Over the course of December 2019, Gibson Dunn published its “Current Guide to Direct Listings” and “An Interim Update on Direct Listing Rules” discussing, among other things, the direct listing as an evolving pathway to the public capital markets and the U.S. Securities and Exchange Commission’s (SEC) rejection of a proposal by the New York Stock Exchange (NYSE) to permit a privately held company to conduct a direct listing in connection with a primary offering, respectively.

The NYSE continued to revise its proposal in consultation with the SEC and, on August 26, 2020, the SEC approved an amendment to the NYSE’s proposal that will permit primary offerings in connection with direct listings. The August 26 order, which would have become effective 30 days after being published in the Federal Register, was stayed by the SEC on September 1, 2020 in response to a notice from the Council of Institutional Investors (CII) that it intended to file a petition for the SEC to review the SEC’s approval. On December 22, 2020, the SEC issued its final approval of the NYSE’s proposed rules. Consequently, Gibson Dunn has updated and republished its Current Guide to Direct Listings to reflect today’s landscape, including an overview of certain issues to monitor as direct listing practice evolves included as Appendix I hereto.

Direct Listings: An evolving pathway to the public capital markets.

Direct listings have increasingly been gaining attention as a means for a private company to go public. A direct listing refers to the listing of a privately held company’s stock for trading on a national stock exchange (either the NYSE or Nasdaq) without conducting an underwritten offering, spin-off or transfer quotation from another regulated stock exchange. Under historical stock exchange rules, direct listings involve the registration of a secondary offering of a company’s shares on a registration statement on Form S-1 or other applicable registration form publicly filed with, and declared effective by, the Securities and Exchange Commission, or the SEC, at least 15 days in advance of launch—referred to as a Selling Shareholder Direct Listing.[1] Existing shareholders, such as employees and early stage investors, whose shares are registered for resale or that may be resold under Rule 144 under the Securities Act, are able to sell their shares on the applicable exchange, but are not obligated to do so, providing flexibility and value to such shareholders by creating a public market and liquidity for the company’s stock. Historically, companies were not permitted to raise fresh capital as part of the direct listing process. On December 22, 2020, however, the SEC issued its final approval of rules proposed by the NYSE that permit a primary offering along with, or in lieu of, a direct secondary listing—referred to as a Primary Direct Floor Listing.[2] Upon listing of the company’s stock, the company becomes subject to the reporting and governance requirements applicable to publicly traded companies, including periodic reporting requirements under the Securities Exchange Act of 1934, as amended (the Exchange Act), and governance requirements of the applicable exchange.

Companies may pursue a direct listing to provide liquidity and a broader trading market for their shareholders; however, the listing company can also benefit even if not raising capital in a Primary Direct Floor Listing. A direct listing, whether a Primary Direct Floor Listing or a Selling Shareholder Direct Listing, will provide a company with many of the benefits of a traditional IPO, including access to the public markets for capital raising and the ability to use publicly traded equity as an acquisition currency.

Advantages of a direct listing as compared to an IPO.

Immediate Benefits to Existing Shareholders.

In both a Selling Shareholder Direct Listing and Primary Direct Floor Listing, all selling shareholders whose shares are registered on the applicable registration statement or whose shares are eligible for resale under Rule 144 will have the opportunity to participate in the first day of trading of the company’s stock. Shareholders who choose to sell are able to do so at market trading prices, rather than only at the initial price to the public set in an IPO. The ability to sell at market prices on the first day of a listing can be a significant benefit to existing shareholders who elect to sell. However, this benefit assumes there is sufficient market demand for the shares offered for resale.

Potentially Wider Initial Market Participation.

The traditional IPO process includes a focused set of participants, and institutional buyers tend to feature prominently in the initial allocation of shares to be sold by the underwriting syndicate. Direct listings offer access to a wider group of investors, as any investor may place orders through its broker. In a Selling Shareholder Direct Listing, any prospective purchasers of shares are able to place orders with their broker-dealer of choice, at whatever price they believe is appropriate, and such orders become part of the initial-reference, price-setting process. The price-setting mechanisms applicable to Primary Direct Floor Listings differ in material respects from the practice that has developed with respect to Selling Shareholder Direct Listings. In a Primary Direct Floor Listing, prospective purchasers of shares are able to place orders with their broker-dealer of choice at whatever price they believe is appropriate, but will have priority for purchases at the minimum offering price specified in the related prospectus.

Flexibility in Marketing.

IPO marketing has become more flexible since the introduction of rules providing for “testing-the-waters” communications by Emerging Growth Companies and, starting December 3, 2019, all companies.[3] However, a direct listing allows a company to avoid the rigidity of the traditional roadshow conducted for a specified period of time following the publicly announced launch of an IPO and allows it to tailor marketing activities to the specific considerations underlying the direct listing. For instance, the traditional roadshow has been replaced in some direct listings by an investor day whereby the company invites investors to learn about the company one-to-many, such as via a webcast, which can be considered more democratic as all investors have access to the same educational materials at once. Marketing efforts may include one or more of these investor days and a roadshow-like presentation, conducted at times deemed most advantageous (although the applicable registration statement must still be publicly filed for at least 15 days in advance of any such marketing efforts). Although the approximate timing of the direct listing can be inferred from the status of the publicly filed registration statement, the company may have more flexibility as to the day its shares commence trading on the applicable stock exchange.

Brand Visibility.

As direct listings are still a relatively novel concept in U.S. capital markets, any direct listing with moderate success, in particular a direct listing involving a primary capital raise, will likely draw broad interest from market participants and relevant media. This effect is multiplied when the listing company has a well-recognized brand name.

No Underwriting Fees.

A direct listing can save money by allowing companies to avoid underwriting discounts and commissions on the shares sold in the IPO. In direct listings to date, the companies have engaged financial advisers to assist with the positioning of the company and the preparation of the registration statement. Such financial advisors have been paid significant fees, though substantially less than traditional IPO underwriting discounts and commissions. This may marginally decrease a company’s cost of capital, although the company will still incur significant fees to market makers or specialists, independent valuation agents, auditors and legal counsel.

More Flexible Lockup Agreements.

In most direct listings to date, existing management and significant shareholders are not typically subject to the restrictions imposed by 180-day lockup agreements standard in IPOs. Notwithstanding, as practice evolves, practice may vary from transaction to transaction. For example, Spotify’s largest non-management shareholder was subject to a lockup and Palantir’s directors and executive officers were subject to a lockup period. We expect that lockup arrangements in direct listings will continue to be more tailored to the particular company’s circumstances than in traditional IPOs.

Certain issues to consider before choosing a direct listing.

Establishing a Price Range or Initial Reference Price.

No marketing efforts are permissible without a compliant preliminary prospectus on file with the SEC, and such prospectus must include an estimated price range. In a traditional IPO and Primary Direct Floor Listing, the cover page of the preliminary prospectus contains a price range of the anticipated initial sale price of the shares. In a Selling Shareholder Direct Listing, the current market practice is to describe how the initial reference price is derived (e.g., by buy-and-sell orders collected by the applicable exchange from various broker-dealers). These buy-and-sell orders have in the past been largely determined with reference to high and low sales prices per share in recent private transactions of the subject company. In cases where a company does not have such transactions to reference, additional information will be necessary to educate and assist investors and help establish an initial bid price. In addition, the listing company in a direct listing may elect to increase the period between the effectiveness of its registration statement and its first day of trading, thereby allowing time for additional buy-and-sell orders to be placed. In either case, the financial advisor to the company will play an important role in establishing a price range or initial reference price, as applicable.

Financial Advisors and Their Independence.

In a Selling Shareholder Direct Listing, the rules of both the NYSE and Nasdaq require that the listing company appoint a financial advisor to provide an independent valuation of the listing company’s “publicly held” shares and, in practice, assist the applicable exchange’s market maker or specialists, as applicable, in setting a price range or initial reference price, as applicable. In past direct listings, in particular those involving the NYSE, the financial advisor that served this role was not the financial advisor the listing company engaged to advise generally, including to assist the company define objectives for the listing, position the equity story of the company, advise on the registration statement, assist in preparing presentations and other public communications and help establish a firm price range in a Primary Direct Floor Listing. As reviewed in detail below, the financial advisor that values the “publicly held” shares and assists the applicable exchange’s market maker or specialists, as applicable, must be independent, which under the relevant rules disqualifies any broker-dealer that has provided investment banking services to the listing company within the 12 months preceding the date of the valuation.

Shares to be Registered.

In a direct listing, in addition to new shares being issued in connection with a Primary Direct Floor Listing, a company generally registers for resale all of its outstanding common equity which cannot then be sold pursuant to an applicable exemption from registration (such as Rule 144), including those subject to registration rights obligations. The company may also register shares held by affiliates and non-affiliates who have held the shares for less than one year or otherwise did not meet the requirements for transactions without restriction under Rule 144.[4] Companies may also register shares held by employees to address any regulatory concerns that resales of shares by employees occurring around the time of the direct listing may not have been entitled to an exemption from registration under the Securities Act. All shares subject to registration may be freely resold pursuant to the registration statement only as long as the registration statement remains effective and current. The company will typically bear the related costs.

Direct Listing-Specific Risks.

Traditional IPOs offer certain advantages that are not currently present in direct listings. Going public without the structure of an IPO process is not without risk, such as the need to obtain research coverage in the absence of an underwriting syndicate that has research analysts or the need to educate investors on the company’s business model. Any company considering a direct listing should contemplate whether its investor relations apparatus is capable of playing an outsized role in coordinating marketing efforts and outreach to potential investors, both in connection with the listing and after the transaction. Notably, in a Selling Shareholder Direct Listing, the listing company’s management plays no role in setting the initial reference price, and certain market-making activities conducted by the underwriting syndicate may be unavailable. In a Primary Direct Floor Listing, the listing company’s management may play an outsized role in determining an initial price range. Either scenario may present unacceptable risk for companies that may otherwise be poised to undertake a direct listing.

The NYSE and Nasdaq rules applicable to a direct listing.

Background.

The direct listing rules of both the NYSE[5] and Nasdaq Global Select Market[6] are substantially similar and are structured as an exception to each exchange’s requirement concerning the aggregate market value of the company to be listed. Prior to the direct listing rules, companies that did not previously have their common equity registered under the Exchange Act were required to show an aggregate market value of “publicly held” shares in excess of $100 million ($110 million for Nasdaq Global Select Market, under certain circumstances), such market value being established by both an independent third-party valuation and recent trading prices in a trading market for unregistered securities (commonly referred to as the Private Placement Market).

“Publicly held” shares include those held by persons other than directors, officers and presumed affiliates (shareholders holding in excess of 10%). The Private Placement Market includes trading platforms operated by any national securities exchange or registered broker-dealers. Generally, in a direct listing, the relevant company either (i) does not have its shares traded on a Private Placement Market prior its listing or (ii) underlying trading in the Private Placement Market is not sufficient to provide a reasonable basis for reaching conclusions about a company’s trading price.

Direct Listings on Secondary Markets.

Nasdaq rules permit direct listings onto the Nasdaq Global Market and Nasdaq Capital Market, the second- and third-tier Nasdaq markets, respectively.[7] If the company to be listed on a secondary market does not have recent sustained trading activity in a Private Placement Market, and thereby must rely on an independent third-party valuation consistent with the rules described above, such calculation must reflect a (i) tentative initial bid price, (ii) market value of listed securities and (iii) market value of publicly held shares that each exceed 200 percent of the otherwise applicable requirements.

Requirements for a Direct Listing.

The direct listing rules discussed above were intended to provide relief for privately held “unicorns,” or companies that are otherwise sufficiently capitalized and which do not need to raise money. Each exchange’s listing standards applicable to direct listings by U.S. companies are summarized, by relevant exchange, in the table that follows:

Overview of Listing Standards Applicable to Direct Listings

	NYSE (Selling Shareholder Direct Listing)	NYSE (Primary Direct Floor Listing)	Nasdaq Global Select Market	Nasdaq Global Market	Nasdaq Capital Market
Market Value of Publicly Held Shares (i.e., held by persons other than directors, officers and presumed affiliates)	The listing company must have a recent valuation from an independent third party indicating at least $250 million in aggregate market value of publicly held shares. (Rule 102.01A(E))[8]	The listing company (i) must sell at least $100 million of shares in the opening auction or (ii) show that the aggregate market value of shares sold in the opening auction, together with publicly held shares, exceeds $250 million, in each case with market value calculated using the lowest price per share set forth in the related prospectus.	The listing company must have a recent valuation from an independent third party indicating at least $250 million in aggregate market value of publicly held shares. (Rule IM-5315-1(b))9	The listing company must have a recent valuation[9] from an independent third party indicating in excess of $16 million to $40 million in aggregate market value of publicly held shares, depending on the financial standard met below. (Rule 5405)	The listing company must have a recent valuation10 from an independent third party indicating in excess of $10 million to $30 million in aggregate market value of publicly held shares, depending on the financial standard met below. (Rule 5505)
Financial Standards	The listing company is required to meet one of the following applicable financial standards: (i) Each of (a) aggregate adjusted pre-tax income for the last three fiscal years in excess of $10 million, (b) with at least $2 million in each of the two most recent fiscal years and (c) positive income in each of the last three fiscal years (the “NYSE Earnings Test”). (ii) Global market capitalization of $200 million (the “Global Market Capitalization Test”).	Same as the NYSE (Selling Shareholder)	The listing company is required to meet one of the following applicable financial standards: (i) Each of (a) aggregate adjusted pre-tax income for the last three fiscal years in excess of $11 million, (b) with at least $2.2 million in each of the two most recent fiscal years and (c) positive income in each of the last three fiscal years (the “Nasdaq Earnings Standard”). (ii) Each of (a) average market capitalization in excess of $550 million over the prior 12 months, (b) $110 million in revenue for the previous fiscal year and (c) aggregate cash flows for the last three fiscal years in excess of $27.5 million and positive cash flows for each of the last three fiscal years (the “Capitalization with Cash Flow Standard”). (iii) Each of (a) average market capitalization in excess of $850 million over the prior 12 months and (b) $90 million in revenue for the previous fiscal year (the “Capitalization with Revenue Standard”). (iv) Each of (a) market capitalization in excess of $160 million, (b) total assets in excess of $80 million, and (c) stockholders’ equity in excess of $55 million (the “Assets with Equity Standard”).	The listing company is required to meet one of the following applicable financial standards: (i) Each of (a) aggregate adjusted pre-tax income in excess of $1 million in the latest fiscal year or in two of the last three fiscal years and (b) Stockholders’ equity in excess of $15 million. (ii) Each of (a) Stockholders’ equity in excess of $30 million and (b) two years of operating history. (iii) Market value of listed securities in excess of $150 million. (iv) Total assets and total revenue in excess of $75 million in the latest fiscal year or in two of the last three fiscal years.	The listing company is required to meet one of the following applicable financial standards: (i) Each of (a) Stockholders’ equity in excess of $15 million and (b) two years of operating history. (ii) Each of (a) Stockholders’ equity in excess of $4 million and (b) market value of listed securities in excess of $100 million. (iii) Total assets and total revenue in excess of $75 million in the latest fiscal year or in two of the last three fiscal years.
Distribution Standards	The listing company must meet all of the following distribution standards: (i) 400 round lot shareholders; (ii) 1.1 million publicly held shares; and (iii) Minimum initial reference price of $4.00.	Same as the NYSE (Selling Shareholder)	The listing company must meet all of the following liquidity requirements: (i) 450 round lot shareholders or 2,200 total shareholders; (ii) 1.25 million publicly held shares; and (iii) Minimum initial reference price of $4.00.	The listing company must meet all of the following distribution standards: (i) 400 round lot shareholders; (ii) 1.1 million publicly held shares; and (iii) Minimum initial reference price of $8.00.	The listing company must meet all of the following liquidity requirements: (i) 300 round lot shareholders; (ii) 1 million publicly held shares; and (iii) Minimum initial reference price of $8.00 OR closing price of $6.00.[10]
Engagement of Financial Advisor	Any valuation used in connection with a direct listing must be provided by an entity that has significant experience and demonstrable competence in the provision of such valuations. (Rule 102.01A(E)) A valuation agent will not be deemed to be independent if (Rule 102.01A(E)): (i) At the time it provides such valuation, the valuation agent or any affiliated person or persons beneficially own in the aggregate, as of the date of the valuation, more than 5% of the class of securities to be listed, including any right to receive any such securities exercisable within 60 days. (ii) The valuation agent or any affiliated entity has provided any investment banking services to the listing applicant within the 12 months preceding the date of the valuation. For purposes of this provision, “investment banking services” include, without limitation, acting as an underwriter in an offering for the issuer; acting as a financial adviser in a merger or acquisition; providing venture capital, equity lines of credit, PIPEs (private investment, public equity transactions), or similar investments; serving as placement agent for the issuer; or acting as a member of a selling group in a securities underwriting. (iii) The valuation agent or any affiliated entity has been engaged to provide investment banking services to the listing applicant in connection with the proposed listing or any related financings or other related transactions.	Not required in connection with a Primary Direct Floor Listings as the related prospectus is required to include a price range within which the company anticipates selling the shares it is offering.	Any valuation used in connection with a direct listing must be provided by an entity that has significant experience and demonstrable competence in the provision of such valuations. (Rule IM-5315-1(e)) A valuation agent shall not be considered independent if (Rule IM-5315-1(f)): (i) At the time it provides such valuation, the valuation agent or any affiliated person or persons beneficially own in the aggregate, as of the date of the valuation, more than 5% of the class of securities to be listed, including any right to receive any such securities exercisable within 60 days. (ii) The valuation agent or any affiliated entity has provided any investment banking services to the listing applicant within the 12 months preceding the date of the valuation. For purposes of this provision, “investment banking services” include, without limitation, acting as an underwriter in an offering for the issuer; acting as a financial adviser in a merger or acquisition; providing venture capital, equity lines of credit, PIPEs (private investment, public equity transactions), or similar investments; serving as placement agent for the issuer; or acting as a member of a selling group in a securities underwriting. (iii) The valuation agent or any affiliated entity has been engaged to provide investment banking services to the listing applicant in connection with the proposed listing or any related financings or other related transactions.	Same as the Nasdaq Global Select Market	Same as the Nasdaq Global Select Market

Upon satisfaction of the above requirements of the applicable exchange, the exchange will generally file a certification with the SEC, confirming that its requirements have been met by the listing company. After such filing, the company’s registration statement may be declared effective by the SEC (assuming the SEC review has run its course). In practice, the SEC has reviewed registration statements that contemplate a direct listing in substantially the same manner it reviews traditional IPO registration statements, with some additional focus on process as direct listing practice and the related rules evolve. After the registration statement is declared effective by the SEC, the company becomes subject to the governance requirements of the applicable exchange (subject to compliance periods) and the reporting requirements under the Exchange Act. The company may then establish the day its equity will commence trading in consultation with the applicable exchange, which could be the same day as the SEC declares the registration statement effective, assuming, in the case of a Selling Shareholder Direct Listing, the exchange’s market maker or specialists, as applicable, and the financial advisor appointed by the company are able to determine an initial reference price.

NYSE’s recent rule changes: Primary capital raise via direct listing

Allowing companies to conduct their initial public offering outside of the traditional IPO format (i.e., an underwritten firm commitment) could potentially revolutionize the way in which companies go public. Historically, companies were not permitted to raise fresh capital as part of the direct listing process. On June 22, 2020, the NYSE filed a revised proposal with the SEC that would allow companies to publicly raise capital through a direct listing, which was approved by the SEC staff on August 26, 2020. The NYSE’s proposal, which would have become effective 30 days after being published in the Federal Register, was stayed by the SEC on September 1, 2020, after the Council of Institutional Investors (CII) made public its intention to file a petition for the SEC’s Commissioners to review the August 26 order approving the NYSE’s proposal. The grounds for CII’s Petition for Review of an Order are discussed below. On December 22, 2020, the SEC issued its final approval of the NYSE’s proposed rules. The NYSE’s rules, which we expect will become effective 30 days after being published in the Federal Register, will allow a company to sell shares on its own behalf, without underwriters, in addition to or in place of a secondary offering by shareholders.

Under the NYSE’s rules, companies hoping to conduct a primary offering while listing pursuant to the NYSE’s proposed rules will be required to either:

sell at least $100 million in the opening auction on the first day of listing, thereby ensuring that there will be at least $100 million in public float after the first trade; or
the aggregate market value of publicly held shares immediately prior to listing together with the market value of shares sold by the company in the opening auction totals at least $250 million, with such market value calculated using a price per share equal to the lowest price of the price range established in the related prospectus.

The NYSE previously proposed a “Distribution Standard Compliance Period” whereby, in a Primary Direct Floor Listing, the requirements to have 400 round lot shareholders and 1.1 million publicly held shares would be operative after a 90-day grace period. Under the proposal approved by the SEC, companies conducting a Primary Direct Floor Listing must meet these and all other initial listing requirements at the time of initial listing.

To facilitate Primary Direct Floor Listings, the NYSE’s proposal includes a new order type that would permit a Primary Direct Floor Listing to settle only if (i) the auction price would be within the price range specified by the company in its effective registration statement and (ii) all shares to be offered by the company can be sold within the specified price range, together with other technical revisions to the order process to enable and ensure compliance with the foregoing. Notably, the NYSE will create a new order type to be used by the issuer in a Primary Direct Floor Listing, referred to as an Issuer Direct Offering Order (“IDO Order”), which would be a limit order to sell that is to be traded only in a Primary Direct Floor Listing. The IDO Order would have the following requirements: (1) only one IDO Order may be entered on behalf of the issuer and only by one member organization; (2) the limit price of the IDO Order must be equal to the lowest price set forth in the applicable prospectus; (3) the IDO Order must be for the quantity of shares offered by the issuer, as disclosed in the prospectus in the effective registration statement; (4) the IDO Order may not be cancelled or modified; and (5) the IDO Order must be executed in full in the direct listing auction. The NYSE’s proposal also includes additional revisions to related definitions that are “intended to clarify the application of the existing rule and . . . not substantively change it.”

Nasdaq.

The Nasdaq Stock Market also has pending before the SEC a proposed rule change to allow primary-offering, direct listings in the context of Nasdaq’s own distinct market model, some of which require fewer record holders than the NYSE for direct listings. Additionally, on December 22, Nasdaq submitted a separate proposed rule change on this issue for which Nasdaq seeks immediate effectiveness without a prior public comment period. On December 23, the Staff of the Division of Trading and Markets of the SEC issued a public statement that “the Staff intends to work to expeditiously complete, as promptly as possible accommodating public comment, a review of these proposals, and as with all self-regulatory organizations’ proposed rule changes, will evaluate, among other things, whether they are consistent with the requirements of the Exchange Act and Commission rules.”

CII’s Objection & SEC Response

On August 31, 2020, the Council of Institutional Investors (CII) notified the SEC of its intention to file a petition for the SEC’s Commissioners to review the August 26 order approving the NYSE’s proposed rule change.[11] On September 8, 2020, CII filed its petition for review with the SEC, setting forth its principal criticism that liberalization of direct listing regulations in the face of current limitations on investors’ legal recourse for material misstatements and omissions is not consistent with Section 6(b)(5) of the Exchange Act,[12] which requires exchange rules be “designed . . . to protect investors and the public interest.” CII previously raised concerns that the NYSE proposal would not guarantee sufficient liquidity for a trading market in the securities to develop after the listing, but did not raise this concern in its petition for review.

Section 11 & Traceability Concerns.

Section 11 of the Securities Act of 1933 (Section 11) provides legal action against a wide range of corporate actors in connection with material misstatements or omissions contained in a registration statement, where a person acquires securities traceable to that registration statement in reliance on such misstatements or omissions. Under the precedent established in Barnes v. Osovsky,[13] a person bringing such a claim for material misstatements or omissions contained in a registration statement under Section 11 must generally show that either the securities they held were purchased at the time of their initial offering or that they were issued under the deficient registration statement and purchased at a later time in the secondary market, which is referred to in concept as traceability. As discussed above, in a direct listing, a company generally registers for resale all of its outstanding common equity that cannot then be sold pursuant to an applicable exemption from registration. Generally, holders of shares that are eligible for resale pursuant to an applicable exemption from registration may, simultaneous with shares sold under an effective registration statement, sell unregistered shares in transactions under Rule 144 or otherwise not subject to, or exempt from, registration under the Securities Act. As a result, shares available in the market upon a direct listing include both shares sold under the registration statement and shares sold pursuant to an exemption from registration (and therefore not under the registration statement). At a high level, shares sold pursuant to a registration statement may be subject to claims under Section 11 as well as under Rule 10b-5 under the Exchange Act (the general anti-fraud provisions of the Exchange Act), while shares sold otherwise than under a registration statement may be subject to claims only under Rule 10b-5. Due to differences in the standards of the two rules, and defenses available to the company or other defendants, it may generally be more difficult for a holder to make successful claims with respect to shares not sold pursuant to a registration statement.

As highlighted by CII in its petition, investor concerns about the traceability of shares sold in a direct listing were highlighted in a recent case of first impression concerning direct listings.[14] In that case, the listing company argued that a Section 11 claim could not be brought as the complaining investors could not distinguish between the shares sold under the registration statement and unregistered shares sold by an insider and were consequently unable to establish traceability. Although the district court in that case denied the motion to dismiss, appeal of the issue before the U.S. Court of Appeals for the Ninth Circuit is pending. The ultimate decision in the Ninth Circuit, which includes Silicon Valley, could play an outsized role in future cases.

In earlier commentary, the SEC noted that although the NYSE’s proposal did present a “recurring” Section 11 concern, as the issue was not “exclusive” to Primary Direct Floor Listings, approval of the NYSE’s proposal did not pose a “heighted risk to investors” (emphasis added). CII’s petition also raises certain proposals that it argues would alleviate investors’ burden in proving traceability, such as the introduction of blockchain-traceable shares, and should be addressed in advance of liberalizing direct listing rules to accommodate Primary Direct Floor Listings.

Final Approval.

On December 22, 2020, the SEC issued its final approval of the NYSE’s proposed rules, finding the NYSE’s proposal is consistent with the Exchange Act and the rules and regulations issued thereunder and, furthermore, that the proposed rules would “foster[] competition by providing an alternate method for companies of sufficient size [to] decide they would rather not conduct a firm commitment underwritten offering.” The SEC’s December 22 order discussed several procedural safeguards included by the NYSE in its proposed rules that were intended to “clarify the role of the issuer and financial advisor in a direct listing” and “explain how compliance with various rules and regulations” would be addressed. These changes include the introduction of an “IDO Order type,” the clarification of how market value would be determined in connection with primary direct listings and the agreement to retain FINRA to monitor compliance with Regulation M and other anti-manipulation provisions of federal securities laws.

Notably, the SEC’s December 22 order rejects the notion that offerings not involving a traditional underwriter would “‘rip off’ investors, reduce transparency, or involve reduced offering requirements or accounting methods,” finding that the relevant “traceability issues are not exclusive to nor necessarily inherent in” Primary Direct Floor Listings. In approving the NYSE’s proposal and reaching its conclusion that the NYSE’s proposal provided a “reasonable level of assurance” that the applicable market value threshold supports a public listing and the maintenance of fair and orderly markets, the SEC specifically noted that the applicable thresholds for the equity market value under the revised rules were at least two and a half times greater than the market value standard that exists for a traditional IPO ($40 million). The SEC order also positively discusses steps taken by the NYSE to ensure compliance by participants in the direct listing process with Regulation M and other provisions of the federal securities laws.

The two Commissioners who dissented (Allison Herren Lee and Caroline A. Crenshaw) and certain investor protection groups have issued statements expressing concern that, because of the absence of traditional underwriters, the primary direct listing process will lack a key gatekeeper present in traditional IPOs that helps prevent poorly run or fraudulent companies from going public. In its order approving the NYSE’s revised rules on Primary Direct Floor Listings, the SEC suggests that, depending on the facts and circumstances, a company’s independent financial adviser could be subject to Securities Act liability, or at least lawsuits alleging underwriter liability, in connection with direct listings. The two dissenting Commissioners, however, suggest that guidance as to what may trigger status as a statutory underwriter should have been considered and concurrently provided.

Conclusion

In any event, direct listings are a sign of the times. As U.S. companies raise increasingly large amounts of capital in the private markets, the public capital markets are responding to the need to provide a wider variety of means for a private company to enter the public capital markets and provide liquidity to existing shareholders. Although direct listings will undoubtedly provide new opportunities for entrepreneurial companies with a well-recognized brand name or easily understood business model, we do not expect direct listings to replace IPOs any time soon. Direct listing practice is evolving and involves new risks and speedbumps. There are a number of novel issues and open questions raised by the evolving direct listing landscape, some of which are highlighted in Appendix I hereto (Open Questions for Direct Listings). Regulatory divergence between the price-setting mechanisms applicable to Primary Direct Floor Listings and Selling Shareholder Direct Listings may spur further rulemaking to conform to applicable standards. Gibson Dunn will also continue to update this Current Guide to Direct Listings from time to time to further describe the applicable rules and provide commentary as practices evolve. Any company considering an entry to the public capital markets through a direct listing is encouraged to carefully consider the risks and benefits in consultation with counsel and financial advisors. Members of the Gibson Dunn Capital Markets team are available to discuss strategy, options and considerations as the rules and practice concerning direct listings evolve.

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[1] Many foreign private issuers have listed their shares, in the form of American Depositary Shares (evidenced by American Depositary Receipts), on U.S. exchanges without a simultaneous U.S. capital raising, seeking such listing in connection with the company’s filing of a registration statement on Form 20-F under the Securities Exchange Act of 1934, as amended, and the depositary bank’s filing of a registration statement on Form F-6 under the Securities Act of 1933, as amended (a so-called “Level II ADR facility”). Such Level II ADR facilities are outside the scope of this article and should be separately considered with the advice of counsel.

[2] The NYSE’s most recent proposal, submitted on June 22, 2020, is available at the following link: https://www.sec.gov/comments/sr-nyse-2019-67/srnyse201967-7332320-218590.pdf. The NYSE’s prior proposal, submitted on December 12, 2019, is available at the following link: https://www.nyse.com/publicdocs/nyse/markets/nyse /rule-filings/filings/2019/SR-NYSE-2019-67%2c%20Re-file.pdf. The NYSE’s initial proposal, submitted on November 26, 2019, which was withdrawn, is available at the following link: https://www.nyse.com/publicdocs/nyse/markets/nyse/rule-filings/filings/2019/SR-NYSE-2019-67.pdf.

[3] The SEC’s revision to Rule 163B under the Securities Act of 1933, as amended, which permits “testing-the-waters” communications by all issuers, was adopted on September 25, 2019. The adopting release is available at the following link: https://www.sec.gov/rules/final/2019/33-10699.pdf.

[4] The SEC has published a helpful guide concerning Rule 144 transactions that is available at the following link: https://www.sec.gov/reportspubs/investor-publications/investorpubsrule144htm.html. Such a transaction is outside the scope of this article and should be separately considered with the advice of counsel

[5] Certain NYSE rules are reviewed herein. The NYSE Listed Company Manual, which contains all of the listing standards and other rules applicable to a company listed on the NYSE, is available at the following link: https://nyse.wolterskluwer.cloud/listed-company-manual.

[6] Certain Nasdaq rules are reviewed herein. The Nasdaq Equity Rules, which contain all of the listing standards and other rules applicable to a company listed on Nasdaq, are available at the following link: http://nasdaq.cchwallstreet.com/.

[7] On August 15, 2019, Nasdaq submitted to the SEC proposed rule changes related to direct listings on the Nasdaq Global Market and Nasdaq Capital Market, the second- and third-tier Nasdaq markets, respectively. The Nasdaq proposal, submitted on August 15, 2019, is available at the following link: https://www.sec.gov/rules/sro/nasdaq/2019/34-86792.pdf. Nasdaq’s amendment to its proposal, submitted on November 26, 2019, is available at the following link: https://www.sec.gov/comments/sr-nasdaq-2019-059/srnasdaq2019059-6482012-199454.pdf. The SEC’s adopting release approving the Nasdaq proposal is available at the following link: https://www.sec.gov/rules/sro/nasdaq/2019/34-87648.pdf.

[8] There must be an independent valuation where a company goes public without an underwriting syndicate that would otherwise represent to the applicable exchange that such exchange’s distribution requirements will be met by the contemplated offering. If consistent and reliable private-market trading quotes are available, both the independent valuation and valuation based on private-market trading quotes must show a market value of “publicly held” shares in excess of $100 million ($110 million for Nasdaq Global Select Market, under certain circumstances).

[9] In lieu of a valuation for listings on the Nasdaq Global Market and Nasdaq Capital Market, the exchange may accept “other compelling evidence” that the (i) tentative initial bid price, (ii) market value of listed securities and (iii) market value of publicly held shares each exceed 250 percent of the otherwise applicable requirements. Under the rules, as amended, such compelling evidence is currently limited to cash tender offers by the company or an unaffiliated third party that meet certain other requirements.

[10] To qualify under the closing price alternative, the listing company must have: (i) average annual revenues of $6 million for three years, or (ii) net tangible assets of $5 million, or (iii) net tangible assets of $2 million and a three-year operating history, in addition to satisfying the other financial and liquidity requirements listed above. If listing on the Nasdaq Capital Markets under the NCM Listed Securities Standard in reliance on the closing price alternative, such closing price must be in excess of $4.00.

[11] The Council of Institutional Investors’ August 31 notice to the SEC is available at the following link: https://www.cii.org/ files/issues_and_advocacy/correspondence/2020/August%2031%202020%20%20letter%20to%20SEC-AB.pdf. The SEC’s letter to the NYSE notifying the exchange of the stay of the SEC staff’s August 26 order is available at the following link: https://www.sec.gov/rules/sro/nyse/2020/34-89684-carey-letter.pdf.

[12] The Council of Institutional Investors’ Petition for Review of an Order is available at the following link: https://www.sec.gov/rules/sro/nyse/2020/34-89684-petition.pdf.

[13] 373 F.2d 269 (2d Cir. 1967).

[14] See generally Pirani v. Slack Technologies, Inc., 445 F.3d 367 (N.D. Cal. 2020).

APPENDIX I

Open Questions for Direct Listings (as of January 8, 2021)

Some of the relevant open questions include:

Will the loss of a traditional firm-commitment underwriter create additional risks for investors? The NYSE’s revised rules permit companies to raise new capital without using a firm-commitment underwriter. The two Commissioners who dissented (Allison Herren Lee and Caroline A. Crenshaw) and certain investor protection groups have expressed concern that the absence of a traditional underwriter removes a key gatekeeper present in traditional IPOs that helps prevent inaccurate or misleading disclosures. In its order approving the NYSE’s revised rules on Primary Direct Floor Listings, the SEC suggests that, depending on the facts and circumstances, a company’s financial advisers could be subject to Securities Act liability, or at least lawsuits alleging underwriter liability, in connection with direct listings. The two dissenting Commissioners, however, suggest that guidance as to what may trigger status as a statutory underwriter should have been considered and concurrently provided.
Will a Primary Direct Floor Listing create new risks for the listing company? Under current rules and precedent, in a Primary Direct Floor Listing the listing company may have more rather than less liability in a direct listing than a traditional IPO. In a traditional IPO, because of customary lockup arrangements, investors can generally guarantee the traceability of their shares to the registration statement because only shares issued under the registration statement are trading in the market until the lockup period expires. Under current case law, which is being appealed, the tracing requirement has been seemingly abandoned, meaning all the shares in the market can potentially make claims under Section 11.
How will legal, diligence and auditing practices develop around direct listings? Because the listing must be accompanied by an effective registration statement under the Securities Act, the liability provisions of Section 11 and 12 of the Securities Act will be applicable to sales made under the registration statement. We note that in many of the direct listings to date, the companies have engaged financial advisors to assist with the positioning of the equity story of the company and advise on preparation of the registration statement, in a process very similar to the process of preparing a registration statement for a traditional IPO. Because a company will be subject to the same standard for liability under the federal securities laws with respect to material misstatements and omissions in a registration statement for a direct listing to the same extent as for a registration statement for an IPO, a company’s incentives to conduct diligence to support the statements in its registration statement do not differ between the two types of transactions. Similarly, financial statement requirements, and the requirements as to independent auditor opinions and consents, do not differ between registration statements for direct listings and IPOs. Furthermore, follow-on offerings by the company that involve firm-commitment underwriting or at-the-market programs will require the traditional diligence practices. To date, there have been no lawsuits alleging that financial advisers in a direct listing could be subject to Securities Act liability in connection with direct listings.
What impact will the expanded availability of direct listings have on IPO activity? One could argue that the greatest attraction of a direct listing is that it can nearly match private markets in being faster and less costly than an IPO. In some cases, it could provide similar liquidity as a traditional IPO, although trading price certainty and trading volume could be lower following a direct listing than following an IPO. Direct listings have been available on the NYSE and Nasdaq for a decade but have not been utilized regularly by large private companies in lieu of a traditional IPO. In any event, the requirement for 400 round lot holders will continue to be a hurdle for many private companies looking to list directly.
How will the initial reference price and/or price range in the prospectus be determined? There is no reference price from another market for the DMM to apply and no negotiation between the issuer and the underwriter as in an IPO. The NYSE seems to bridge this gap with the requirement for the DMM to consult with an independent financial adviser to determine the initial reference price in a Selling Shareholder Direct Listing and, in a Primary Direct Floor Listing, to determine the price range to be set forth in the applicable prospectus. Eventually, a standardized set of practices around the financial adviser’s work and presentation of the price to the issuer and the Exchange should develop.
Without the firm-commitment IPO process, in which the offering is oversold and heavily marketed, how will direct listed shares trade in the aftermarket? Without an underwritten offering, the issuer will not engage in price finding and book building activities. In a direct listing, the issuer will also take on much of the role of investor outreach that is borne by underwriters in a traditional IPO. Although direct listing marketing efforts may include one or more investor days and a roadshow-like presentation, sell-side analysts will presumably not be involved, building models and educating investors. It may be more difficult for the issuer to tell its forward-looking story and build value into the trading price of the stock without research coverage prior to or after the listing. For this reason, the most successful direct listings to date have been well-known companies with widely recognized brands that have successfully engaged with a broad set of new investors. We expect that companies engaging in direct listings will continue to develop more robust internal investor/shareholder relations functions than may be needed for a company conducting a traditional IPO.
Will large private placements (often called “private IPOs”) have a new advantage? The expanded option to direct list, whether in a secondary or primary format, through an independent valuation alone may mean investors in a private company can have access to public markets faster than through an IPO process. When private companies market private equity capital raises, including private IPOs, they might use the direct listing option as a marketing tool to attract investors to the private placement.
Are there any companies that are well-positioned for a Primary Direct Floor Listing? The NYSE’s revised rules may prompt well-positioned companies to consider a capital raise where the private or IPO markets are otherwise unattractive. Furthermore, until Nasdaq’s rules are approved, how will the NYSE’s rules affect the decision of where to list?

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Capital Markets or Securities Regulation and Corporate Governance practice groups, or the authors:

Alan Bannister– New York (+1 212-351-2310, abannister@gibsondunn.com)
Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com)
Boris Dolgonos – New York (+1 212-351-4046, bdolgonos@gibsondunn.com)
Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com)
James J. Moloney – Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com)
Evan Shepherd* – Houston (+1 346-718-6603, eshepherd@gibsondunn.com)

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

Capital Markets Group:
Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com)
Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com)
Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com)
Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com)

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

*Mr. Shepherd is admitted only in New York and is practicing under the supervision of Principals of the Firm.

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This Alert reports on recent intellectual property law developments relating to the COVID-19 pandemic, and provides updates on various developments we covered in previous alerts. First, we briefly review the intellectual property-related provisions of the COVID-19 relief and government funding bill that the President signed into law at the end of December. Second, we discuss ongoing efforts around the world to facilitate the donation of intellectual property rights, including through the Open COVID Pledge, and a proposal pending before the World Trade Organization (“WTO”). Finally, we include updated figures regarding the frequency of patent litigation in 2020, and note manufacturer 3M’s success in using trademark law to combat price gouging of its personal protective equipment.

(1) New Intellectual Property Laws in the COVID-19 Relief and Government Funding Bill

The COVID-19 relief and government funding bill that became law on December 27, 2020 incorporates three sections focused on intellectual property-related measures: the Copyright Alternative in Small-Claims Enforcement Act (“CASE Act”), which amends certain provisions of the Copyright Act, 17 U.S.C. § 101 et seq; amendments to the Federal Criminal Code that make it a felony to engage in unauthorized streaming of copyrighted content (commonly referred to as the Protecting Lawful Streaming Act); and the Trademark Modernization Act, which includes revisions to the Lanham Act, 15 U.S.C. § 1051 et seq. We summarize these developments below; more detailed discussions can be found in Gibson Dunn’s prior alerts about the intellectual property Acts in the bill, available here and here.

The CASE Act (Consolidated Appropriations Act of 2021, Division Q, Title II, Subtitle A) establishes a new Copyright Claims Board (“Board”) within the United States Copyright Office to serve as an alternative forum to federal courts for parties to resolve small copyright infringement claims, with streamlined procedures, and limited remedies amounting to no more than $30,000 in total damages in a single proceeding for registered works, and $15,000 of the same for unregistered works.[1] Decisions of the Board will not be precedential, and the Act provides for limited appellate review. This new procedure has the potential to provide individual rights holders (such as composers and graphic artists), an alternative mechanism that should be more efficient and affordable than federal court litigation for resolving small claims. Whether copyright owners will use this alternative forum remains to be seen.

An additional measure, widely referred to as “The Protecting Lawful Streaming Act” (Consolidated Appropriations Act of 2021, Division Q, Title II, Subtitle A), adds a new Section 2319C to the federal criminal code that makes it a criminal offense for a person “to willfully, and for purposes of commercial advantage or private financial gain” digitally transmit material without authorization of the copyright owner, or the law. The provision will allow the Department of Justice to bring felony charges against digital transmission services that are “primarily designed” for the purpose of streaming copyrighted materials without authorization. The maximum penalty for violation is imprisonment for up to ten years.[2] Before this provision, criminal copyright infringement based on unauthorized streaming could be charged only as a misdemeanor.

The Trademark Modernization Act of 2020 (Consolidated Appropriations Act of 2021, Division Q, Title II, Subtitle B) revises various provisions of the Lanham Act, 15 U.S.C. §§ 1501 et seq., in response to a recent rise in fraudulent trademark applications. Specifically, the Act enhances trademark examination proceedings by formalizing the process third-parties may use to submit evidence to the USPTO, and by providing the Office with greater authority and flexibility to set deadlines for trademark applicants to respond to actions taken by examiners.[3] The Act also clarifies the standard for finding the irreparable harm necessary for injunctions in trademark cases, bringing uniformity in response to inconsistencies that have emerged across federal courts after the Supreme Court’s decision in eBay Inc. v. MercExchange, LLC, 547 U.S. 388 (2006).[4]

(2) Ongoing Efforts to Facilitate the Donation of Intellectual Property Rights During the COVID-19 Pandemic

WTO Proposal to Suspend IP Rights Under the TRIPS Agreement. The TRIPS council met again on December 10, 2020, to discuss a proposal, originally submitted in October by South Africa and India, seeking the temporary waiver of various provisions in Section II of the TRIPS Agreement that grant Member countries intellectual property rights, and impose obligations to enforce them. The proposal, if passed, would effectively waive all copyright, trademark, industrial design, and patent rights provided under the TRIPS Agreement, insofar as such rights relate to the prevention, containment, or treatment of COVID-19; the effective waiver would apply until vaccination is widespread and “the majority of the world’s population has developed immunity” to the virus.[5] The TRIPS Agreement already includes provisions that require compulsory licensing of intellectual property rights during health emergencies to assist low-income countries that do not have the capacity to make pharmaceutical products. Proponents of the proposed waiver contend that these provisions are cumbersome and do not facilitate the necessary access to other personal protective equipment and vaccines.[6]

The TRIPS proposal has gained support from more than 99 countries, but major players, including the United States, the United Kingdom, Japan, Canada, and the European Union oppose it. The United Kingdom explained that its opposition to the proposal arises in part from a lack of “clear ways in which IP has acted as a barrier to accessing vaccines, treatments, or technologies” in the response to COVID-19.[7] The WTO has postponed further discussion of the proposal.

Open COVID Pledge. Organizations continue to sign onto the Open COVID Pledge, through which signatories grant a non-exclusive, royalty-free, worldwide license to use their patents and copyrights “for the sole purpose of ending” the COVID-19 pandemic. The pledge now includes patents related to wearable technology to perform contact tracing and proximity alerts, face covering and face shield designs, and computer software relating to diagnosing the virus. A Japanese-led Open COVID Pledge Coalition was founded last spring. That coalition, which includes several major Japanese companies, has also continued to grow, with voluntary pledges now having contributed approximately 1 million patents.

COVID-19 Technology Access Framework. The COVID-19 Technology Access Framework, which was established in April, creates a mechanism for universities to grant “non-exclusive royalty free licenses . . . for the purpose of making and distributing products to prevent, diagnose and treat COVID-19 infection during the pandemic and for a short period thereafter.” Since our prior reporting on the framework (see here), 21 more universities have now signed on.

Medicines Patent Pooling. As we previously reported, the UN-backed nonprofit Medicines Patent Pool (“MPP”) has been compiling patent information relating to products that are being used in clinical trials to treat COVID-19. The MPP also negotiates licenses with patent holders to facilitate widespread access to treatments. Twenty-one generic pharmaceutical manufacturers have now signed a pledge to work with the MPP to (among other things) negotiate licenses for patented COVID-19 therapeutics, and to accelerate development and delivery timelines for new treatments.

(3) Patent Litigation Sees Steady Increase While 3M’s Use of Trademark Law to Combat Price Gouging Proves Successful

Patent Lawsuits. Nearly 4,000 patent cases were filed in federal district courts in 2020, an increase of approximately 400 cases over 2019.[8] The Patent Trial and Appeal Board has seen a small increase in filings, with approximately 1500 petitions for inter partes, covered business method, and post-grant review, filed in 2020—an increase of approximately 200 proceedings over 2019.[9] District courts across the country continue to delay jury trials, and hold hearings remotely. The Federal Circuit’s May 18, 2020 order suspending in-person oral arguments indefinitely, and opting in favor of telephonic arguments (or no argument at all, if the Court so orders) remains in effect. In the Eastern District of Texas, Judge Gilstrap announced in November that all of his jury trials would be postponed until March 2021, with other judges ordering similar delays. Many courts, however, continue to hold the majority of proceedings online and have ordered jury trials to be continued. The Western District of Texas has postponed all jury trials until after January 31 while the Southern District of New York has postponed the same until after February 12.

3M Litigation. As reported in a previous update, in the summer of 2020, manufacturer 3M brought a wave of lawsuits across the country against online vendors, asserting claims under the Lanham Act for the sale of counterfeit PPE using 3M’s trademarks, and related state law claims, in an effort to combat both the counterfeit production of PPE, as well as price gouging of the same. In some of these cases, 3M established irreparable harm under a reputational theory of injury—namely, that “[n]o amount of money could repair the damage to 3M’s brand and reputation” if it were associated with “price-gouging at the expense of healthcare workers and other first responders in the midst of the COVID-19 crisis.”[10] In analyzing these trademark infringement claims based on the sale of counterfeit PPE at inflated prices, courts have also paid particular attention to the “bad faith” prong of the trademark infringement analysis, with one, for example, noting that the defendant’s decision to stop selling automobiles in favor of selling N95 masks constituted “textbook bad faith.”[11]

* * *

We are continuing to monitor intellectual property-related updates and trends relating to COVID-19.

____________________

[1] 17 U.S.C. § 1504(e)(1)(A), (D).

[2] Id. § 2319C(c).

[3] 15 U.S.C. § 1051(f).

[4] 15 U.S.C. § 1116(a).

[5] WTO, Council for Trade-Related Aspects of Intellectual Property Rights, Waiver from Certain Provisions of the TRIPS Agreement for the Prevention, Containment and Treatment of COVID-19, p. 2, October 2, 2020, https://docs.wto.org/dol2fe/Pages/SS/directdoc.aspx?filename=q:/IP/C/W669.pdf&Open=True.

[6] See WTO, Members discuss intellectual property response to the COVID-19 pandemic, October 20, 2020, https://www.wto.org/english/news_e/news20_e/trip_20oct20_e.htm.

[7] See, e.g., UK Mission to the WTO, UN, and Other International Organizations (Geneva), “UK Statement to the TRIPS Council: Item 15 Waiver Proposal for COVID-19,” UK Government, October 16, 2020.

[8] These figures were obtained from Docket Navigator’s Omnibus Reporting of Patent Cases by year. A “patent case” here refers to actions “addressing the infringement, validity or enforceability of a U.S. patent flagged with Nature of Suit (“NOS”) 830 in the PACER system as well as other cases that are known to meet the above criteria.” Docket Navigator, Scope of Data Available in Docket Navigator, https://search.docketnavigator.com/help/scope.html (last visited January 6, 2021).

[9] Docket Navigator, Omnibus Report PTAB Petitions, https://search.docketnavigator.com/patent/binder/390087/13 (last visited January 8, 2021). This does not include proceedings conducted pursuant to 35 U.S.C. § 6(b)(1)-(3), such as appeals of adverse decisions of examiners, appeals of reexaminations, or derivation proceedings.

[10] 3M Co. v. Performance Supply, LLC, 1:20-cv-02949, Dkt. No. 23 (S.D.N.Y. May 4, 2020).

[11] Id.

Gibson Dunn lawyers regularly counsel clients on the issues raised by this pandemic, and we are working with many of our clients on their response to COVID-19. For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team. Please also feel free to contact the Gibson Dunn lawyer with whom you usually work, or the authors in New York:

Richard Mark (+1 212-351-3818, rmark@gibsondunn.com)
Joe Evall (+1 212-351-3902, jevall@gibsondunn.com)
Doran Satanove (+1 212-351-4098, dsatanove@gibsondunn.com)
Wendy Cai (+1 212-351-6306, wcai@gibsondunn.com)

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

Los Angeles partner Maurice Suh, of counsel Daniel Weiss and associate Zathrina Perez are the authors of “Supreme Court needs to rethink NCAA ‘amateurism’” [PDF] published by the Daily Journal on January 5, 2021.

Washington, D.C. counsel Roscoe Jones Jr., New York partner Joel Cohen, Washington, D.C. partner Michael Bopp, New York partner Arthur Long, Washington, D.C. partner Jeffrey Steiner, Washington, D.C. associate Samantha Ostrom, Orange County associate Maggie Zhang and San Francisco associate Alexandra Farmer are the authors of “Financial Policy in the Incoming Biden Administration: What Can We Expect?” [PDF] published by Wall Street Lawyer in its December 2020 issue.

President-elect Joe Biden has signaled that robust consumer protection will be a major focus of his policy agenda. In this webcast, an experienced team of Gibson Dunn consumer protection attorneys will preview the incoming administration’s anticipated consumer protection agenda in areas including consumer fraud, privacy, and consumer financial protection. We also will discuss what, if any, impact this policy shift is likely to have on state-level enforcement. Topics to be discussed include:

DOJ and SEC consumer fraud enforcement;
FTC consumer protection enforcement, including privacy and cybersecurity enforcement;
HHS privacy enforcement;
CFPB consumer financial protection enforcement; and
State Attorney General consumer protection enforcement in key jurisdictions, including New York and California.

View Slides (PDF)

PANELISTS:

Joel M. Cohen is a partner in the New York office and Co-Chair of the firm’s global White Collar Defense and Investigations Practice Group. He is a trial lawyer and former federal prosecutor highly-rated in Chambers and ranked a “Super Lawyer” in Criminal Litigation by Global Investigations Review. Mr. Cohen’s practice focuses on financial institution litigation, FCPA/anticorruption issues, and other international disputes and discovery.

Alex Southwell is a partner in the New York office and Co-Chair of the firm’s Privacy, Cybersecurity and Consumer Protection Practice Group. He is a Chambers-ranked former federal prosecutor and was named a “Cybersecurity and Data Privacy Trailblazer” by The National Law Journal. Mr. Southwell’s practice focuses on white-collar criminal and regulatory enforcement defense, internal investigations and compliance monitoring, and he has considerable experience in information technology-related investigations, counseling, and litigation.

Ryan Bergsieker is a partner in the Denver office and a former federal cybercrimes prosecutor. He is recognized by Chambers as one of the top white collar defense and government investigations lawyers in Colorado, and was named by BTI to its Client Service All-Stars List. Mr. Bergsieker’s practice focuses on government investigations, complex civil litigation, and cybersecurity/ data privacy counseling.

Winston Y. Chan is a former federal prosecutor and litigation partner in the San Francisco office. He has particular expertise representing clients in enforcement actions and investigations by California’s Attorney General and local district attorneys. Mr. Chan is a Chambers-ranked attorney in White Collar Crime and Government Investigations, recognized by Benchmark Litigation as a “Litigation Star”, and recommended annually by Global Investigations Review.

Mylan Denerstein is a partner in the New York office and Co-Chair of the firm’s Public Policy Practice Group. Ms. Denerstein leads complex litigation and internal investigations and represents companies facing a diverse range of legal issues, typically involving federal, state and municipal government agencies. She is a former federal prosecutor and also served as Counsel to New York State Governor Andrew Cuomo. She was named by Benchmark Litigation as a 2021 “Top 250 Women in Litigation” and a 2021 “Litigation Star” nationally and in New York.

Elizabeth Papez is a litigation and regulatory partner in the Washington D.C. office and a former federal prosecutor and Justice Department official. She is repeatedly recognized as one of Benchmark USA’s Top 250 Women in Litigation nationwide. Ms. Papez’s practice focuses on high-stakes consumer protection, securities, and antitrust matters with parallel civil regulatory and litigation exposure. She has particular experience with the application of federal competition and consumer protection laws and multi-jurisdictional discovery and data-sharing considerations.

Ashley Rogers is a partner in the Dallas office. She is a member of the firm’s Litigation Department and practices in the Privacy, Cybersecurity and Consumer Protection Practice Group. Ms. Rogers’ practice focuses on a wide range of data privacy and consumer protection matters, and she has particular experience representing clients in the technology and internet industries in putative data privacy class actions and in government investigations.

Amanda Aycock is a senior associate in the New York office, and a member of the firm’s Litigation Department and Privacy, Cybersecurity and Consumer Protection Practice Group. Her practice is cross-disciplinary and includes significant experience in consumer protection, data privacy, contract, antitrust, and criminal law. She was named in 2020 by Legal 500 as a Rising Star” in corporate investigations and white collar criminal defense, and as a “Name to Note” for white collar matters emanating from the technology, media and entertainment industries.

Victoria Weatherford is a senior associate in the San Francisco office and member of the firm’s Litigation Department. She has particular experience representing clients in enforcement actions and investigations by California’s Attorney General and local district and city attorneys, in California writs and appeals, and at trial. She is recognized as one of the ABA’s “On the Rise – Top 40 Young Lawyers” in 2020. From 2014-2018, she served as a Deputy City Attorney in the San Francisco City Attorney’s Office, where she first-chaired statewide consumer protection cases to trial under California’s Unfair Competition Law and False Advertising Law.

MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.5 credit hours, of which 1.5 credit hours may be applied toward the areas of professional practice requirement.

This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact CLE@gibsondunn.com to request the MCLE form.

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California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

San Francisco partner Ethan Dettmer and Washington, D.C. associates Suria Bahadue and Matthew Rozen are the authors of “Invalid appointments and the restoration of DACA,” [PDF] published by the Daily Journal on January 4, 2021.

On 18 December 2020, the European Commission (the “Commission”) launched a comprehensive public consultation (the “Consultation”) on the revision of the European Union (“EU”) antitrust rules specifically applicable to distribution agreements, namely, the 2010 Vertical Block Exemption Regulation (Regulation 330/2010 or “VBER”) and the 2010 Vertical Guidelines, both of which will expire on 31 May 2022.[1]

The Commission is consulting with a view to gathering feedback on a number of policy options:[2]

On one side, the Commission proposes to adopt an arguably more lenient approach to the application of EU competition rules to certain types of vertical arrangements, ranging from: long-term non-compete obligations, efficiency-generating resale price maintenance (“RPM”), sustainability agreements in the context of the European Green Deal,[3] active sale restrictions outside of pure exclusive distribution, and measures indirectly restricting online sales.
On the other side, the Commission is considering adopting a stricter competition law enforcement strategy in relation to other types of vertical agreements such as: restrictions on price comparison websites and on online advertising, dual distribution and parity obligations (e.g., most favoured nation, or “MFN” clauses).

The Consultation is open until 26 March 2021, and will be followed by a report on the findings and results of the impact assessment phase. This will result in the publication of the proposed new draft VBER and accompanying Vertical Guidelines. Given the range of policy options under consideration by the Commission, this Consultation gives companies involved in both traditional and online retail business a unique opportunity to seek to influence the shape of future vertical restraint policies.

1. Background & Historical Context

Since the 1960s, the Commission has had in place regulations and guidance exempting certain categories of distribution agreements from the application of EU competition rules prohibiting anti-competitive agreements or arrangements.[4] The current VBER entered into force on 1 June 2010.

The VBER block exempts from the application of EU competition law distribution agreements where the market shares of the supplier and reseller do not exceed 30% in the respective relevant markets. The exemption applies if the agreement does not include so-called ‘hard-core’ restrictions.[5] Where companies cannot safely determine that their distribution agreement is covered by the VBER ‘safe harbour’, the company will need to consider: (i) if the agreement contains any ‘hard-core’ or excluded restrictions, (ii) if it may have any foreseeably anti-competitive effects on competition, and (iii) if there are any efficiencies that may benefit the agreement from an individual exemption under Article 101(3) TFEU. The Vertical Guidelines provide guidance to companies to perform these individual assessments.

**2. The 2010 VBER and Vertical Guidelines and the Commission’s Approach to E-Commerce and Other Restrictions**

The VBER and the Vertical Guidelines currently in force include rules and guidance that aim at fostering cross-border trade and online commerce as well as promoting competition. For example, the 2000 Vertical Guidelines allowed suppliers to require that quality standards be met in order to allow the resale of products through a distributor’s website.[6] The 2010 version of the Guidelines implicitly limited the application of such quality standards in the context of the Internet to situations involving selective distribution arrangements. And in any event, the standards had to be applied in an “overall equivalent” manner to both physical and online points of sale (i.e., stricter standards could not be applied only to online sales).[7] The 2010 Vertical Guidelines also set out a list of obligations and restrictions that suppliers were not permitted to impose on online resellers without potentially breaching EU competition law.[8]

The application of antitrust rules to e-commerce was significantly influenced by the 2011 Judgment of the Court of Justice of the EU (“CJEU”) in Pierre Fabre, which found that EU competition law prohibited manufacturers from engaging generally in online sales restrictions. In Pierre Fabre, the restriction resulted from the obligation on distributors to sell personal care products only in the presence of qualified pharmacists, de facto excluding sales through distributors’ websites.[9] The CJEU fully endorsed the view that e-commerce constituted a legitimate channel for the resale of products, and that a prohibition of e-commerce sales amounted to a hard-core restriction of competition ‘by object’. Pierre Fabre was followed by other decisions at EU and national level which confirmed the strict approach of European competition authorities and courts against measures likely to restrict e-commerce.[10]

By 2017, however, the Commission and the CJEU had started to become more nuanced in their approach to e-commerce, in particular regarding the sale of goods in online marketplaces. In the Commission’s final report in its E-Commerce Sector Enquiry, the Commission considered the perceived erosion of manufacturers’ freedom to limit online sales, and concluded that suppliers’ restrictions on distributors which made sales on online marketplaces were not per se anti-competitive.[11] Later that year, in Coty, the CJEU confirmed that manufacturers of luxury goods could seek to preserve the luxury image of those goods by preventing their sale in online marketplaces.[12]

3. The Commission’s Review of the VBER and the Vertical Guidelines

Against the backdrop of the findings of the E-Commerce Sector Enquiry and the Coty judgment, in 2018 the Commission launched a review of the 2010 VBER and the Vertical Guidelines, which are due to be replaced by 31 May 2022.

The first part of the review process lasted through September 2020, with the Commission gathering evidence on the functioning of the current VBER and the Vertical Guidelines. Respondents indicated that both the 2010 VBER and the Vertical Guidelines had to be revised, especially in light of the profound impact of e-commerce and digitalisation, the increase in direct sales by manufacturers to customers, the wider use of retail price parity clauses, and the emergence of online platforms. Furthermore, the Commission found that there are certain practices and restrictions that have become more commonplace over the past few years, for which additional guidance is required (e.g., dual distribution, online platform bans and restrictions on the use of price comparison websites).[13]

4. The Commission’s Ongoing Impact Assessment

On 23 October 2020, the Commission published a Roadmap[14] for an impact assessment of the initiatives tabled to address the deficiencies identified in the 2010 VBER and Vertical Guidelines, identifying the following priorities:

1)   The need to clarify, simplify and complete EU competition rules applicable to vertical agreements regarding:

the assessment of possible efficiencies resulting from resale price maintenance (“RPM”), which is currently a hard-core restriction under the VBER.

how to address restrictions that have become more prevalent since 2010 (e.g., restrictions on the use of price comparison websites, or online advertising restrictions).

the treatment of new market players, such as online platforms and marketplaces, especially in areas of distribution not addressed by the current case law, such as agency agreements and dual distribution (i.e., situations in which a supplier sells its goods or services directly to end customers, thereby competing with its distributors at the retail level).

the objectives of the European Green Deal,[15] in relation to agreements pursuing sustainability objectives.

2)   Non-compete clauses: These include obligations imposed on buyers not to manufacture, purchase, sell or resell goods or services which compete with those of the supplier, and are currently block exempted by the VBER provided that, inter alia, their duration does not exceed five years and is not automatically renewable. The Commission will consider a more lenient treatment of non-compete clauses whose duration may exceed this period due to automatic extensions, provided that they are subject to termination rights or renegotiation obligations.

3)   Dual distribution: This occurs where a supplier sells its products to consumers both directly and through independent resellers. The growth of online sales has led to a significant increase in dual distribution practices, leading the Commission to consider issues such as: (i) horizontal competition concerns arising from suppliers’ activities in the same market as resellers; (ii) the ability of dual distribution to satisfy the test for efficiencies that is used under Article 101(3) TFEU; and (iii) the comparison of the supplier’s situation with that of other wholesale distributors and resellers which are not in a position to benefit from the VBER in comparable situations.

To address the more widespread use of dual distribution, the Commission has identified the following policy options (with the possibility of Options 2 and 3 being introduced in combination):

Option 1: baseline scenario (i.e., no policy change).

Option 2: limiting the scope of the exemption to situations that are not likely to raise horizontal concerns by, for example, by introducing a threshold based on the parties’ market shares in the retail market, and by aligning the exemption with what is considered to be capable of being exempted in the case of agreements among competitors.[16]

Option 3: extending the exemption to dual distribution practices by wholesalers and/or importers.

Option 4: removing the exemption from the VBER, thereby requiring an individual assessment under Article 101(3) TFEU for all dual distribution cases.

4)   Active sales restrictions: The VBER treats as ‘hard-core’ situations where a supplier restricts the territory into which, or the customers to whom, a reseller can sell the products. Resellers should generally be allowed to approach direct individual customers (‘active sales’) and to respond to unsolicited requests from individual customers (‘passive sales’). However, the current rules permit restrictions on active sales in limited cases, notably where they are justified to protect investments made by exclusive distributors.

The rigidity of the current VBER framework regarding the treatment of active and passive sales can render it difficult for suppliers to implement distribution networks that are tailored to their specific needs. For example, the VBER and the Vertical Guidelines do not foresee the use of ‘shared exclusivities’ between two or more distributors in a particular territory (i.e., shielded from active sales by distributors established outside of their territory), or the genuine combination of exclusive and selective distribution methods for the same product lines in the same territory.[17]

The Commission has therefore identified the following policy options (with Options 2 and 3 possibly being introduced in combination):

Option 1: baseline scenario (i.e., no policy change).

Option 2: expanding the existing exemptions available for the prohibition of active sales in order to give suppliers more flexibility to design their distribution systems.

Option 3: ensuring more effective protection for selective distribution systems, by allowing restrictions on sales made from outside the allocated selective distribution territory to unauthorised distributors inside that territory.

5)   Indirect measures restricting online sales: As noted above, most restrictions on distributors to sell through the Internet are considered to be ‘hard-core’ restrictions, which will generally not benefit from the automatic exemption under the VBER.[18] The current versions of the VBER and the Vertical Guidelines apply the same approach to certain indirect measures that might hinder online sales, such as charging the same distributor a higher wholesale price for products intended to be sold online than with respect to products sold off-line (‘dual pricing’), or where selective criteria are imposed for online sales that are not truly equivalent to the criteria imposed in brick-and-mortar shops (the “overall equivalence” principle).[19]

The Commission recognises that, by not allowing suppliers to charge different wholesale prices depending on the actual costs of maintaining different channels, the current rules may prevent them from incentivising associated investments, notably in physical stores.

As a result, the Commission has identified the following policy options (with Options 2 and 3 possibly being introduced in combination):

Option 1: baseline scenario (i.e., no policy change).

Option 2: no longer treating dual pricing strategies as a ‘hard-core’ competition restriction, with certain safeguards to be defined in accordance with principles established under case law.

Option 3: no longer considering as a ‘hard-core’ restriction the imposition of selective criteria for online sales that are not “overall equivalent” to the criteria imposed in brick-and-mortar shops, with safeguards to be defined in accordance with principles set forth under case law.

6)   Parity obligations (so-called ‘most-favoured nation’, or “MFN”, clauses): These types of clause require a business to offer the same or better conditions to its contracting party as those it offers to any other party, or by the company itself through its direct sales channels. Parity obligations are generally block exempted under the conditions of the VBER. However, the increase in their use, notably by online platforms, has led to the identification of possible anti-competitive effects under certain scenarios (e.g., obligations that require parity with other indirect sales or marketing channels).

In order to address these scenarios, the Commission has identified the following policy options:

Option 1: baseline scenario (i.e., no policy change).

Option 2: removing the benefit of the VBER and including within the list of excluded restrictions (Article 5 VBER) obligations that require parity relative to specific types of sales channel – thereby requiring an individual effects-based assessment of such obligations under Article 101 TFEU. For example, the benefit of the VBER could be generally excluded for parity obligations that relate to indirect sales and marketing channels, including online platforms and other intermediaries.

Conversely, parity obligations relating to other types of sales channel would continue to benefit from the block exemption, on the basis that they are more likely to create efficiencies that satisfy the conditions of Article 101(3) TFEU.

Option 3: removing the benefit of the VBER ‘safe harbour’ for all types of parity obligations, by including them in the list of excluded restrictions (Article 5 VBER). This option would require companies to perform an individual effects-based assessment in all such cases.

5. The Consultation – A Call for Action

With the release of its Consultation on 18 December 2020, the Commission is seeking to address the wide range of issues described above and to prepare for the adoption of a revised VBER and Vertical Guidelines in 2022.

While some of the issues addressed in the Consultation have long been highlighted by antitrust agencies, practitioners and industry stakeholders, a number of other issues have also raised heightened attention because of the extra impetus enjoyed by e-commerce during the last years.

The issues and potential solutions identified by the Commission in the Consultation (which is open until 26 March 2021) are important for manufacturers and resellers of all products, but especially for consumer products. Companies may therefore wish to take this opportunity to try to shape the future form of the EU competition rules which will apply to their distribution arrangements.

_____________________

[1] The Consultation is available in the following link: https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12636-Revision-of-the-Vertical-Block-Exemption-Regulation/public-consultation.

[2] These issues and policy options were first set out in the VBER’s inception impact assessment, published on 23 October 2020. See Ref. Ares(2020)5822391 – 23.10.2020, available at: https://ec.europa.eu/info/law/better-regulation/.

[3] The European Green Deal is the EU plan to create a sustainable economy, and provides for an action plan to boost the efficient use of resources by moving to a clean, circular economy, and to restore biodiversity and cut pollution. See further: https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en.

[4] Article 101(1) TFEU prohibits all agreements or concerted practices that have as their object or effect the restriction of competition where the effect of that restriction may affect trade between Member States.

[5] See Article 4 of the VBER for a list of ‘hard-core’ restrictions. The VBER also identifies a limited number of restrictions which, if contained in a vertical arrangement, do not benefit from the VBER ‘safe harbour’ but which do not preclude the application of the VBER ‘safe harbour’ to the rest of the agreement (provided that the other conditions set out in the VBER are fulfilled).

[6] See Commission notice – Guidelines on Vertical Restraints, OJ C 291, 13 October 2000, pp. 1-44, para. 51.

[7] See Vertical Guidelines, para. 54.

[8] See Vertical Guidelines, para. 52.

[9] See Case C-439/09 Pierre Fabre Dermo-Cosmetique EU:C:2011:649.

[10] For more information, see A. Font Galarza, E. Dziadykiewicz, and A. Guerrero Perez, ‘Selective Distribution and e-Commerce: Recent developments in EU and national case law’, e-Competitions Bulletin, No. 63958, 2014. See further, e.g., Case COMP/AT.40428 – Guess.

[11] See Report from the Commission to the Council and the European Parliament, Final report on the E-commerce Sector Inquiry, COM(2017) 229 final, 10 May 2017; and the accompanying Staff Working Document, SWD(2017) 154 final, 10 May 2017, Section 4.4.8.

[12] See Case C-230/16 Coty Germany GmbH v Parfümerie Akzente GmbH EU:C:2017:941.

[13] See Commission Staff Working Document Evaluation of the Vertical Block Exemption Regulation, SWD(2020) 172 final, 8 September 2020.

[14] See: https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12636-Revision-of-the-Vertical-Block-Exemption-Regulation.

[15] The European Green Deal is the EU plan to create a sustainable economy, and provides for an action plan to boost the efficient use of resources by moving to a clean, circular economy, and to restore biodiversity and cut pollution. See further: https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en.

[16] For Commission regulations that establish block exemptions applicable to horizontal agreements among competitors, see, e.g., Commission Regulation (EU) No 1217/2010 of 14 December 2010 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to certain categories of research and development agreements, OJ L 335, 18 December 2010, pp. 36-42; Commission Regulation (EU) No 1218/2010 of 14 December 2010 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to certain categories of specialisation agreements, OJ L 335, 18 December 2010, pp. 43-47; and Commission Regulation (EU) No 316/2014 of 21 March 2014 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to categories of technology transfer agreements, OJ L 93, 28 March 2014, pp. 17-23.

[17] The Vertical Guidelines currently find that combined selective and exclusive distribution can only be block exempted if active selling in other territories is not restricted (para. 152). This dilutes significantly the impact that exclusivities are meant to have in a distribution network. The Vertical Guidelines currently only foresee the possibility of restricting active sales by selective retailers into other territories for the purpose of overcoming free-riding problems pursuant to an individual assessment (para. 63).

[18] As indicated above, qualitative criteria that are “overall equivalent” to criteria imposed on physical stores may also be imposed on Internet stores. Suppliers may also request that distributors have one or more brick-and-mortar shops or showrooms as a condition for becoming a member of its distribution system (Vertical Guidelines, para. 54).

[19] See Vertical Guidelines, paras. 52-56. The Commission foresees very specific exceptional scenarios where dual distribution may benefit from an individual exemption under Article 101(3) TFEU (see para. 64).

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

Kai Gesing – Munich (+49 89 189 33 180, kgesing@gibsondunn.com)
Alejandro Guerrero – Brussels (+32 2 554 7218, aguerrero@gibsondunn.com)
Jens-Olrik Murach – Brussels (+32 2 554 7240, jmurach@gibsondunn.com)
Christian Riis-Madsen – Brussels (+32 2 554 72 05, criis@gibsondunn.com)
Deirdre Taylor – London (+44 20 7071 4274, dtaylor2@gibsondunn.com)
David Wood – Brussels (+32 2 554 7210, dwood@gibsondunn.com)

Antitrust and Competition Group:

Brussels
Peter Alexiadis (+32 2 554 7200, palexiadis@gibsondunn.com)
Attila Borsos (+32 2 554 72 11, aborsos@gibsondunn.com)
Jens-Olrik Murach (+32 2 554 7240, jmurach@gibsondunn.com)
Christian Riis-Madsen (+32 2 554 72 05, criis@gibsondunn.com)
Lena Sandberg (+32 2 554 72 60, lsandberg@gibsondunn.com)
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Charles Falconer (+44 20 7071 4270, cfalconer@gibsondunn.com)
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Scott D. Hammond (+1 202-887-3684, shammond@gibsondunn.com)
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In a surprise u-turn, on 31 December 2020, the UK government took steps to narrow the scope of mandatory reporting under DAC 6. In the UK, only cross-border arrangements falling under the Category D hallmark (broadly, those that (a) have the effect of circumventing the OECD’s Common Reporting Standard or (b) obscure beneficial ownership) will be reportable. The change will apply to both historic, and future, cross-border arrangements.

The amendment to the existing legislation is intended as a temporary step. In the coming year, the UK intends to introduce, and consult on, legislation to implement mandatory reporting under the OECD Mandatory Disclosure Rules (the “MDR”).

These actions will significantly reduce the number of arrangements that need to be reported to HMRC. Nevertheless, reporting under DAC 6 is already required in some EU member states (such as Germany), and will be required elsewhere in Europe in the coming months. Accordingly, it needs to be considered whether arrangements that would previously have been reportable to HMRC under DAC 6 now need to be reported to other tax authorities.

EU Council Directive 2011/16 (as amended) (known as DAC 6) requires UK intermediaries (or failing which, taxpayers) to report, and HMRC to exchange, information regarding cross-border arrangements which meet one or more specified characteristics (hallmarks) and which concern at least one EU country. Regulations implementing DAC 6 reporting obligations into UK law (the “Regulations”) came into force on 1 July 2020.

At the end of the Brexit transition period at 11pm on 31 December 2020, obligations requiring the UK to implement DAC 6 fell away. During the course of last year, the UK government had indicated that DAC 6’s UK implementation would be unaffected by, and that the Regulations would remain in force following, the end of the Brexit transition period. However, under the Free Trade Agreement agreed between the UK and the EU on 24 December 2020, the UK is only required to ensure any legislation it implements at the end of the transition period relating to the exchange of information concerning potential cross-border tax planning arrangements offers the level of protection provided for by the “standards and rules which have been agreed in the OECD…”.

Accordingly, on 31 December 2020, the UK government published legislation (taking effect at the end of the transition period) to narrow the scope of the Regulations in line with the MDR. As a result, only cross-border arrangements (i.e. those concerning the UK or an EU member state) that fall within Category D of Part II of DAC 6 will fall within the scope of UK reporting obligations.[1] Broadly, an arrangement will be reportable under Category D if the arrangement either: (i) has the effect of undermining reporting obligations under agreements for the automatic exchange of information (e.g. the EU Common Reporting System, or the OECD’s Common Reporting Standards); or (ii) involves non-transparent legal or beneficial ownership chains that:

do not carry on a substantive economic activity;
are incorporated, managed, resident, controlled or established in any jurisdiction other than the jurisdiction of residence of one or more of the beneficial owners of the assets held by such persons, legal arrangements or structures; and
have unidentifiable beneficial owners.

Historic arrangements

For reportable transactions after 30 June 2020, the first UK DAC 6 reporting deadline is 30 January 2021, and for transactions on or before 30 June 2020 where the first step in implementation was taken on or after 25 June 2018, it is 28 February 2021.

The effect of the amending Regulations (which has been confirmed by HMRC) is that the narrower reporting obligation will not only apply to future arrangements, but will also apply to historic arrangements for the period prior to 31 December 2020. Accordingly, only those arrangements which fall within a hallmark under Category D would need to be reported to HMRC.

Practical impact

The amendments to the Regulations have reduced the scope of disclosures to HMRC under DAC 6. Nevertheless, a full DAC 6 assessment and hallmark analysis will still be required in respect of EU jurisdictions involved in a transaction, in order to determine whether a DAC 6 filing obligation arises in those member states. Cross-border transactions that would otherwise have been reportable to HMRC may need to be reported to EU tax authorities. It is expected that the exception would be cross-border transactions that were reportable under hallmarks A, B, C and E of DAC 6 solely as a result of a UK nexus. However, it remains to be seen whether EU member states will update their domestic legislation implementing DAC 6 to require reporting of arrangements that concern only the UK and a non-EU jurisdiction. Such amendments would likely raise a number of practical issues, including, for example, questions as to who should bear the reporting obligation where intermediaries in the relevant EU jurisdiction have limited knowledge of the wider arrangements.

From a practical perspective, the UK’s divergence from the DAC 6 standard may create additional administrative burdens for those intermediaries and taxpayers with pan-European operations that had planned to coordinate and submit DAC 6 reports in the UK. As the UK’s actions were not trailed, these businesses may, at short notice, need to shift the coordination and submission of reports to an EU member state involved in the reportable arrangement. For those businesses that had already begun preparing data for submission using HMRC’s XML schema, additional administrative work may be needed to ensure this data can be submitted to other relevant EU member states’ databases. It remains to be seen whether (to lessen such burdens) HMRC may be willing to accept submissions on a voluntary basis or whether (if HMRC was so willing) this would be permissible under the laws of relevant EU member states.

Going forward

OECD Mandatory Disclosure Rules

We understand that the UK government will consult on draft legislation to implement the MDR in due course. The MDR were first published in March 2018, and form part of the OECD’s recommendations set out in the “Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures”.[2] They are designed for jurisdictions wanting to implement disclosure obligations on certain intermediaries involved in arrangements intended to circumvent disclosure obligations under the OECD’s Common Reporting Standard.[3]

It is unclear whether such legislation would, in the immediate term, substantively alter the scope of mandatory reporting obligations provided for under the Regulations (as amended). Looking forward, however, enhanced reporting is fast becoming a popular measure, internationally, for tackling tax avoidance, evasion and non-compliance. Countries outside the EU have introduced disclosure requirements that go beyond the MDR (with Mexico being the latest country to implement a disclosure regime modelled on DAC 6). Given this trend, it is expected that the OECD will further expand the scope of the MDR in the future. Accordingly, despite the reduced scope of the UK’s current reporting regime, wider mandatory disclosure obligations may well become standard practice for taxpayers party to, and intermediaries advising on, cross-border arrangements.

Exchange of tax information

Before the end of the transition period, the UK was required to exchange tax information (including information relating to tax rulings and advance transfer pricing agreements, EU Common Reporting Standards, country-by-country reporting and beneficial ownership) with EU member states under the various provisions of Directive 2011/16/EU (the “DAC”). However, it is not yet clear: (i) how reports relating to Category D cross-border arrangements will be shared between HMRC and other tax authorities under the current DAC 6 exchange framework; (ii) whether HMRC will have access to information relating to cross-border arrangements falling within hallmarks A, B, C or E; and (iii) whether HMRC will retain access to other information currently shared under the DAC, given that the UK is no longer part of the EU. The FTA, for example, is silent on such matters.[4]

Outside of the DAC, there are existing international frameworks that allow for the exchange of tax information between tax authorities. In particular, (a) the OECD provides a platform for the spontaneous exchange of tax rulings and advance transfer pricing agreements and (b) most double tax treaties between the UK and EU member states allow for the exchange of information between the treaty parties on request, in each case where the information is foreseeably relevant to the recipient tax authority. Furthermore, the OECD provides an information sharing platform for jurisdictions that have entered into bilateral agreements to exchange information, should the UK seek to enter into such agreements with EU member states. For the moment, however, it remains to be seen whether existing frameworks will provide sufficient information sharing rights for HMRC.

_____________________

[1] The Category D hallmarks are contained in Annex IV Part II of the EU Council Directive 2018/822 of 25 May 2018 amending Directive 2011/16/EU at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex:32018L0822

[2] OECD (2018), Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures, OECD, Paris. https://www.oecd.org/tax/exchange-of-tax-information/model-mandatory-disclosure-rules-for-crs-avoidance-arrangements-and-opaque-offshore-structures.htm

[3] The CRS was introduced in 2014 as a global reporting standard for the cross-border exchange of financial information.

[4] https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:22020A1231(01)&from=EN

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

Sandy Bhogal – London (+44 (0) 20 7071 4266, sbhogal@gibsondunn.com)
Benjamin Fryer – London (+44 (0) 20 7071 4232, bfryer@gibsondunn.com)
Bridget English – London (+44 (0) 20 7071 4228, benglish@gibsondunn.com)
Fareed Muhammed – London (+44 (0) 20 7071 4230, fmuhammed@gibsondunn.com)
Barbara Onuonga – London (+44 (0) 20 7071 4139,bonuonga@gibsondunn.com)
Aoibhin O’ Hare – London (+44 (0) 20 7071 4170, aohare@gibsondunn.com)
Avi Kaye – London (+44 (0) 20 7071 4210, akaye@gibsondunn.com)

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

On December 18, 2020, three federal banking regulators—the Office of the Comptroller of the Currency (“OCC”), the Board of Governors of the Federal Reserve System (“Board”), and the Federal Deposit Insurance Corporation (“FDIC”)—jointly issued a notice of proposed rulemaking that would impose rapid notification requirements on banking organizations and bank service providers following “significant” computer-security incidents.

Under the proposal, “banking organizations” include all institutions subject to a primary federal bank regulator: for the OCC, national banks, federal savings associations, and federal branches and agencies of non-U.S. banks; for the Board, all U.S. bank holding companies and savings and loan holding companies, state member banks, the U.S. operations of foreign banking organizations, and Edge and agreement corporations; and for the FDIC, all insured state nonmember banks, insured state-licensed branches of foreign banks, and state savings associations.

The proposal defines “bank service providers” by reference to the Bank Service Company Act (“BSCA”) as entities that provide BSCA-regulated services—“check and deposit sorting and posting, computation and posting of interest and other credits and charges, preparation and mailing of checks, statements, notices, and similar items, or any other clerical, bookkeeping, accounting, statistical, or similar functions performed for a depository institution,” including “data processing, back office services, and activities related to credit extensions.”[1] With the increasing significant use of third-party vendors to supply technology-related services to banks, this inclusion is important.

The proposal would require a banking organization to notify its primary federal regulator when it believes in “good faith” that it has experienced a “significant” computer-security incident—which the proposal terms a “notification incident.” Notification of regulators would be required “as soon as possible and no later than 36 hours” after the organization determines that a notification incident has occurred. The proposal defines a “computer-security incident” as “an occurrence that—(i) [r]esults in actual or potential harm to the confidentiality, integrity, or availability of an information system or the information that the system processes, stores, or transmits; or (ii) [c]onstitutes a violation or imminent threat of violation of security policies, security procedures, or acceptable use policies.” The proposal describes a “notification incident” as a computer-security incident that “could jeopardize the viability of the operations of an individual banking organization, result in customers being unable to access their deposit and other accounts, or impact the stability of the financial sector.”[2] Notification incidents can arise from both criminal and non-malicious computer-security incidents.

The proposal would require a bank service provider to notify “at least two individuals at affected banking organization customers immediately after experiencing a computer-security incident that it believes in good faith could disrupt, degrade, or impair services provided subject to the BSCA for four or more hours.” The bank service provider would not be required to determine if such an incident rises to the level of a “notification incident” for particular banking organizations; rather, the bank service provider would be required to inform affected banking organization customers, who would themselves have that responsibility.

Additionally, the proposal would require a banking organization subsidiary of another banking organization to notify both its primary federal regulator and its parent banking organization that the subsidiary had experienced a notification incident “as soon as possible.” The proposal would then require the subsidiary’s parent banking organization to make a separate assessment about whether the parent organization had also suffered a notification incident requiring it to notify its primary federal regulator as result of the incident at the subsidiary. Thus, the proposal would require both the subsidiary and parent banking organizations to separately determine whether they had each suffered a notification incident, and should both make such a determination, would require both to notify their regulators individually.

In contrast, the proposal would not require a non-bank subsidiary of a banking organization to notify its regulator following a notification incident at the non-bank subsidiary. Instead, the proposal would seemingly require the non-bank subsidiary to notify its parent banking organization. The parent banking organization would then be required to determine whether the computer-security incident at its non-bank subsidiary constituted a notification incident, and if so, to notify the parent banking organization’s primary federal regulator.

Entities that wish to comment on the proposed rule must submit their comments no later than 90 days after the proposal is published in the Federal Register.

The proposed rule is the latest attempt to impose obligations on financial institutions that have suffered a cyber incident. Regulations requiring notification following a data breach have been in place for years, but, as we have previously noted, state and federal regulators have recently begun imposing rules requiring faster and more in-depth notifications following cybersecurity incidents. For example, since 2017, the New York Department of Financial Services has required financial institutions to notify the Superintendent of Financial Services “as promptly as possible but in no event later than 72 hours” following a cybersecurity incident.[3]

These proposed and enacted regulations requiring rapid notification following cybersecurity incidents highlight the need for financial institutions to be able to respond quickly to and report accurately and effectively on cyber events. Such notification requirements will help incentivize banking organizations to assess whether they have a well-functioning incident response plan and effective lines of communication among their information security, legal, and other relevant departments already in place before a cybersecurity incident occurs. This is important for organizations to be able to quickly assess incidents—which can often be challenging to understand fully—and be positioned to notify regulators within the required time period following an incident. Among other preparation measures, cross-departmental training exercises can help improve the functionality of response processes before they are tested in an actual cybersecurity event.

_____________________

[1] See 12 U.S.C. §§ 1861-1867.

[2] The proposed rule’s complete definition of “notification incident” is “a computer-security incident that a banking organization believes in good faith could materially disrupt, degrade, or impair—(i) the ability of the banking organization to carry out banking operations, activities, or processes, or deliver banking products and services to a material portion of its customer base, in the ordinary course of business; (ii) any business line of a banking organization, including associated operations, services, functions and support, and would result in a material loss of revenue, profit, or franchise value; or (iii) those operations of a banking organization, including associated services, functions and support, as applicable, the failure or discontinuance of which would pose a threat to the financial stability of the United States.”

[3] N.Y. Comp. Codes R. & Regs. tit. 23, § 500.17 (2020).

The following Gibson Dunn lawyers assisted in the preparation of this article: Ryan T. Bergsieker, Arthur S. Long, Alexander H. Southwell and Marie D. Zoglo.

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 any member of the firm’s Privacy, Cybersecurity and Consumer Protection or Financial Institutions practice groups.

Financial Institutions Group:

Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)

Privacy, Cybersecurity and Consumer Protection Group:

United States
Alexander H. Southwell – Co-Chair, PCCP Practice, New York (+1 212-351-3981, asouthwell@gibsondunn.com)
Debra Wong Yang – Los Angeles (+1 213-229-7472, dwongyang@gibsondunn.com)
Matthew Benjamin – New York (+1 212-351-4079, mbenjamin@gibsondunn.com)
Ryan T. Bergsieker – Denver (+1 303-298-5774, rbergsieker@gibsondunn.com)
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, jjessen@gibsondunn.com)
Kristin A. Linsley – San Francisco (+1 415-393-8395, klinsley@gibsondunn.com)
H. Mark Lyon – Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com)
Karl G. Nelson – Dallas (+1 214-698-3203, knelson@gibsondunn.com)
Ashley Rogers – Dallas (+1 214-698-3316, arogers@gibsondunn.com)
Deborah L. Stein – Los Angeles (+1 213-229-7164, dstein@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)

Europe
Ahmed Baladi – Co-Chair, PCCP Practice, Paris (+33 (0)1 56 43 13 00, abaladi@gibsondunn.com)
James A. Cox – London (+44 (0)20 7071 4250, jacox@gibsondunn.com)
Patrick Doris – London (+44 (0)20 7071 4276, pdoris@gibsondunn.com)
Bernard Grinspan – Paris (+33 (0)1 56 43 13 00, bgrinspan@gibsondunn.com)
Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com)
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Alejandro Guerrero – Brussels (+32 2 554 7218, aguerrero@gibsondunn.com)
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Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com)
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Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

After a complicated path to passage, today the Senate completed the override of President Trump’s veto of the National Defense Authorization Act and, as part of that legislation, passed the Anti-Money Laundering Act of 2020 (“AMLA” or the “Act”).[1] The AMLA is the most comprehensive set of reforms to the anti-money laundering (“AML”) laws in the United States since the USA PATRIOT Act was passed in 2001. The Act’s provisions range from requiring many smaller companies to disclose beneficial ownership information to FinCEN to mandating awards to whistleblowers that report actionable information about Bank Secrecy Act (“BSA”)/AML violations. This alert identifies 10 of the biggest takeaways for financial institutions from the AMLA.[2]

The AMLA May Lead to More AML Enforcement, Including Through Expanded Whistleblower Provisions

The AMLA has a number of provisions that could result in significantly increased civil and criminal enforcement of AML violations. First and foremost, it provides for a significantly expanded whistleblower award program. Specifically, it states that when an AML enforcement action brought by DOJ or the U.S. Treasury Department results in monetary sanctions over $1 million, the Secretary of the Treasury “shall” pay an award of up to 30 percent of what was collected to whistleblowers who “voluntarily provided original information” that led to a successful enforcement action.[3] The previous whistleblower award program limited awards in most cases to $150,000 and was discretionary[4] – in our experience, that much more modest award program did not generate significant interest among potential whistleblowers or the plaintiffs’ bar. The Act also includes anti-retaliation protections for whistleblowers and, in the event of a violation of these provisions, allows them to file a complaint with the Department of Labor and, if it is not adjudicated within a certain period of time, to seek recourse in federal district court.[5]

It would be hard to overstate the far-reaching potential effects of this new program. By way of analogy, in 2010, the SEC announced its own whistleblower program to reward individuals who provided the agency with high-quality information.[6] The program has prompted a significant number of tips to the SEC. As of October 2020, the SEC Office of the Whistleblower had received more than 40,000 tips from whistleblowers in every state in the United States and approximately 130 countries around the world.[7] And this program has led to some significant SEC whistleblower awards, which may have encouraged further reporting. In October 2020, for instance, the SEC awarded $114 million to a whistleblower, the largest single award in history.[8]

As with the SEC whistleblower program, the new awards for BSA whistleblowers may incentivize employees and plaintiffs’ attorneys to provide a substantial number of new tips to law enforcement, even if many of them do not result in enforcement actions. Indeed, the number of employees at financial institutions who have access to information that could potentially form the basis for an AML whistleblower complaint is many times greater than in other contexts. Many large financial institutions employ hundreds of individuals in functions with AML responsibilities. For example, it remains to be seen whether this provision will weaponize the information held by even front-line compliance employees tasked with elevating suspicious activity for potential SAR filings when those employees do not see a SAR ultimately get filed.

The AMLA Increases Penalties for BSA/AML Violations in a Number of Ways

Another harbinger of increased enforcement is the expanded penalties enacted under the AMLA. As we explained in a January 2020 client alert, in recent years DOJ has been increasingly aggressive in using its money laundering authority to police international corruption and bribery, as illustrated by the 1MDB, FIFA, and PDVSA prosecutions.[9] And the incoming Biden administration has indicated that cracking down on illicit finance at home and abroad will be a top priority.[10]

The AMLA creates a number of new penalties that will help the government do so. It creates a new prohibition on knowingly concealing or misrepresenting a material fact from or to a financial institution concerning the ownership or control of assets involved in transactions over $1 million involving assets of a senior foreign political figure, close family member, or other close associate.[11] The Act also makes it a crime to knowingly conceal or misrepresent a material fact from or to a financial institution concerning the source of funds in a transaction that involves an entity that is a primary money laundering concern.[12] The penalties for violating these provisions are up to 10 years imprisonment and/or a $1 million fine.[13]

The Act also generally enhances penalties for various BSA/AML violations. For instance, it provides that any person “convicted” of violating the BSA shall, “in addition to any other fine under this section, be fined in an amount that is equal to the profit gained by such person by reason of such violation,” and, in the event the person was employed at a financial institution at the time of the violation, repay to the financial institution any bonus paid during the calendar year during or after which the violation occurred.[14] The Act additionally prohibits individuals who have committed an “egregious” violation of the BSA from sitting on the boards of U.S. financial institutions for 10 years.[15] Furthermore, the AMLA creates enhanced penalties for repeat violators, providing that if a person has previously violated the BSA, the Secretary of the Treasury “may impose” additional civil penalties of up to the greater of three times the profit gained or loss avoided by such person as a result of the violation or two times the maximum statutory penalty associated with the violation.[16]

The AMLA Significantly Increases the Government Resources Committed to Address Money Laundering

The AMLA also contains a host of provisions designed to better resource the government to address money laundering. It establishes special hiring authority for FinCEN and the Office of Terrorism and Financial Intelligence.[17] It also creates a number of unique roles, including FinCEN domestic liaisons to oversee different regions of the United States, as well as Treasury attachés and FinCEN foreign intelligence unit liaisons to be stationed at U.S. embassies or foreign government facilities.[18] The Act additionally creates a Subcommittee on Innovation and Technology to advise the Secretary of the Treasury on innovation with respect to AML and calls for BSA “Innovation Officers” and “Information Security Officers” at FinCEN and other federal financial regulators.[19] Although these staffing reforms may not directly impact financial institutions, the government’s increased focus and sophistication in addressing money laundering may result in additional inquiries from law enforcement, regulations, and guidance.

The AMLA Provides Additional Statutory Authority for DOJ to Seek Documents from Foreign Financial Institutions

DOJ typically has three avenues to pursue documents from foreign financial institutions. It can: (i) make a request under the Mutual Legal Assistance Treaty (or, in the absence of a treaty, a letter rogatory) with the country in question, which can be a slow process; (ii) it can issue a Bank of Nova Scotia subpoena, which requires written approval from DOJ’s Office of International Affairs[20]; or (iii) it can issue a subpoena pursuant to 31 U.S.C. § 5318(k) to a foreign financial institution that maintains a correspondent bank account in the United States.

The AMLA significantly expands the scope of DOJ’s (and Treasury’s) authority to seek and enforce correspondent account subpoenas under Section 5318. Previously, these subpoenas could be issued to any foreign bank that maintained a correspondent account in the United States and could “request records related to such correspondent account.”[21] The AMLA broadens this authority to allow DOJ to seek “any records relating to the correspondent account or any account at the foreign bank, including records maintained outside of the United States,” if the records are the subject of an investigation that relates to a violation of U.S. criminal laws, a violation of the BSA, a civil forfeiture action, or a Section 5318A investigation.[22] Thus, by statute, DOJ now has the authority to subpoena from foreign banks not only records related to correspondent accounts, but records from any account at the foreign bank if they fall within one of the broad investigative categories identified in the statute. The AMLA also requires the foreign financial institution to authenticate all records produced.[23] In the event a foreign financial institution fails to comply, the Act authorizes the Attorney General to seek contempt sanctions, and the Attorney General or Secretary of the Treasury may direct covered U.S. financial institutions to terminate their correspondent relationships with the foreign financial institution refusing to comply and can impose penalties on those institutions that fail to do so.[24]

The AMLA Includes a Pilot Project for Sharing SAR Data Across International Borders

An issue that many of our financial institution clients face is how to share information contained in suspicious activity reports (“SARs”) across U.S. borders to affiliates located in other countries.[25] Historically, FinCEN has issued guidance to partially address the problem by permitting sharing of SAR information with foreign parent organizations or U.S. affiliates.[26] The AMLA further addresses this issue by providing that within a year after the legislation is enacted, the Treasury Department shall issue rules that create a pilot program for financial institutions to share information related to SARs, including their existence, “with the institution’s foreign branches, subsidiaries, and affiliates for the purpose of combating illicit finance risks.”[27] Notably, it contains jurisdictional carve-outs that would not permit sharing with any entities located in China or Russia (which can be waived by the Secretary of the Treasury on a case-by-case basis for national-security reasons) or in jurisdictions that are state sponsors of terrorism, subject to U.S. sanctions, or that the Secretary of the Treasury determines cannot reasonably protect the security and confidentiality of the data.[28] The pilot project is set to last three years, and can be extended for an additional two years upon a showing by the Treasury Department that it is useful and in the U.S. national interest.[29]

The AMLA Specifically Applies the BSA to Nontraditional Value Transfers, Including Cryptocurrency

As financial institutions have become more adept at fighting money laundering in the past decade, the government has become increasingly concerned that criminals may turn to other mediums, such as cryptocurrency and art, to try to launder money. For instance, in November 2020, DOJ announced that it seized over $1 billion worth of Bitcoin that was tied to drug sales and other illicit products and services on the online marketplace Silk Road before it was shut down.[30] And using high-end artwork was one of the ways in which the alleged co-conspirators in the 1MDB scandal attempted to launder the proceeds of their alleged crimes, by purchasing various high-end pieces of art and then seeking banks or financiers “who take art as security for … bank loans.”[31]

While U.S. enforcers had argued that preexisting anti-money laundering authorities could reach transactions involving cryptocurrency and art, the application of preexisting AML regulations to cryptocurrency, in particular, has often been an uneasy fit. The preexisting AML regime was a set of rules written largely for an analog world, and its application to the digital realm left open important questions, particularly in the context of criminal enforcement actions. Now, however, the Act expands the definition of financial institution and money transmitting business to include businesses engaged in the exchange or transmission of “value that substitutes for currency,” potentially reinforcing the government’s position that the BSA applies to cryptocurrency.[32] The AMLA also adds antiquities dealers, advisors, and consultants to the definition of “financial institution” under the BSA.[33] As to art, the AMLA requires the government to prepare a study within a year that assesses money laundering and terrorist financing through the art trade, including “which markets … should be subject to regulation,” “the degree to which the regulations, if any, should focus on high-value trade in works of art,” and “the need, if any, to identify persons who are dealers, advisors, consultants, or any other persons who engage as a business in the trade in works of art.”[34]

Many Smaller Companies Will Be Required to Disclose Beneficial Ownership Information to FinCEN, Which Will Also Be Available to Financial Institutions

The lack of a requirement for corporations to provide beneficial ownership information at the state or federal level in the United States has long been seen by law enforcement as a loophole that criminals can exploit. For instance, in 2016, the Financial Action Task Force (“FATF,” an international body that sets AML standards) recommended that the United States “[t]ake steps to ensure that adequate, accurate and current [beneficial owner] information of U.S. legal persons is available to competent authorities in a timely manner, by requiring that such information is obtained at the Federal level.”[35]

Accordingly, one of the most significant developments in the AMLA is the requirement for “reporting compan[ies]” to disclose beneficial ownership information to FinCEN, which will in turn maintain a nonpublic beneficial ownership database.[36] The definition of “reporting company” exempts a wide range of entities, including many classes of financial institutions (such as registered issuers, credit unions, broker-dealers, money transmitters, and exchanges) and larger U.S. companies, which are defined as companies that employ more than 20 full-time employees in the United States, had more than $5 million in gross revenue in the past year, and are operating at a physical office in the United States.[37] Thus, the new requirement is aimed at smaller businesses and shell companies.

Although the reporting requirement generally does not apply to financial institutions, it nevertheless has important consequences for them. The Act allows FinCEN to disclose beneficial ownership information to a financial institution with the reporting company’s consent to facilitate the financial institution’s compliance with Customer Due Diligence requirements.[38] As such, financial institutions will have to develop processes to effectively evaluate information from this beneficial ownership database. Moreover, the AMLA provides significant penalties for misuse of beneficial ownership information. Failure to disclose beneficial ownership information subjects a person to civil monetary penalties of $500 per day and a fine up to $10,000 and/or imprisonment of up to two years.[39] By contrast, unauthorized disclosure of beneficial ownership information is subject to the same civil penalty, but with fines up to $250,000—25 times the fine for failure to report—and/or imprisonment of up to five years.[40]

The AMLA Requires the Government to Establish AML Priorities That Will Feed Into Examinations of Financial Institutions

The AMLA requires the Secretary of the Treasury to publish “public priorities for anti-money laundering and countering the financing of terrorism policy” within 180 days after the law’s enactment.[41] The priorities must be “consistent with the national strategy for countering the financing of terrorism and related forms of illicit finance.”[42] FinCEN will have 180 days after the priorities are released to promulgate rules to carry out these priorities.[43] Financial institutions, for their part, will be required to “review” and “incorporat[e]” these priorities into their AML programs, which will be a measure “on which a financial institution is supervised and examined.”[44]

The AMLA Begins to Address Inefficiencies in SAR and CTR Filing Processes

Some argue that the current SAR and CTR filing processes are the worst of both worlds: they are incredibly burdensome for financial institutions but simultaneously bury enforcers with so much information that they cannot separate the wheat from the chaff. The $10,000 threshold for CTRs, for example, was set in 1970, and were it to be adjusted for inflation, the current threshold for filing a CTR today would be more than $60,000.[45] The lack of indexing for these thresholds has resulted in a swelling volume of mandatory reports; more than 16 million CTRs were filed in 2019.[46] Similarly, the SAR thresholds were set over 20 years ago, and the “current regime promotes the filing of SARs that may never be read, much less followed up on as part of an investigation”[47]—resulting in over 2.7 million SARs filed in 2019.[48]

The AMLA begins to take steps to address these criticisms. It requires that, when imposing requirements to report suspicious transactions, the Secretary of the Treasury shall, among other things, “establish streamlined, including automated, processes to, as appropriate, permit the filing of noncomplex categories of reports.”[49] It also requires the government to conduct formal reviews of whether the CTR and SAR thresholds should be adjusted and to determine if there are changes that can be made to the filing process to “reduce any unnecessarily burdensome regulatory requirements” while ensuring the information has a high degree of usefulness to enforcers.[50]

The AMLA also contains a number of provisions to try to ensure the usefulness of information provided by financial institutions. For instance, it requires FinCEN to periodically disclose to financial institutions “in summary form[] information on suspicious activity reports filed that proved useful to Federal or State criminal or civil law enforcement agencies during the period since the most recent disclosure,” provided the information does not relate to an ongoing investigation or implicate national security.[51] Similarly, the AMLA requires FinCEN to publish threat pattern and trend information at least twice a year to provide meaningful information about the preparation, use, and value of reports filed under the BSA.[52]

The AMLA Continues to Promote Collaboration Between the Public and Private Sectors

As FinCEN has recognized, “[s]haring information through … public-private partnerships supports more, and higher-quality, reports to FinCEN and assists law enforcement in detecting, preventing, and prosecuting terrorism, organized crime, money laundering, and other financial crimes.”[53] To that end, FinCEN has sought to improve collaboration between law enforcement and financial institutions over the years. For instance, in 2017, FinCEN created the “FinCEN Exchange” to “enhance information sharing with financial institutions.”[54]

The AMLA contains a number of provisions designed to further promote collaboration between the public and private sectors. It formalizes the FinCEN Exchange by statute, and requires the Secretary of the Treasury to periodically report to Congress about the utility of the Exchange and recommendations for further improvements.[55] The Act requires that data shared under the Exchange be done so in accordance with federal law and in “such a manner as to ensure the appropriate confidentiality of personal information”; it also “shall not be used for any purpose” other than identifying and reporting on financial crimes.[56] Furthermore, the Act requires the Secretary of the Treasury to convene a team consisting of stakeholders from the public and private sector “to examine strategies to increase cooperation between the public and private sectors for purposes of countering illicit finance.”[57]

________________________

[1] William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, H.R. 6395. Division F of the NDAA is the Anti-Money Laundering Act of 2020, and Title XCVII within the bill contains additional provisions relevant to the financial services industry.

[2] This alert is not a comprehensive summary of every provision of the AMLA, the specific provisions of the law discussed herein, or the broader NDAA. For example, the NDAA contains a provision providing the SEC explicit authority to seek disgorgement in federal court, which is discussed in a separate Gibson Dunn client alert available here.

[3] AMLA, § 6314 (adding 31 U.S.C. § 5323(b)(1)).

[4] See 31 U.S.C. § 5323.

[5] AMLA, § 6314 (adding 31 U.S.C. § 5323(g)).

[6] Press Release, U.S. Secs. & Exch. Comm’n, SEC Proposes New Whistleblower Program Under Dodd-Frank Act, (Nov. 3, 2010), https://www.sec.gov/news/press/2010/2010-213.htm.

[7] U.S. Secs. & Exch. Comm’n, Whistleblower Program Annual Report 27-30 (2020), https://www.sec.gov/files/2020%20Annual%20Report_0.pdf.

[8] Press Release, SEC Issues Record $114 Million Whistleblower Award, Securities and Exchange Commission, Oct. 22, 2020, https://www.sec.gov/news/press-release/2020-266.

[9] Developments in the Defense of Financial Institutions – The International Reach of the U.S. Money Laundering Statutes, Gibson Dunn (Jan. 9, 2020), https://www.gibsondunn.com/developments-in-defense-of-financial-institutions-january-2020/.

[10] Amy MacKinnon, Biden Expected to Put the World’s Kleptocrats on Notice, Foreign Policy (Dec. 3, 2020), https://foreignpolicy.com/2020/12/03/biden-kleptocrats-dirty-money-illicit-finance-crackdown/.

[11] AMLA, § 6313 (adding 31 U.S.C. § 5335(b)).

[12] AMLA, § 6313 (adding 31 U.S.C. § 5335(c)).

[13] AMLA, § 6313 (adding 31 U.S.C. § 5335(d)).

[14] AMLA, § 6312 (adding 31 U.S.C. § 5322(e)).

[15] AMLA, § 6310 (adding 31 U.S.C. § 5321(g)).

[16] AMLA, § 6309 (adding 31 U.S.C. § 5321(f)).

[17] AMLA, § 6105.

[18] AMLA, §§ 6106, 6107, 6108.

[19] AMLA, §§ 6207, 6208, 6303.

[20] Justice Manual § 9-13.525, U.S. Department of Justice, https://www.justice.gov/jm/jm-9-13000-obtaining-evidence#9-13.525 (“[A]ll Federal prosecutors must obtain written approval from the Criminal Division through the Office of International Affairs (OIA) before issuing any unilateral compulsory measure to persons or entities in the United States for records located abroad.”).

[21] 31 U.S.C. § 5318(k)(3)(A).

[22] AMLA, § 6308 (31 U.S.C. § 5318(k)(3)(A)(i) as revised).

[23] AMLA, § 6308 (31 U.S.C. § 5318(k)(3)(A)(ii) as revised).

[24] AMLA, § 6308 (31 U.S.C. § 5318(k)(D), (E) as revised).

[25] See 31 U.S.C. § 5318(g)(2)(A)(i) (providing that financial institutions or their employees involved in reporting suspicious transactions may not notify “any person involved in the transaction that the transaction has been reported.”).

[26] Interagency Guidance on Sharing Suspicious Activity Reports with Head Offices or Controlling Companies (Jan. 20, 2006), https://www.fincen.gov/sites/default/files/guidance/sarsharingguidance01122006.pdf; Fin. Crimes Enf’t Network, FIN-2010-G006, Sharing Suspicious Activity Reports by Depository Institutions with Certain U.S. Affiliates (Nov. 23, 2010), https://www.fincen.gov/sites/default/files/shared/fin-2010-g006.pdf.

[27] AMLA, § 6212 (adding 31 U.S.C. § 5318(g)(8)(B)(i)).

[28] AMLA, § 6212 (adding 31 U.S.C. § 5318(g)(8)(C)).

[29] AMLA, § 6212 (adding 31 U.S.C. § 5318(g)(8)(B)(iii)).

[30] Press Release, U.S. Dept. of Justice, United States Files A Civil Action To Forfeit Cryptocurrency Valued At Over One Billion U.S. Dollars, (Nov. 5, 2020), https://www.justice.gov/usao-ndca/pr/united-states-files-civil-action-forfeit-cryptocurrency-valued-over-one-billion-us.

[31] United States of America v. One Pen and Ink Drawing By Vincent Van Gogh Titled “La Maison De Vincent A Arles” et al., No. 2:16-cv-5366 (C.D. Cal. July 20, 2016), Dkt. 1 ¶¶ 440-43, https://www.justice.gov/archives/opa/page/file/877156/download

[32] AMLA, § 6102(d); see also Press Release, Sen. Mark Warner, Warner, Rounds, Jones Applaud Inclusion of Bipartisan Anti-Money Laundering Legislation in NDAA (Dec. 3, 2020), https://www.warner.senate.gov/public/index.cfm/2020/12/warner-rounds-jones-applaud-inclusion-of-bipartisan-anti-money-laundering-legislation-in-ndaa (highlighting “[e]nsuring the inclusion of current and future payment systems in the AML-CFT regime” as among the achievements of the new NDAA).

[33] AMLA, § 6110(a)(1) (31 U.S.C. § 5312(a)(2)(Y) as amended).

[34] AMLA, § 6111(e).

[35] FATF, Anti-money laundering and counter-terrorist financing measures in the United States: Executive Summary 11 (2016), http://www.fatf-gafi.org/media/fatf/documents/reports/mer4/MER-United-States-2016-Executive-Summary.pdf.

[36] AMLA, § 6403 (adding 31 U.S.C. § 5336)

[37] AMLA, § 6403 (adding 31 U.S.C. § 5336(a)(11)).

[38] AMLA, § 6403 (adding 31 U.S.C. § 5336(c)(2)(B)(iii)).

[39] AMLA, § 6403 (adding 31 U.S.C. § 5336(h)(3)(A)).

[40] AMLA, § 6403 (adding 31 U.S.C. § 5336(h)(3)(B)).

[41] AMLA, § 6101(a) (adding 31 U.S.C. § 5311(b)(4)(A)).

[42] AMLA, § 6101(a) (adding 31 U.S.C. § 5311(b)(4)(C)).

[43] AMLA, § 6101(a) (adding 31 U.S.C. § 5311(b)(4)(D)).

[44] AMLA, § 6101(a) (adding 31 U.S.C. § 5311(b)(4)(E)).

[45] Blaine Luetkemeyer, Steve Pearce, It’s Time to Modernize the Bank Secrecy Act, American Banker (June 13, 2018), https://www.americanbanker.com/opinion/its-time-to-modernize-the-bank-secrecy-act.

[46] FinCEN Report of Transactions in Currency, 85 Fed. Reg. 29,022, 29,023 (May 14, 2020), https://www.govinfo.gov/content/pkg/FR-2020-05-14/pdf/2020-10310.pdf.

[47] The Clearing House, A New Paradigm: Redesigning the U.S. AML/CFT Framework to Protect National Security and Aid Law Enforcement 13 (2017), here.

[48] See FinCEN Report of Reports by Financial Institutions of Suspicious Transactions, 85 Fed. Reg. 31,598, 31,599 (May 26, 2020), https://www.govinfo.gov/content/pkg/FR-2020-05-26/pdf/2020-11247.pdf.

[49] AMLA, § 6202 (adding 31 U.S.C. § 5318(g)(5)(D)).

[50] AMLA, §§ 6204, 6205.

[51] AMLA, § 6203(b).

[52] AMLA, § 6206 (adding 31 U.S.C. § 5318(g)(6)).

[53] Press Release, Fin. Crimes Enf’t Network, FinCEN Exchange in New York City Focuses on Virtual Currency, https://www.fincen.gov/resources/financial-crime-enforcement-network-exchange.

[54] Press Release, Fin. Crimes Enf’t Network, FinCEN Launches “FinCEN Exchange” to Enhance Public-Private Information Sharing, (Dec. 4, 2017), https://www.fincen.gov/news/news-releases/fincen-launches-fincen-exchange-enhance-public-private-information-sharing.

[55] AMLA, § 6103 (adding 31 U.S.C. § 310(d)(2), (3)).

[56] AMLA, § 6103 (adding 31 U.S.C. § 310(d)(4)(A), (4)(B), 5(B)).

[57] AMLA, § 6214.

The following Gibson Dunn lawyers assisted in preparing this client alert: Stephanie Brooker, M. Kendall Day, Linda Noonan, Ella Alves Capone, Chris Jones and Alexander Moss.

Gibson Dunn has deep experience with issues relating to the Bank Secrecy Act, other AML and sanctions laws and regulations, and the defense of financial institutions more broadly. For assistance navigating white collar or regulatory enforcement issues involving financial institutions, please contact any of the authors, the Gibson Dunn lawyer with whom you usually work, or any of the leaders and members of the firm’s Financial Institutions, White Collar Defense and Investigations, or International Trade practice groups.

Stephanie Brooker – Washington, D.C. (+1 202-887 3502, sbrooker@gibsondunn.com)
M. Kendall Day– Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Linda Noonan – Washington, D.C. (+1 202-887-3595, lnoonan@gibsondunn.com)
Ella Alves Capone – Washington, D.C. (+1 202-887-3511, ecapone@gibsondunn.com)
Chris Jones* – San Francisco (+1 415-393-8320, crjones@gibsondunn.com)
Alexander Moss – Washington, D.C. (+1 202.887.3615, amoss@gibsondunn.com)

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

Financial Institutions Group:
Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)

White Collar Defense and Investigations Group:
Joel M. Cohen – New York (+1 212-351-2664, jcohen@gibsondunn.com)
Charles J. Stevens – San Francisco (+1 415-393-8391, cstevens@gibsondunn.com)
F. Joseph Warin – Washington, D.C. (+1 202-887-3609, fwarin@gibsondunn.com)

International Trade Group:

Ronald Kirk – Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Judith Alison Lee – Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)

*Mr. Jones is admitted only in New York and Washington, D.C. and is practicing under the supervision of Principals of the Firm.

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On December 4, 2020, Judge Rakoff of the Southern District of New York denied a motion to dismiss breach of fiduciary duty claims against former directors of Jones Group (the predecessor to Nine West).[1] The lawsuit arises from the board of directors’ approval of a buyout transaction that distributed $1.2 billion to Jones Group shareholders, while allegedly rendering the company insolvent. The Court allowed the claims to proceed, finding that the directors, by their own admission, failed to conduct a reasonable investigation into whether the transaction as a whole was beneficial to the company or would render the company insolvent. The Court concluded that the director defendants were not exempt from responsibility for the steps of the integrated transaction that were implemented after they resigned from the board because they allegedly knew that those steps were part of an integrated multi-step transaction and would be completed substantially concurrently with their resignation. The directors were not entitled to the protections of the business judgment rule because they expressly avoided any investigation regarding two key steps in the transaction; they allegedly turned a blind eye to the intention to complete those steps after the initial merger.

This preliminary decision merits discussion, but it does not represent a watershed expansion of exposure for directors or expansion of their fiduciary duties. Instead, it reinforces the simple rule that in order to obtain the protection of the business judgment rule the board must in fact make an informed business judgment, and declining to review key components of an integrated multi-step transaction is reckless. Ordinarily, the business judgment rule and the exculpatory provisions in a company’s bylaws offer a significant shield against liability for directors, except in the most egregious of circumstances. However, those protections only operate when the directors make a reasonable investigation and a business judgment, which the Jones Group directors expressly chose not to do when they opted not to approve or disapprove the key elements of the multi-step transaction that allegedly rendered the company insolvent. As the Court very aptly noted, “the business judgment rule presupposes that directors made a business judgment.”[2]

Facts of the Case

In the years leading up to the 2014 leverage buyout transaction, Jones Group—a publicly traded global footwear and apparel company—was suffering financially. The only bright spot was the performance of two brands, Stuart Weitzman and Kurt Geiger, that Jones Group had purchased for $800 million just a few years earlier.

In July of 2012, the board began considering a sale of the company and retained Citigroup Global Markets to act as its advisor. Citigroup advised the board, in relevant part, that in a transaction where Jones Group retained all of its businesses (including the successful Stuart Weitzman and Kurt Geiger brands), the company could support a maximum debt to EBITDA ratio of 5.1. The following year, the private equity firm Sycamore Partners Management reached a deal to purchase Jones Group for $15 per share, representing a $2.15 billion implied enterprise value for the company.

The merger agreement between Jones Group and Sycamore Partners originally involved five allegedly integrated components:

Jones Group would merge with a Sycamore affiliate;
Sycamore would contribute at least $385 million in equity to the post-merger surviving entity (“Nine West”);
Nine West would increase its total debt burden from $1 billion to $1.2 billion;
Jones Group shareholders would be cashed out at $15 per share (for a total of $1.2 billion); and
the successful Stuart Weitzman and Kurt Geiger brands, along with one additional business unit, would be sold to another Sycamore affiliate for substantially less than fair market value.

The board unanimously approved the merger agreement on December 19, 2013 but excluded from its approval the 3rd and 5th steps (the debt increase and the carve-out transaction of the Stuart Weitzman and Kurt Geiger brands). The merger agreement included provisions that obligated Jones Group to assist Sycamore in both planning the carve-out transaction and syndicating the additional debt. The directors allegedly knew that these were parts of an integrated transaction, that all steps would occur substantially concurrently, and that their affirmative vote was putting the wheels in motion to strip the most valuable assets out of the merged company and burden it with unsustainable debt. They allegedly chose to approve parts of the multi-step transaction and turn a blind-eye to the harmful steps they allegedly knew they were facilitating.

Prior to the closing, Sycamore reduced its equity contribution from $395 million to $120 million, and increased the total amount of new debt from $1.2 billion to $1.55 billion. This raised the company’s post-transaction debt to EBITDA ratio to between 6.6 and 7.8.—well above the 5.1 maximum ratio that Citigroup initially indicated was sustainable. Although the merger agreement contained a fiduciary out clause, the directors did not reconsider their approval even after the initial transaction was modified in ways detrimental to the company.

In anticipation of the carve-out transaction, Sycamore hired valuation advisors to provide a solvency opinion for Jones Group as it would exist after the transfer of the successful Stuart Weitzman and Kurt Geiger brands (Jones Group without the successful brands, “RemainCo”). Sycamore allegedly created and provided to their advisors “unreasonable and unjustified” EBITDA projections for RemainCo to inflate its value and justify the below-market price for the Stuart Weitzman and Kurt Geiger brands. Sycamore ultimately settled on a $1.58 billion valuation of RemainCo, just above the $1.55 billion total debt burden that was planned by Sycamore. The directors of Jones Group were not, according to the complaint, directly aware of the fact that Sycamore had manipulated the projections of RemainCo in order to achieve the $1.58 billion valuation. However, the complaint alleged that the directors received updated reports and projections from Jones Group management on a monthly basis and were therefore aware of the poor performance of Jones Group overall, as well as the comparatively stellar performance of the Stuart Weitzman and Kurt Geiger brands.

The merger closed on April 8, 2014, at which point Jones Group directors were replaced by two Sycamore principals. As part of the closing of the merger, the new directors caused Nine West to sell the Stuart Weitzman and Kurt Geiger brands to a newly formed Sycamore affiliate for just $641 million. This number was far less than the $800 million that Jones Group had paid to acquire these brands just a few years earlier, even though these brands had been very successful during the interim. The complaint alleged that the fair market value of these brands was $1 billion. In April of 2018, about four years after the merger closed, Nine West filed for bankruptcy.

Allegations

The Court found that the following allegations justified denial of the motion to dismiss and refusal to apply the deferential business judgment standard of review to the actions of the directors:

The directors chose not to review or approve two of the major steps of the merger transaction—the issuance of additional debt and a carve-out transaction that sold off the most successful parts of the company post-merger, even though they knew their approval of the merger would lead to the completion of these additional steps in the intended multi-step transaction. Both steps were crucially important in causing the overleveraging that eventually led to the bankruptcy of the company.
The directors allegedly ignored certain “red flags” that should have caused them to investigate potential solvency issues related to the transaction. The failure to investigate these red flags when the directors could have withdrawn support for the transaction was, according to the Court, reckless.

Breach of Fiduciary Duty Claim

The director defendants moved to dismiss the breach of fiduciary duty claims on two grounds. First, they argued that their approval of the transaction was protected by the business judgment rule, and second, that even if the business judgment rule did not apply, they were protected by exculpatory provisions in Jones Group’s bylaws. The Court rejected both arguments based on the same fundamental allegations: the directors had not in fact exercised any business judgment because they expressly avoided approving the two key steps of the multi-step transaction, and the directors were responsible for those steps because they knew the entire multi-step transaction would be consummated substantially concurrently. The directors’ failure to review the merits of each step of the transaction was reckless.

Under Pennsylvania law, which is especially deferential towards directors in the merger context, adherence to the business judgment standard is presumed so long as a majority of the disinterested directors approve the merger unless the disinterested directors did not assent to such act in good faith after reasonable investigation.

The Court found that the complaint sufficiently alleged that the directors failed to conduct a reasonable investigation into whether the transaction as whole (including the additional debt burden and the carve-out transaction) would render the company insolvent. The complaint alleged that the directors had excluded from their approval the two steps in the multi-step transaction that rendered RemainCo insolvent, even after Sycamore substantially increased the debt burden and decreased its equity contribution. The Court concluded that the business judgment rule did not apply because the rule, even under the deferential merger standard, only protects decisions undertaken after reasonable investigation and the complaint alleged there was no investigation (reasonable or otherwise).

Furthermore, the Court rejected the directors’ argument that they could not be liable for actions effectuated after they ceased to be in control of the company, explaining that, accepting the allegation in the complaint as true for purposes of the motion to dismiss, the multi-step transaction “reasonably collapses into a single integrated plan.”[3] In making this determination, the Court found it significant that the directors allegedly knew about the post-merger steps and, further, that those post-merger steps were certain to occur upon approval of the transaction. In a different recent decision in the Southern District of New York, In re Tribune Co. Fraudulent Conveyance Litigation, 2018 WL 6329139 (S.D.N.Y. Nov. 30, 2018), the court declined to collapse a two-step LBO transaction where the second step occurred more than six months after the first and its occurrence was subject to various preconditions including regulatory approval and the issuance of a second solvency opinion.[4] Contrasted to the facts here, where all five steps of the transaction were certain to occur substantially concurrently, the second step in Tribune was subject to conditions precedent that might not be satisfied and, therefore, was not certain to occur when the first step occurred or when the board members resigned.[5]

Exculpatory Bylaw Provisions Did Not Protect the Directors

Jones Group’s bylaws contained an exculpatory provision that limited a director’s monetary liability to breaches involving self-dealing, willful misconduct, or recklessness. The Court found that the complaint sufficiently alleged that the directors’ decision to set in motion the multi-step transaction, including the two steps that allegedly rendered the company insolvent and stripped it of its best assets, without reviewing the merits of those steps, was reckless.

The complaint alleged that the directors consciously disregarded whether the additional debt and carve-out transactions were in the best interests of the company by specifically excluding those elements of the transaction from their assessment or approval. The Court found that the complaint also alleged certain “red flags” that should have put the director defendants on notice that the additional debt and carve-out transactions would leave the company insolvent.

The first red flag was that the $2.2 billion valuation that the company received in the transaction, minus the $800 million historical purchase price of the carve-out businesses, implied that the rest of Jones Group was worth, at most, $1.4 billion. This relatively simple math—that a company worth no more than $1.4 billion was to be saddled with $1.55 billion of debt—should have alerted the directors that they needed to investigate RemainCo’s solvency. The second red flag was the simple fact that the increased debt burden would increase the debt to EBITDA ratio to between 6.6 and 7.8—both of which were substantially above the 5.1 maximum ratio that Citigroup had previously advised the board was sustainable.

The Court held that the red flags alleged in the complaint, coupled with the failure of the board to conduct any investigation in the face of such notice, was reckless. The denial of the motion to dismiss and conclusion that the complaint adequately alleged recklessness is premised in large part on the directors’ alleged decision to abdicate their duties by not reviewing the merits of two of the steps of the multi-step transaction and not an indication that an informed, but incorrect, assessment of the merits of the transaction would not have been protected.

Aiding and Abetting the Breach of Fiduciary Duty Claim

In addition to claims for their own breaches of fiduciary duty, the directors also faced allegations of aiding and abetting the breaches of the fiduciary duties of the two Sycamore principals who became directors after the closing of the merger. The Court, rather summarily, upheld this claim for two reasons.

First, the Court rejected the directors’ argument that any acts taken before the Sycamore principals became directors cannot form the basis of this claim, finding that no such temporal requirement for the fiduciary relationship existed, and that there were no grounds for creating one. The allegations that the directors had enabled the Sycamore directors to strip away assets and overleverage RemainCo by approving the merger without reviewing the merits of the transfers of the crown jewels or the additional debt, even though the directors allegedly had actual knowledge these additional steps would be taken post-merger, was sufficient to state a claim for aiding an abetting the actions of the Sycamore directors.

Second, the complaint adequately pled that the director defendants knowingly participated in the breaches because the same “red flags” discussed above were sufficient to show that the directors had actual or constructive knowledge that the contemplated carve-out transactions constituted a breach of fiduciary duty by the Sycamore principals, which the director defendants knew the Sycamore directors intended to carry out as part of the multi-step transaction. The directors’ decision not to address the merits of two critical steps in the multi-step transaction may even justify an inference that the directors knew that these steps were problematic.

Key Considerations

While this decision is not a departure from established law, it does provide guidance to directors and other interested parties as to what practices must be employed to satisfy their fiduciary duties and minimize liability risk. Process is critical. To obtain the benefits of the business judgment rule directors must actually exercise business judgement and cannot intentionally distance themselves from responsibility for certain steps in an integrated multi-step transaction that they knowingly facilitate, especially when all steps in the transaction occur substantially concurrently.

This opinion denies a motion by the director defendants to dismiss the claims against them. It is not a ruling finally imposing liability. On a motion to dismiss, the court is required to accept all facts in the plaintiff’s complaint as true and to view them in the light most favorable to the plaintiff. Additionally, the Court was applying Pennsylvania law. While fiduciary duty law is fairly similar across jurisdictions, this decision is merely persuasive authority regarding one state’s fiduciary duty laws. That said, the Court refused to apply the business judgment standard, which is one of the key protections available to directors.

This decision reaffirms that directors must thoroughly and meaningfully review all parts of a transaction that are contemplated when they decide whether to approve it, even if some steps of a multi-step integrated transaction may occur after the director is no longer a board member. A director cannot evade the obligation to review part of the transaction by simply excluding it from the board approval analysis. Directors should anticipate that a multi-step transaction may be viewed by a court as a single transaction, even if certain steps are to be completed post-closing by different directors or entities. However, directors can further protect themselves by insisting on a bifurcated transaction structure with meaningful conditions so that any risky steps (e.g., incurrence of additional debt, spinoff transactions, etc.) will only occur if the company is solvent and can support the transaction.

In evaluating a transaction, directors should also consider whether the valuation metrics they receive are compatible all other current financial information that had been provided to the directors. While there is nothing in the Nine West decision to indicate that directors cannot rely on the analyses and presentations of advisors and experts, the Court’s comments regarding the disconnect between the numbers provided to the valuation advisors by the proposed buyer and other information available to the directors may imply an expectation that a reasonable exercise of business judgment requires directors to consider whether valuation metrics are at odds with the other information that they have regarding financial performance of the company.

______________________

[1] In re Nine W. LBO Sec. Litit., __ F. Supp. 3d __, 2020 WL 7090277 (S.D.N.Y. Dec. 4, 2020). All of the facts and legal analysis in this memorandum are from the above citation unless otherwise noted.

[2] Id. at * 29.

[3] Id. at * 30.

[4] In re Tribune Co. Fraudulent Conveyance Litig., 2018 WL 6329139, at *8-9 (S.D.N.Y. Nov. 30, 2018). In step one of the Tribune transaction, the company borrowed money to repurchase approximately 50% of its outstanding stock, and then in step two the company borrowed additional money to redeem the remaining stock through a go-private transaction. Id. at *2.

[5] This decision does not suggest that a director would be liable for a transaction undertaken by a future board for which the prior board had no knowledge. But these cases suggest that a board may be able to insulate itself from liability for future actions undertaken for which it has knowledge, so long as those future actions are considered in a meaningful way or, like in Tribune, future transactions are meaningfully bifurcated from the transaction that the directors approve.

Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or any of the following:

Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com)
Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com)
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Matthew G. Bouslog – Orange County, CA (+1 949-451-4030, mbouslog@gibsondunn.com)
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Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com)
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Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On December 27, 2020, President Trump signed the bipartisan COVID-19 relief and government funding bill, which incorporated the Copyright Alternative in Small-Claims Enforcement Act of 2020 (“CASE Act”) that had been pending as part of H.R. 133, as well as legislation designed to increase criminal penalties for illicit streaming of copyright-protected content. The CASE Act contains various revisions to the Copyright Act, 17 U.S.C. §§ 101 et seq., with the goal of creating a new avenue for copyright owners to enforce their rights without having to file a lawsuit in federal court. The CASE Act creates a Copyright Claims Board within the United States Copyright Office that may adjudicate small claims of copyright infringement using streamlined procedures and award limited remedies, including no more than $30,000 in total damages in any single proceeding. The stimulus package also includes the language of a separate bipartisan bill, the Protecting Lawful Streaming Act, that amends Title 18 of the U.S. Code to make it a felony (rather than just a misdemeanor) to unlawfully stream copyright-protected content online for profit, with penalties of up to 10 years of imprisonment. We briefly summarize these key copyright provisions below.

Creation of Copyright Claims Board. While federal courts generally exercise exclusive jurisdiction over claims of copyright infringement,[1] the CASE Act establishes a Copyright Claims Board as an alternative forum in which parties may voluntarily resolve small claims of copyright infringement arising under Section 106 of the Copyright Act.[2] The Board consists of three Copyright Claims Officers who may conduct individualized proceedings to resolve disputes before them, including by managing discovery and conducting hearings as necessary, and awarding monetary and other relief.[3] The Officers must issue written decisions setting forth their factual findings and legal conclusions.[4] But parties that choose to proceed before the Board waive their right to formal motion practice and a jury trial.[5] Participation in a proceeding before the Board is voluntary, and parties may opt out upon being served with a claim, choosing instead to resolve their dispute in federal court.[6]
Board Decisions. The CASE Act grants the Register of Copyrights authority to issue regulations setting forth specific claim-resolution procedures, but the CASE Act expressly articulates choice-of-law principles and states that Board decisions are not precedential.
- Choice of Law: Although the Board sits within the Copyright Office in Washington, D.C., the Board must follow the law in the federal jurisdiction in which the action could have been brought if filed in federal court.[7] Given the conflicts that could arise where an action could have been brought in multiple jurisdictions that are split on a legal question, the Act provides that the Board may apply the law of the jurisdiction the Board determines has the most significant ties to the parties and conduct at issue.[8]
- Board Decisions Are Not Precedential: The CASE Act provides that Board decisions may not be cited or relied upon as legal precedent in any action before any tribunal, including the Board.[9] And Board decisions have preclusive effect solely with respect to the parties to the proceeding and the claims asserted and resolved in the proceeding.[10]
Board Remedies. As in federal court, parties before the Board may seek actual or statutory damages. But the CASE Act caps the amount of damages the Board may award. Specifically, the Board may not award more than $15,000 in statutory damages per work, may not consider whether infringement was willful (and, therefore, may not increase a per work statutory award based on willfulness, as is permitted in federal court), and may not award more than $30,000 in total actual or statutory damages in any single proceeding, notwithstanding the number of claims asserted.[11] While attorneys’ fees are recoverable under the Copyright Act,[12] the Board may not award attorneys’ fees except in the case of bad faith conduct—in which case, any fee award may not exceed $5,000, absent extraordinary circumstances, such as where a party has engaged in a pattern of bad faith conduct.[13]
Limited Appellate Review. The CASE Act permits parties to seek limited review of Board decisions. After the Board issues its written decision in a matter, a party may submit to the Board a written request for reconsideration.[14] If the Board declines to reconsider its decision, the party may ask the Register of Copyrights to review the Board’s decision under an abuse of discretion standard of review.[15] If the Register does not provide the requested relief, the party may then seek an order from a district court vacating, modifying, or correcting the Board’s determination under only very limited circumstances: if (a) the determination was the result of fraud, corruption, misrepresentation, or other misconduct; (b) the Board exceeded its authority or failed to render a final determination; or (c) the determination was based on a default or failure to prosecute due to excusable neglect.[16]
Bar on Repeat Frivolous Filings. In an attempt to deter copyright trolls from filing repeated, frivolous claims before the Board, the CASE Act provides that any party who pursues a claim or defense in bad faith more than once in a 12-month period may be barred from initiating a claim before the Board for 12 months.[17] The CASE Act also grants the Register of Copyrights authority to issue regulations limiting the number of proceedings a claimant may initiate in any given year.[18]
Implications of the CASE Act. The CASE Act authorizes the Register of Copyrights to issue implementing regulations setting forth specific procedures for proceedings before the Board, so it remains to be seen exactly how the Board will conduct proceedings before it. It also is an open question how and whether the Board will resolve constitutional questions that arise in copyright infringement actions, such as First Amendment questions relating to the fair use defense. Further, it remains to be seen whether defendants in small copyright disputes will consent to Board proceedings, or will opt out in favor of the federal courts. Regardless, the CASE Act creates mechanisms for the more efficient and economical pursuit of small claims of copyright infringement, where the expense of litigating in federal court would otherwise exceed any potential recovery.
Protecting Lawful Streaming Act. The separate criminal copyright provisions tucked into the stimulus bill are designed to address a loophole under current law that allows the reproduction and distribution of copyright-protected material to be charged as felonies, but only allows the live streaming (or “publicly performing”) of such works to be charged as a misdemeanor. According to the legislative history, the bill sponsors thought it was important to recognize that streaming, rather than copying, has become the primary way that audiences consume entertainment. This new statutory language will allow the U.S. Justice Department to bring felony charges not against individual users, but rather against a digital transmission service that: (1) is primarily designed or provided for the purpose of streaming copyrighted works without the authority of the copyright owner or the law; (2) has no commercially significant purpose or use other than to stream copyrighted works without the authority of the copyright owner or the law; or (3) is intentionally marketed or directed to promote its use in streaming copyrighted works without the authority of the copyright owner or the law.[19] The statutory language represents a compromise with some critics who had feared that broader criminal provisions could be used to limit free speech online.

______________________

[1] 28 U.S.C. § 1338(a) (“The district courts shall have original jurisdiction of any civil action arising under any Act of Congress relating to … copyrights,” and “[n]o State court shall have jurisdiction over any claim for relief arising under any Act of Congress relating to … copyrights.”).

[2] H.R. 133 § 1502(a); § 1504(c); see also 17 U.S.C. § 106 (“the owner of copyright under this title has the exclusive rights to … reproduce the copyrighted work”; “to prepare derivative works based upon the copyrighted work”; “to distribute copies or phonorecords of the copyrighted work to the public”; “to perform the copyrighted work publicly”; “to display the copyrighted work publicly”; and “to perform the copyrighted work publicly”).

[3] H.R. 133 §§ 1502(b)(1)–(3), 1503(a)–(b), 1504(e)(2).

[4] Id. § 1506(s)–(t).

[5] Id. § 1506(c), (e)-(g), (m), (p).

[6] Id. §§ 1504(a), 1506(g).

[7] Id. § 1506(a)(2).

[8] Id. § 1506(a)(2).

[9] Id. § 1507(a)(3).

[10] Id. § 1507(a).

[11] Id. § 1504(e)(1)(A), (D).

[12] 17 U.S.C. § 505.

[13] H.R. 133 §§ 1504(e)(3), 1506(y)(2).

[14] Id. § 1506(w).

[15] Id. § 1506(x).

[16] Id. § 1508(c).

[17] Id. § 1506(y)(3).

[18] Id. § 1504(g).

[19] 18 U.S.C. § 2319C.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please feel free to contact the Gibson Dunn lawyer with whom you usually work in the firm’s Intellectual Property, Media, Entertainment and Technology, or Fashion, Retail, and Consumer Products practice groups, or the following authors:

Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Ilissa Samplin – Los Angeles (+1 213-229-7354, isamplin@gibsondunn.com)
Jonathan N. Soleimani – Los Angeles (+1 213-229-7761, jsoleimani@gibsondunn.com)
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Orin Snyder – New York (+1 212-351-2400, osnyder@gibsondunn.com)

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

On December 21, 2020, Congress passed a massive $2.3 trillion, 5,593-page, bicameral and bipartisan year-end legislation package to fund the government and provide long-delayed coronavirus relief. H.R. 133 includes $1.4 trillion to fund the government and $900 billion in coronavirus relief via the Coronavirus Response and Relief Supplemental Appropriations Act, 2021 (the “Act”). Following the $2.3 trillion coronavirus relief package signed into law last March, the current legislation is the second-largest economic stimulus in U.S. history. This is the fourth coronavirus relief package that Congress has passed this year, bringing the total sum that Congress has spent on coronavirus relief up to roughly $3 trillion.

The Act passed Congress overwhelmingly, by a vote of 359-53 in the House and 92-6 in the Senate. President Trump has criticized the bill sharply, but the strong votes in both chambers may dissuade him from vetoing the measure. The passage of the massive legislation marks nearly nine months since Congress last provided coronavirus relief to a nation besieged by a pandemic and businesses on the brink of economic collapse in the absence of federal funding.

While the Act includes a wide variety of provisions, this alert will focus largely on language relating to the Paycheck Protection Program (“PPP”), which allows for second draw loans for the hardest-hit businesses. The Act also expands the list of expenses PPP funds may cover and clarifies that ordinarily tax deductible business expenses are still deductible even if PPP loans were used to cover those costs. Other provisions of the Act include PPP set-asides for businesses that traditionally have difficulty accessing mainstream banking services and expanded the types of organizations eligible for relief. The Act also provides funding for the SBA to conduct auditing and fraud-detection efforts over the administration of PPP loans.

Other COVID-19 relief provisions include billions in funding for “shuttered venue operators,” such as live venues, closed movie theaters, and museums. Moreover, any entity that received an Economic Disaster Injury Loan advance under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) no longer needs to deduct the amount of their advance from their PPP loan forgiveness amount. Below is a summary of the key provisions most relevant to our clients and friends.

Paycheck Protection Program Revival and Changes

The Act revives and makes key changes to the Paycheck Protection Program Flexibility Act of 2020 (“PPP Flexibility Act”) that Congress passed, and the President signed into law, in June of 2020.[i] As discussed in a previous Gibson Dunn client alert, President Signs Paycheck Protection Program Flexibility Act, the PPP Flexibility Act relaxed certain requirements of and restrictions on PPP loans, which were established by the CARES Act and clarified by subsequent guidance from the Small Business Administration (“SBA”) and the U.S. Department of the Treasury. If President Trump signs the legislation, the SBA is required to establish regulations on implementing the programs in the Act within 10 days of the signing.

Importantly, the Act revives the signature small-business relief effort that Congress established last spring, committing $285 billion for additional PPP loans and extending the deadline to apply for PPP loans to March 31, 2021. The Act allows the hardest-hit businesses to receive a second draw PPP loan, with extra relief provided to food services and hotels; expands the list of eligible expenses that PPP funds may cover; and permits PPP recipients to deduct expenses covered with PPP funds. The Act also expands the types of programs eligible for first-time PPP loans, while prohibiting publicly-traded companies and companies affiliated with China or Hong Kong from receiving new loans.

The first round of PPP loans was largely viewed as a success. As of August 8, 2020—when the first round of PPP loans closed—the SBA had approved 5,212,128 PPP loans. More than 5,000 lenders participated in administering the program, and the average loan was approximately $100,729. In total, the loans amounted to more than $525 billion.[ii] As of November 22, 2020, the SBA had received 595,144 loan forgiveness applications, totaling approximately $83 billion, of which the SBA had forgiven approximately $38 billion.

Second Draw Loans

Significantly, the Act reopens the PPP to certain businesses that already received a PPP loan. The program’s expiration in August of this year left over $130 billion in unused funds that will now be reallocated to the General Treasury, and the program’s rules initially prevented businesses who received loans from obtaining a second PPP loan. The Act offers a second PPP loan to companies who meet certain eligibility criteria. Specifically, businesses applying for a second draw loan must show that they—and their affiliates— “employ not more than 300 employees.” Additionally, businesses are eligible only if they have used or will use the full amount of their initial PPP loan and have lost at least 25 percent of their revenue in any quarter of 2020. Although initial press reports covering the Act indicated that eligible businesses must have at least a 30 percent reduction in their revenue, the finalized Act created a lower eligibility threshold. Specifically, eligible entities must have gross receipts that demonstrate a 25 percent or more reduction from the gross receipts of the entity during the same quarter in 2019. Entities that submit applications on or after January 1, 2021 are eligible to utilize their gross receipts from the fourth quarter of 2020. However, entities not in operation on or after February 15, 2020 are not eligible for initial PPP loans nor second draw loans.

Maximum Second Draw Loan Amount

While the loan amount for most borrowers will be the same as the amount of their initial PPP loans, second draw loans are capped at $2 million per borrower. This is significantly lower than the $10 million cap placed on initial PPP loans in the CARES Act. For borrowers who received a PPP loan within the last 90 days at the time of their second draw application, the proposed bill requires that the aggregate of the initial and second draw loan does not exceed $10 million.

Larger Second Draw Loan Amounts for Food and Hotel Industries

Second draw loan borrowers are generally allowed to receive a loan amount of up to two-and-one-half times their average monthly payroll. The Act, however, allows businesses within the accommodation and food services industries to receive second draw loans of up to three-and-one-half times their monthly average payroll costs. The maximum loan amount of $2 million still applies.

Restrictions on People’s Republic of China and Hong Kong Affiliated Entities

Notably, the second draw loan provision also restricts businesses or entities affiliated with the People’s Republic of China (“PRC”) or the Special Administrative Region of Hong Kong (“Hong Kong”) from receiving additional relief. The Act states that a borrower is ineligible for a second draw loan if: 1) an entity created in or organized under the laws of the PRC or Hong Kong or with significant operations in the PRC or Hong Kong holds 20 percent or more interest in the borrower; or 2) a member of the borrower’s Board of Directors is a resident of the PRC.

Changes to PPP Eligibility

The Act made changes and clarifications to what kinds of entities are eligible for PPP loans. Significantly, 501(c)(6) organizations—that were previously not eligible to receive PPP assistance—will now be eligible to receive a first-time loan under the PPP program. To be eligible, 501(c)(6) organizations must have no more than 300 employees and may not be primarily engaged in political or lobbying activities. Specifically, the lobbying activities of the organization cannot comprise more than 15 percent of the business’s total activities and cannot exceed $1 million in costs during the most recent tax year of the organization that ended prior to February 15, 2020. The Act defines lobbying activities to include any entity that is organized for research or for engaging in advocacy in areas such as public policy or political strategy or otherwise describes itself as a think tank in any public documents.

The Act also allows certain news organizations that were previously ineligible because of affiliation with other newspapers or other businesses to access PPP loans. Under the Act, any station that is licensed by the Federal Communications Commission (“FCC”) under Title III of the Communications Act of 1934 is eligible to receive a PPP loan if the entity either: 1) employs not more than 500 employees per physical location or otherwise meets the applicable SBA size standard; or 2) is a nonprofit organization designated as a public broadcasting entity by the Communications Act of 1934. The news outlet must be majority-owned or controlled by a business that is a newspaper publisher or in the radio and television broadcasting industry, as defined by the North American Industry Classification Code (the “Code”), unless it is a public broadcasting entity, in which case its trade or business must fall under the Code. All news organizations must certify that proceeds of the loan will be used to support the component of the business that produces or distributes locally-focused or emergency information.

The Act also excludes entities that are not otherwise eligible under the SBA’s traditional eligibility rules codified under 13 C.F.R. § 120.110.[iii] Additionally, publicly traded companies are not eligible for PPP loans under the Act, codifying what was previously understood through guidance from the Department of the Treasury, but unclear on the face of CARES Act.

PPP Loan Forgiveness – Covered Period and Range of Eligible Expenses

The covered period is the time allotted for borrowers to spend PPP loan proceeds on qualified expenses for purposes of forgiveness. The legislation allows borrowers to choose a “covered period” of 8 or 24 months.

Congress also voted to expand the number of forgivable expenses under the Act. Forgivable expenses, which were previously limited to payroll costs and certain mortgage, rent, and utility expenses, now include supplier costs, investments in facility modifications, and personal protective equipment that businesses require to operate safely. Business software and cloud computing services that help facilitate business operations are also included.

Repeal of Emergency Injury Disaster Loan Advance Deduction Prohibition

The Act repeals a provision in the CARES Act requiring PPP borrowers to deduct the amount of their Economic Injury Disaster Loan (“EIDL”) advance—up to $10,000—from their PPP forgiveness amount. The Act reflects Congress’s view that those that received EIDL advances should be afforded additional relief.

Permitted Tax Deductions for PPP Borrowers

The Act clarifies that organizations receiving PPP loans will be allowed to deduct from taxable income expenses paid for by funds received under the loan. Secretary of the Treasury, Steven Mnuchin, previously prohibited corporations from making such tax deductions, citing the Administration’s view that allowing the deductions would amount to “double-dipping” because the loan forgiveness amount is already excluded from income for tax purposes. However, the Act clarifies that it was Congress’s intent that the CARES Act allow for such tax deductions. Thus, businesses receiving PPP funds will be allowed to deduct business expenses as if they used non-PPP funds to cover those costs.

Simplified Forgiveness Applications for Small PPP Loans

The Act simplifies the loan forgiveness process for recipients of a PPP loan of $150,000 or less. To begin the loan forgiveness process, recipients must sign and submit a letter of certification, which will be provided by the SBA Administrator no later than 24 days after the Act’s enactment. The certification letter will be no more than one page in length and will verify the loan recipient’s eligibility to their lender. The letter must provide specific information relating to the entity’s loan including: 1) the number of employees the eligible recipient was able to retain because of the covered loan; 2) the estimated amount of the covered loan amount spent by the eligible recipient on payroll costs; and 3) the total loan value.

No Enforcement Action Against Lenders

The Act makes clear that an enforcement action may not be brought against lenders that rely on an applicant’s certification for an initial PPP loan or second draw PPP loan as long as the lender: 1) acts in good faith relating to loan origination or forgiveness of the PPP loan; and 2) all other relevant Federal, State, local, and other statutory and regulatory requirements applicable to the lender are satisfied with respect to the PPP loan.

Funds for Community Development Financial Institutions

The Act includes PPP set-asides for very small businesses with ten employees or fewer through community-based lenders like Community Development Financial Institutions and Minority Depository Institutions. In total, the Act provides $12 billion in capital investments to support these institutions, which makes loans and grants to businesses that are often unable to get traditional banks to do business with them.

Conflicts of Interest for Government Officials

As a nod to public concerns about PPP forgiveness, the Act places disclosure requirements on high-level government officials who receive a PPP loan. This provision applies to the President, Vice President, heads of executive agencies, and Members of Congress, including their spouses. The public disclosure must be made within 30 days of forgiveness of the PPP loan.

Additional Notable Provisions of the Act

The Act also includes various other COVID-19 relief provisions, including:

Grants for Shuttered Venue Operators. The Act authorizes $15 billion in relief to eligible live venues, closed movie theaters, zoos, and museums, which were particularly hard-hit by the pandemic. Of the allocation, $2 billion goes toward eligible entities that have no more than 50 full-time employees. The bill takes an incremental approach to disbursing funds. Only eligible entities that saw a 90 percent or more loss in revenue during the period beginning on April 1, 2020 and ending on December 31, 2020 when compared to the same period in 2019 are eligible to receive funds within the initial 14 days during which the SBA allocates funds. Entities with a 70 percent or more loss in revenue are eligible to receive funds after the initial 14-day period ends. After the first 28 days of issuing grants, the SBA may award a grant to any eligible entity.
SBA Fraud and Prevention Programs. Congress allocated $50 million to the Small Business Administration for audits and other fraud prevention programs to monitor the agency’s administration of PPP loans.
Rental Assistance. The Act extends the Centers for Disease Control and Prevention’s September 4, 2020 eviction moratorium through January 31, 2021.
Transportation Relief. The Act extends the Payroll Support Program included in the CARES Act, to support the airline industry and airline industry workers. Specifically, the Act allocates $15 billion for airline payroll support, $1 billion for airline contractor payrolls, and $2 billion for airports and airport concessionaires.
Business Meal Expense Deduction. The Trump Administration secured a provision within the Act that allows all corporations to temporarily deduct meal expenses. Advocates of the provision believe that it will provide a significant boost to the restaurant industry, encouraging corporations to cover meal expenses. The business meal deduction will be available until January 1, 2023.
Affirming Federal Reserve Emergency Loan Powers. Title VI of the Act re-allocates $429 billion in unused Treasury direct loans and excess funds from Federal Reserve facilities authorized by the CARES Act back into the general Treasury Fund. Although ending the Federal Reserve’s emergency loan authority was a source of contention for lawmakers, the Act struck a compromise, requiring Congress to authorize any future emergency loans issued by the Federal Reserve, rather than ending the Federal Reserve’s ability to lend altogether.
No Corporate Immunity Provision. Although discussed during negotiations, lawmakers declined to include within the Act a corporate immunity provision, which would have granted corporate employers immunity from COVID-19 related lawsuits brought by employees.

_______________________

[i] For additional details about the PPP please refer to Gibson Dunn’s Frequently Asked Questions to Assist Small Businesses and Nonprofits in Navigating the COVID-19 Pandemic and prior Client Alerts about the Program: Federal Reserve Modifies Main Street Lending Programs to Expand Eligibility and Attractiveness; President Signs Paycheck Protection Program Flexibility Act; SBA “Paycheck Protection” Loan Program Under the CARES Act; Small Business Administration and Department of Treasury Publish Paycheck Protection Program Loan Application Form and Instructions to Help Businesses Keep Workforce Employed; Small Business Administration Issues Interim Final Rule and Final Application Form for Paycheck Protection Program; Small Business Administration Issues Interim Final Rule on Affiliation, Summary of Affiliation Tests, Lender Application Form and Agreement, and FAQs for Paycheck Protection Program; Analysis of Small Business Administration Memorandum on Affiliation Rules and FAQs on Paycheck Protection Program; Small Business Administration Publishes Additional Interim Final Rules and New Guidance Related to PPP Loan Eligibility and Accessibility; and Small Business Administration Publishes Loan Forgiveness Application.

[ii] This data was collected from the U.S. Small Business Administration website and may be reviewed here. The data does not reflect any changes or cancellations to PPP loans made after August 8, 2020.

[iii] Excluded businesses also include financial business primarily engaged in the business of lending; passive businesses owned by developers or landlords that do not actively use or occupy the assets acquired or improved with the loan proceeds; life insurance companies; business organizations located in a foreign country; pyramid sale distribution plans; businesses deriving more than one-third of gross annual revenue from legal gambling activities; businesses engaged in any illegal activity; private clubs and businesses which limit the number of memberships for reasons other than capacity; government-owned entities (except for businesses owned or controlled by a Native American tribe); loan packagers earning more than one third of their gross annual revenue from packaging SBA loans; businesses with an Associate who is incarcerated, on probation, on parole, or has been indicted for a felony or a crime of moral turpitude; businesses in which the lender or CDC, or any of its Associates owns an equity interest; businesses primarily engaged in political or lobbying activities; speculative businesses; and unless waived by the SBA, businesses that have previously defaulted on a Federal loan or Federally assisted financing. 13 C.F.R. § 120.110 (What businesses are ineligible for SBA business loans?).

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)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
William Lawrence – Washington, D.C. (+1 202-887-3654, wlawrence@gibsondunn.com)
Amanda Sadra * – Los Angeles, CA (+1 213-229-7016, asadra@gibsondunn.com)

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

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

New York partner Akiva Shapiro and associates Lee Crain and Amanda LeSavage are the authors of “Tips for District Court Amicus Brief Success,” [PDF] published by the New York Law Journal on December 23, 2020.

Brussels of counsel Alejandro Guerrero and London of counsel Sarah Wazen are the contributors to the “Belgium” chapter of the Data Protection & Privacy Laws feature published by Financier Worldwide in November 2020.

Paris partner Ahmed Baladi is the contributor to the “France” [PDF] chapter of the Data Protection & Privacy Laws feature published by Financier Worldwide in November 2020.

New York associate James Manzione is the author of “Real Estate Partnerships: The Basics and Some Technical Stuff,” [PDF] published by Tax Notes Federal on November 23, 2020.

The UK, and the international economy, have faced momentous challenges in the past year. The UK economy shrank 11 per cent – the largest drop in over 300 years – and, according to last month’s figures from the UK’s Office for Budget Responsibility, its debt level is set to balloon to £394 billion in 2020 – the highest recorded level of borrowing in the UK since 1944 and equivalent to 19% of GDP. Conversely, however, interest rates on government debt are at a historic low and are expected to remain so for some time.

The Chancellor vowed in October to make “hard choices” that are needed to “balance the books” and to address the high levels of national debt incurred during the COVID-19 coronavirus pandemic. However, the International Monetary Fund warned the Chancellor that now is not the appropriate time to balance the books. The economic outlook for the UK remains highly uncertain and its success depends upon a multitude of factors, including the effectiveness and timing of vaccines, the outcome of the Brexit negotiations and the response of businesses and households to these events. Whilst the UK Government does expect relatively rapid economic recovery in the UK, the costs of COVID-19 combined with the head wind pressures from a post-Brexit world undoubtedly will put pressure on the UK economy, at least in the near term. Another tension is the desire to attract investment (by way of illustration, see the two consultations mentioned below). It is inevitable that revenues will need to be raised, though not necessarily as soon as 2021. As the Autumn Statement was cancelled this year, it remains to be seen how UK tax policy may change in response.

In the meantime, however, there have been plenty of incremental proposed (and actual) changes to the UK, and the international, tax landscape. Following a positive reception to an initial consultation on the UK asset holding company (“AHC”) regime, the UK government recently launched a second stage consultation on more detailed design features of a new AHC regime (including targeted changes to the UK real estate investment trust regime). The government is also currently consulting on new legislation relating to “UK property rich” collective investment vehicles and their investors for UK capital gains tax purposes, broadly designed to address administrative burdens borne by specified investors under existing rules. We will cover these topics and address any published outcomes of these consultations in our next Quarterly Alert (together with the recent OECD publications on transfer pricing and the impact of COVID-19).

CONTENTS

A. INTERNATIONAL AND UK DEVELOPMENTS

I. BEPS 2.0 – OECD Blueprints

II. OECD consultation on dispute resolution mechanics

III. Updates to the Directive on Administrative Cooperation (DAC)

IV. UK developments

V. UK and EU VAT updates

B. NOTABLE CASES

I. Blackrock HoldCo 5 LLC v HMRC [2020] UKFTT 443 (TC)

II. Dunsby v HMRC [2020] UKFTT 0271 (TC) and Bostan Khan v HMRC [2020] UKUT 168 (TCC) (2 June)

III. Bluejay Mining plc [2020] UKFTT 473 (TC)

A. International and UK developments

I. BEPS 2.0 – OECD Blueprints

In October, the OECD’s Inclusive Framework (the “IF”) released blue-prints for its Pillar I and Pillar II initiatives – addressing respectively, (a) new nexus rules for the digital economy and (b) “top-up tax” mechanics to secure an international minimum tax rate. The blueprints focus on technical aspects of the proposals and illustrate that the proposals are becoming increasingly complex. They also acknowledge that there are many points on which political agreement has yet to be reached. It remains to be seen whether the IF’s aim of reaching consensus on both Pillar I and II by mid-2021 remains achievable.

Pillar I[1]

Pillar I focuses on the allocation of taxing rights (rather than the tax base itself) and seeks to redistribute taxing rights to so-called “market jurisdictions” (i.e. jurisdictions into which a group’s “in scope” services and products are supplied and/or its users are located). The blueprint does not seek to fit this new “nexus” rule into the existing international tax framework, but rather, layers it over the framework.

Though much remains to be agreed politically, the blueprint sets out the direction of travel for many technical aspects of the proposals:

Scope: The proposals will apply to: (a) “automated digital services” businesses, including social media platforms, online search engines and cloud computing businesses and (b) “consumer facing businesses” (i.e. retail businesses). Some IF members favour a staggered introduction of the rules, with delayed implementation for consumer facing businesses.
Thresholds: It is proposed that the new nexus rules would only apply to global businesses with revenue from “in-scope” activities above certain (yet to be politically agreed) thresholds both: (a) globally and (b) in jurisdictions that don’t currently tax the relevant income (on existing residence / permanent establishment principles). The former threshold is expected to be set at c.€750 million.
Exclusions: Blanket carve-outs are proposed for the financial industry (asset managers, insurers, pension funds, and banks), the extractives and natural resources industries, and international airlines and shipping.
Calculation of tax base: The amount of income available to be allocated to market jurisdictions (so called “Amount A”) is not determined on the basis of principles. Rather, (once a political decision is reached on the various thresholds) its calculation is intended to be a highly mechanical exercise. In high level terms:
- Amount A is intended to represent the group’s global “excess profit” from in-scope activities – i.e. income exceeding an agreed level of profitability, which would be calculated using agreed formulae (that would vary by industry). Determining the level at which “excess profit” is set is likely to be highly contentious.
- The starting point for the calculation would be the group’s consolidated accounts, with the various formulae (to calculate the tax base, and the allocations) being applied to figures set out therein. Where a group has both in-scope and out-of-scope activities, it is proposed that taxpayers prepare additional “segmented” accounts (but that losses from out-of-scope activities could not be set against profits from in-scope activities). This raises the prospect that businesses could be subject to additional tax in multiple jurisdictions, even if they are loss-making overall.
Nexus: It is proposed that Amount A would only be shared between market jurisdictions in which the group has an “active and sustained participation”. This would be tested by reference to revenue generated in that jurisdiction over a certain number of (yet to be decided) years. It is contemplated that, for consumer facing businesses, market jurisdictions may need to meet higher thresholds (of revenue and/or other qualitative factors) to meet this test.
Novel “dispute prevention” mechanisms: In expanding the pool of jurisdictions to which taxing rights are awarded, the proposals materially increase the scope for double taxation. The blueprint recognises this – and that existing dispute resolution processes (such as mutual agreement procedures, discussed further below) may be ill-equipped to resolve disputes between tax authorities regarding their rights to tax “in scope” income. The blueprint therefore focuses on novel “dispute prevention processes”. In particular, the blueprint contemplates that many aspects of the proposals (including the amount of income to be allocated to market jurisdictions generally, and to specific jurisdictions in particular) would, for each in-scope taxpayer, be subject to advance review both by (a) the tax authorities of interested jurisdictions and (b) if there is disagreement, panel(s) of representatives from tax administrations in IF member states. Such innovation is to be welcomed. Nevertheless, concerns have been raised about the practicality of such measures. In the absence of willingness and (perhaps more significantly) means on the part of tax authorities to allocate resources to the proposals, demand for pre-agreement is likely to outstrip capacity, with taxpayers potentially suffering the cost of double taxation whilst they wait.
Implementation: The blueprint contemplates that the proposals would be implemented via a multi-lateral instrument (an “MLI”). Past experience with 2018’s MLI (giving effect to BEPS 1.0 initiatives) illustrates that, in practice, implementation of MLIs is highly staggered. To prevent businesses facing significant double taxation risks during such a transitional period, it is hoped that streamlined implementation can be achieved.
Matters for political decision: In addition to the points raised above, swathes of the proposal remain subject to political agreement – not least: (a) whether Pillar A will be introduced on a mandatory or (as the US proposes) optional basis (as to which, see our July Tax Quarterly Alert) and (b) the various thresholds and percentages inherent in the proposed calculations.

The complexity of the new rules is apparent, even at this relatively early stage of the process. With such an ambitious project, some degree of complexity (and additional compliance burden) was unavoidable. Nevertheless, it seems likely that this has been exacerbated by the early choice not to fit Pillar I proposals within existing tax frameworks (e.g. by expanding the traditional concept of a physical “permanent establishment” to accommodate digital presences). Moreover, the significant risk of double taxation inherent in the project’s aims has led the IF to favour a model based on formulae (offering certainty) over principles (offering flexibility). While such certainty may be welcome in the short term, it is not without challenges. Though not acknowledged by the blueprint, it seems likely, for example, that the various thresholds and percentages intrinsic to the rules would need to be refreshed every 5-10 years in response to inflation, the changing fortunes of particular industries, and human ingenuity as to the various means by which value can be created. As such, even if consensus can be reached next year, it is unlikely to be the end of the multinational political decision making on which the rules rely.

Pillar II[2]

In contrast to Pillar I, Pillar II expressly aims to increase the amount of tax paid by certain multinational groups. It would do so by introducing an international minimum effective tax rate. The level at which this would be set has yet to be agreed between IF members.

The blueprint gives significant shape to the proposal:

Scope: The blueprint contemplates that Pillar II would, in any given year, only apply to groups with a consolidated gross revenue in excess of €750 million (in the immediately preceding fiscal year).
Exclusions: In good news for the investment management industry, it is proposed that certain types of entities heading multinational groups (such as investment entities, sovereign wealth funds and pension funds) would be exempt – although the proposals could apply to entities lower down the ownership chain. However, (in contrast to Pillar I) it appears that there is limited political will for including a broader carve out.
The blueprint largely focuses on two proposed “top-up” tools:
- The income inclusion rule (the “IIR”): The IIR gives the jurisdiction in which the group’s parent is resident the power to levy a “top-up” income tax, on the parent, in respect of the difference between the group’s effective tax rate and the (yet to be agreed) minimum rate. The proposal is supported by a “switch-over rule” which would effectively disapply obstacles to such taxing rights in double tax treaties.
- The “undertaxed payments rule” (the “UTPR”): Broadly, the UTPR empowers source jurisdictions to apply withholding tax to, or deny a deduction for, related party payments which are not taxed (or are subject to low tax) on receipt. This proposal is supported by the “subject to tax rule”, which would amend treaties to give effect to source countries’ new taxing rights.
A key element of both proposals is the manner in which the group’s effective tax rate (the “ETR”) is calculated:
- Blending: The IF appears to have rejected an approach based on “global blending”, which would have calculated the ETR at group level. Instead, the IIR favours “jurisdictional blending” – which requires groups to calculate the ETR for each jurisdiction in which they have a taxable presence. While the blueprint moots the possibility of certain simplification processes (such as a safe harbour where the ETR (calculated for county-by-country reporting purposes) is a certain level above the minimum tax rate) it acknowledges that such proposals are in their infancy. Indeed, even with simplification methods, a jurisdiction-focused approach is likely to result in a significant compliance burden (particularly when compared to the simplicity offered by global blending).
- Financial accounts as a starting point: Interestingly, notwithstanding the preference for jurisdictional blending, the blueprint proposes that the ETR be calculated using the parent’s consolidated accounts. Many taxpayers had favoured simpler alternatives, including: (a) a “proxy” ETR calculation, based on consolidated accounts only (which, while divorced from the tax actually paid, would minimise the compliance burden) or (b) an ETR calculation based on the tax actually paid in each jurisdiction (which would align the proposals with the economic reality, and use information that taxpayers are already required to prepare at a local level). The proposed approach creates particular difficulties for many businesses in the financial industry, for whom there are often material mismatches between the consolidated accounting, and tax, position. Examples include insurers (who are often taxed on a fundamentally different basis than ordinary corporate income taxpayers) and issuers of additional tier 1 capital instruments and other hybrid instruments. Under the proposals, such businesses could be subject to additional tax in circumstances where their actual ETR is above the minimum level.
- Measures to address tax volatility: The IF recognise “the principle that Pillar II proposals should not seek to impose additional tax where a low ETR is merely a product of timing differences in the recognition of income or the imposition of taxes”. The blueprint therefore proposes certain mechanics to address these points, such as the right to carry forward “excess” ETR (over the minimum rate) and off-set it against a low ETR in subsequent years. However, it is contemplated that this carry-forward right may be limited to seven years.
- IIR substance carve outs: Similar to another notable erosion rule, the US’ “global intangible low-taxed income rule (“GILTI”), the blueprint contemplates that certain types of income would be carved out of the ETR calculation. These include payroll taxes, and (a fixed amount of) income from fixed assets. This is, the blueprint notes, because Pillar II “focuses on excess income, such as intangible-related income, which is most susceptible to base erosion”. Nevertheless, the narrow scope of the exclusion omits many additional sources of income which are not “mobile”, including income from traditional non-digital businesses which rely on a fixed establishment and a local consumer base.
Other matters addressed in the blueprint include:
- Interaction between IIR and UTPR: The blueprint notes the IF’s intention that the UTPR operate as a “backstop” to the IIR, applying only where the parent’s jurisdiction of residence has not implemented the IIR. However, the blueprint’s proposals do not quite achieve this stated aim. In particular, the blueprint contemplates that the UTPR could apply to payments made to a parent entity that is subject to the IIR, if the ETR in its jurisdiction of residence is below the minimum rate. This raises the prospect that parent entities could be subject to both the IIR and the UTPR, creating the potential for multiple layers of tax, and a heavy compliance burden.
- Implementation: The blueprint proposes that treaty changes needed to implement the switch-over-rule and the subject-to-tax rule would be implemented via an MLI signed and ratified by IF members. As regards the IIR and the UTPR, it is contemplated that the OECD would produce draft legislation for implementation by IF member states. While the latter approach is designed to limit the difficulties that would be created by mismatches in implementation (such as increased compliance costs and an enhanced risk of double taxation) such differences are likely unavoidable. As regards the risk of double tax in particular, (in contrast to Pillar I) the blueprint signals an intent to rely solely on existing dispute resolution procedures. The weaknesses in these processes (discussed further below) have raised concerns as to whether this goes far enough.
- Matters for political decision: Key elements, however, remain subject to political agreement. These include (a) the rate at which the minimum tax will be set and (b) the interaction between Pillar II proposals and (broadly equivalent) base erosion taxes (such as the US’ GILTI and the base erosion anti-abuse tax). On the latter point in particular, it is hoped that a sensible agreement can be reached to minimise double tax risk.

The IF has been subject to intense pressure to reach a consensus on the proposals – not least from the EU, who have threatened to introduce equivalent measures if the IF cannot reach agreement – and possibly even if they do (see further our July Tax Quarterly Alert). Nevertheless, given the significant, once-in a-generation, changes contemplated by the blueprints, the short period of public consultation (which ran for two months to 14 December) is notable. It is hoped that the IF can resist pressure to hurry these significant projects, increase taxpayer engagement and take the time needed to develop proposals that best achieve the aims of: (a) imposing tax only where there is economic under-taxation and (b) minimising the compliance burden on taxpayers.

II. OECD consultation on dispute resolution mechanics

In November, the OECD published a consultation document on mechanisms to make double tax treaty dispute resolution procedures more effective. Proposals include implementing a requirement for tax authorities to submit to binding arbitration where they cannot otherwise reach agreement within two years (so called “MAP arbitration”). The effectiveness of treaty dispute resolution mechanisms is set to take on increased significance for certain UK taxpayers. Earlier this month, the UK government announced the repeal of two EU directives which provide for MAP arbitration where tax authorities from EU member states cannot reach agreement on tax treaty disputes. The process will therefore no longer apply to disputes under the UK’s treaties with 11 EU jurisdictions (including Italy, Denmark, Poland and Romania).

Double tax treaty disputes arise where a taxpayer has been taxed by two states, each of whom believes that the treaty between them entitles them to do so. Such disputes are currently resolved through “mutual agreement procedures” (so called “MAP”) – a process by which the relevant tax authorities, through discussion, attempt to resolve disagreements about the effect of the relevant treaty. Though the outcome of the dispute will determine the amount of tax the taxpayer must pay, and to whom, the taxpayer is not party to the discussions.

MAP’s weaknesses are well known. For example:

It relies on tax authorities reaching agreement: The process can be inherently uncertain. Though treaty provisions require tax authorities to “endeavour to resolve” the dispute, the taxpayer bears the risk that they will not, and that the relevant double tax will not be relieved.
It is time consuming: Recent figures from the OECD indicate that on average, transfer pricing cases take 30.5 months to resolve via MAP, while other cases take 22 months[3]. Interestingly, in 2019, the UK was the jurisdiction with the fastest resolution of cases via MAP (taking an average of 21 months for transfer pricing cases and 6 months for other cases). These figures are likely to increase going forward, with taxpayer requests for MAP having doubled since 2016.

The Consultation

The consultation asks stakeholders to “share any general comments on their experiences with, and views on, the status of dispute resolution and suggestions for improvement”. However, in contrast to the approach to Pillar I dispute resolution processes (described above), it does not seek to challenge the primacy of MAP, or to address its weaknesses with significant reforms. Some key issues with MAP, such as the above-mentioned delays, are not addressed at all.

Rather, narrow changes to existing systems and procedures are proposed. These centre around possible steps to strengthen the minimum standards that IF members have (since 2016) committed to adhere to on the subject (the “Minimum Standards”), and include mandatory:

Programmes for bilateral advance transfer pricing agreements, pursuant to which taxpayers seek advance clearance from tax authorities that their arrangements will be treated as arm’s length. Interestingly, the consultation acknowledges that many jurisdictions already have such programmes in place. Moreover, those that do not would be exempt if they have only a minimal number of transfer pricing MAP cases.
Training on international tax issues for tax authorities’ auditors and examination personnel (with a view to preventing excessive adjustments likely to give rise to disputes).
Suspension of tax collection while MAP is on-going (if/to the extent that such measures apply to domestic challenges).
Rules enabling MAP agreements to be implemented, notwithstanding domestic time limits (where the matter is not addressed in the terms of the treaty itself).
MAP arbitration.

Importantly, the proposals put forward in the consultation do not represent IF consensus, and therefore function as mere discussion points. Some proposals are, accordingly, disappointingly modest in their aims (e.g. (a) and (b) above). Others (such as those at (c) and (d) above) do not seek to fix dispute resolution mechanisms themselves, but instead seek to accommodate MAP’s weaknesses (perhaps recognising that support for an effective alternative remains quite a way off). While this is helpful in the short-term, it does not represent a long term solution.

In particular, the consultation strikes a pessimistic note on the likelihood of achieving consensus on mandatory MAP arbitration, noting that “a number of [IF members] have clearly indicated that MAP arbitration raises several issues around constitutional and sovereignty concerns, [and] practical issues including cost, capacity and resource constraints, which is why they do not support its inclusion into the Minimum Standard and consider it very difficult to move away from such position”. The statement is informed, no doubt, by the less than enthusiastic response to such provisions in the 2018 MLI, with all but 33 of the signatories opting out.

Nevertheless, as tax laws become ever more complicated, the scope for disagreement grows. Tax treaties will increasingly fail in their objective of preventing double tax if tax authorities have the option of merely “agreeing to disagree”. Indeed, this problem will be amplified if/ when Pillar I and II proposals take effect. It is therefore hoped that, once BEPS 2.0 processes wind down, the OECD will refocus its attention (and its resources) on this fundamental issue.

Brexit

Unfortunately, global reluctance to embrace MAP arbitration is likely to gain increasing significance for certain UK taxpayers. Earlier this month, the UK government announced that it would repeal UK laws that give effect to two EU directives that provide for MAP arbitration in disputes between EU tax authorities[4]. From 1 January 2021, applications for MAP thereunder will not be accepted. Many EU jurisdictions have, like the UK, opted into the MLI’s MAP arbitration provisions, or otherwise have bilateral treaties with the UK that include such provisions. The repeal will not impact taxpayers’ positions under those double tax treaties. However the UK’s treaties with Italy, Poland, Denmark, Romania, Czech Republic, Croatia, Slovakia, Bulgaria, Estonia, Latvia and Lithuania do not provide for MAP arbitration, and these jurisdictions have not opted into the MLI’s arbitration provisions. If a taxpayer is subject to double tax in the UK and any one of these jurisdictions, they will face an increased risk that any MAP proceedings, if initiated, will not be resolved. It remains to be seen whether the UK will seek to renegotiate the relevant bilateral treaties.

III. Updates to the Directive on Administrative Cooperation (DAC)

(i) DAC 6 update

See our Gibson Dunn presentation on DAC 6 here.

The first UK DAC 6 reporting deadline, on 30 January 2021, is fast approaching. As a result, parties to cross border arrangements are increasingly focusing their thinking on the practical implications of mandatory reporting obligations, with DAC 6 provisions starting to feature in contractual arrangements. Other recent developments include the publication of further guidance from HMRC on the application of the DAC 6 in the UK, and the removal of the Cayman Islands from the EU’s non-cooperative tax jurisdictions list (though unanswered questions remain with respect to whether certain payments to the Cayman Islands will be subject to DAC 6 reporting obligations in the UK).

The EU Council Directive 2011/16 (as amended), known as DAC 6, requires intermediaries (or failing which, taxpayers) to report, and tax authorities to exchange, information regarding certain cross-border tax arrangements with an EU nexus. Due to the COVID-19 coronavirus pandemic, the implementation of DAC 6 was deferred (on an optional basis). Certain jurisdictions, such as Germany and Finland, chose to proceed as planned, with mandatory reporting beginning in July. The UK opted to defer, and the first UK reporting deadlines, beginning on 30 January 2021, are now fast approaching (for further detail, see our July 2020 Quarterly Update here). (It’s worth noting in particular that DAC 6 obligations will be unaffected by, and will remain in force following, the end of the Brexit transition period).

In the meantime, DAC 6 developments continue. Of particular note has been the recent (widely anticipated) removal of the Cayman Islands from the EU list of non-cooperative jurisdictions, which might be short-lived as its removal provoked further discussions and even calls for it to be re-added to the list (primarily on the basis of the secrecy laws of the jurisdiction and the scale of offshore financial activities taking place there). One of the many adverse tax implications of being on the list is that a DAC 6 reporting obligation can be triggered if the recipient of a deductible cross-border payment, between associated enterprises, is resident in a jurisdiction on the list. Unfortunately, it is not yet clear how this development interacts with the deferral of reporting in the UK – in particular whether such payments to a Cayman recipient while Cayman was on the list (between 18 February 2020 and 6 October 2020) are required to be reported to HMRC. The point will be particularly relevant to those sectors which regularly use Cayman vehicles in investment structuring and it is hoped that HMRC will clarify the point before the reporting deadline for transactions in the period (being 30 January 2021 for reportable transactions after 30 June 2020, and 28 February 2021, for transactions on or before 30 June 2020 where the first step in implementation was taken on or after 25 June 2018).

HMRC has, however, published updated guidance on other aspects of the rules. The revised guidance:

Confirms that an arrangement that otherwise concerns only one jurisdiction will not be considered “cross-border” solely because an intermediary involved in that arrangement is located in a different jurisdiction.
Confirms that a non-UK, non-EU branch of a UK resident company, that provides aid, assistance or advice in respect of a reportable arrangement, will be subject to UK reporting obligations. However, HMRC would therefore not usually expect a DAC 6 report to be made where local data laws would restrict the ability to report, unless transactions were being actively routed through a branch in order to avoid DAC 6 reporting obligations.
Addresses, in particular, the triggers for reporting (the so called “hallmarks”) which incorporate transfer pricing concepts. For example, as regards the hallmark for arrangements involving:
- the use of unilateral safe harbour rules, HMRC has confirmed that (a) safe harbour rules agreed by jurisdictions on a bilateral or multilateral basis (such as OECD agreements) and (b) arrangements that have been properly priced on an arm’s length basis (even if they also happen to fall within a safe harbour rule) should not be in scope;
- the transfer, between associated enterprises, of “hard-to-value intangibles” (i.e. those for which no reliable comparables exist and projections of future cash flows or income therefrom are “highly uncertain”), HMRC has confirmed that the degree of uncertainty must be higher than a normal level of uncertainty. While helpful, unfortunately, the subjective nature of the clarification leaves residual uncertainties as to how this is to be applied in practice; and
- intragroup cross-border transfers of functions, risks or assets (where the earnings before interest and taxes (“EBIT”) of the transferor, are decreased by 50%), HMRC has provided additional guidance on the calculation of EBIT.

Given the impending reporting deadline, attention is now being focused toward the more practical aspects of mandatory reporting obligations. For example, trends are developing toward addressing reporting obligations in relevant contractual arrangements (including fund investor side letters and tax deeds in an M&A context). In addition, there continue to be substantive differences in how key aspects of DAC 6 have been implemented in different jurisdictions, including the applicability of hallmarks and the operation of legal professional privilege.

(ii) DAC 7 update

Consensus has been reached on DAC 7, paving the way for the bolstering of information-gathering powers of tax administrations regarding income generated via the digital platform economy. The main aim is to provide better cooperation across tax administrations, whilst keeping business compliance costs to a minimum through providing a common EU reporting standard.

EU member states recently “reached consensus” on the proposed amendment (published on 15 July 2020) to Council directive 2011/16/EU (“DAC 7”) which requires the automatic exchange of information on revenues generated by sellers on digital platforms. In a departure from previous iterations, which focused on direct taxes, DAC 7 will also cover VAT. (For further information on its scope, see our April Tax Quarterly Alert. This update was tweeted by Benjamin Angel, Director of Direct Taxation at the European Commission’s Directorate-General for Taxation and Customs Union: “Consensus reached on DAC 7…DAC 7 will ensure that tax administrations get information from platforms on transactions done by users in Member States, be the platforms located within the EU or outside.”[5] It is unclear when DAC 7 will become law, but it is expected in the very near term, as work has already begun on the next amendments to Council Directive 2011/16/EU – DAC 8 (see below).

(iii) DAC 8: proposal for the automatic exchange of information relating to crypto-assets

Work has begun on “DAC 8” – the next version of the European Council Directive on Administrative Cooperation in the Field of Taxation (Council Directive 2011/16/EU). The proposals form part of EU efforts to create a framework for the (regulatory and tax) automatic exchange of information mechanics of crypto-assets. Feedback on the EU’s proposals is requested by 21 December 2020. Following a public consultation period (anticipated in the first quarter of 2021), the European Commission expects to publish legislation in the third quarter of 2021.

Last year, European Commission President, Ursula von der Leyen, emphasized the need for “a common approach with Member States on cryptocurrencies to ensure we understand how to make the most of the opportunities they create and address the new risks they may pose.”[6] The European Commission elaborated on that plan in mid-November, publishing a roadmap for bringing crypto-assets and e-money within the scope of existing automatic exchange of information mechanics. It is proposed that this would be achieved via a further amendment to the Directive on Administrative Cooperation in the field of taxation (a proposed “DAC 8”). If implemented, current information reporting and exchange regimes (such as the exchange of information on financial accounts reported by financial institutions) would extend to crypto-assets (as well as intermediaries for these assets, such as crypto-exchanges and brokers).

Crypto assets are digital assets based on distributed ledger technology (“DLT”) and cryptography. DLT is a decentralised database used to record, share and synchronise the transaction of assets. The European Commission roadmap acknowledges that income derived from crypto-assets could be subject to taxation – a view widely held by tax authorities internationally. HMRC, for example, first published (non-binding) guidance on how it considers UK tax law applies to arrangements involving crypto-assets back in 2014. This guidance was subsequently updated, and supplemented, with guidance for businesses on the taxation of crypto-assets in 2019. Indeed last month, HMRC announced (at the OECD’s virtual Global Blockchain Policy Forum) its plans to soon release an entire manual of guidance on the subject.

However, the ability of tax authorities to ensure the appropriate application, and proper enforcement, of tax legislation to (and to transactions in) crypto-assets is hindered by two key issues which DAC 8 aims to tackle:

First, the lack of information at national tax authority levels about the use of crypto-assets and e-money: As crypto-assets and e-money (and relevant intermediaries such as crypto-exchanges and brokers) are not fully covered by the existing provisions of DAC, tax authorities: (a) have to rely on taxpayers’ ordinary course self-assessment obligations and (b) (notwithstanding the international reach of crypto-asset technology) have limited tools to exchange any information which is reported between them. Moreover, there are inherent difficulties in identifying and taxing these new assets in the same way as more traditional assets, including (as identified by the Commission) “[t]he lack of centralised control for crypto assets, its pseudo-anonymity, valuation difficulties, hybrid characteristics and the rapid evolution of the underlying technology as well as their form…” [7]
Second, the exclusion of crypto-assets and e-money from the scope of existing EU legislation, resulting in ‘disparity in sanctions applied’ thereunder to crypto-assets and e-money on one hand, and more traditional assets and currencies on the other.

The above concerns reflect that lack of information on crypto-assets and e-money is a major stumbling block for tax authorities and that, unless addressed, this will likely undermine the integrity of other information exchange initiatives in place to tackle tax evasion, such as the exchange of information from financial institutions on financial accounts set up by DAC 2 in 2014. Among other measures, the proposals would address this gap by extending DAC2 obligations to crypto-assets, and those who facilitate the holding of, and transactions in, them (e.g. exchanges and brokers). Feedback on the proposals was sought by 21 December 2020, to be followed by a public consultation in the first quarter of 2021, and the publication of an amending Directive in the third quarter.

IV. UK developments

(i) Fundamental changes to UK capital gains tax proposed in report published by Office of Tax Simplification

In November 2020, the Office of Tax Simplification (“OTS”) published the first of two reports on their review of the UK capital gains tax (“CGT”) regime, recommending significant changes. If implemented, the changes could potentially result in material changes to liabilities for UK taxpayers. Any recommendations adopted could be implemented as early as March 2021, when the Spring Budget is expected.

The OTS is the independent adviser to the government on simplifying the UK tax system. In response to a request from the Chancellor in July 2020, the OTS carried out a review of UK CGT, with the aim of identifying the policy design of, and the principals underpinning, CGT and then exploring opportunities to address any areas where the present rules distort behavior or do not meet their policy intent. The first report addressing the policy design and principles underpinning CGT was published in November (the “Report”) and a second, technical report, is expected in early 2021. Whilst there has been a lot of media coverage of certain aspects of the OTS review (and certain areas that it highlights for review), it is important to note that the objective of the OTS is to set out a framework of policy choice about the design of tax.

The OTS formulated their Report by reference to four policy areas: (1) rates and boundaries; (2) the Annual Exempt Amount; (3) capital transfers, and (4) business reliefs.

The proposals focus on the liabilities of individuals, but cover neither the attribution of offshore gains to UK resident individuals, nor the CGT implications of an individual’s arrival or departure from the UK. The CGT treatment of trusts was also not addressed.

Eleven recommendations were made, with the most fundamental proposals related to addressing the disparity between the current rates of CGT (generally 20%) and income tax (from 20% to 45% for higher income earners). This discrepancy is correctly highlighted as one of the main sources of complexity in the area of individual taxation. Given that CGT rates are lower, individuals can be incentivised to arrange their affairs so as to re-characterise income as capital gains. There is, accordingly, a raft of complex UK anti-avoidance legislation targeting such re-characterisation techniques, such as the “transactions in securities rules” (which operate to tax a profit as income, rather than as a chargeable gain subject to CGT) and the “transactions in UK land” provisions (which seek, broadly, to ensure that profit arising in the context of trading transactions involving certain disposals of interests in UK real estate will be taxed as income, rather than chargeable gains). The areas that the Report indicates would most notably benefit from a greater convergence of the income tax and CGT rates are: (a) share-based remuneration, and (b) the accumulation of retained earnings in smaller owner-managed companies.

The Report does, however, also highlight the many arguments against raising CGT – in particular: (i) the inappropriateness of taxing an increase in value that is due simply to inflation, and (ii) a CGT rate increase may incentivise taxpayers to hold assets or otherwise alter commercial strategies in relation to in-scope assets.

The Report notes that, if the government did increase CGT rates, further knock-on amendments would be required in other aspects of the relevant tax legislation, including the anti-avoidance provisions referred to above, and there would be a case for considering a greater degree of flexibility in the use of capital losses.

Other proposals of interest in the OTS report include:

a lowering of the annual exempt amount (£12,300 in tax year 2020-21) to a de minimis amount (on the basis that it is an ineffective means to achieve its stated objective of compensating for inflation, because it does not take holding periods or asset values into account). Instead, the OTS propose a broader exemption for personal effects (with only specific categories of assets being taxable).
the replacement of Business Asset Disposal Relief (formerly Entrepreneurs’ Relief – which, by way of reminder, reduces the CGT rate to 10% on the disposal of assets and shares meeting certain conditions) with a relief more focused on retirement.

It is not clear whether (and if so, to what extent) the UK government will adopt the recommendations from this Report or the OTS.

(ii) Finance Bill 2021 – updates following consultation responses

The UK government has published draft legislation for the Finance Bill 2021, alongside explanatory notes, responses to consultations and other supporting documents (see our previous July 2020 Quarterly Update for list of tax policy consultations). Certain draft provisions for the Finance Bill 2021 were published in July 2020, at which point there was intended to be an Autumn Budget later in 2020. This was however cancelled as a result of the COVID-19 pandemic, and on 12 November, the government instead published further draft legislation, (without a budget). Consultation on the draft legislation will close on 7 January 2021, with the Finance Bill 2021 expected to be introduced to Parliament in spring 2021 and to receive royal assent in summer 2021. Notably, the publication of further legislation in spring 2021 raises the possibility that further new legislation will be introduced in 2021 with a very short consultation window.

(a) LIBOR withdrawal

Following its consultation, over the summer, on the potential tax implications of the withdrawal of the London Interbank Offered Rate (“LIBOR”), HMRC has published its response, together with updated guidance for businesses and new draft guidance for individuals. The guidance, which should provide UK taxpayers with a path to circumvent potential adverse tax impacts of the withdrawal, will be welcomed by affected parties.

The publication of LIBOR is expected to cease after the end of 2021, such that parties to financial instruments, with a term beyond 2021, that reference LIBOR (so called “legacy contracts) will need to be amended to refer to (or replaced with contracts that refer to) one of several alternate reference rates.

The consultation aimed: (i) to seek views on how the several UK statutory references to LIBOR should be amended as a result of the LIBOR withdrawal and (ii) to identify the tax impacts that could arise from the reform of LIBOR (and other benchmark rates). With only a few references to LIBOR in the tax legislation (dealing with treatment of certain leases), on 12 November 2020, HMRC published draft legislation for inclusion in the Finance Bill 2020/21 to ensure the leasing provisions continue to function as intended. Helpfully, the draft legislation also introduces a power to allow any unintended tax consequences arising from the transition away from LIBOR (and other benchmark rates) to be addressed separately in secondary legislation.

HMRC has also produced guidance (updated on 12 November 2020 following responses to the consultation) that explains its view on the tax implications of amending financial instruments to respond to the benchmark reform. As discussed in our previous Alert, the guidance (published in draft form in March):

confirms that any amounts recognised in taxpayers’ profit and loss statements as a result of such amendments will generally be taxed / relieved in the usual way; and
addresses other potential tax implications, confirming, among other things that (a) amendments to legacy contracts would not generally be treated as giving rise to a new contract – provided amendments are on (broadly) economically equivalent terms, and (b) in such circumstances, provisions requiring taxpayers to test the economic reasonableness of the contracts’ terms (such as transfer pricing, distributions and stamp duty relief, provisions) would not generally need to be revisited.

The guidance has now additionally been updated to:

provide comfort that HMRC would generally treat amendments to financial contracts pursuant to (or on terms which mirror) market standard documentation (such as ISDA’s IBOR Fallbacks Protocol) as constituting amendments on economically equivalent terms, (and hence as not generally giving rise to a new contract) – irrespective of whether amendments were booked as a new trade in internal systems;
confirm that amendments to financial contracts via (or on terms which mirror) such market standard documents should generally be considered arm’s length for transfer pricing purposes;
confirm that the VAT treatment of one-off additional payments, made in connection with transition-related amendments, will follow the treatment of the underlying supply (and hence will generally be exempt for most financial transactions); and
confirm that relief can be sought, under existing provisions of the hybrid mismatch rules, if differences in the tax treatment of the transition across relevant jurisdictions gives rise to timing mismatches.

In addition, HMRC published guidance for individuals, mirroring the position set out in the business guidance and additionally confirming that amendments to financial instruments would not generally give rise to a disposal for capital gains tax purposes.

It is worth noting that the tax treatment described above, and in the guidance, would not generally apply where taxpayers respond to LIBOR’s withdrawal by replacing, rather than amending, legacy contracts. Nevertheless, for those taxpayers that opt to amend legacy contracts (on economically equivalent terms), the guidance should provide a path to minimising the tax implications of transition, and will be welcome relief for affected parties.

(b) Amendments to the hybrid and other mismatches regime

On 12 November 2020, HMRC published its response to its consultation on certain aspects of the UK hybrid and other mismatches regime, together with some draft legislation to amend the rules, explanatory notes and a policy paper summarising other proposed legislative changes to be included in the Finance Bill 2021. The majority of measures will be welcomed by businesses. However, certain aspects of the regime continue to represent a missed opportunity to address certain instances where tax deductions are disallowed even in the absence of an economic mismatch.

The UK hybrid and other mismatches regime was introduced in 2017 to counter arrangements that give rise to hybrid mismatch outcomes and generate a tax mismatch. As mentioned in our previous April and July Tax Quarterly Alerts, HMRC consulted on certain aspects of the regime over the summer, particularly:

the rules applying to “double deductions”, and the application of section 259ID income (a provision introduced in 2018 which broadly takes account of certain taxable income where there is no corresponding deduction);
the definition of “acting together” (for the purposes of rules which broadly, aggregate the interests of persons acting together when testing whether parties to arrangements are under sufficient “commonality of ownership” to fall within the scope of the regime); and
the application of the regime to certain categories of exempt investors in hybrid entities.

On 12 November 2020, HMRC published its response to the consultation, draft legislation and a policy paper summarising proposed new legislation to be included in the Finance Bill 2021. As the consultation process welcomed broader views on the UK hybrid regime, the scope of the policy paper details wider reforms and further draft legislation can be expected at some point in the future. Certain measures (noted with an asterisk* below) are proposed to take effect retrospectively from 1 January 2017.

Whilst the majority of measures are intended to be helpful, some aspects continue to represent a missed opportunity to address certain instances where tax deductions are disallowed in the absence of an economic mismatch. A non-exhaustive list of key proposed measures is set out below:

Changes will be made to provide reliefs to certain categories of taxpayer:
- The definition of “acting together” will be amended to exclude cases where: (i) a party has a direct or indirect equity stake in a paying entity no greater than 5%, including votes and economic entitlements*, and (ii) any investor holds less than 10% of a partnership that is a collective investment scheme (not dissimilar to Luxembourg’s implementation of anti-hybrid mismatch rules), which will take effect from the date of Royal Assent of the Finance Bill 2021. The changes, will be welcome news to investment managers, and funds, focusing on portfolio interests.
- Counteractions will be prevented under certain parts of the rules where the recipient of a relevant payment is a tax exempt investor (akin to a qualifying institutional investor within the UK substantial shareholding exemption rules). It is intended that this will apply from the date of Royal Assent of the Finance Bill 2021.
- Counteractions will be prevented where payments are made to and from entities taxed as securitisation vehicles under the UK securitisation regulations*.
Amendments will be made to address the application of reliefs where there is dual inclusion income (broadly a single amount of ordinary income that is recognised twice for tax purposes where the relevant entities and jurisdictions involved correspond to those that benefit from a double deduction)
- Section 259ID will be repealed*. Instead, the definition of dual inclusion income will be widened to include income that is brought into account for tax purposes in the UK without generating a tax deduction in any other jurisdiction (e.g. payments from a US parent to a UK subsidiary that is disregarded for US federal income tax purposes). This treatment will only apply where that outcome would not have arisen but for the hybridity of the UK recipient which gives rise to a counteraction under the UK hybrid rules*.
- A new surrender mechanism for “surplus” dual inclusion income is to be introduced. This will allow entities within a group relief group to surrender dual inclusion income, for set-off against doubly deductible amounts elsewhere in the group. It is intended that this will apply from 1 January 2021.
- In our April Tax Quarterly Alert, we discussed potential issues with the current application of the double deduction mismatch rules (where section 259ID does not obviously apply). In particular, we considered a scenario where an intra-group payment by a US parent company to a UK subsidiary (that is disregarded for US federal income tax purposes) may give rise to a disallowance, under the UK hybrid rules, for an otherwise deductible expense incurred by the UK subsidiary – resulting in taxation on profits it does not economically possess. The example highlighted a broader issue with HMRC’s previous “fix” introduced in 2018 by section 259ID, which is highly narrow in its application. The above changes address the issues raised in the example, albeit with one caveat – that this treatment will only be available where the inclusion/no deduction treatment was created by the same element of hybridity as the double deduction under consideration. So, where a US parent makes a payment to its disregarded UK subsidiary, the new treatment will be available (i.e. it would have been the disregarded status of the UK subsidiary which gives rise to the inclusion/no deduction mismatch). Whilst the widened definition of dual inclusion income will be helpful for certain taxpayers, for others it will not. Common structures where UK subsidiaries that have been checked open incur costs from third parties, whilst only receiving reimbursement from another subsidiary or sister company that is also checked open, but resident in neither the US nor the UK, continue to face economic double taxation. That is unfortunate, particularly given that other countries (such as Ireland) have adopted a more pragmatic approach to the implementation of their hybrid regimes to prevent such an outcome occurring for taxpayers (and consistent with the OECD principle that double taxation should be avoided).
More generally:
- The carry forward treatment of illegitimate overseas deductions (amounts for which it is reasonable to suppose that (part of) a hybrid entity’s double deduction amount is deducted under non-UK law for a taxable period from the income of any person, excluding the investor) under the hybrid rules is to be amended, so that where a relief is used by a multinational or dual resident company to set against its own single inclusion income, the relief will not be permanently denied in the subsidiary or branch. The amendments will take effect from the date of Royal Assent of the Finance Bill 2021.
- Acknowledging that the interaction of the US Dual Consolidated Loss rules with Part 6A of the hybrid rules should not operate to deny loss relief in both jurisdictions, HMRC in its response to the consultation has indicated that the new surrender mechanism and changes to the definition of illegitimate overseas deductions above should simplify the economic effects of the US rules. HMRC guidance is also expected to be published in the future to clarify the interaction. The imported mismatch rule, will be amended so that: (i) condition E (which previously required the overseas regime to apply similar provisions to the relevant part of the UK rules) will instead test whether an overseas regime seen as a whole is equivalent to the UK hybrid rules and prevents any counteraction if it is (to apply from the date of Royal Assent of the Finance Bill 2021); and (ii) condition F (which provided taxpayers with a degree of protection against a counteraction by allowing consideration of UK tax attributes to mitigate against a foreign mismatch payment) will be repealed*.

The draft legislation published to date only relates to the double deduction rules, and the application of section 259ID income. Although a timeline was not provided by HMRC, further draft legislation can be expected at some point in the future to address the remaining measures in the policy paper. HMRC has also indicated it will provide further clarification of certain points in forthcoming updates of its guidance on the hybrid regime.

Despite the many proposed changes, certain requests from consultation respondents have been explicitly rejected. These include the addition of a tax avoidance motive to the regime, an exclusion for small and medium-sized enterprises and the treatment of the US global intangible low-taxed income (GILTI) rules as an equivalent regime (so as to prevent a UK counteraction where a GILTI charge applies).

Given the scale of the hybrid and other mismatches rules and respective HMRC guidance, there has understandably been criticism of the UK’s overly mechanical approach (as opposed to a more principles based approach taken by certain other EU jurisdictions).

(c) Delay in the implementation – uncertain tax treatment rules

A proposed new obligation for businesses to notify HMRC of uncertain tax positions taken in their tax returns has been delayed until April 2022.

HMRC consulted, over the summer, on a proposed new requirement for large businesses to notify HMRC where they have adopted an uncertain tax treatment (an uncertain tax treatment being one where the business believes that HMRC may not agree with their interpretation of the legislation, case law or guidance). The proposals are designed to improve HMRC’s ability to identify tax treatments adopted by large businesses that do not stand up to legal scrutiny. In part, this is intended to aid HMRC’s efforts to open an inquiry into relevant tax positions before the statutory deadlines have passed.

The consultation concluded on 27 August 2020, and attracted strong criticism from respondents for the level of ambiguity inherent in the proposed reporting requirement (in effect requiring a judgement as to what action HMRC might take in relation to any tax position – across the full range of UK taxes). The proposals were originally due to apply to tax returns filed after April 2021, but have now been delayed until April 2022. Helpfully, HMRC appears to have now accepted the original proposal was perhaps too subjective and difficult for businesses to assess. Consequently, it is looking at ways to make the definition more objective and straightforward to comply with, whilst minimising the administrative impact on businesses.

Businesses will understandably be relieved that HMRC is revisiting the proposals in light of critical responses to the consultation. In addition, the delay provides respite from a potentially costly administrative burden at an uncertain time for many businesses.

(d) Extension of the annual investment allowance

The UK government has announced an extension, until 1 January 2022, to the £1 million annual investment allowance for capital allowances purposes. The allowance gives relief for 100% of expenditure qualifying for capital allowances, up to the threshold, in the tax year the expenditure is incurred. The allowance was previously increased to a maximum of £1 million (from £200,000) for a 2-year period, but was due to expire at the end of 2020. The announcement will be welcome news for businesses, who may be incentivised to increase capital investment at a time where managing short-term liabilities may have otherwise been more in focus.

V. UK and EU VAT updates

(i) UK VAT grouping – Establishment, Eligibility and Registration Call for Evidence

In August, HM Treasury published a call for evidence (“CfE”) to gather stakeholders’ views on certain elements of the UK VAT grouping rules. Feedback has been sought, in particular, on (a) the interaction of the UK’s establishment rules with other EU Member States’ and the application of the rules to overseas branches; (b) possible compulsory VAT grouping; and (c) grouping eligibility criteria for limited partnerships and Scottish limited partnerships.

VAT Grouping

Broadly, VAT grouping rules enable “eligible entities”[8] under common control to register for VAT as a group, and be treated as a single taxable entity for VAT purposes. A VAT group files one VAT return through the group’s representative member and supplies made between VAT group members are disregarded for UK VAT purposes. The purpose of VAT grouping is to allow administrative efficiency and while the purpose of the mechanism is not to achieve VAT savings, in practice, in some circumstances, VAT grouping supports this result.

Establishment provisions

The UK applies a “whole establishment” approach to VAT grouping. This means that “fixed establishments” (broadly akin to branches) of eligible persons, whether in the UK or abroad, are treated as part of the UK VAT group. This contrasts with other EU countries’ “establishment only” provisions, which the UK does not utilise. The “establishment only” rules provide that where an entity has “fixed establishments”[9] (or “branches”) in multiple jurisdictions, it is only the establishment in the country in which the VAT group is based that can be included in that VAT group.

Differences in VAT grouping rules have led to additional administrative and operational complexities for businesses. The document therefore calls for feedback on the benefits of adopting the “establishment only” provisions.

If the UK adopted the “establishment only” approach, only UK fixed establishments of foreign companies could be within a UK VAT group. This means that overseas branches of that foreign company could not join the UK VAT group – with the effect that supplies from foreign headquarters to a UK branch or a UK branch to foreign headquarters would be subject to VAT.

For entities/groups making exempt or partially exempt supplies, any input VAT incurred in connection with supplies from non-UK branches of the head-office (or other members of the group) would be irrecoverable (or partially irrecoverable), representing an actual cost for these groups. For those making solely taxable supplies, any input VAT incurred in connection with those supplies will be recoverable – albeit, that there may be a cash flow impact if periods of account are not aligned.

The CfE notes that an “establishment only” approach may reduce the administrative burden as groups will only then have to account for a reverse charge for VAT, and would not have to engage with anti-avoidance provisions introduced to prevent abuse of the existing rules (which the CfE contemplates would be repealed if the UK moved toward an “establishment only” approach). It is arguable whether the benefit of removing the anti-avoidance provisions will outweigh the additional administrative requirements that will come from adopting an “establishment only” approach – particularly for groups heavily reliant on internal supplies. Under the latter approach, compliance burdens may equally arise from the requirement to charge and account for VAT on certain recharges of staff costs, and any other supplies made between branches that are currently part of a UK VAT group.

Implications of Skandia[10]

As a result of the Court of Justice of the European Union’s (“CJEU’s”) judgment in Skandia, the UK introduced an exception to the “whole establishment” approach, effective 1 January 2016. Under this exception, if the overseas branch is a member of a VAT group in its local jurisdiction (which applies an “establishment only” approach to VAT grouping), then the UK head office and the overseas branch cannot be treated as the same taxable person, and VAT is applied to supplies made between them.

The call for evidence seeks feedback on the potential reversal of the UK’s changes to the VAT grouping rules following Skandia, acknowledging that the application of Skandia is administratively onerous for businesses. While this reversal would alleviate some VAT costs and compliance burdens for taxpayers, these benefits would be significantly outweighed by the costs associated with the introduction of any of the other proposals suggested in the CfE.

Compulsory VAT grouping

VAT grouping in the UK is currently optional for entities that meet the relevant control and establishment conditions. In particular, corporate groups can choose: (a) whether or not to form a VAT group and (b) which eligible entities in a corporate group should be a part of that VAT group.

In certain jurisdictions, however, VAT is compulsory for specific sectors. The government states that compulsory VAT grouping can offer administrative benefits, and level the playing field for businesses who would then all operate under the same VAT treatment.[11] The CfE seeks feedback on the introduction of compulsory VAT grouping into the UK.

Concerns have been raised, in particular, that compulsory VAT grouping is an “inflexible” approach, which will have significant adverse commercial consequences because of enforced joint and several liability that attaches to membership. It is notable that the recent introduction of compulsory grouping in Luxembourg is widely considered to have been unsuccessful, as a result of inflexibilities and resultant commercial difficulties.

Eligibility criteria

For VAT purposes, in a UK fund context (where the fund vehicle is typically either a limited partner (“LP”) or a Scottish limited partnership (“SLP”)):

1. The activities of the general partner (the “GP”) of the LP / SLP are treated as the activities of the fund vehicle (i.e. the LP / SLP, as applicable). The fund vehicle is therefore generally able to form a VAT group with the investment manager for the fund (as the GP will usually be part of the same investment management group as, and eligible to be grouped for VAT purposes with, the investment manager) allowing investment management supplies to be made to the fund free from VAT.
2. Since last year, LPs and SLPs have been entitled (but not required) to join a VAT group if the LP / SLP controls all the entities in the VAT group. “Control”, in this context, is tested by reference to whether the LP / SLP would, if it was a body corporate, be the holding company of the entities – a test which is itself determined by reference to voting rights / ability to appoint directors. Generally, this enables the fund LP / SLP (acting through the GP) and accordingly, the investment manager, to also be part of a VAT group with the fund’s portfolio companies.

The CfE acknowledges the position described in paragraph (a) above, noting that the current VAT grouping rules enable LPs / SLPs to receive supplies from entities other than the GP free of VAT – notwithstanding that the GP typically has limited rights to the profits / assets of the funds – which are held, by fund investors, outside of the VAT group. The CfE therefore: (a) contemplates limiting LPs’ / SLPs’ ability to join VAT groups, by imposing a requirement for common beneficial ownership and control, and (b) asks for stakeholders’ views on the impact of such changes.

It was the combination of the rules in (a) and (b) above that led to the decision in Melford[12] (discussed in our April Tax Quarterly Alert). By way of recap, in Melford: (a) the fund’s investment manager was grouped with the fund vehicle but (b) the parties had chosen not to include the underlying portfolio entities in the VAT group. As a result, (a) the investment manager was able to provide taxable supplies to the portfolio companies (thereby improving its recovery position) but (b) the fund was able to receive investment management services from the investment manager free from VAT (as those supplies were between members of the same VAT group, and hence disregarded). It is therefore possible that the result in Melford may have been the trigger for the CfE – with HMRC possibly seeking to (a) gauge whether/how to change existing rules to prevent the outcome achieved by the taxpayers in Melford, and (b) collect information regarding the collateral damage of the alternative approaches.

If this is indeed the case, it seems likely that restricting current fund grouping arrangements would cause material harm. In a funds context (or where an LP / SLP otherwise serves as a collective investment vehicle), if the proposals in the CfE were implemented, the fund vehicle LP / SLP would no longer be eligible to join a VAT group with:

its GP and investment manager, with the effect that VAT would be payable by the LP / SLP on investment management services received from the investment manager; or
the fund’s portfolio companies, with the effect that VAT would be payable by the portfolio companies on any investment management services received from the LP / SLP.

This would increase compliance costs, and it’s possible that at least some of the VAT payable by the fund LP / SLP, and/or the portfolio entities, may be irrecoverable. The proposals would, therefore, increase the cost of using UK fund structures. For existing funds in particular, these costs would not have been assumed at the time the fund was set up, or reflected in economic modelling (and accordingly, may distort results).

Next steps

It is expected that the proposals mooted in the CfE would, if implemented, give rise to an increase in VAT costs for many UK taxpayers, in particular, for fund structures and financial services groups. UK VAT groups should continue to monitor this consultation process. We would expect further dialogue from HMRC in respect of this CfE over the coming months.

(iii) Input VAT recovery for financial services provided to customers outside the UK

The Chancellor has announced that from 1 January 2021 (following the end of the Brexit- transition period), the VAT recovery position of UK financial and insurance service providers will not be restricted as a result of their making supplies to persons belonging outside the UK. Legislation to give effect to the proposals has not yet been published.

In order to obtain full recovery of input VAT incurred on costs, either: (a) the relevant costs must be directly related to the provision of taxable supplies or (b) the costs must form part of general overheads (and may be only partially recoverable to the extent the taxpayer makes exempt supplies). Financial services are generally exempt for UK VAT purposes. Accordingly, input VAT incurred in connection with the provision of financial services is currently generally irrecoverable.

In November, HMRC announced proposals which, broadly (if implemented), would mean that UK providers of financial services and insurance (including intermediary) services would be able to recover input VAT incurred on: (i) financial and insurance services supplied to customers belonging outside the UK (including to persons belonging in the EU) or directly related to an export of goods; or (ii) the making of arrangements for these supplies.

Supplies to UK customers will remain exempt for UK VAT purposes. Accordingly, UK financial and insurance businesses that make supplies to both UK and non-UK customers will need to calculate input VAT recovery in accordance with the partial exemption method.

As a result of the announcement, financial and insurance groups may wish to reconsider their intragroup VAT planning, particularly where the UK VAT group includes entities with EU branches (to whom the UK VAT group currently makes non-taxable supplies). Depending on their particular circumstances, it may be the case that the UK VAT group’s recovery position could be improved by de-grouping such UK entities, with a view to recognising the supplies made to its EU branch for VAT purposes.

From a documentation perspective, it is important that suppliers maintain evidence to support the input VAT claimed, including invoices and any relevant correspondence establishing the connection between the input VAT claimed and supplies made to EU. Given the potential benefits of the proposed changes (if they are implemented), maintaining documentation and monitoring internal processes will become increasingly important.

(iv) VAT treatment of termination fees – HMRC issues revised guidance

HMRC has changed its position on the VAT treatment of termination charges and compensation payments, following the CJEU’s judgements in Meo and Vodafone Portugal. HMRC’s new position, set out in HMRC’s Revenue and Customs Brief 12/20 , states that charges arising from early contract termination will generally be subject to VAT. Notably, this includes payments described as compensation or liquidated damages.

HMRC has changed its position on the VAT treatment of termination charges and compensation payments, following the CJEU’s judgements in Meo and Vodafone Portugal. HMRC’s new position, set out in HMRC’s Revenue and Customs Brief 12/20[13], states that charges arising from early contract termination will generally be subject to VAT. Notably, this includes payments described as compensation or liquidated damages.

Prior to Brief 12/20, which was published in September, payments arising out of early contract termination were generally treated as outside the scope of VAT. In particular, payments would only be outside the scope of VAT to the extent that the termination payment, or the payment of liquidated damages, was contemplated in the relevant contract between the parties.

Following the CJEU’s decision in Meo[14] and Vodafone Portugal,[15], HMRC has revised this position, now concluding that payments by a customer for early termination or cancellation of a contract in fact constitutes consideration for the original supply that the customer had contracted for. The new position applies to cases where the original contract contemplates such a payment, as well as cases where a separate agreement (outside of the original contract) is reached.

In Meo, the CJEU held that early termination charges (in the case at issue, under a telecom contract) reflect consideration for the supply of the original services, regardless of whether the customer uses that supply or not. More recently, in Vodafone Portugal, the CJEU confirmed that this would be the case even where the payment is not calculated by reference to the value of the services that would have been provided under the contract (but for the termination). HMRC’s guidance confirms that, for the payment to be subject to VAT, there just needs to be a “direct link” between the termination payment and a taxable supply.

Rate of VAT

While we would expect the VAT treatment of termination payments to match the VAT treatment of the underlying supplies, it is not entirely clear whether this will be the case or whether such payments will be standard-rated. Further clarification is expected on this point.

Retrospective effect

Brief 12/20 states that any taxable person that has failed to account for VAT to HMRC on such termination payments should correct the error. This implies that HMRC intends the guidance to apply retrospectively. While it is not mentioned, we would expect the general VAT time limits for correcting past errors to apply. Consequently, termination payments received in accounting periods that ended within the past four years should be reviewed. If an adjustment is required, the supplier will need to pay the VAT due to HMRC and amend their VAT returns. (HMRC has not stated whether it intends to charge interest and/or penalties on any late-paid VAT where an adjustment is required. However, we would expect further clarification from HMRC on this point).

Suppliers should, in such circumstances, consider whether the contractual terms underlying the supply would enable them to pass the VAT cost on to their counterparty. However, even if counterparties are required, under such contracts, to bear the cost of such VAT, given the passage of time, there may be practical difficulties in recovering these amounts, particularly given the current economic climate. Looking forward, early termination and compensation clauses should be drafted to account for VAT costs and potential VAT adjustments.

Particular applications

Property-related transactions

The revised guidance will likely have a significant impact on property-related contracts. The VAT position of landlords, property managers and developers should be reviewed where termination payments have been charged. Past and future payments for breaking a commercial lease will likely be subject to UK VAT, where the landlord has opted to tax the property. Similarly, for residential developers, termination payments incurred in connection with certain construction-related services (e.g. architect fees, surveyor costs, supervisory services), where these services do not constitute a single “design and build” contract, may attract UK VAT at the standard rate. It is expected that payments for breach of contract, such as dilapidation payments, will remain outside the scope of VAT.

M&A break-up fees

There is a question as to whether the guidance extends to “break-fees” – a common compensatory clause in an M&A context, which requires one party to compensate the other if the agreement does not complete. This so-called “break-fee” is typically calculated as a percentage of the consideration that would have been payable had completion occurred. We consider it likely that:

Where the contract provides for the seller (or the target) to pay the break-fee, the fee should not be subject to VAT. This is on the basis that the payment is disconnected from the consideration for the supply (that would otherwise have been made) under the contract – as that consideration would have come from the buyer, rather than the seller.
If the break-fee is payable by the buyer, it is possible that the payment may be subject to VAT. However, the circumstances do differ from those contemplated in HMRC’s updated guidance – which describes the early termination of a supply that has (to some extent at least) taken place. A break fee, in contrast, is payable in circumstances where completion never occurred, and no supply was ever made from the seller to the buyer. On that basis, HMRC may take the view that break fees are outside the scope of VAT, even if payable by the buyer. In any event, if the contract was for the sale of shares, that supply would have been exempt from VAT, and the same treatment should extend to the break-fee.

Brexit

On 31 December 2020, the Brexit transition period will come to an end and the legal consequences of the UK’s decision to leave the EU will take effect. This will have implications from a tax perspective – irrespective of whether a no-deal Brexit can be avoided. While the UK direct tax, and transfer tax, consequences are expected to be minimal, there will be some changes to national insurance contribution and VAT rules. Most significantly, customs duties may apply on the importation of a range of goods into the UK from the EU customs market (and vice versa). Indeed, the consequences are not limited to UK tax: leakage may be suffered on investment structures involving the UK and any of Germany, Italy and / or Portugal and certain EU resident subsidiaries of UK resident companies may face obstacles in accessing US double tax treaties.

Although the UK left the EU on 31 January 2020, from a tax perspective at least, the effect will not be felt until the end of the transition period, at 11pm on 31 December 2020. A non-exhaustive list of the key changes that will then take effect are set out below.

UK direct tax

The legal effects of Brexit will be minimised by the European Union Withdrawal Act 2018 (the “Withdrawal Act”). Broadly, the Withdrawal Act provides: (a) for EU law to be retained as a part of UK domestic law (except to the extent specifically repealed by the UK parliament) and (b) for EU case law, handed down prior to the end of the transition period, to remain binding for UK legal (and tax) purposes – to the extent not overruled by a decision of the UK Supreme Court or (as is proposed) High Court[16]. As a result, significant changes to UK direct taxes are not expected on 31 December.[17]

Nevertheless, there will be changes (and practical difficulties too). While it seems likely that the UK parliament may be keen to exercise these new powers, the enthusiasm of the UK courts remains to be seen. In the recent Volkerrail[18] case, the First Tier Tribunal opted to disapply certain UK tax provisions (restricting the surrender of losses between UK resident, and UK branches of EU resident, taxpayers) on grounds of incompatibility with EU law. Should HMRC appeal, it may present one of the first opportunities to test the High Court’s interest in exercising their freedom to depart from the CJEU. Moreover, following the end of the transition period, UK courts will no longer be able to refer questions about the application of EU law to the CJEU. Last week’s referral from the Upper Tribunal to the CJEU in Gallagher[19] (regarding the compatibility with EU law of territorial limitations on UK relief for intra-group transfers) is likely to be the last of its kind. Thus, even if retained EU laws remain on UK statute books, there is scope for conflicting applications in the EU and the UK– bringing an inherent risk of double taxation and enhanced compliance costs.

UK transfer taxes

Certain provisions of EU law prevent a 1.5% stamp duty / stamp duty reserve tax charge applying: (a) on issuances of securities into a clearing system or depositary receipt system in connection with the raising of capital or (b) on transfers of securities into such systems which are integral to such capital raising. The UK government has confirmed that these reliefs, which are frequently relied upon in capital markets transactions, will be retained.

Social security contributions

EU regulations[20], which prevent internationally mobile workers from paying social security contributions in more than one EU member state, will cease to apply from 31 December. (For existing arrangements, a slight extension has been provided for “so long as the [arrangements] continue without interruption”). The UK has introduced legislation which (broadly) attempts to replicate the positon under the regulations. However, as (most) EU member states have not reciprocated, the risk of double tax continues. The UK has, however, secured a bilateral agreement with Ireland, and intends to pursue similar agreements with other member states.

VAT

Under current rules, goods imported into the UK from the EU (and vice versa) are generally subject to acquisition VAT – which the importer accounts for by way of reverse charge (if registered for VAT purposes). From the end of the transition period, such imports will instead be subject to import VAT (which under current rules, must be accounted for immediately). The UK government has introduced legislation, to take effect from 31 December, to ensure that this change does not accelerate the time at which importers must account for VAT. Equivalent treatment will be extended to imports from non-EU jurisdictions as well.

Customs duties

The cost of the UK’s departure from the EU is likely to be most apparent in the context of customs duties. From 31 December 2020, (except to the extent otherwise agreed) customs duties, at rates determined by applicable World Trade Organisation (“WTO”) trading terms, will apply on goods imported into the UK from the EU (and vice versa). The UK published its WTO trading terms (the so-called “UK Global Tariff”) in May[21]. That contemplates that approximately 60% of items will be tariff-free, with the remaining 40% attracting duties at an average rate of approximately 6%. The EU, meanwhile, will apply its “Common External Tariff” (which imposes duties at an average rate of approximately 7%) to imports from the UK. Even if a “no-deal Brexit” can be avoided, any agreement under consideration at the moment is unlikely to be sufficiently expansive to materially improve this position. As the EU is the UK’s largest global trading partner, the economic impact is expected to be significant.

European tax

The UK’s departure from the EU may also impact taxpayers’ position under the laws of EU member states. In particular, taxpayers will need to consider whether they can continue to access reliefs available under (a) the EU Interest and Royalties Directive[22] (the “IRD”), which generally prevents withholding tax arising on intra-group payments of interest and royalties and (b) the EU Parent / Subsidiary Directive[23], which generally prevents withholding tax and direct tax applying on dividend payments (in each case, between EU-resident companies). Interestingly, the UK Withdrawal Act operates to preserve the benefit of these EU tax reliefs for EU taxpayers transacting with UK taxpayers. Unfortunately, this position has not been reciprocated by EU member states. As a result, even if treaty relief is available, (a) dividends paid from German entities to UK entities will now be subject to German withholding tax of at least 5%, (b) intra-group interest and royalties paid between UK- and Italian- resident companies will generally be subject to withholding tax of at least 10% and 8%, respectively and (ii) intra-group interest and royalties paid between UK- and Portuguese- resident companies will generally be subject to withholding tax of at least 10% and 5%, respectively (in each case subject to any domestic reliefs).

Finally, for EU-resident subsidiaries of UK-resident companies, access to treaty relief under their residence jurisdiction’s treaty with the US may be impeded. This is because their parent would no longer be a resident of an EC / EEA member state for the purposes of the “derivative benefits” exemption to the limitation of benefits article in the treaty. For further information, see our Client Alert on the subject.

Going forward

The Withdrawal Agreement’s retention of EU retained law will, to some extent, smooth the end of the transition period. However, significant portions of retained EU law cannot fully maintain the status quo, because this would require reciprocity from EU member states. It is therefore hoped that the UK government will continue to engage with EU member states (bilaterally if necessary) to remove (or at least reduce) leakage on EU/UK transactions.

More generally, from the end of the transition period, it can be expected that EU and UK tax law will begin to diverge. The extent of this divergence, and the substantive areas in which UK policy and legislation will depart from the EU, remain to be seen. Nevertheless, (particularly in the administratively-heavy field of VAT) it seems likely that the mere fact of such divergence will generate increased compliance costs for pan-European businesses.

B. Notable Cases

I. Blackrock HoldCo 5 LLC v HMRC [2020] UKFTT 443 (TC)

HMRC sought to disallow UK tax deductions for all of the interest payable on $4 billion worth of loans pursuant to UK and international transfer pricing rules and the unallowable purpose rule contained in the Corporation Tax Act 2009. The First-tier Tribunal rejected HMRC’s arguments and found for the taxpayer in respect of both issues. However, it is likely that HMRC will appeal the decision.

This case arose following HMRC’s decision to disallow the deduction by BlackRock Holdco 5 LLC (“LLC5”) of loan relationship debits in respect of interest payable on $4 billion worth of loan notes issued by LLC5 to its parent company, Blackrock Holdco 4 LLC (“LLC4”), under each of the unallowable purpose and transfer pricing rules.

Background

LLC5 appealed HMRC’s decision in the First-tier Tribunal (“FTT”) and the following issues were identified in the appeal:

Was a / one of the main purpose[s] of LLC5 being a party to the loan relationships with LLC4 to secure a tax advantage for LLC5 or any other person?
What amount of any debit is attributable to the main purpose of securing a tax advantage (if any) on a just and reasonable apportionment? (issues 1 and 2 being the “Unallowable Purpose Issue”)
Do the loans between the LLC5 and LLC4 differ from those which would have been made between independent enterprises? (the “Transfer Pricing Issue”)

The dispute with HMRC arose from the acquisition structure of the US part of Barclays Global Investors business (“BGI US”) in December 2009. Blackrock Holdco 6 LLC, (“LLC6”), LLC4 and LLC5 were incorporated on 16 September 2009 and LLC 4 elected to be a disregarded entity for US tax purposes and as such interest accruing to it from the acquisition would not be taxed in the US.

On 31 March 2012, LLC5 entered into a loan agreement with LLC6, pursuant to which LLC6 loaned $92,640,000 to LLC5. . LLC5 used these funds to make the interest payments due on certain tranches of the loan notes. On 30 September 2012, LLC5 entered into a loan agreement with LLC6, pursuant to which LLC6 loaned $92,728,008 to LLC5. LLC5 used these funds to make the interest payments due to LLC4 in September 2012 on certain tranches of the loan notes.

LLC5 filed company tax returns for accounting periods ending 30 November 2010 to 31 December 2015 and claimed deductions on its interest expenses under the loan notes for the relevant accounting periods.

For each of the returns, HMRC concluded that “no amount of the interest payable or the finance charges/or the payment to vary the terms of loan notes/or the other finance costs [by LLC5 in respect of the Loan Notes in the return period] is deductible for UK tax purposes and no amount may be included within the non-trade deficits arising on loan relationships as recorded on the company tax return for the period.”

Unallowable Purpose Issue

The relevant provisions of the Corporation Taxes Act 2009 as applicable at the time of the transaction provided are contained in sections 441 and 442. In summary, Section 441 provided that a company may not bring into account any debits which on a “just and reasonable apportionment” is attributable to an unallowable purpose. Section 442 provided that a loan relationship of a company has an unallowable purpose if a party to the relevant loan relationship entered into a transaction which included a purpose (“the unallowable purpose”) which is not amongst the business or other commercial purposes of the company. Section 442 further provided that a tax avoidance purpose is only regarded as a business or other commercial purpose of the company if it is not “(a) the main purpose for which the company is a party to the loan relationship or, as the case may be, enters into the related transaction, or (b) one of the main purposes for which it is or does so”. References to a tax avoidance purpose are references to any purpose which consists of securing a tax advantage for the company or any other person.

Tax advantage is construed widely under the Corporation Tax Act 2010 as “a relief from tax or increased relief from tax…”

The FTT quoted a number of cases in relation to the identification of the “purpose” of a company.[24] The FTT went on to state that it was common ground that the deduction of loan relationship debits in respect of interest is a tax advantage and that it is the subjective purpose of LLC5 that is to be considered in order to determine whether securing a tax advantage was the “main purpose” or “one of the main purposes” of its loan relationship with LLC4. The FTT considered the evidence of a board member of LLC5 who stated that he had not taken account of any UK tax advantage in the decision to proceed with the relevant transaction. The FTT adopted the reasoning of the House of Lords in Mallalieu v Drummond, and stated that it was necessary to look beyond the conscious motives of LLC5 and take into account the inevitable consequences of entering into the loan relationship with LLC4 – one of which was the securing of a tax advantage. The FTT concluded that there was both a commercial and tax purpose in entering into the relevant loans and as such it was necessary to consider a “just and reasonable apportionment”. The FTT followed the obiter comments of Judge Beare in Oxford Instruments UK 2013 Limited v HMRC and concluded that as the tax advantage purpose had not increased the debits, on a “just and reasonable basis”, all of the relevant debits arising in respect of the relevant loans should be apportioned to the commercial main purpose rather than the tax advantage main purpose.

The Transfer Pricing Issue

The FTT considered whether the terms of the loans entered into between LLC5 and LLC4 differ from those which would have been made between independent enterprises, taking account of all relevant information, including:

(a) Would the parties have entered into the loans on the same terms and in the same amounts if they had been independent enterprises?

(b) If the answer to question (a) is negative, would they, as independent enterprises, have entered into the loans at all, and if so, in what amounts, at what rate(s) of interest, and on what other terms?

The FTT took into account the analysis of expert witnesses on behalf of LLC5 (the “Joint Statement”) and HMRC (the “Gaysford Statement”) relating to transfer pricing. Both the Joint Statement and the Gaysford Statement agreed that it would have been possible for LLC5 to execute a $4 billion debt transaction in December 2009 with an independent enterprise at similar interest rates to the actual transaction that took place between LLC5 and LLC4, but subject to different terms and conditions that independent lenders would have required to manage the credit risks appropriately.

The FTT stated that although paragraph 1.42 of the Organisation for Economic Co-operation and Development (OECD) Guidelines[25] recognises that, “it may be helpful to understand the structure and organisation of the group and how they influence the context in which the taxpayer operates”, it is clear from the OECD Guidelines that a separate entity approach should be adopted. This approach is outlined in paragraph 1.6 of the OECD Guidelines as follows: By seeking to adjust profits by reference to the conditions which would have obtained between independent enterprises in comparable transactions and comparable circumstances (i.e. in “comparable uncontrolled transactions”), the arm’s length principle follows the approach of treating the members of an MNE [multinational enterprise] group as operating as separate entities rather than as inseparable parts of a single unified business. The FTT noted that such an approach is also consistent with the UK tax legislation, namely section 147(1)(a) Taxation (International and Other Provisions) Act 2010, which concerns the transaction or series of transactions made or imposed between “any two persons”. Accordingly, the FTT stated that the transactions to be compared are the actual transaction, a $4 billion loan by LLC4 to LLC5 and the hypothetical transaction, a $4 billion loan by an independent lender to LLC5 having regard to the covenants which such an independent lender would have required. The FTT concluded that, given the expert evidence, even though an independent enterprise would not have entered into the relevant loan on the same terms as the actual transaction it would, subject to various covenants, have entered into the relevant loans on the same terms as the parties in the actual transaction.

II. Dunsby v HMRC [2020] UKFTT 0271 (TC) and Bostan Khan v HMRC [2020] UKUT 168 (TCC) (2 June)

The First Tier Tribunal and the Upper Tribunal (“UT”) recently considered and applied the Ramsay principle of statutory interpretation in two separate cases: Dunsby v Revenue and Customs Commissioners [2020] UKFTT 271 (TC) and B Khan v HMRC [2020] UKUT 168 (TCC) (2 June), respectively. Its application in these cases sheds some light on limitations of the principle, including that the UK courts will not recharacterise a composite transaction if the purposive interpretation of relevant tax legislation does not require it.

Briefly, the facts in Dunsby were as follows: the appellant (“D”) was the sole original shareholder and director of a company (the “Company”). D and the Company implemented a tax avoidance scheme (sold to them by a promoter) that was, in the words of the FTT, designed to allow shareholders in trading companies with distributable profits to receive those profits free of income tax. Broadly, the scheme involved the Company issuing a single share in a new class (the “S share”) to a non-UK resident, unconnected recipient (“G”). In exchange for a small subscription amount (£100), the holder of the S share had the right to receive income profits and distributions, but had no voting rights. The return of capital of the S share was limited to its nominal value. G created a Jersey trust (the “Trust”) and transferred the S share to the trustee. The terms of the trust essentially provided a de minimis hurdle payment for a charity; a de minimis hurdle payment for G and the majority of any further income (98%) would be received on trust for the benefit of D (0.5.% and 1.5% of the further income would go to a charity and G, respectively). The Company declared a single dividend payment in respect of the S Share. D did not pay income tax on the amount received. HMRC (by way of a closure notice) amended D’s self-assessment tax return – D appealed. The FTT dismissed the appeal, finding that the payment from the Company would be treated as income (and therefore taxable as income) received by D (either under the settlements anti-avoidance legislation, or – if that was the incorrect basis – under the transfer of assets abroad legislation). HMRC successfully argued that the receipt was to be treated as income to D under the settlements legislation.

What is particularly interesting about the judgment, however, is the FTT’s application of Ramsay to arguments proposed by HMRC. The FTT (in dismissing one of HMRC’s arguments) set out that it would be an incorrect interpretation of the Ramsay principle to, when applying tax legislation to a factual scenario, simply disregard transactions or elements of transactions which had no commercial purpose. Such an approach was dismissed by the FTT as “going too far”. In Dunsby, HMRC had tried to argue an interpretation that ignored the true facts of the arrangement. The payments from the Company were in accordance with company law treatment of the transactions. When applying tax legislation to a set of facts, two steps are required: (i) determine on a purposive basis the precise transaction the provisions are to apply to; and (ii) apply that tax legislation to the transaction identified. The Ramsay principle was whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically (Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46 at [35]). Whilst the taxpayer was unsuccessful in this case, Dunsby serves as a reminder as to some of the limits of the Ramsay principle, frequently used by HMRC in defending its position.

The UT in B Khan[26] considered – and dismissed – arguments put forward by HMRC based on the Ramsay principle. The case concerned the tax treatment of the sale of a target company (the “Company”) to an individual (“K”) and of subsequent payments made from the Company. K acquired 100% of the Company for £1.95 million plus the net asset value of the Company. Immediately following the acquisition, the Company bought back 98 of the total 99 shares for consideration of £1.95 million. HMRC issued a closure notice, amending K’s tax return by increasing the income tax due (on the basis that the buy-back of the 98 shares was a taxable distribution and subject to income tax).

K’s (unsuccessful) appeal to the UT was based on the grounds that the FTT erred in failing to recognise the “true substance” of the transaction, which K asserted was that it was a composite transaction pursuant to which K, in return for entering into the various transactions, received the remaining share in the Company without £1.95 million distributable reserves. On this basis K (unsuccessfully) asserted that his income tax liability should have been calculated on his net receipt of the single share (rather than the single share, plus £1.95 million).

Of note with respect to the Ramsay principle, the FTT considered whether the construction of a tax statute, using a purposive statutory interpretation, required the court to consider solely one element of a composition transaction or, on the other hand, the whole of the transactions viewed together as a composite. The UT considered a line of case law that sets out what it considers to be the modern approach to the interpretation of taxing statutes (Barclays Mercantile Business Finance Ltd v Mawson [2005] STC 1; UBS AG and DB Group Services v HMRC [2016] UKSC 13; Inland Revenue Commissioners v Wesleyan and General Assurance Society (1946) 30 TC 11). The UT found that, whilst the process of statutory construction may reveal the relevance or otherwise of the economic effect of transactions, it should not be assumed that economically equivalent transactions should be taxed in the same way. The UK courts will not re-characterise a composite transaction if the purposive interpretation of relevant tax legislation does not require it.

III. Bluejay Mining plc [2020] UKFTT 473 (TC)

HMRC denied Bluejay Mining plc (“Bluejay”) credit for input VAT incurred for the relevant VAT accounting period on the basis that Bluejay, a holding company, was not making taxable supplies to its subsidiaries for consideration and/or that there was no economic activity being carried on by Bluejay. The FTT instead found that Bluejay was carrying on an economic activity and allowed the appeal.

Bluejay is a UK incorporated holding company which is listed on the Alternative Investment Market. It operates in the mineral exploration and mining industry. Bluejay’s business model broadly consisted of Bluejay identifying a possible mining project following which the necessary exploration licence would be acquired by a locally resident subsidiary. Bluejay would provide technical services to the local subsidiary and would loans the funds to pay for such services to the local subsidiary. If and when the project is successful or the licences and relevant assets are sold to another company which is willing and able to take the project to exploitation, the intracompany debt is repaid.

As explained by the FTT, HMRC’s position was that Bluejay’s central activity is to make a return through investing by buying shares in foreign mining companies. It also supplies technical services to its foreign subsidiaries. HMRC contended that in order to be able to claim input tax in relation to supplies of the services to the subsidiaries, Bluejay needed to be able to show that those services are supplied in return for a consideration. It also needed to show that those services are provided for the purpose of generating income on a continuing basis from the provision of those services, i.e., that it is carrying on an economic activity. Accordingly, HMRC’s position was that the purpose of the provision of the services was not to generate income on a continuing basis but to enhance the value of Bluejay’s investment in the subsidiary, and, as such, the services did not amount to an economic activity. The FTT noted that HMRC’s position required a re-characterisation of the contracts between Bluejay and its subsidiaries as HMRC were arguing that the “contracts as drafted do not represent the economic and commercial reality of the situation”.

The FTT concluded that the contracts do reflect the underlying economic and commercial reality of the transactions. The FTT stated that it was important that “the contract for services provides that invoices are to be settled within 30 days of the invoice being submitted and I cannot see this as anything other than consideration for the services rendered”.

In relation to the question as to whether Bluejay was carrying on an economic activity, the FTT considered the case of Polysar Investments Netherlands v Inspecteur der Invoerrechten en Accijnzen C-60/90[27] in the Court of Justice of the European Union (“CJEU”) and concluded that it is necessary to examine the actual services provided to a subsidiary in order to establish if the holding company is carrying on an economic activity. The FTT concluded that Bluejay was carrying on an activity when supplying technical services to its subsidiaries. It remains to be seen whether HMRC will appeal the decision.

____________

[1] The Pillar 1 blueprint is available here: https://www.oecd.org/tax/beps/tax-challenges-arising-from-digitalisation-report-on-pillar-one-blueprint.pdf

[2] The Pillar II blueprint is available here: https://www.oecd.org/tax/beps/tax-challenges-arising-from-digitalisation-report-on-pillar-two-blueprint.pdf

[3] https://www.oecd.org/tax/dispute/mutual-agreement-procedure-statistics.htm and https://www.oecd.org/tax/dispute/mutual-agreement-procedure-2019-awards.htm

[4] Directive (EEC) 90/463 on the elimination of double taxation in connection with the adjustment of associated enterprises (the so-called “Union Arbitration Convention”) and Directive (EU) 2017/1852 on tax dispute mechanisms in the EU (the so-called “Arbitration Directive”)

[5] https://twitter.com/benjaminangelEU/status/1330223479300497410

[6] Mission letter of President-elect Von der Leyen to Vice-President Dombrovskis, 10 September 2019. https://ec.europa.eu/commission/sites/beta-political/files/mission-letter-valdis-dombrovskis-2019_en.pdf

[7] European Commission Inception Impact Assessment. Ref. Ares(2020)7030524 – 23/11/2020 https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12632-Tax-fraud-evasion-strengthening-rules-on-administrative-cooperation-and-expanding-the-exchange-of-information

[8] “Eligible entities” are generally bodies corporate, but can also include individuals, partnerships and Scottish partnerships, in certain circumstances.

[9] For UK VAT purposes, a “fixed establishment” is an ‘establishment other than the business establishment, which has the human and technical resources necessary for providing or receiving services permanently present’ (HMRC VAT Notice 741A).

[10] Skandia America Incorporation (USA), filial Sverige v Skatteverket (Case C-7/13) EU:C:2014:2225 (17 September 2004) (Advocate General: M. Wathelet).

[11] https://www.gov.uk/government/publications/vat-grouping-establishment-eligibility-and-registration-call-for-evidence

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

[13] https://www.gov.uk/government/publications/revenue-and-customs-brief-12-2020-vat-early-termination-fees-and-compensation-payments/revenue-and-customs-brief-12-2020-vat-early-termination-fees-and-compensation-payments

[14] MEO – Serviços de Comunicações e Multimédia SA v Autoridade Tributária e Aduaneira (Case C-295/17) EU:C:2018:942 (22 November 2018) (Advocate General: J. Kokott).

[15] Vodafone Portugal – Comunicações Pessoais, SA v Autoridade Tributária e Aduaneira (Case C-43/19)EU:C:2020:465 (11 June 2020) (Advocate General: G. Pitruzzella)

[16] Although the UK government has announced that it intends for the UK High Court to also have such power, legislation is not yet in place. Cases decided by the CJEU after 31 December 2020 will be merely persuasive authorities in UK proceedings.

[17] Following the end of the transition period, UK courts will no longer be able to refer questions about the application of EU law to the CJEU. In what may well be the last such referral for UK tax purposes, the UK’s Upper Tribunal this week referred questions to the CJEU about the compatibility of certain UK tax provisions (relating to reliefs for intra-group transfers) with EU law. The responses of the CJEU will only be relevant for transfers taking place prior to 31 December 2020.

[18] Volkerrail Plant Ltd and others v HMRC [2020] UKFTT 476 (TC)

[19] Gallaher Ltd v HMRC [2020] UKUT 354 (TCC). The responses of the CJEU will only be relevant for transfers taking place prior to 31 December 2020.

[20] Regulations (EC) No. 883/2004 and 987/2009

[21] For further information see https://www.gov.uk/guidance/uk-tariffs-from-1-january-2021

[22] Council Directive 2003/49/EC

[23] Council Directive 2011/96/EU

[24] House of Lords case of Inland Revenue Commissioners v Brebner 1967 2 AC 18 as authority that it is the company’s subjective purposes that mattered. The case of Mallalieu v Drummond (Inspector of Taxes) 1983 2 AC 861 as authority that when identifying a “subjective purpose”, such purpose can be wider than the conscious motive of the person concerned. In the case of Oxford Instruments UK 2013 Limited v HMRC 2019 UKFTT 254 (TC), Judge Beare considered the extent to which on a “just and reasonable apportionment” how much of any debit is attributable to an unallowable purpose whereby there are one or more commercial main purposes. Judge Beare stated that “as long as the company can show that it had one or more commercial main purposes unrelated to any tax advantage in entering into, and remaining party to, that loan relationship, and that the relevant debits would have been incurred in any event, even in the absence of the company’s tax advantage main purpose in so doing, then none of the relevant debits should be apportioned to the tax advantage main purpose”. Judge Beare’s comments on this issue did not form part of the court’s conclusion on the facts of that particular case but provides a helpful analysis.

[25] Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations approved by the OECD on 22 July 2010

[26] B Khan v HMRC [2020] UKUT 168 (TCC) (2 June)

[27] In Polysar, the CJEU stated as follows: “It does not follow from that judgment, however, that the mere acquisition and holding of shares in a company is to be regarded as an economic activity, within the meaning of the Sixth Directive, conferring on the holder the status of a taxable person… It is otherwise where the holding is accompanied by direct or indirect involvement in the management of the companies in which the holding has been acquired, without prejudice to the rights held by the holding company as shareholder”.

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On December 22, 2020, Congress passed the content of a pending bill, H.R. 6196, the “Trademark Modernization Act of 2020,” as part of its year-end virus relief and spending package.[1] The Act includes various revisions to the Lanham Act, 15 U.S.C. §§ 1051 et seq., intended to respond to a recent rise in fraudulent trademark applications. Among other things, the Act seeks to create more efficient processes to challenge registrations that are not being used in commerce, including by establishing new ex parte proceedings. The Act also seeks to unify the standard for irreparable harm with respect to injunctions in trademark cases, in light of inconsistencies that have emerged across federal courts after the Supreme Court’s decision in eBay v. MercExchange, LLC, 547 U.S. 388 (2006). We briefly summarize these key features of the Act below.

Presumption of Irreparable Harm. Section 6 of the Act provides that a “plaintiff seeking an injunction shall be entitled to a rebuttable presumption of irreparable harm” upon a finding of a violation or a likelihood of success on the merits, depending on the type of injunction sought.[2] That language effectively reinstates the standard that most courts applied in trademark cases until the Supreme Court’s decision in the patent case, eBay v. MercExchange, LLC, 547 U.S. 388 (2006). Before eBay, courts generally treated proof of likelihood of confusion as sufficient to establish both a likelihood of success on the merits and irreparable harm. In eBay, however, the Supreme Court concluded that courts deciding whether an injunction should issue must consider only “traditional equitable principles,” which do not permit “broad classifications.” Id. at 393. In light of that decision, some courts determined that liability for trademark infringement no longer presumptively supported injunctive relief and that irreparable injury had to be shown independently.[3] This Act resolves the division among the courts following eBay and clarifies that a rebuttable presumption of irreparable harm applies for trademark violations.
New Ex Parte Processes. Section 5 of the Act creates two new ex parte cancellation proceedings, designed to address concerns that the trademark register is becoming overcrowded with marks that have not been used in commerce properly, as the Lanham Act requires.[4] The first creates a new Section 16A to the Lanham Act, that allows for ex parte expungement of a registration that has never been used before in commerce.[5] The second creates a new Section 16B to the Lanham Act that allows for ex parte reexamination of a registration where the mark was not in use in commerce at the time of either the first claimed use, or when the application was filed.[6] The Act further authorizes the Director to promulgate regulations regarding the conduct of these proceedings.[7]
Changes to the Examination Process. The Act establishes two notable updates to the trademark examination process: first, it formalizes the process by which third-parties can submit evidence to the United States Patent and Trademark Office concerning a given application; second, it provides the Office with greater authority and flexibility to set the deadlines by which trademark applicants must respond to actions taken by the examiner.
- Third-Party Evidence: The Act effectively codifies the longstanding informal practice by which third parties submit evidence to the Office regarding the registrability of a mark during the examination process. Section 3 expressly permits the submission of this evidence and also establishes new formalities concerning the process to do so—including by requiring that the submitted evidence include a description identifying the ground of refusal to which it relates, and by providing the Office with the authority to charge a fee for the submission.[8]
  The Act also imposes a two-month deadline for the Office to act on a third-party submission,[9] which should incentivize third-parties to submit relevant evidence to the examiner before he or she makes any decision on an initial application.
- Response Times: Section 4 of the Act amends the Lanham Act’s provision that imposes a six month deadline for an applicant to respond to an examiner’s actions during the application process.[10]
  Specifically, Section 4 grants the Office the authority to determine, by regulation, response periods for different categories of applications, so long as the period is between 60 days and six months.[11]

It remains to be seen how the Office will interpret the Act and what procedures it will promulgate. It is also an open question whether the new ex parte and examination procedures created by the Act will address Congress’ underlying concerns that the register has become overcrowded with fraudulent registrations obtained by foreign entities, especially from China.[12] But it is clear that the Act will open up new fronts for administrative proceedings to challenge registered trademarks, and create new weapons for those who believe they are or would be affected by a pending application or registration. At the same time, the restoration of a formal presumption of irreparable harm in trademark infringement cases will make it procedurally easier for trademark owners to enjoin uses of confusingly similar marks and avoid consumer confusion about the source of a good or service.

_______________________

[1] See Office of Congressman Hank Johnson, Congressman Johnson’s Bipartisan, Bicameral Trademark Modernization Act Becomes Law, available at https://hankjohnson.house.gov/media-center/press-releases/congressman-johnson-s-bipartisan-bicameral-trademark-modernization-act (Dec. 22, 2020).

[2] The Act also clarifies that this amendment “shall not be construed to mean that a plaintiff seeking an injunction was not entitled to a presumption of irreparable harm before the date of the enactment of this Act.” H.R. 6196 § 6(a).

[3] See, e.g., Herb Reed Enters., LLC v. Fla. Entm’t Mgmt., Inc., 736 F.3d 1239, 1249 (9th Cir. 2013) (reading eBay as signaling “a shift away from the presumption of irreparable harm” and holding that a plaintiff must separately establish irreparable harm for a preliminary injunction to issue in a trademark infringement case); Salinger v. Colting, 607 F.3d 68, 78 n.7 (2d Cir. 2010) (suggesting that eBay’s “central lesson” that courts should not “presume that a party has met an element of the injunction standard” applies to all injunctions); see also Voice of the Arab World, Inc. v. MDTV Med. News Now, Inc., 645 F.3d 26, 31 (1st Cir. 2011) (questioning whether, after eBay, irreparable harm can be presumed upon a finding of likelihood of success on the merits of an infringement claim).

[4] See H.R. 6196 § 5(a); House Report Section C.1 (explaining the intent behind the new proceedings).

[5] H.R. 6196 § 5(a).

[6] Id. § 5(c).

[7] Id. § 5(d) (providing that the Director “shall issue regulations to carry out” the new “sections 16A and 16B” “[n]ot later than one year after the date of the enactment of this Act.”).

[8] See H.R. 6196 § 3(a) (“A third party may submit for consideration for inclusion in the record of an application evidence relevant to a ground for refusal of registration. The third-party submission shall identify the ground for refusal and include a concise description of each piece of evidence submitted in support of each identified ground for refusal. Within two months after the date on which the submission is filed, the Director shall determine whether the evidence should be included in the record of the application. The Director shall establish by regulation appropriate procedures for the consideration of evidence submitted by a third party under this subsection and may prescribe a fee to accompany the submission.”).

[9] Id.

[10] See 15 U.S.C. § 1062(b).

[11] See H.R. 6196 § 4.

[12] See, e.g., Tim Lince, Fraudulent Specimens at the USPTO: Five Takeaways from Our Investigation – Share Your Experience, World Trademark Rev. (June 19, 2019), https://www.worldtrademarkreview.com/brand-management/fraudulent-specimens-uspto-five-takeaways-our-investigation-share-your (reporting on investigation of nearly 10,000 US trademark applications filed in May 2019 with many seemingly fraudulent specimens originating from China).

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please feel free to contact the Gibson Dunn lawyer with whom you usually work in the firm’s Intellectual Property, Fashion, Retail, and Consumer Products, or Media, Entertainment and Technology practice groups, or the following authors:

Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Alexandra Perloff-Giles – New York (+1 212-351-6307, aperloff-giles@gibsondunn.com)
Doran J. Satanove – New York (+1 212-351-4098, dsatanove@gibsondunn.com)

Please also feel free to contact the following practice leaders:

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The substantive provisions of Hong Kong’s Competition Ordinance (“Ordinance”) came into force in December 2015. This note looks at the main achievements in the first five years and some of the challenges laying ahead.

The main achievements of the Hong Kong Competition Commission (“Commission”) are first and foremost building up—from scratch—a competent and trustworthy institution. The Commission has hired seasoned enforcers from overseas with impeccable reputations which has brought immediate credibility to the Commission. It has embarked on a wide range of educational activities, including seminars, advertising and publishing guidelines detailing its enforcement priorities and interpretation of the Ordinance. The Commission has also adopted a world-class leniency programme to facilitate the prosecution of cartels, its main priority. The Commission proceeded to win its first case in court thereby confirming that it is a force to be reckoned with.

Nevertheless, it is still early days and the Commission will face significant challenges in the next few years. The Competition Tribunal (“Tribunal”)’s decision in the Nutanix case that the criminal standard of proof applies where the Commission seeks to have financial penalties imposed is likely to limit the Commission’s enforcement activities to clear cut cartel cases, and prevent enforcement actions in relation to most cases of abuses of substantial market power. Also, while the Tribunal has vindicated the Commission’s decision to also prosecute individuals, the Tribunal still needs to rule on the level of fines that may be imposed on individuals. This will have a direct impact on the Ordinance’s deterrent effect and on incentives to self-report under the leniency policy.

Further, it remains to be seen whether the Government and the legislature will have any appetite to revise the Ordinance in order to foster more competition and give more teeth to the Ordinance. Among possible changes are an extension of the merger control regime, currently limited to the telecommunications sector, to apply generally to all sectors. Observers are also calling for an increase in the level of fines and the introduction of stand-alone private litigation.

1. The Competition Ordinance in a Nutshell

The Ordinance prohibits three types of conduct:

agreements and concerted practices having the object or effect of preventing, restricting or harming competition (“First Conduct Rule”);
abuses of a substantial degree of market power having the object or effect of preventing, restricting or harming competition (“Second Conduct Rule”); and
mergers in the telecommunications sector that are likely to have the effect of substantially lessening competition (“Merger Rule”).

The Commission does not have the power to impose sanctions on its own, but must apply to the Tribunal for that purpose. The Tribunal has wide-ranging powers, including the authority to impose fines of up to 10% of the Hong Kong turnover per year of infringement (up to a maximum of 3 years), impose a cease and desist order, disqualify directors, and award damages.[1]

A private party cannot bring a stand-alone action before the Tribunal. Instead, the Tribunal must first rule on the legality of the alleged contravention in proceedings commenced by the Commission, after which time, a private party can commence a follow-on action for damages.[2]

2. Cartels

The Commission has from the start made it clear that prosecuting cartels would be a priority. The adoption of a leniency regime was an important step towards that goal. The initial leniency programme, while a step in the right direction, contained too many disincentives to self-report cartel conduct. In 2020, the Commission brought major changes to its leniency policy and adopted what is clearly a world-class framework. In addition, the Commission attracted highly experienced officials from foreign competition agencies reinforcing the level of credibility of its leniency programme.

It is unclear at this stage to what extent the new leniency programme has been successful. As with other leading regimes, it is likely that additional cases resulting in high financial penalties (or penalties on individuals) are necessary before companies widely see the benefit of self-reporting in Hong Kong.

2.1 The Leniency Programme

Section 80 of the Ordinance grants the Commission the ability to enter into a “leniency agreement”.

Under the Leniency Policy for Undertakings, leniency is available for the first cartel member that either reports participation in a cartel which the Commission is not already investigating (known as Type 1 applicant) or provides substantial assistance to an ongoing investigation by the Commission (known as Type 2 applicant).[3] In exchange for a successful applicant’s cooperation with the Commission, the Commission will agree not to take any proceedings against it before the Tribunal in relation to the reported conduct. Because the Tribunal may only impose pecuniary penalties on application by the Commission, successful leniency applicants will therefore receive full immunity from pecuniary sanctions.[4]

For successful Type 1 applicants only, the Commission will also agree not to require the applicant to admit to a contravention of the First Conduct Rule. Because follow-on actions may only be initiated in Hong Kong after the Tribunal or another Hong Kong court has made a decision that an act is a contravention of a conduct rule, or when a person has made an admission to the Commission that the person has contravened a conduct rule, this will protect successful Type 1 leniency applicants from follow-on damages claims in Hong Kong. Type 2 applicants, on the other hand, may be require to admit to a contravention, potentially exposing them to follow-on damages claims.

The Leniency Policy for Individuals allows individuals to self-report anticompetitive conduct, in exchange for the Commission not initiating any proceedings against the leniency applicant in relation to the reported conduct.[5]

The Cooperation Policy establishes a framework by which cooperating cartel members that are not the first to report may receive a discount on the penalty that the Commission would otherwise recommend to the Tribunal.[6] The policy lays out several “bands” of discounts on the recommended pecuniary penalty based on the order in which participating undertakings express their interest in cooperating. Undertakings assigned to Band 1 will receive a discount of between 35% and 50% of the recommended penalty; those assigned to Band 2 will receive a discount of between 20% and 40%; and those assigned to Band 3 will receive a discount of up to 25%. The Commission will “ordinarily” assign the first undertaking to express its interest to cooperate to Band 1. Later applicants will be assigned to Band 2 or 3, depending on the order in which they came forward. The Commission may recommend a discount of up to 20% if an undertaking cooperates with the Commission only after enforcement proceedings against it have commenced. Finally, the Cooperation Policy offers an additional “leniency plus” discount: if a cooperating undertaking finds that, in addition to the first cartel, it has engaged in a completely separate cartel and enters into a leniency agreement with the Commission for its role in the second cartel, the Commission will apply an additional discount of up to 10% on the undertaking’s recommended pecuniary penalty for its role in the first cartel.

2.2 Enforcement Actions at the Tribunal

The Commission has initiated six enforcement actions before the Tribunal and they all concern cartel conduct. Decisions have been issued in two actions and the remaining four are pending as of the date of this article.

Competition Commission v Nutanix Hong Kong Limited and others: In its first enforcement action before the Tribunal, the Commission alleged that a supplier of IT equipment (Nutanix) had engaged in bid rigging with four of its distributors and resellers in relation to a tender conducted by the YWCA.[7] In particular, in order to ensure that YWCA would receive the required number of valid bids in order to award the contract, Nutanix had asked several of its distributors and resellers to submit a dummy bid. The Tribunal ruled in favor of the Commission, except in relation to one of the resellers for which it decided that the isolated conduct of the employee who prepared the dummy bid could not be attributed to its employer. The Tribunal imposed fines totalling about HKD 7 million and the defendants were ordered to pay the Commission’s costs for about HKD 9 million. This case is now before the Court of Appeal.

The main lesson from this decision is that the Tribunal confirmed that where the Commission seeks to have financial penalties imposed, the criminal standard of proof will apply. The Commission therefore has to demonstrate “beyond a reasonable doubt” that an infringement has taken place. This is likely to have a major impact on the Commission’s enforcement powers as it will make it very difficult for the Commission to have financial penalties imposed where the infringement does not have the “object” of restricting competition but only a possible “effect”. This would include, for example, most abuses of substantial market power, some forms of exchange of information, or agreements between competitors that have some pro-competitive effects. The Commission’s enforcement powers against these types of conduct may be limited to obtaining a cease and desist order, which should be subject to the civil standard of the balance of probabilities, which may not have a strong deterrent effect.

A second lesson from that case is that an employer does not enjoy privilege against self-incrimination with regard to statements made by its employees in the competition law context.[8] Section 45(2) of the Ordinance provides that no statements made by a person in responding to the Commission’s requests for information is admissible against that person in proceedings. The Tribunal found that, where the Commission’s requests for information are addressed to a natural person, the responses given by the individual are personal to him and do not bind his employer, such that the individual, and not the employer, is liable for any false or misleading answers. As such, the individual could not be perceived to be acting on behalf of his employer when he attends an interview before the Commission, even if he attends the interview with the employer’s lawyers. The Tribunal’s decision limits the beneficiary of the statutory protection against self-incrimination under Section 45(2) to the person compelled to attend before the Commission.

Finally, this case shows that although fines may be on the low side, the costs of defending a case before the Tribunal are significant. The defendants have likely spent over a combined USD 20 million to defend themselves (solicitors, barristers, experts,…), in addition to paying part of the Commission’s costs. The high cost of litigation in Hong Kong is a significant incentive to comply with the law or to promptly self-report problematic conduct.

Competition Commission v W. Hing Construction Company Limited and others: In April 2020, the Tribunal issued its second dispositive judgment and found that ten decoration contractors entered into a market sharing and price fixing agreement, in contravention of the First Conduct Rule, regarding the decoration works at a public rental housing estate.[9] Importantly, in this case, the Tribunal set out the methodology that it will follow when imposing fines on undertakings in breach of the prohibition on cartel conduct. The methodology is similar to the approaches taken in the UK and the EU. The Tribunal followed, by and large, the recommendations of the Commission but emphasized that while that there were strong public interest in facilitating cooperation by parties, at the same time that the Tribunal, as an independent Tribunal, is not bound by any recommendation of the Commission.

In particular, the Tribunal adopted a four-step approach in calculating the fine: (1) determining the base amount; (2) making adjustments for aggravating, mitigating and other factors; (3) applying the ceiling which a penalty may not exceed under the Ordinance; and (4) applying any fine reductions based on cooperation or an inability to pay. However, it should be noted that it remains unclear how the framework adopted by the Tribunal would apply in case of fines on individuals. Moreover, the facts did not require the Tribunal to assess a recommendation by the Commission on the fine reductions based on a party’s cooperation pursuant to the Commission’s Cooperation and Settlement Policy.

The noteworthy development in the four other pending cases is that the Commission decided to enforce the Ordinance against individuals. In Competition Commission v Kam Kwong Engineering Company Limited and others, the Commission commenced proceedings against three decoration contractors and two individuals at the Tribunal alleging that the parties entered into a market sharing and price fixing agreement regarding the decoration works at a subsidized sale flats housing estate.[10] Three of the parties admitted to the contravention and entered into a settlement with the Commission, which was approved by the Tribunal in July 2020.

In Competition Commission v Fungs E & M Engineering Company Limited and others, the Commission commenced proceedings against six decoration contractors (and three involved individuals) alleging that the parties entered into a market sharing and price fixing agreement regarding the decoration works at a public rental housing estate.[11] In this case, one of the involved directors admitted liability for a contravention of the First Conduct Rule and the Tribunal issued its first ever director disqualification order against that director, prohibiting him from serving as a director for one year and ten months.

In Competition Commission v Quantr Limited and another, the Commission issued its first infringement notices to Quantr Limited and Nintex Proprietary Limited alleging that the two companies exchanged information regarding the intended fee quotes in relation to a bidding exercise organized by Ocean Park.[12] Nintex accepted the Commission’s infringement notice and committed to comply with the requirements imposed by the Commission, which resulted in the Commission not commencing proceedings against Nintex. Quantr disputed the infringement notice and the Commission commenced proceedings against it and its sole director. In November 2020, Quantr and its sole director entered into a settlement with the Commission, where is admitted to a contravention of the First Conduct Rule and agreed to pay pecuniary penalty.

In Competition Commission v T.H. Lee Book Company Limited and others, the Commission commenced proceedings against three publishing companies (and one of their directors) alleging that the companies engaged in price fixing, market sharing, and/or bid-rigging in relation to tenders for the supply of textbooks to primary and secondary schools in Hong Kong.[13]

3. Other Nonmerger Enforcement Actions taken by the Commission

3.1 Court cases

On 21 December 2020, the Commission initiated its first abuse of market power case before the Tribunal. It alleged that Linde had a substantial degree of market power in the medical gases supply market in Hong Kong and that it had committed a breach of the Second Conduct Rule by refusing to supply a competitor in the downstream market of medical gas pipeline system maintenance, in what seems an essential facility case. It is unclear at this stage when the case will be heard.

3.2 Block Exemptions

Section 15 of the Ordinance grants the Commission the ability to issue “block exemption orders” to exempt a particular category of agreements because they enhance overall economic efficiency.

Vessel Sharing Agreements Block Exemption.[14] The Hong Kong Liner Shipping Association, which represents most shipping lines in Hong Kong, applied for a block exemption order in relation to liner shipping agreements, including vessel sharing agreements (“VSA”) and voluntary discussion agreements (“VDAs”).

The Commission granted a block exemption in relation to VSAs. These are operating arrangements between shipping lines in relation to the provision of liner shipping services, including the coordination of joint operation of vessel services, and the exchange or charter of vessel space (these agreements are commonly called “alliances”, “consortia”, “slot charter agreements” joint services agreements” or “slot swap agreements”). The block exemption is subject to the following conditions: (i) parties to a particular VSA do not have a combined market share in excess of 40%, (ii) the VSA does not authorize or require its members to engage in price fixing, capacity or sale limitations, market/customer allocation, and (iii) parties can withdraw from a VSA without penalty or unreasonable notice period.

However, the Commission’s block exemption order does not extend to VDAs. These are agreements between carriers in which parties discuss commercial issues relating to a particular trade, including prices (freight rates and surcharges), agreements on recommended freight rates and surcharges, and exchanges of commercial information (such as statistics on costs, capacity, deployment, etc.). The Commission considered that exchanges of future price intentions and an agreement on recommended prices constituted infringements by object of the First Conduct Rule and could not benefit from a block exemption.

3.3 Decisions

Section 9(1) of the Ordinance empowers the Commission to issue a decision that the First Conduct Rule does not apply to a particular agreement because one of more exclusions or exemptions in the Ordinance apply.

Code of Banking Practice.[15] A series of banks applied to the Commission for a decision that the Code of Banking Practice (“Code”) issued by the Hong Kong Association of Banks (“HKAB”) and endorsed by the Hong Kong Monetary Authority (“HKMA”) was exempted from the First Conduct Rule because it was adopted to comply with legal requirements, a ground for exemption under the Ordinance. After a detailed assessment of the regulatory framework and the specific language in the Ordinance, the Commission concluded that agreeing to the Code is not the result of a legal requirement and that the application of the First Conduct Rule is therefore not excluded. However, the Commission indicated that it had no current intention to pursue an investigation or enforcement action in respect of the Code. The Commission noted indeed that the Code is intended to promote good banking practices through setting out minimum standards, that the Code has been formulated with input and support from the Consumer Council, the HKMA and other public bodies, and was endorsed by the HKMA.

Pharmaceutical Sales Survey.[16] The Hong Kong Association of the Pharmaceutical Industry (“HKAPI”) applied for a decision that a proposed arrangement to conduct and publish a survey comprising data on the sales of prescriptions and over-the-counter pharmaceutical products in Hong Kong did not infringe the First Conduct Rule, including because such exchange of information will enhance economic efficiency. The Commission ruled against the HKAPI, finding that the proposed exchange of information was not excluded or exempted from the First Conduct Rule under the efficiency exclusion.

In particular, the Commission took issue with the proposed exchange of product level sales data, this is sales data for specific, named products by sector (government, private, trade and Macau) grouped by supplier or according to the ATC3 class. The proposed survey would have been published on a quarterly basis, one month after the end of each quarter. According to the Commission, the exchange of product level sales data would enhance transparency on the market and reduce independent decision-making and/or facilitate coordination. In particular, the Commission considered that quarterly data published one month after the end of the quarter did not constitute “historical data”.

The exchange of other data was considered as unlikely to raise concerns, such as the exchange of total sales data per company (unless a particular company only has one product on the market). In addition, the Commission did not object to the exchange of sales data per ATC3 category, unless a particular class only included a limited number of products or competitors.

The precedential value of this decision may be limited. Indeed, as the Commission itself recognized, assessing the competition concerns relating to an exchange of information require consideration of the context of the exchange and can differ depending on the products, markets and characteristics of the information exchange in question. Therefore, the analysis in the decision may not apply to exchanges of information in other contexts.

3.4 Commitments

Section 60 of the Ordinance allows the Commission to accept commitments from undertakings in exchange for terminating an investigation or not initiating proceedings before the Tribunal.

Seaport Alliance.[17] The Commission accepted commitments in relation to the Seaport Alliance (“Alliance”). This was a cooperative joint venture by four of the five terminal operators at Kwai Tsing Container Terminal. The purpose of the joint venture was to pool and share their capacity, coordinate prices, commercial terms and customer allocation, and sharing profit and losses. In essence, this was a model similar to the “metal-neutral” joint ventures in the airlines business.

The Commission considered that the Alliance was likely to result in anticompetitive effects as it eliminated competition between the largest operators at Kwai Tsing, covered between 80-90% of all the throughput at that port and the remaining operator had limited ability to expand capacity to operate as an alternative to the Alliance. As such, the Alliance’s members would be able to increase prices or decrease service levels.

In order to address the Commission’s concerns, the Alliance proposed a series of behavioural commitments. In essence, the Alliance agreed to (i) cap the charges for services to customers and maintain a minimum service level, (ii) maintain reciprocal overflow arrangements with the remaining port operator, and (ii) eliminate cross-directorships in specified other ports in Mainland China.

Online Travel Agents.[18] The Commission accepted commitments from three large online travel agents operating in Hong Kong, namely Booking.com, Expedia.com and Trip.com, in respect of the agreements entered into between the online travel agents and hotels. These agreements included provisions requiring hotels to provide the same or better room price, room condition and room availability to the online travel agents as the hotel provided to other third party sales channels.

The Commission considered that these provisions, which were akin to most-favoured nation clauses, were likely to have the effect of softening competition between travel agents by reducing the incentives for travel agents to lower the commission charged. As an effect of these provisions, hotels have limited incentives to offer better terms to new or smaller travel agents who seeks to attract business by charging less commission, as the hotels would have to offer the same terms to the three online travel agents pursuant to the abovementioned provisions.

In order to address the Commission’s concerns, the three online travel agents dropped these provisions. As a result, the Commission terminated its investigation.

4. Private Litigation

Private litigation is limited under the Ordinance. Parties can only initiate a case before the Tribunal after the Tribunal has ruled that an infringement has taken place. As an exception to that rule, private parties can raise defences based on the Ordinance in any litigation before the Court of First Instance. In that case, there is a possibility to transfer the case (or parts of it) to the Tribunal. For example, in Taching Petroleum Company, Limited and Shell Hong Kong Limited v Meyer Aluminium Limited [19], Taching and Shell commenced proceedings in the Hong Kong High Court against Meyer to recover outstanding unpaid invoices in relation to the supply of diesel. In defending such proceedings, Meyer alleged that Taching (a reseller of Sinopec diesel) and Shell had breached the First Conduct Rule by colluding to, inter alia, fix prices and exchange price information (the “Defence”), possibly with other suppliers. Meyer referred to a series of parallel price announcements by Taching and Shell. The case was transferred from the Hong Kong High Court to the Tribunal and the case remains pending before the Tribunal. Whilst the Defence was transferred to the Tribunal for determination and set down for trial in late 2020, as a result of the introduction by Meyer of expert evidence, along with other interlocutory applications, which the Tribunal largely determined against Meyer and which are subject to possible appeals, the trial has been adjourned to a future date. The Tribunal did allow expert evidence, but limited to “whether the uniformity in the pricing mechanisms and adjustments of Taching and Shell between January 2011 and June 2017 could be better explained on the hypothesis of collusion or on the hypothesis of independent conduct”.

Meyer’s claims of a conspiracy seems inconsistent with the findings of the Commission in its autofuel market study in which it came essentially to the conclusion that there was no evidence of collusion among suppliers of gasoline despite the similarity in retail prices and the fact that suppliers would increase/decrease prices at the same time.[20] Although the Tribunal should be commended for allowing Meyer to state its case, it seems that the various procedures amount to a waste of resources. If Shell and Taching prevail, Meyer risks being faced with a costs claim that is without proportion to the amounts at stake.

5. Mergers

The Merger Rule only applies to the telecommunications sector. Therefore, the Communications Authority (“CA”) will ordinarily take the lead in enforcing the Merger Rule.

There is no mandatory pre-closing notification system so there is no need to obtain approvals from the CA in order to close a transaction. The CA may initiate a preliminary investigation within thirty days after becoming aware that a merger took place. If, after carrying out that investigation, the CA has reasonable cause to believe that a merger could be in breach of the Ordinance, it has six months (starting from the day it became aware of the merger or the day the merger closed, whichever is the later) to initiate proceedings before the Tribunal to stop the merger process or unwind the merger. Merger parties can voluntary notify their merger to obtain (confidential) informal advice. This is likely to be a process of limited value because the CA will not reach out to third parties to obtain their views. Parties may also apply for a decision that their transaction does not breach the Ordinance but the CA is only required to consider such application if the merger raises essentially novel questions. Finally, the CA is empowered to accept commitments from the merger parties.

Enforcement activity in the merger space has been limited. The only decision relates to a merger between two fixed network operators, Hong Kong Broadband Network Limited and WTT HK Ltd, essentially a 4-to-3 merger. The CA initiated a preliminary investigation into the merger but the merger parties offered a set of commitment to address the concerns raised by the CA.[21] These commitments included (i) an obligation to facilitate access to non-residential buildings where both merging parties have already installed their own communications lines, and (ii) an obligation to continue to provide wholesale inputs to downstream rivals (e.g. mobile backhaul services).

Looking forward, the key issue is whether Hong Kong will extend the scope of the Merger Rule and adopt a cross-sector prohibition on anticompetitive mergers.

____________________

[1] Part 6 and Schedule 3 of the Ordinance.

[2] See Section 110 of the Ordinance.

[3] Leniency Policy for Undertakings Engaged in Cartel Conduct (Revised April 2020 version).

[4] Section 93(1) of the Ordinance.

[5] Leniency Policy for Individuals Involved in Cartel Conduct (April 2020 version).

[6] Cooperation and Settlement Policy for Undertakings Engaged in Cartel Conduct (April 2019 version).

[7] Competition Commission v Nutanix Hong Kong Limited and others (CTEA1/2017) [2019] HKCT 2.

[8] Competition Commission v Nutanix Hong Kong Ltd and Others (CTEA1/2017) [2017] 5 HKLRD 712.

[9] Competition Commission v W. Hing Construction Company Limited and others (CTEA2/2017) [2020] 2 HKLRD 1229, [2020] HKCT 1.

[10] Competition Commission v Kam Kwong Engineering Company Limited and others (CTEA1/2018) [2020] 4 HKLRD 61, [2020] HKCT 3.

[11] Competition Commission v Fungs E & M Engineering Company Limited and others (CTEA1/2019) [2020] HKCT 9.

[12] Competition Commission v Quantr Limited and another (CTEA1/2020) [2020] HKCT 10; Commitment to Comply with Requirements of Infringement Notice issued to Nintex Proprietary Limited by Competition Commission, 16 January 2020.

[13] Competition Commission v T.H. Lee Book Company Limited and others (CTEA2/2020).

[14] Competition (Block Exemption For Vessel Sharing Agreements) Order 2017.

[15] Commission Decision under section 11(1) of the Competition Ordinance in respect of the Code of Banking Practice, 15 October 2018.

[16] Commission Decision under section 11(1) of the Competition Ordinance in respect of a proposed pharmaceutical sales survey, 26 September 2019.

[17] Commitments by Modern Terminals Limited and HPHT Limited (Case EC/03AY), 30 October 2020.

[18] Commitment by Booking.com B.V., 13 May 2020; Commitment by Expedia Lodging Partner Services Sarl, 13 May 2020; and Commitment by Trip International Travel (Hong Kong) Limited and Ctrip.com (Hong Kong) Limited, 13 May 2020.

[19] [2018] HKCFI 2095, [2019] HKCFI 515, [2019] HKCT 1 and [2019] HKCT 2.

[20] Report on Study into Hong Kong’s Auto-fuel Market, 4 May 2017.

[21] Notice of Acceptance by the Communications Authority of Commitments Offered by Hong Kong Broadband Network Limited, HKBN Enterprise Solutions Limited and WTT HK Limited under Section 60 of the Competition Ordinance in relation to the Proposed Acquisition of WTT Holding Corp. by HKBN Ltd., 17 April 2019.

The following Gibson Dunn lawyers assisted in the preparation of this client update: Sébastien Evrard, Winson Chu, Bonnie Tong and Adam Ismail.

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, any member of the firm’s Antitrust and Competition Practice Group, or the following lawyers in the firm’s Hong Kong office:

Sébastien Evrard (+852 2214 3798, sevrard@gibsondunn.com)
Kelly Austin (+852 2214 3788, kaustin@gibsondunn.com)
Winson S. Chu (+852 2214 3713, wchu@gibsondunn.com)
Bonnie Tong (+852 2214 3762, btong@gibsondunn.com)

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