This prohibition applies to the act of offering the agreement itself, regardless of whether the employee ultimately accepts its terms.  The motive of the employer or surrounding circumstances — which the Baylor Medical and IGT decisions found critical — do not impact the Board’s analysis under McLaren Macomb, which examines the text of the agreement itself.  The GC’s memorandum makes clear her view that only narrowly tailored confidentiality and non-disparagement provisions are permitted under the NLRA.

The GC also identifies other provisions that could potentially draw the Board’s scrutiny (i.e. broad restrictive covenants, broad releases that extend beyond employment claims, and broad cooperation clauses).  Nonetheless, the GC notes that generally unlawful provisions can be voided without voiding an entire agreement, regardless of whether there is a severability clause.  The Board encourages employers to take affirmative steps to address any agreements presently out of compliance.

The McLaren Macomb holding may face court challenges either in this case or in subsequent cases.

In the meantime, employers should consider whether broad non-disparagement and confidentiality provisions are necessary in severance agreements offered to non-supervisory employees.  According to the GC, any disclaimer language should focus on “Section 7 activities that are of primary importance toward the fulfillment of the Act’s purposes, commonly engaged in by employees and likely to be chilled by overbroad rules.”  Employers should consider including an express statement in the agreement that makes clear that nothing in the Agreement precludes employees from exercising Section 7 rights.  Disclaimers of this nature would fit with many standard carveouts for other protected activity under state and federal law.  Although GC Abruzzo takes the position in her recent memo that including disclaimer language in a severance agreement “would not necessarily cure overly broad provisions,” she acknowledges that it nonetheless can be useful to “resolve ambiguity,” and such carve-outs likely will strengthen employer arguments that the agreement does not violate the NLRA.

_________________________

[1] A GC’s memorandum aims to provide policy guidance and is not legally binding or owed deference by courts.  See Bray Sheet Metal Co. v. Int’l Ass’n of Sheet Metal, Air, Rail, & Transportation Workers, No. 21-2374, 2021 WL 6097517 (8th Cir. July 21, 2021).

[2] GC Abruzzo’s memo explains that although supervisors are generally not protected by the NLRA, under existing Board precedent, supervisors may be protected from retaliation in certain circumstances for assisting non-supervisory employees in exercising rights protected by the NLRA.  Parker-Robb Chevrolet, 262 NLRB 402 (1982), enfd. sub. nom. Automobile Salesmen Union v. NLRB, 711 F.2d 383 (D.C. Cir. 1983);  For example, the GC asserts that it would be unlawful for an employer to retaliate against a supervisor for refusing to offer an unlawful severance agreement or to offer a severance agreement to a supervisor in order to prevent the supervisor from participating in a Board proceeding.

[3] See 29 U.S.C. § 152

[4] Id.

[5] See, e.g., Shamrock Foods Co., 366 NLRB No. 117 (2018), enfd. 779 F. App’x 752 (D.C. Cir. 2019); Clark Distribution Systems, 336 NLRB 747 (2001); Metro Networks, 336 NLRB 63 (2001); Phillips Pipe Line Co., 302 NLRB 732 (1991).

[6] See Baylor University Medical Center (369 NLRB No. 43 (2020)); IGT d/b/a International Game Technology (370 NLRB No. 50 (2020)).

[7] Section 7 guarantees non-supervisory employees the “right to self-organization, to form, join, or assist labor organizations, to bargain collectively through representatives of their own choosing, and to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection.”  29 U.S.C. § 157.

---

The following Gibson Dunn attorneys assisted in preparing this client update: Jason Schwartz, Katherine V.A. Smith, Karl Nelson, Harris Mufson, Danielle Moss, Hayley Fritchie, Meika Freeman, and Nick Rawlinson.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding 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 Labor and Employment practice group, or Jason Schwartz and Katherine Smith.

Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, jschwartz@gibsondunn.com)

Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, ksmith@gibsondunn.com)

© 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 20, 2023, the U.S. Equal Employment Opportunity Commission (“EEOC”) announced that it had entered into a conciliation agreement with DHI Group, Inc. (“DHI”), a job search website operator, after it found “reasonable cause” to believe that job ads posted by DHI’s customers were violating Title VII of the Civil Rights Act of 1964 (“Title VII”) by discouraging workers of American national origin from applying.[i]

5 Key Takeaways for Employers

1. Rewriting Code: Under the agreement, DHI agreed to rewrite its programming to “scrape” for keywords such as “OPT,” “H1B,” or “Visa” that appear near the words “only” or “must” in new job postings.  The agreement requiring DHI to rewrite its algorithms is reminiscent of, albeit less extreme than, the Federal Trade Commission (“FTC”) requiring companies to delete models and algorithms developed using impermissibly collected data, and may be a sign of the EEOC’s approach going forward.[ii]
2. Customer Posts: The charges of discrimination filed against DHI were due to job ads posted by DHI’s customers.  Accordingly, the agreement requires DHI to revise its guidance to customers to specify that certain language (e.g., “H-1Bs Only” or “H-1Bs and OPT Preferred”) must be avoided in job ads.
3. Employment Agencies: In the EEOC’s press release, the Miami District Office Director stated that the agreement “serves as a reminder that the provisions of Title VII extend to employment agencies.”  The EEOC’s characterization of the website operator here as an “employment agency” is a position that is worth watching and might well generate litigation in the future.
4. Other Public Actions: While this is likely the first conciliation agreement of its kind for the EEOC, the agency previously filed a complaint alleging algorithmic age discrimination in May 2022 against iTutorGroup, Inc.[iii]  Thus far, this case has made little progress beyond iTutorGroup filing an answer to the amended complaint on March 9, 2023.
5. Maintained Focus on AI: The EEOC’s draft strategic enforcement plan for 2023 through 2027 (the “SEP”) released in January 2023 indicated that the agency plans to focus on the use of AI tools across the employment lifecycle, as well as eliminating barriers arising from exclusionary job advertisements.[iv]  In addition to its settlement agreement with DHI, the EEOC has shown its continued focus on this area through a pair of recent AI-centric expert panels.  On March 11, 2023, EEOC Chair Charlotte A. Burrows moderated a panel titled, “Is AI the New HR? Protecting Civil Rights at Work.”[v]  As with the EEOC’s public hearing on January 31, 2023,[vi] this panel notably did not include employers or developers or vendors of AI tools.  Indeed, during the EEOC’s public hearing, Commissioners Keith Sonderling and Andrea Lucas both underscored their disappointment with these key perspectives being absent from the expert panels.

*          *          *          *

From the outset of 2023, there has been a significant uptick in proposed legislation seeking to govern automated decision-making in employment at the state level.  We anticipate that this trend will continue and are carefully monitoring developments with these bills along with any updated guidance or regulations from the EEOC.  Employers that have already implemented or are considering implementing automated tools in the workplace should consider the impact of these developments to ensure compliance with upcoming laws and enhanced regulatory scrutiny.

________________________

[i] EEOC Press Release, DHI Group, Inc. Conciliates EEOC National Origin Discrimination Finding (Mar. 20, 2023), https://www.eeoc.gov/newsroom/dhi-group-inc-conciliates-eeoc-national-origin-discrimination-finding.

[ii] See, e.g., FTC Takes Action Against Company Formerly Known as Weight Watchers for Illegally Collecting Kids’ Sensitive Health Data, Fed. Trade Comm’n (Mar. 4, 2022), https://www.ftc.gov/news-events/news/press-releases/2022/03/ftc-takes-action-against-company-formerly-known-weight-watchers-illegally-collecting-kids-sensitive (requiring destruction of any models or algorithms allegedly developed with the use of impermissibly collected data); California Company Settles FTC Allegations It Deceived Consumers about use of Facial Recognition in Photo Storage App, Fed. Trade Comm’n (Jan. 11, 2021), https://www.ftc.gov/news-events/news/press-releases/2021/01/california-company-settles-ftc-allegations-it-deceived-consumers-about-use-facial-recognition-photo (requiring deletion of models and algorithms allegedly developed using photos and videos obtained without express consent from users).

[iii] EEOC v. iTutorGroup, Inc., No. 1:22-cv-02565 (E.D.N.Y. May 5, 2022).

[iv] For more information, please see Gibson Dunn’s Client Alert, Keeping Up with the EEOC: 10 Key Takeaways from its Just-Released Draft Strategic Enforcement Plan.

[v] SXSW, Is AI the New HR? Protecting Civil Rights at Work (Mar. 11, 2023), https://schedule.sxsw.com/2023/events/PP130959

[vi] EEOC, Meeting of January 31, 2023 – Navigating Employment Discrimination in AI and Automated Systems: A New Civil Rights Frontier (Jan. 31, 2023), https://www.eeoc.gov/meetings/meeting-january-31-2023-navigating-employment-discrimination-ai-and-automated-systems-new.

---

The following Gibson Dunn attorneys assisted in preparing this client update: Jason Schwartz, Molly Senger, Danielle Moss, Harris Mufson, Naima Farrell, and Emily Maxim Lamm.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding 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 Labor and Employment practice group, or Jason Schwartz and Katherine Smith.

Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, jschwartz@gibsondunn.com)

Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, ksmith@gibsondunn.com)

© 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.

Gibson Dunn’s Supreme Court Round-Up provides an overview of cases argued during the October 2022 Term and other key developments on the Court’s docket. To date, the Court has heard argument in 44 cases, with another 15 cases scheduled to be argued before the end of the October 2022 Term. The Court has released six opinions from these arguments and dismissed one case as improvidently granted.

Spearheaded by former Solicitor General Theodore B. Olson, the Supreme Court Round-Up keeps clients apprised of the Court’s most recent actions.  The Round-Up previews cases scheduled for argument, tracks the actions of the Office of the Solicitor General, and recaps recent opinions.  The Round-Up provides a concise, substantive analysis of the Court’s actions.  Its easy-to-use format allows the reader to identify what is on the Court’s docket at any given time, and to see what issues the Court will be taking up next.  The Round-Up is the ideal resource for busy practitioners seeking an in-depth, timely, and objective report on the Court’s actions.

To view the Round-Up, click here.

---

Gibson Dunn has a longstanding, high-profile presence before the Supreme Court of the United States, appearing numerous times in the past decade in a variety of cases. During the Supreme Court’s 7 most recent Terms, 11 different Gibson Dunn partners will have presented oral argument; the firm will have argued a total of 17 cases in the Supreme Court during that period, including closely watched cases with far-reaching significance in the areas of intellectual property, securities, separation of powers, and federalism. Moreover, although the grant rate for petitions for certiorari is below 1%, Gibson Dunn’s petitions have captured the Court’s attention: Gibson Dunn has persuaded the Court to grant 34 petitions for certiorari since 2006.

*   *   *  *

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 attorneys in the firm’s Washington, D.C. office, or any member of the Appellate and Constitutional Law Practice Group.

Theodore B. Olson (+1 202.955.8668, tolson@gibsondunn.com)
Amir C. Tayrani (+1 202.887.3692, atayrani@gibsondunn.com)
Katherine Moran Meeks (+1 202.955.8258, kmeeks@gibsondunn.com)
Jessica L. Wagner (+1 202.955.8652, jwagner@gibsondunn.com)

2022 was another busy year for Employee Retirement Income Security Act (“ERISA”) litigation, and practitioners saw regulatory changes and challenges as well as several impactful decisions by the federal appeals courts in this space.

This year’s annual ERISA litigation update covers important legal decisions and developments from the past year in order to assist plan sponsors and administrators navigating the ever-evolving ERISA landscape.

Section I begins by analyzing the impact of two notable decisions from the United States Supreme Court—Hughes v. Northwestern University and Dobbs v. Jackson Women’s Health Organization.  Hughes concerns the standard of review in ERISA excessive-fee litigation, and Dobbs addresses Constitutional protections for abortions.  We address below the ways in which both decisions have had far-reaching impacts on employer-sponsored retirement and health-care benefits.

Section II builds on our analysis in the 2021 ERISA Litigation Update by providing further guidance on how the courts of appeals are assessing the enforceability of ERISA plan arbitration provisions.

Section III then explores other noteworthy legal developments for ERISA-governed retirement plans, including the Seventh Circuit’s guidance concerning the implications of a plan fiduciary delegating investment decisions over company stock to independent fiduciaries, and the Department of Labor’s rule changes concerning environment, social, and governance (“ESG”) investing, and the implications of those changes for ERISA plan fiduciaries.

Section IV offers an overview of judicial opinions impacting employer-provided health plans, such as a trade libel suit against Aetna that third-party plaintiffs may try to use as a back door to bring denial of benefits claims, and the Ninth Circuit’s recent decision to reject a facial challenge to medical-necessity guidelines.

And finally, Section V looks ahead to key ERISA issues and cases that we expect to see litigated this year.

I. Key Supreme Court Decisions

The United States Supreme Court decided two cases in 2022 with significant implications for ERISA plans and their sponsors and administrators.  In Hughes v. Northwestern Univ., 142 S. Ct. 737 (2022), the Court emphasized, in determining whether ERISA plaintiffs stated a plausible claim of fiduciary breach, that “courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise” while applying “the pleading standard discussed in” Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) and Ashcroft v. Iqbal, 556 U.S. 662 (2009).  The Supreme Court also issued its landmark decision in Dobbs v. Jackson Women’s Health Org., 142 S. Ct. 2228 (2022), overturning Roe v. Wade, 410 U.S. 113 (1973), and removing constitutional protections for abortion care.  We address below the implications of these cases for plan administrators and sponsors.

A. Hughes v. Northwestern University and Its Subsequent Interpretation by Courts of Appeals

As we addressed in our 2021 update, the pleading standard in ERISA “excessive fees” fiduciary breach suits is a key—and frequently contested—issue for ERISA litigants.  In Hughes v. Northwestern Univ., 142 S. Ct. 737, 742 (2022), the Supreme Court reiterated that a plaintiff alleging ERISA claims must still satisfy the pleading standard set out in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) and Ashcroft v. Iqbal, 556 U.S. 662 (2009).  In reiterating that standard, the Court also directed that when a district court reviews a pleading challenge in an ERISA fiduciary breach suit, it must conduct a “context-specific inquiry” into whether the plaintiff plausibly alleges that plan fiduciaries failed to act prudently.  The Court also underscored the importance of affording deference to plan fiduciaries, noting the difficult tradeoffs that often come with making these types of decisions.  Hughes, 142 S. Ct. at 742.  The Court’s narrow holding left open whether simply alleging a difference in performance of differently managed investments is enough to state a claim of fiduciary imprudence under ERISA.  In the year since the Hughes decision, the courts of appeals and district courts have weighed in on this issue, with several notable decisions providing guidance for litigants on both sides of ERISA fiduciary breach claims.

In Smith v. CommonSpirit Health, 37 F.4th 1160 (6th Cir. 2022), the Sixth Circuit held that merely pointing to passively managed investment funds that have outperformed actively managed funds does not plausibly plead imprudence.  Id. at 1166.  In Smith, the plaintiff sued her employer for offering several actively managed investment options when index funds available on the market offered higher returns and lower fees.  Id. at 1164.  The plaintiff pointed to three-year and five-year performance for various funds to support her allegations that CommonSpirit acted imprudently, in violation of ERISA.  Chief Judge Sutton disagreed, writing for the panel that “[m]erely pointing to another investment that has performed better in a five-year snapshot of the lifespan of a fund that is supposed to grow for fifty years does not suffice to plausibly plead an imprudent decision . . . that breaches a fiduciary duty.”  Id. at 1166.  Such allegations did not meet the pleading standards established in Ashcroft and Twombly.  Id. at 1165–66.  Furthermore, as the Supreme Court noted in Hughes, “the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs,” and courts “must give due regard to the range of reasonable judgements a fiduciary may make based on her experience and expertise.”  Id. at 1165 (quoting Hughes, 142 S. Ct. at 742).

In Albert v. Oshkosh Corp., 47 F.4th 570 (7th Cir. 2022), the Seventh Circuit similarly affirmed dismissal of an excessive fees suit, while also signaling its view that Hughes has not materially changed the pleading standard for ERISA claims.  Id. at 581.  In Albert, the plaintiff claimed that his former employer acted imprudently because its plan’s administrator, recordkeeper, and advisor charged “unreasonably high fees,” and because his employer failed to select service providers who charged lower fees.  Id. at 573.  The Seventh Circuit found these allegations insufficient to state a claim, concluding that the plaintiff overstated the significance of Hughes.  Id. at 579.  The panel explained that Hughes merely rejected the Seventh Circuit’s holding in that case that “offering a mix of high-cost and low-cost investment options in a plan insulated fiduciaries from liability.”  Id. at 579–80.  The court concluded that limited holding should not be construed to require fiduciaries to regularly solicit bids from service providers or stop providing high-cost investment options.  Id. at 579.  Thus, the court explained that Hughes “does not have any bearing” on the analysis of claims where the plaintiff fails to allege that fees charged are excessive relative to the particular services received in return.  Id. at 580.

In Matousek v. MidAmerican Energy Co., 51 F.4th 274 (8th Cir. 2022), the Eighth Circuit reiterated that in order to plead ERISA imprudence based on a contention of imprudent investment options, plaintiffs must provide “meaningful benchmark[s]” for comparison.  Id. at 280.  In that case, the plaintiffs sued their employer alleging that its investment committee incurred excessive recordkeeping costs and failed to remove imprudent investments.  Id. at 278.  Looking to Hughes, the court acknowledged that fiduciaries “normally have a continuing duty of some kind to monitor investments and remove imprudent ones.”  Id. at 280 (quoting Hughes, 142 S. Ct. at 741).  However, on both counts, the court took issue with the plaintiffs’ failure to identify meaningful benchmarks for the court to compare to the allegedly imprudent fees and investments.  Applying Iqbal, the court found that the industry averages plaintiffs relied upon were not “like-for-like comparison[s]” with the challenged fees and investments.  Id. at 278–79.  Plaintiffs therefore failed to state an imprudence claim.  Id. at 279–82.

By contrast, in Kong v. Trader Joe’s Co., 2022 WL 1125667 (9th Cir. Apr. 15, 2022), the Ninth Circuit relied on Hughes and found plaintiffs’ allegations sufficient to proceed to discovery.  There, plaintiffs alleged, in relevant part, that the defendant offered a number of mutual funds in higher-cost share classes when lower-cost share classes were available on the market.  Id. at *1.  The share classes were alleged to be identical in every way except for the higher fees.  In permitting plaintiffs’ claims to proceed, the Ninth Circuit acknowledged the Supreme Court’s guidance in Hughes that the inquiry into plaintiffs’ allegations should be context specific, but concluded that allegations in that instance were sufficient to withstand the defendant’s pleadings challenge.  Id.

Similarly, in Davis v. Salesforce.com, Inc., 2022 WL 1055557 (9th Cir. Apr. 8, 2022), the plaintiffs alleged that for nine of defendants’ chosen investment funds, the more expensive share classes “were the same in every respect other than price.”  Id. at *1.  As in Kong, the court found these allegations sufficient to state a claim, rejecting at the pleading stage defendants’ explanation that the less expensive share classes served a different purpose in the plan, and were thus not identical. Id. at *1–2.

The Tenth Circuit is likely to be the next court to wade into the post-Hughes waters with Matney v. Barrick Gold of North America, No. 22-4045 (10th Cir. May 20, 2022), currently pending before the court.  Matney involves an appeal from former employees of a mining company seeking to revive their claims alleging mismanagement of their 401(k) plan. The plaintiffs brought the proposed class action against the company, its board of directors and its benefits plan in April 2020, alleging the company kept subpar options in the 401(k) plan, despite having access to funds that were cheaper and performed better.  The plaintiffs appealed from an April 2022 ruling dismissing the suit.  The district court concluded that plaintiffs failed to provide a meaningful benchmark and attempted, unsuccessfully, to leap from the “mere possibility” of misconduct to plausibility.  See Matney v. Barrick Gold of North America, 2022 WL 1186532 at *12 (D. Utah Apr. 21, 2022).

Ultimately, these decisions from the circuit courts of appeals interpreting Hughes confirm that the Supreme Court’s decision was narrow and that ERISA litigants will be held to the pleading standard established in Iqbal and Twombly. 

B. Benefits Administration Post-Dobbs—Considerations for Employers Looking to Provide Abortion-Related Care Benefits

On June 24, 2022, the Supreme Court issued its landmark decision in Dobbs v. Jackson Women’s Health Org., 142 S. Ct. 2228 (2022), overturning Roe v. Wade, 410 U.S. 113 (1973), and removing constitutional protections for abortion care.  Although not framed as an ERISA decision, Dobbs caries significant implications for ERISA plans.  For example, with the nationwide rollback of Roe, employers must now contend with state and local laws creating potential liability for plan sponsors and administrators providing coverage for the cost of abortion-related care.  For example, Texas and Oklahoma have passed “bounty hunter” style laws that create a private cause of action against any person or entity that “aids or abets” the performance or inducement of an abortion, including by paying for or reimbursing the costs.  Several other states have criminalized the act of performing or inducing an abortion.  These laws also leave open the potential for civil and criminal penalties for employers that offer abortion-related health care coverage, benefits, or travel reimbursement.

Benefits administration in a post-Dobbs landscape is not simple, and employers involved in this area should be aware that they are wading into an unsettled, highly politicized issue.  Dobbs raises several important considerations for employers seeking to provide abortion-related health coverage for employees facing restricted access to abortion care and related protections.  When considering whether to provide abortion-related benefits to employees, employers may want to consider what degree of protection, if any, ERISA preemption may offer their employee benefits plans from state legislation and regulation.  Employers should also be aware of their obligations under HIPAA and other privacy laws when dealing with private health information for plan administration purposes, especially in jurisdictions where law enforcement may seek disclosure of that information in furtherance of prosecuting abortion-related activity.

ERISA Preemption:  The Supreme Court’s Dobbs decision raises novel ERISA preemption questions, including whether ERISA preemption may limit a state’s ability to extend civil and/or criminal liability to an employer’s offering of abortion-related care or travel funding through an employer-sponsored, ERISA-governed health plan.  As with many ERISA issues, the law on preemption is not straightforward, and its application may vary depending on whether the state law is civil or criminal.  See 29 U.S.C. § 1144(b)(4).

As background, in order to foster national uniformity in benefits administration, ERISA generally preempts “any and all State laws insofar as they may now or hereafter relate to any employee benefit plan.”  29 U.S.C. § 1144(a).  “A state law relates to an ERISA plan ‘if it has a connection with or reference to such a plan.’”  Egelhoff v. Egelhoff, 532 U.S. 141, 147 (2001) (quoting Shaw v. Delta Air Lines, Inc., 463 U.S. 85, 97 (1983)).  And the state law has a “connection with” an ERISA plan if that law “interferes with nationally uniform plan administration.”  Gobeille v. Liberty Mut. Ins. Co., 577 U.S. 312, 320 (2016).

However, ERISA preemption does not extend to generally applicable state criminal laws.  See § 1144(b)(4).  While there is little case law interpreting the “generally applicable” language in Section 1144(b)(4), courts have taken the view that Congress intended the words “generally applicable” to refer to criminal laws that apply to general conduct like larceny and embezzlement. Walker v. CIGNA Ins. Grp., Nos. 99-3274, 99-3576, 2000 WL 687738, at *2 (E.D. La. May 26, 2000) (quoting Aloha Airlines, Inc. v. Ahue, 12 F.3d 1498, 1506 (9th Cir. 1993)).  Although there are currently no state laws that expressly criminalize aiding-and-abetting an abortion (in contrast to current state laws that carry potential civil penalties for aiding-and-abetting), ERISA preemption might not apply to such laws if passed in the future.

Impact of Privacy Considerations:  Another concern for employers post-Dobbs is the potential for state and local law enforcement to seek personal data in order to facilitate prosecutions in jurisdictions that have attached civil and criminal liability to abortion-related acts.  Employee personal data that employers might potentially have access to—e.g., health records, financial records, geolocation information, and electronic communications—might all be collected and used as evidence.

Employer-sponsored group health plans are subject to HIPAA’s Privacy Rule.  45 C.F.R. § 160.103(1)(ix).  Under the rule, employer plans may use protected health information (“PHI”) to administer benefits but must also abide by HIPAA regulations to avoid disclosure.  Id. § 164.504(f)(1).  Notably, the Privacy Rule provides several exceptions, including access for law enforcement.  This exception permits covered entities to disclose data to law enforcement officials pursuant to a court order, warrant, grand jury subpoena, or administrative subpoena meeting certain conditions.

In “direct response” to the Dobbs decision, the U.S. Dep’t for Health and Human Services issued relevant guidance on the disclosure of information related to reproductive care and HIPAA’s Privacy Rule.  See U.S. Dep’t of Health & Human Servs., Press Release, HHS Issues Guidance to Protect Patient Privacy in Wake of Supreme Court Decision on Roe (June 29, 2022).  The guidance directs that covered entities, and to some extent, their business associates, “can use or disclose PHI, without an individual’s signed authorization, only as expressly permitted or required by the Privacy Rule.”  U.S. Dep’t of Health & Human Servs., HIPAA Privacy Rule and Disclosures of Information Relating to Reproductive Health Care (June 29, 2022).  The guidance also analyzes three situations where the Privacy Rule permits, but does not necessarily require, covered entities to disclose PHI without an individual’s authorization: (1) disclosures required by law; (2) disclosures for law enforcement purposes; and (3) disclosures to avert a serious threat to health or safety.  Id.  Specifically, the guidance is intended to clarify that disclosures of PHI for purposes not related to health care—such as disclosures to law enforcement—are “permitted only in narrow circumstances tailored to protect the individual’s privacy and support their access to health care, including abortion care.”  U.S. Dep’t of Health & Human Servs., Press Release.

Gibson Dunn attorneys are continuing to monitor legislative, judicial, and regulatory developments in this rapidly changing area and are prepared to advise and assist employers in navigating this complex space.

II. Arbitrability of ERISA Benefits Claims

The arbitrability of ERISA Section 502(a)(2) fiduciary-breach claims continues to be a hotly litigated issue.  As we detailed in our 2020 and 2021 year-end updates, the Ninth Circuit’s watershed decision in Dorman v. Charles Schwab Corp., 934 F.3d 1107 (9th Cir. 2019), overturned decades of case law that had held that ERISA fiduciary-breach suits could not be arbitrated.  Id. at 1111–12.  Reacting to Dorman, companies increasingly began incorporating arbitration provisions into their ERISA plans and courts across the county have since faced a jumble of complicated arbitration issues.  As we reported in last year’s ERISA update, courts have grappled with questions related to the scope, enforceability, and application of arbitration provisions.  And, unsurprisingly, courts have taken different tacks in addressing these issues.

For example, as we reported last year, in Smith v. Bd. of Dirs. of Triad Mfg., Inc., 13 F.4th 613, 615 (7th Cir. 2021), the Seventh Circuit held that an arbitration provision was not enforceable because it improperly foreclosed remedies that ERISA “expressly permit[s].”  Id. at 623.  Then, in Cooper v. Ruane Cunniff & Goldfarb Inc., 990 F.3d 173 (2d Cir. 2021), the Second Circuit declined to assess the enforceability of a similar arbitration provision, concluding instead that plaintiff’s claims did not fall within the provision’s scope.  Id. at 175–76.

This year, the Sixth and Tenth Circuits weighed in on this issue, declining to compel arbitration of plaintiffs’ Section 502(a)(2) fiduciary breach claims despite their agreements to arbitrate.

In the Sixth Circuit case, Hawkins v. Cintas Corp., 32 F.4th 625 (6th Cir. 2022), plaintiffs alleged that their employer “breached the fiduciary duties it owed to the company’s retirement plan.”  Id. at 627.  The court acknowledged that the plaintiffs had signed employment agreements containing arbitration provisions, but after surveying case law from other courts of appeals, it concluded that “[t]he weight of authority and the nature of § 502(a)(2) claims suggest that these claims belong to the plan, not to individual plaintiffs.”   Id.  The court explained that plaintiffs “are seeking Plan-wide relief through a statutory mechanism that is designed for representative actions on behalf of the Plan.”  Id. at 635.  “Therefore, the arbitration provisions in these individual employment agreements—which only establish the Plaintiffs’ consent to arbitration, not the plan’s—do not mandate that these claims be arbitrated.”  Id. at 627.  On January 9, 2023, the Supreme Court denied certiorari in Hawkins.

The Tenth Circuit followed the Sixth Circuit’s lead in Harrison v. Envision Mgmt. Holding, Inc. Bd. of Dirs., 59 F.4th 1090 (10th Cir. 2023), affirming a district court’s ruling invalidating a plan arbitration provision because it prevented participants from effectively vindicating their rights to pursue plan-wide remedies under ERISA.  The panel explained that “[i]f the Sixth Circuit is correct” that Section 502(a)(2) claims “should be thought of as Plan claims, not [the plaintiff’s claims],” then an arbitration agreement’s provision prohibiting “a claimant [from] proceeding in a representative capacity is inconsistent with, and prevents a claimant from effectively vindicating the remedies afforded by” Section 502(a)(2).  Id. at 1106.  In other words, because the arbitration provision in Harrison required all claims to be arbitrated on an individual basis, and because Section 502(a)(2) was interpreted by the court to provide a statutory mechanism for seeking plan-wide claims, the arbitration provision was invalid as precluding participants from pursuing relief otherwise available to them under ERISA.

Currently, two other cases centering the issue of arbitrability of Section 502(a)(2) claims are pending before the Second and Third Circuits.  See Cedeno v. Argent Tr. Co., No. 21-2891 (2d Cir. Nov. 22, 2021); Henry v. Wilmington Tr. NA, No. 21-2801 (3d Cir. Oct. 1, 2021).  We anticipate that the arbitrability of Section 502(a)(2) claims will continue to be a focal point of litigation across the country this year.

III. Further Important Developments Concerning ERISA-Governed Retirement Plans

In addition to litigation concerning pleading standards and arbitrability, other legal and regulatory changes in 2022 had significant impact on ERISA-governed retirement plans.  Notably, the Seventh Circuit issued an important decision in Burke v. Boeing Co., 42 F.4th 716 (7th Cir. 2022), concerning the implications of a plan fiduciary delegating investment decisions over company stock to independent fiduciaries, and the Department of Labor announced its final rule concerning consideration of ESG factors in plan investing.

A. Seventh Circuit Decision Provides Guidance to Plan Fiduciaries Regarding Delegation of Investment Decisions to Third Parties

In Burke v. Boeing Co., 42 F.4th 716 (7th Cir. 2022), the Seventh Circuit held that Boeing was insulated from liability in an ERISA lawsuit alleging that the company unlawfully inflated its stock price by hiding issues with its 737 Max jets because the company had handed off fiduciary responsibilities for managing the company’s employee stock ownership plan to an independent investment manager.  Plaintiffs were participants in Boeing’s 401(k) Plan whose savings had been invested in the Boeing Stock Fund.  Id. at 721.  In late 2019, Boeing’s stock price fell substantially after its 737 Max series of airliners was grounded worldwide due to safety issues.  Id. at 720.  Plaintiffs contended that Boeing breached its fiduciary duties by failing to disclose the 737 Max’s safety issues.  Id. at 722, 727.  The Seventh Circuit affirmed the district court’s dismissal of the plaintiffs’ claims.  Id. at 720.  Importantly, the court held that Boeing had no fiduciary duty with respect to managing the investments in the Boeing Stock Fund, because Boeing had delegated, through its plan investment committee, the “exclusive fiduciary authority and responsibility” for choosing and managing the investments of the Boeing Stock Fund to an independent, third-party investment manager.  Id.

The plaintiffs argued that any duty not expressly delegated to the third party remained Boeing’s duty—including “the duty to make public disclosures of nonpublic information” based on federal securities law.  Burke, 42 F.4th at 727.  The Seventh Circuit disagreed, however, stating that ERISA does not “impose[] such a duty that would be layered on top of federal securities laws governing public disclosures of information material to investors.”  Id.  The court explained that the “delegation to [the independent fiduciary] anticipated exactly this sort of case, in which Boeing insiders would be accused of facing conflicting fiduciary loyalties.”  Id. at 728.  Boeing could not be held liable for breaching fiduciary duties that it “simply did not have.”  Id.

Finally, plaintiffs argued that ERISA, as opposed to federal securities law, included a non-delegable duty to disclose non-public information to Plan participants.  Burke, 42 F.4th at 728–29.  The Seventh Circuit again disagreed because plaintiffs failed to provide evidence of “either an intentionally misleading statement, or a material omission where the fiduciary’s silence can be construed as misleading,” as required under ERISA.  Id. at 729 (citation and internal quotation marks omitted).

A number of similar cases have been filed and litigated over the last several years, and the Burke decision is consistent with other rulings in the area.  As the court recognized, independent fiduciaries “can serve a valuable and legitimate purpose in managing” the potential conflict between a company’s duties to its shareholders and its plan participants that may arise in connection with company stock funds.  Burke, 42 F.4th at 732.   Importantly, however, companies must still exercise their duties of prudence and loyalty in selecting the independent third party and delegating the investment-related duties—an area that could give rise to future litigation.

B. An Update on the Department of Labor’s ESG Rulemaking

As we discussed in our update last year, the Department of Labor (“DOL”) has been actively engaged in rulemaking concerning environmental, social, and governance (“ESG”) investing for the better part of a decade.  On November 22, 2022, the DOL released its final rule (the “2022 Rule”), supplanting two Trump-era rules, and stating that “fiduciaries may consider climate change and other [ESG] factors when they make investment decisions and when they exercise shareholder rights, including voting on shareholder resolutions and board nominations.”  U.S. Dep’t of Labor, Emp. Benefits Sec. Admin. (“EBSA”), Fact Sheet, Final Rule on Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.

The 2020 Rules:  To understand the import of the 2022 Rule, some additional background is required with regard to the regulatory landscape prior to its publication.  In November 2020, the DOL published a final rule adopting amendments to 29 C.F.R § 2550.404a-1, commonly referred to as ERISA’s Investment Duties regulation.  See Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 72846 (Nov. 13, 2020) (hereinafter, the “2020 ESG Rule”).  Then, in December 2020, the DOL published a related final rule which also adopted amendments to the Investment Duties regulation.  See Fiduciary Duties Regarding Proxy Voting and Shareholder Rights, 85 Fed. Reg. 81658 (Dec. 16, 2020) (hereinafter, the “2020 Proxy Rule”).  Together, these rules (the “2020 Rules”) sought to address concerns that fiduciaries would subordinate the interests of plan participants and beneficiaries to non-pecuniary objections, in violation of the duties of prudence and loyalty.  See 85 Fed. Reg. at 72873 and 81658.

The 2020 ESG Rule required plan fiduciaries to select investments and make investment decisions based solely on consideration of pecuniary factors, as defined in the regulation. 85 Fed. Reg. at 72851.  Although the preamble to the 2020 ESG Rule stated that ESG considerations could at times be appropriate pecuniary factors—including significant environmental risk and troubled corporate governance—the regulatory text itself included no reference to SG factors and the DOL declined to opine that ESG factors are necessarily pecuniary.  Id. at 72858.  Significantly, the 2020 ESG Rule stated that in no circumstances could any investment fund or product be added as a qualified default investment alternative (“QDIA”) if its “investment objectives, goals, or principal investment strategies include, consider, or indicate the use or one or more non-pecuniary factors.”  Id. at 72865.  The DOL adopted this “heightened prophylactic approach” for QDIAs because it would be inappropriate for participants in QDIAs, who tend to have “less investment experience and sophistication than more active investors,” to be defaulted into a retirement savings fund that may have “other objectives absent their affirmative decision.”  Id. at 72866.

Finally, the 2020 ESG Rule provided that non-pecuniary factors could be considered by fiduciaries in selecting investments or an investment course of action only as tiebreakers, when investment alternatives were indistinguishable based solely on pecuniary factors.  85 Fed. Reg. 72862.  This tiebreaking standard required fiduciaries to document their decision.  Id.

The 2020 Proxy Rule concerned plan fiduciaries’ ERISA obligations when voting proxies and exercising other shareholder rights in connection with plan investments in shares of stock.  85 Fed. Reg. 81658.  The 2020 Proxy Rule stated that fiduciaries were not required to vote every proxy or exercise every shareholder right.  Id. at 81663.  However, when voting proxies or exercising shareholder rights, plan fiduciaries were required to thoroughly document the decision.   Id. at 81669.  And where fiduciaries delegated the authority to manage shareholder rights to third-parties, the 2020 Proxy Rule imposed separate monitoring obligations.  Id.  Last but not least, the 2020 Proxy Rule created safe harbor provisions, permitting the adoption of uniform proxy voting policies.  Id. at 81672.

The 2022 Rule: In March 2021, following direction from the Biden Administration, the DOL issued an enforcement policy statement under ERISA stating that, until the publication of further guidance, the DOL would not enforce the 2020 Rules.  U.S. Dep’t of Labor, ESBA, Statement Regarding Enforcement of Final Rules on ESG Investments and Proxy Voting by Employee Benefit Plans (Mar. 10, 2021).  In the fall of that same year, the DOL published a Notice of Proposed Rulemaking to amend the “Investment Duties” regulation.  See Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, 85 Fed. Reg. 57272, 57276 (proposed Oct. 14, 2021).  Then, in November 2022, the DOL announced the final rule. 85 Fed. Reg. 73822 (to be codified at 29 C.F.R. § 2550.404a-1).  The DOL’s stated rationale for the change was that the 2020 Rules “created uncertainty for ERISA fiduciaries around considering climate change and other ESG factors in investment decisions,” which in turn deterred fiduciaries from improving investment portfolio resilience or acting as other investors would in order to enhance investment value and performance.  U.S. Dep’t of Labor, EBSA, Fact Sheet, Final Rule, at 3. See also 85 Fed. Reg. at 73826.

Notably, the final 2022 Rule omits proposed language suggesting that evaluating an investment “may often require” fiduciaries to account for ESG factors.  Id. at 73830–31.  This omission clarifies that the 2022 Rule does not mandate consideration of ESG factors in all investment decisions or favor ESG investment.  Id. at 73831.  ESG factors should not be treated differently from any other relevant investment consideration, and the weight given to any one factor should mirror its impact on risk and return.  Id.

In other words, the 2022 Rule does not change the principle at the center of the “Investment Duties” regulation: that plan fiduciaries are obligated by the duties of prudence and loyalty under ERISA to focus investment decisions on relevant risk-return factors.  However, the 2022 Rule expands the definition of risk-return factors beyond solely “pecuniary” considerations and expressly includes ESG factors as potential components of a risk-return analysis, as well as any other factors the fiduciary “reasonably determines” to be relevant to a risk-return analysis.  See 29 C.F.R. § 2550.404a-1(b)(4).

Another small but noteworthy change made by the 2022 Rule is the addition of the term “or menu” clarifying “the portfolio.”  See 29 C.F.R. § 2550.404a-1(b)(2) (“‘[A]ppropriate consideration’ shall include, but is not necessarily limited to: a determination by the fiduciary that the particular investment or investment course of action is reasonably designed, as part of the portfolio (or, where applicable, that portion of the plan portfolio with respect to which the fiduciary has investment duties) or menu . . .”).  The DOL further clarifies that the determination factors at § 2550.404(b)(2)(i) apply to menu construction, while the factors at § 2550.404(b)(2)(ii) do not. 85 Fed. Reg. at 73830.  This change further emphasizes menu construction as a fiduciary act subject to the fiduciary duties of loyalty and prudence.  See, e.g., Hughes v. Northwestern Univ., 142 S.Ct. 737, 742 (2022) (“[P]lan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options.”).

Next, the 2022 Rule softens the tiebreaker standard, loosening restrictions imposed by the 2020 ESG Rule as to the types of collateral benefits fiduciaries may consider.  See 29 C.F.R. § 2550.404a-1(c)(2).  The DOL emphasized that fiduciaries are not required to use the tiebreaker standard when selecting investments.  See 85 Fed. Reg. at 73836–37; see also 29 C.F.R. § 2550.404a-1(c)(2) (“If a fiduciary prudently concludes that competing investments . . . equally serve the financial interests of the plan . . . the fiduciary is not prohibited from selecting the investment . . . based on collateral benefits other than investment returns.”) (emphasis added).   However, a fiduciary may not accept “expected reduced returns or greater risk” in order to secure collateral benefits.  Id.  The 2022 Rule also lifts the documentation requirements for fiduciaries who choose to employ the tiebreaker standard, applying the same general prudence standard in this context as to all other investment decisions.  See 85 Fed. Reg. at 73860.

The 2022 Rule also provides that fiduciaries may consider participant preferences, and act upon those preferences, without violating the duty of loyalty, so long as the resulting investment is otherwise prudent.  29 C.F.R. § 2550.404a-1(c)(3).  This provides fiduciaries with flexibility to consider plan participants’ nonpecuniary preferences—such as policy or social preferences—when making investment decisions for participant-directed plans, which could enhance plan participation and contribution rates.  See 85 Fed. Reg. at 73842.

Finally, the 2022 Rule eliminates the blanket prohibition imposed by the 2020 ESG Rule on QDIA status for investments that consider ESG factors as part of their investment objectives, regardless of a fiduciary’s reasons for selecting the investments.  See 85 Fed. Reg. at 73843.  The prior restriction effectively prevented fiduciaries from selecting QDIA offerings that incorporated collateral benefits, even when the fund is otherwise prudent and superior to competing options.  Id.  This change means that, under the 2022 Rule, a fiduciary may choose a QDIA with collateral benefit considerations as part of an investment menu.  The 2022 Rule returns the selection of QDIAs to the same legal standards as other defined contribution plan investments.

The Rule at Risk:  The 2022 Rule has had a number of notable detractors.  On January 26, 2023, attorneys general from 25 states (the “State Plaintiffs”) filed a lawsuit in the Northern District of Texas, seeking to prevent the Rule from taking effect.  The State Plaintiffs argue that the Rule oversteps the DOL’s authority under ERISA and is arbitrary and capricious, in violation of the Administrative Procedure Act.  Utah v. Walsh, No. 23-16, Compl. for Decl. and Inj. Relief ¶¶ 4–5, ECF No. 1.  Specifically, the State Plaintiffs complain that the Rule conflicts with ERISA’s exclusive purpose requirements, which obligate fiduciaries to consider only financial benefits and not any nonpecuniary benefits.  Id. ¶ 126.  The State Plaintiffs claim Article III standing, alleging harms in the form of lowered tax revenue, reduced investments in the fossil fuel industry, diminished economic well-being for residents, and special solicitude.  Id. ¶¶ 60–63.  Private parties also joined the suit, claiming they will lose the protections put in place by the prior rules and be forced to expend additional time and resources monitoring and reviewing recommendations from advisers without the benefit of the “clearer” regulations limiting the focus to purely pecuniary considerations.  Id. ¶¶ 46, 53, 57.

A second lawsuit, Braun v. Walsh, No. 23-234, Compl., ECF No. 1, was filed in late February in the Eastern District of Wisconsin.  The Braun plaintiffs, who both participate in ERISA-regulated retirement plans, argue that the Rule violates ERISA and exceeds the statutory authority granted to the Secretary of Labor and DOL.  Id. ¶¶ 119–20.

On the legislative front, Senate Republicans announced a plan in early February 2023 to reintroduce legislation from last session seeking to overturn the 2022 Rule pursuant to the Congressional Review Act (the “CRA”).  Overturning the 2022 Rule using the CRA would prevent the DOL from issuing a new rule in substantially the same form as the disapproved rule, unless specifically authorized by a subsequent law.  On February 28, 2023, the House passed a resolution nullifying the 2022 Rule and, on March 1, 2023, the Senate passed the same in a narrow 50-46 vote.  On March 20, 2023, President Biden issued a veto on the resolution—the first in his presidency. At this time, it appears unlikely that Congress will reach the two-thirds majority needed in both chambers in order to override the veto.

Gibson Dunn will continue to monitor the broader legal and regulatory landscape surrounding the 2022 Rule, the role of ESG factors, and the impact of these initiatives on plan fiduciaries, financial institutions, and other asset managers.

IV. Developments for Health Plans

ERISA-governed health benefit plans remain an active source of litigation.  Although determining whether a particular plan covers a particular treatment for a particular beneficiary often requires individualized determinations that may be better suited for resolution in an individual action, beneficiaries and treatment providers have continued to innovate to identify novel strategies for litigating coverage disputes en masse, either through class actions or through actions by providers representing multiple patients.  These strategies have met mixed results this year, with courts rejecting novel “reprocessing” class actions in Wit v. United Behavioral Health, 58 F.4th 1080 (9th Cir. 2023), and Berceanu v. UMR, Inc., 2023 WL 1927693 (W.D. Wis. Feb. 10, 2023), while allowing a novel trade libel claim to proceed in Conformis, Inc. v. Aetna, Inc., 58 F.4th 517 (1st Cir. 2023).  In addition, litigation challenging the Biden administration’s regulations implementing the No Surprises Act is likely to have significance consequences for ERISA health plans and their administrations.

A. Courts Limit Novel ERISA Class Actions Seeking “Reprocessing” of Denied Coverage Requests

In two recent and significant decisions, courts rejected attempts by plaintiffs to challenge benefits denials through a “reprocessing” class action—a strategy that gained steam over the past years as a way to challenge ERISA benefits decisions on a class-wide basis.  Gibson Dunn represented the defendants in both cases rejecting this approach.

In Wit v. United Behavioral Health, the Ninth Circuit rejected a facial challenge to guidelines used to make medical necessity determinations for thousands of different health plans, through which plaintiffs sought “reprocessing” of denied coverage requests rather than seeking to recover benefits, as a way to avoid individualized medical necessity and other issues.  See 58 F.4th 1080, 1093 (9th Cir. 2023).

The plaintiffs in Wit were beneficiaries of a number of ERISA-governed health benefit plans who filed suit on behalf of three putative classes, representing nearly 70,000 coverage determinations under as many as 3,000 different plans.  58 F.4th at 1088.  Defendant United Behavioral Health (“UBH”) acted as the claims administrator for these plans, and for a subset of plans, also as the insurer.  Id.  The plaintiffs had all submitted coverage requests that UBH denied after applying certain “Guidelines” that UBH had developed to implement the governing plans’ coverage criteria—including, among other things, a requirement that treatment be consistent with generally accepted standards of care (“GASC”), and that treatment not fall into other exclusions from coverage.  See id. at 1088–89.  The plaintiffs alleged that UBH breached fiduciary duties and improperly denied benefits by applying Guidelines more restrictive than GASC.  Id. at 1089.  To evade individualized fact questions that otherwise would have precluded class certification, the plaintiffs framed the relevant injury as the use of an unfair “process,” and disclaimed any attempt to prove that the use of that Guidelines-based process actually caused the improper denial of benefits—seeking instead only “reprocessing” under new Guidelines as relief.  See id.

Over the course of several years, the district court certified the plaintiffs’ requested class, held a bench trial, and entered judgment for the plaintiffs.  58 F.4th at 1090–91.  The court concluded that UBH had violated ERISA by employing Guidelines that impermissibly deviated from GASC, and it ordered both prospective injunctive relief for up to ten years—requiring the use of new Guidelines in the future—and “reprocessing” of class members’ tens of thousands of past claims under those new Guidelines.  Id.

The Ninth Circuit reversed in large part.  It held first that the district court erred in certifying claims seeking “reprocessing,” because that “reprocessing” is not a remedy available under either of the provisions of ERISA on which the plaintiffs relied—29 U.S.C. §§ 1132(a)(1)(B) and 1132(a)(3).   See 58 F.4th at 1094.  Section 1132(a)(1)(B) allows a plan beneficiary to recover benefits due under an ERISA plan or enforce or clarify his or her rights under the plan.  Id.  The panel held that the plaintiffs’ request for “reprocessing,” by contrast, is not a remedy in itself, but merely a “means to” another remedy—the recovery of benefits.  Id.  at 1095.  As a result, “[a] plaintiff asserting a claim for denial of benefits must therefore show that she may be entitled to a positive benefits determination if outstanding factual determinations were resolved in her favor.”  Id.  By certifying the class without requiring such a showing, the district court impermissibly used Rule 23 to enlarge or modify the plaintiffs’ substantive rights, in violation of the Rules Enabling Act, 28 U.S.C. § 2072(b).  Id.  Plaintiffs’ requested “reprocessing” also fell outside the scope of § 1132(a)(3), which provides a cause of action for “‘appropriate equitable relief’”—meaning the type of “relief that, traditionally speaking (i.e., prior to the merger of law and equity) were typically available in equity.”  Id. (internal citations omitted) (emphasis in original).  The panel explained that plaintiffs offered no basis for concluding that reprocessing was relief “typically” available in equity.  Id.

The panel also rejected on the merits the plaintiffs’ principal challenge to UBH’s guidelines, concluding that nothing in the applicable plans required UBH to adopt guidelines that conformed to GASC.  58 F.4th at 1096–97.  Although the plans each excluded coverage for treatment inconsistent with GASC, they did not thereby “compel UBH to cover all treatment that is consistent with GASC.”  Id. at 1097.

Finally, the Ninth Circuit held that, contrary to the district court’s ruling, absent class members cannot be excused from complying with the Plans’ administrative exhaustion requirements.  58 F.4th at 1097.  The Ninth Circuit explained that when an ERISA plan specifies that plan beneficiaries must exhaust administrative remedies before seeking relief in Court, courts are required to enforce those contractual requirements, and cannot create judicial exceptions to compliance.  See id. at 1098.

Following closely on the heels of Wit, the United States District Court for the District of Wisconsin reached a similar outcome in Berceanu. v. UMR, Inc., 2023 WL 1927693 (W.D. Wis. Feb. 10, 2023)—a case brought by the same plaintiffs’ firm challenging the same set of medical necessity guidelines at issue in Wit, which the defendant in Berceanu, UMR, borrowed from its affiliate, UBH.  In Berceanu, the court decertified the class action, holding that individualized issues of Article III standing—i.e., redressability—precluded class treatment of the plaintiffs’ claims for reprocessing.   2023 WL 19272693, at *9.  Specifically, determining whether class members would benefit from a reprocessing would “require an individual, fact intensive inquiry” and will “vary substantially among class members.”  Id.  At base, the court noted that “an order requiring UMR to reprocess plaintiffs’ and all class members’ rejected claims would result in UMR engaging in a major undertaking with no potential for an actual, concrete benefit to plaintiffs or the class members.”  Id.  The court then granted summary judgment in favor of UMR as to the named plaintiffs, echoing the Wit panel’s conclusion that the challenged guidelines used by UMR need not “track” GASC.  Id. at *11–13.  And even if tracking those guidelines were required, the court concluded that the plaintiffs had not presented any evidence that UMR’s guidelines were inconsistent with GASC.  See id. at *12.  Notably, in conducting this analysis, the court explained that its review of UMR’s guidelines was limited to the administrative record considered by UMR in denying the claims.  See id. at *10–11.

The Ninth Circuit’s decision in Wit and the district court’s decision in Berceanu reaffirmed traditional limitations on class actions imposed by ERISA, the Rules Enabling Act, and Rule 23, which together preclude the novel facial challenges advanced by the plaintiffs in those cases.  As a result, neither UBH nor UMR will be required to reprocess claims for behavioral health services from participants in employee health plans.

B. First Circuit Rescues Libel Suit by Device Manufacturer

Plaintiffs’ efforts to litigate coverage issues en masse fared better in Conformis, Inc. v. Aetna, Inc., 58 F.4th 517 (1st Cir. 2023).  There, Aetna—a claims administrator and health insurance provider for ERISA health plans—denied coverage for customized knee implants manufactured by Conformis, after recharacterizing the implants as “experimental and investigational.” See id. at 526–27. Aetna does not cover or reimburse claims for “experimental or investigational” treatments expect in special circumstances.  Id. at 526.  Conformis brought claims challenging the “experimental and investigational” determination under both ERISA and state law claims for tortious interference with a contractual/business relationship and trade libel, but the district court dismissed the ERISA claims for lack of standing.  See Conformis, Inc. v. Aetna, Inc., No. 20-CV-10890, 2021 WL 1210293, at *5 (D. Mass. Mar. 31, 2021).  At trial, Conformis sought to establish standing under ERISA based on the assignment of claims by a recipient of a Conformis implant who was denied coverage under his Aetna health benefits plan.  Id. at *3.  However, the district court dismissed Conformis’s ERISA claims, determining that anti-assignment provisions in the health benefits plan barred the assignment.  Id. at *4–5.  The district court also dismissed Conformis’s state law claims for failure to state a claim under state law.  Id. at *9­–10.

On appeal, the First Circuit rescued Conformis’s trade libel claims, reasoning that Aetna’s revised policy referring to knee implants as “experimental and investigational” plausibly targeted Conformis because the background section to the policy specifically mentioned Conformis’s product.  Conformis, Inc., 58 F.4th at 529.  Further, the panel held that “Conformis plausibly allege[d] that Aetna ignored credible evidence presented to it that called its statement into serious question . . . [a]nd Aetna’s abrupt change in policy, without any explanation . . . form[ed] the basis for a plausible inference that Aetna” knew the assertion was false.  Id. at 536.

The decision thus allows Conformis to use state law—rather than ERISA—to challenge Aetna’s determination that Conformis’s implants constitute “experimental and investigational” treatments.  Under ERISA, a claim administrator’s determination that a particular treatment is experimental is typically a function of plan administration (and thus subject to ERISA preemption) and, in applying ERISA’s rules for such claims, reviewed under a deferential abuse of discretion standard when the plan has conferred discretion on the administrator to make medical determinations.  See Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 102 (1989).

Potential plaintiffs, such as manufacturers and providers, may attempt to exploit this decision as a way around ERISA, so benefit plans and their administrators will want to track this case closely to see how the law continues to develop in this area.

C. Court Strikes Agency Rules Limiting ERISA Arbitrators’ Discretion to Resolve Payment Disputes

A recent decision regarding the Biden Administration’s implementing of the No Surprises Act, Pub. L. No. 116-260, 134 Stat. 2758 (2021), is also likely to have significant implications for ERISA health plans.  A federal district court in Texas vacated new agency regulations issued under the Act that attempted to limit patient’s healthcare costs by providing an arbitration process to address payment amounts for certain services.

The No Surprises Act responds to concerns that patients sometimes face expensive and unexpected bills for emergency or ancillary services from out-of-network providers, called “surprise bills.”  The Act, which took effect on January 1, 2022, targets surprise billing by limiting patients’ costs for most surprise out-of-network services to the in-network cost-sharing amount prescribed by the patient’s insurance.  The Act requires insurers and group health plans (including ERISA plans) to calculate patient cost-sharing for these services at the in-network rate, and to make an “initial payment” to the provider.  29 U.S.C. §§ 1185e(a)(1), (b)(1).  An out-of-network provider unsatisfied with this initial payment can initiate an arbitration process outlined in the statute.  Id. § 1185e(c)(2).  The Act applies to both self-insured and fully-insured health plans, but defers to state laws that already govern the amounts that fully-insured plans must pay providers for surprise out-of-network services.

The arbitration process begins with 30 days of open negotiation; if no agreement is reached, each party submits a final payment offer and the arbitrator chooses the most reasonable offer.  29 U.S.C. § 1185e(c)(1)–(2).  The statute lists factors for arbitrators to consider in making this decision, including: (1) the qualifying payment amount (“QPA”), typically equivalent to the insurer’s median in-network rate for similar services in the geographic region as of 2019 (adjusted for inflation); (2) the parties’ recent contracted rates and good-faith efforts to reach a network agreement; (3) the parties’ market shares; (4) patient acuity; and (5) the quality and scope of services offered by the provider or facility.  Id. § 1185e(c)(5)(C).

In an effort to keep patients’ healthcare costs down, the Departments of Health and Human Services, Labor, and Treasury (the “Departments”) issued regulations interpreting the scope of arbitrators’ discretion in choosing a payment amount.  Several of those regulations focused on the QPA factor.

In September 2021, the Departments issued an interim rule that imposed a “rebuttable presumption” in favor of the offer closest to the QPA.  Healthcare providers challenged this rule, and in February 2022, a Texas federal district court struck it down, holding that it improperly “place[d] its thumb on the scale for the QPA” and “impos[ed] a heightened burden on the remaining statutory factors.”  Texas Med. Ass’n v. U.S. Dep’t of Health & Hum. Servs., 587 F. Supp. 3d 528, 542 (E.D. Tex. 2022) (“TMA 1”).  Later that year, another plaintiff successfully challenged a parallel interim rule that applied to air ambulance service providers.  Lifenet, Inc. v. U.S. Dep’t of Health and Human Servs., No. 6:22-CV-162, 2022 WL 2959715 (E.D. Tex., July 26, 2022); see also 29 C.F.R. § 2590.717-2(b)(3).

The Departments then revised the interim rule and in August 2022 issued a final rule, which replaced the express rebuttable presumption in favor of the QPA with a provision instructing arbitrators to begin with the QPA and “then consider” other non-QPA factors.  29 C.F.R. § 2590.716-8(c)(4)(iii).  The final rule required arbitrators to assess the “credibility” of the non-QPA information before applying it, and prohibited them from “giv[ing] weight” to factors “already accounted for by the QPA.”  Id. § 2590.716-8(c)(4)(iii)(E).  Healthcare providers once again challenged the rule, arguing that it improperly limited arbitrators’ discretion “by making QPA ‘the de facto benchmark for out-of-network reimbursement.’”  Texas Med. Ass’n v. U.S. Dep’t of Health & Hum. Servs., No. 6:22-CV-372, 2023 WL 1781801, at *6–7 (E.D. Tex. Feb. 6, 2023) (“TMA II”).

The court agreed with the plaintiffs, holding that the No Surprises Act “plainly requires arbitrators to consider all the specified information in determining which offer to select” without “weigh[ing] any one factor or circumstance more heavily than the others.”  TMA II, 2023 WL 1781801, at *22–23.  Because the Act’s dispute-resolution process is carried out by independent arbiters, not the agencies themselves, the Departments’ interpretations of the evidentiary rules governing the process were not entitled to any special deference.  Id. at *25–26.  And the record in TMA II indicated that the Departments’ express goal in implementing the rule was “to keep [healthcare] costs down,” improperly “tilting arbitrations in favor of insurers.”  Id. at *27–28.  Because the Department’s rule conflicted with the No Surprises Act (and thereby violated the Administrative Procedure Act), the court vacated and remanded the rules.  As of the publication of this newsletter, the time to appeal this decision has not yet expired, so it remains to be seen how the Biden Administration will respond.

V. Issues on the Horizon

The world of ERISA litigation will continue to evolve in 2023 and beyond.  Among other emerging trends, fiduciaries should be aware of a recent uptick in suits (1) seeking to leverage ERISA fiduciary standards to seek redress for data security and privacy issues, and (2) claiming that fiduciaries acted imprudently in selecting popular, low-fee target-date investments that allegedly underperformed other similar alternatives.

A good example of the recent spate of cybersecurity suits is Disberry v. Employee Relations Committee of the Colgate-Palmolive Co., No. 22-5778, — F. Supp. 3d —-, 2022 WL 17807122 (S.D.N.Y. Dec. 19, 2022).  There, a former Colgate-Palmolive employee filed suit against Colgate’s Employee Relations Committee, a Colgate plan trustee, and another firm providing services to the plan after a fraudster allegedly stole assets from her company retirement account.  Disberry alleges that the defendants breached their ERISA fiduciary duties by allowing her retirement funds to be distributed to a third party who allegedly stole her identity, despite red flags that should have altered them to the fraud.  The court dismissed the trustee from the case in a December 2022 opinion, but it allowed the claims against the other defendants to go forward.  See Disberry, 2022 WL 17807122 at *11­­­–12 (S.D.N.Y. Dec. 19, 2022).  While courts have not yet defined the bounds of potential ERISA fiduciary liability in the cybersecurity context, the issue deserves close attention as cybersecurity threats continue to rise.

As to target-date funds, a single law firm has brought a series of suits against fiduciaries of defined contribution retirement plans offering participants the option to invest in BlackRock Target Date Funds.  The BlackRock funds at issue are examples of popular and widespread investments tied to mutual fund indices that adjust the risk/reward strategy of underlying investments relative to a selected “target” retirement date.  Unlike the excessive fee suits discussed in Section I.A, supra, plaintiffs in these suits allege that the defendants violated their fiduciary duties in offering the BlackRock Target Date Funds because the funds allegedly underperformed relative to other target date fund suites available in the marketplace for a period of time during their relatively long (sometimes decades long) investment horizon.  While several of the BlackRock suits have been dismissed, this departure from the usual “excessive fees” playbook warrants close attention, as a ruling against the fiduciaries could raise the specter of liability for selecting a popular and low-fee fund based on that fund’s subsequent performance during a narrow, selected time span.

---

The following Gibson Dunn lawyers assisted in the preparation of this alert: Karl G. Nelson, Heather Richardson, Geoffrey Sigler, Katherine V.A. Smith, Matthew Rozen, Jennafer Tryck, Alex Bruhn, Max E. Schulman, Claire Piepenburg, Zachary Copeland, Tessa Gellerson, Andrew Gorin, Michelle Lou, Beshoy Shokralla*, and Samuel Speers.

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, or any of the following:

Karl G. Nelson – Dallas (+1 214-698-3203, knelson@gibsondunn.com)
Geoffrey Sigler – Washington, D.C. (+1 202-887-3752, gsigler@gibsondunn.com)
Katherine V.A. Smith – Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)
Heather L. Richardson – Los Angeles (+1 213-229-7409,hrichardson@gibsondunn.com)
Matthew S. Rozen – Washington, D.C. (+1 202-887-3596, mrozen@gibsondunn.com)
Jennafer M. Tryck – Orange County (+1 949-451-4089, jtryck@gibsondunn.com)

*Beshoy Shokralla is an associate working in the firm’s New York office who is not yet admitted to practice law.

© 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.