The legal obligations of an insurer and the insured are governed by the contract between them, which is the insurance policy, and certain state laws. An important aspect of the insurance relationship arising under a liability insurance policy is the insurer’s duty to defend the insured, or to reimburse the insured for defense costs, where the insured timely notifies the insurer of a potentially covered claim. Among other things, where a liability policy includes a right and duty to defend, the insurer must hire and pay for legal counsel to defend an insured in the underlying lawsuit.

Recoupment of Defense Costs

When an insurer provides a defense but it is later determined that there was no duty to defend, the insurer may attempt to recoup defense costs from the insured. Some insurance policies expressly require the insured to reimburse the insurer; most do not. Even where the insurance policy does not include an express provision requiring the insured to reimburse defense costs, an insurer may pursue recoupment. Jurisdictions differ on whether an insurer can recoup defense costs in that situation.

If an insurer has defended the insured under a reservation of rights, courts in some states allow the insurer to recover the costs of defense based on equitable remedies such as implied contract or unjust enrichment. These courts reason that the insured was never entitled to payments for defense costs under the insurance policy if there was no duty to defend from the outset, and the insured must reimburse an insurer for those payments.^[1] Other courts have applied a restitution theory to find that reimbursement is necessary to ensure adherence to the terms of the insurance policy, again reasoning that the policyholder “was never entitled” to a defense under the contract terms.^[2]

Courts in other states, however, restrict an insurer’s right to recoupment only to situations in which the insurance policy expressly provides for such reimbursement. These courts generally hold that a court would be amending or altering the insurance policy if it were to grant the insurer a right that does not exist under the terms of the insurance contract. The decisions frequently rely on state law that imposes a broad duty to defend on liability insurers, one that is broader than the duty to indemnify.

Eleventh Circuit: No Recoupment Absent an Express Policy Provision

In a recent decision applying Georgia law, the U.S. Court of Appeals for the Eleventh Circuit held that insurers should be limited to contractual rights under the language of the insurance policies, not under a new contract supposedly created in the insurers’ reservation of rights letters. The court in Continental Casualty Co. v. Winder Laboratories, LLC (“Winder Labs”) predicted how the Georgia courts would rule on reimbursement of defense costs absent an express reimbursement provision in the policy.^[3] Persuaded by the logic of other jurisdictions that “wide-ranging reimbursement is necessarily inappropriate in a system—like Georgia’s—that is predicated on a broad duty to defend and a more limited duty to indemnify,” the Eleventh Circuit predicted that “the Supreme Court of Georgia would follow that logic to adopt a ‘no recoupment’ rule to protect its insurance system.”^[4]

In so deciding, the court affirmed a Georgia federal district court decision holding that the insurers did not have a duty to defend Winder Laboratories or its manager in an underlying lawsuit alleging that Winder Laboratories falsely or misleadingly advertised a generic pharmaceutical. The operative claim fell within a “failure to conform” exclusion within the policies, so neither insurer had an ongoing duty to defend as a result of the district court’s ruling.^[5]

More significantly, the Eleventh Circuit decided, as a matter of first impression under Georgia law, whether a reservation of rights letter that asserts a right to reimbursement entitles an insurer to recoup defense costs even though the policy does not contain such a condition. The court held that it does not.^[6]

The insurance policies at issue in Winder Labs had no language conferring a right to reimbursement of defense costs and did not specify who would choose defense counsel. After the insurers received notice of the underlying lawsuit, they sent a series of reservation of rights letters that purported to reserve the right to seek reimbursement of defense costs for all claims that were not covered under the policies. The letters also gave the insureds a choice to retain their own defense counsel or to have the insurers choose defense counsel. The insureds responded that they would retain their own defense counsel. After the district court found that the insurers had no duty to defend, the insurers stopped paying defense costs and sought to recoup costs that they had previously paid.

The Eleventh Circuit affirmed the district court’s ruling that the insurers did not have a right to reimbursement of defense costs incurred before the district court’s duty-to-defend ruling, where the purported reimbursement right was asserted in the reservation of rights letters but was not a contractual requirement of the insurance contract. As an initial matter, because insurers have an “extremely” broad duty to defend under Georgia law, based on the allegations in the complaint, the insurers had a defense obligation until the district court ruled otherwise.^[7] The court then rejected two arguments advanced by the insurers in support of their phantom right to reimbursement: (1) the reservation of rights letters created a new contract because the insureds were provided a defense and were allowed to choose their defense counsel, and (2) the insureds were unjustly enriched because they received a defense through the insurers despite the district court ultimately finding no duty to defend.^[8]

The Eleventh Circuit held that the insurers’ new contract argument failed for lack of consideration.^[9] The insurance policies already required the insurers to defend the insureds in the underlying lawsuit (at least at first).^[10] Thus, there was no new consideration received for the agreement to pay for the defense stated in the reservation of rights letters.^[11] The reservation of rights letters merely reiterated a promise to perform a preexisting contractual obligation under the policies.^[12] Similarly, because the insurance policies did not specify who would choose defense counsel, the insurers did not give up any explicit right by allowing the insureds to choose their defense counsel.^[13] The key takeaway is that reservation of rights letters do not create new rights or duties or alter the insurance policy—their purpose is to inform the policyholder about the insurer’s coverage position and issues that may exist based on the policy. The policy itself dictates the rights and duties under the policy.

As for the insurers’ unjust enrichment argument, the Eleventh Circuit questioned whether it failed at the outset because under Georgia law unjust enrichment is an equitable claim precluded by the existence of a written contract.^[14] Even on the merits, though, the Eleventh Circuit concluded that there was nothing unjust about requiring the insurers to fulfill their contractual obligation to provide a defense until the district court ruled that there was no duty to defend.^[15]

Ultimately, on this matter of first impression, the Eleventh Circuit predicted that “the Supreme Court of Georgia would not allow an insurer to recoup its expenses based on a reservation of rights without any contractual provision allowing for reimbursement.”^[16] The Eleventh Circuit also noted its belief that “this position comports with the national trend that disfavors recoupment in similar circumstances,” citing the following language from the Restatement of the Law of Liability Insurance:

Over the past few decades, the pro-recoupment cases have been viewed as stating the majority position, while anti-recoupment cases have been labeled the minority. But in recent years, several state courts, including several state high courts, have faced recoupment of defense costs as an issue of first impression and have rejected a right of recoupment for the insurer, unless that right is established expressly by contract.^[17]

Key Takeaways from Winder Labs

The recent Eleventh Circuit decision in Winder Labs held that, to be actionable, a right to reimbursement must be set forth in the insurance policy or otherwise expressly agreed to by the insurer and the insured. Insurers, however, likely will continue their push to have courts recognize an equitable right to reimbursement, whether or not that right is in the insurance policy. Policyholders therefore should determine—at the time of placing the policy as well as after a liability claim arises—whether their policy expressly provides for reimbursement of defense costs in the event it is later decided that the claim is not covered. After notifying the insurer of a claim, the insured should carefully review all correspondence from the insurer—especially reservation of rights letters—because through the correspondence the insurer may attempt to establish an ancillary agreement to reimburse the insurer for defense costs. The insured also should analyze the applicable jurisdiction’s law to evaluate whether the insurer has an extracontractual basis to argue that defense costs may be reimbursable.

1. See, e.g., Nautilus Ins. Co. v. Access Med., LLC, 137 Nev. 96, 102, 482 P.3d 683, 689 (2021) (concluding “that when a court determines that the insurer never had a duty to defend, and the insurer clearly and expressly reserved its right to seek reimbursement, it is equitable to require the policyholder to pay”). ↑

2. Chiquita Brands Int’l, Inc. v. Nat’l Union Fire Ins. Co., 57 N.E.3d 97, 101 (Ohio Ct. App. Dec. 30, 2015). ↑

3. 73 F.4th 934 (11th Cir. 2023). ↑

4. Id. at 950. ↑

5. Id. at 942. ↑

6. Id. at 945–47. ↑

7. Id. at 944, 948. ↑

8. Id. at 945–47. ↑

9. Id. ↑

10. Id. at 947. ↑

11. Id. ↑

12. Id. at 946. ↑

13. Id. at 947. ↑

14. Id. ↑

15. Id. ↑

16. Id. at 950–51. ↑

17. Id. at 948–49 (citing Restatement of the L. of Liab. Ins. § 21, cmt. a (Am. L. Inst. 2019)). ↑

Scaling cannabis companies face a muddied market, with past highs combating recent lows. Although the future may not be clear, canna-businesses can scale and grow with the help of strategic risk management. This article reviews fundamental elements of managing cannabis risk and industry-specific solutions to help companies scale more quickly.

Understanding the State of the US Cannabis Market

Cannabis is at an interesting crossroads, with different legal outlooks at the local, state, and federal levels, but with society expressing more acceptance. Additionally, several new states have expanded cannabis access recently, with Rhode Island, Maryland, and Missouri legalizing recreational marijuana in 2022. Delaware was the first state to legalize recreational marijuana in 2023, and observers have high hopes of Ohio, Pennsylvania, and Minnesota following suit.

Despite the forward momentum—cannabis sales are expected to reach more than $31.8 billion in 2023—some factors may impact cannabis negatively soon. For starters, many cultivators are experiencing a price compression, where decreased cannabis prices drive down profits. California has been hard hit by these market dynamics. Furthermore, 2022 gifted the industry with a bumper crop, yet it’s created more challenges than opportunities. Unfortunately, the low wholesale costs will be a hurdle for a while longer.

Cannabis leaders hope the industry will successfully navigate these challenges by implementing smart risk management strategies. But first, let’s talk about some common cannabis barriers.

Barriers the Cannabis Industry Faces Daily

Many of the barriers the cannabis industry faces are old news. These challenges seem to resurface year after year, creating compounded issues for cannabis companies to navigate.

We watch new cannabis laws unfold regularly and celebrate the victories, but the fact remains that cannabis is still a Schedule I drug. This classification creates blockades for the industry: investing pushbacks, insurance issues, licensing hurdles, etc. The SAFE Banking Act, which would open many financial doors to cannabis, has given the industry hope on several occasions—only to bring disappointment at its failure to pass.

Some major players have successfully leveraged new research and technology to attract investors and thrive on the open market. Consider the achievements of public companies Bright Green Corporation and HEXO Corp., to name a couple. However, industry departures, like the recent Paychex exit, make the business more challenging, not to mention the cash-only status cannabis companies must traverse.

For businesses that aim to scale, these factors are critical to understand. Remember scaling and growing are different. Where growing increases revenue by adding new resources, scaling increases revenue without additional resources. In short, scaling is a much taller order.

As a result, ambitious leaders must familiarize themselves with these challenges and prevent barriers from becoming overwhelming risks—but how?

Preventing Barriers from Becoming Risks

Knowing what cannabis is up against is the first step to effectively managing risks. The previous section is enough to dissuade many from entering the industry—but cannabis folks are savvy.

Best practices can help address exposure in many areas, including workforce safety efforts. Many scaling cannabis companies rely on massive or high-end equipment, often powered digitally, for daily operations. Keeping humans and networks safe means maintaining equipment and following cybersecurity precautions. Not only is such safety imperative, but covering an employee’s medical bills out-of-pocket could empty a company’s reserves swiftly, not to mention the cost of repairing or replacing damaged equipment or recovering from a cyberattack. Legal costs can weigh heavy on a company’s finances, and unfortunately, claims often involve plenty of legal ramifications.

Noncompliance is expensive. Cannabis companies must know local, state, and federal laws. One slip-up could stall a cannabis operation and ding the bottom line significantly. Consider the following key areas of legal compliance:

• Follow local and state regulations. Each state has its own set of rules for the cannabis industry, and these regulations can be complex and ever-changing. Failing to follow these regulations can result in fines, penalties, or even the loss of a business license.
• Track inventory correctly. Cannabis businesses are required to keep accurate records of their inventory, including the source of the product, the quantity, and the location. Failure to do so can make it difficult to track the movement of products and comply with product testing and labeling regulations.
• Test products properly. Cannabis products must be tested for potency, purity, and contaminants before they can be sold. Failing to do so can result in the sale of unsafe products that could harm consumers.
• Label products properly. Cannabis products must be labeled with accurate information about the product, including the ingredients, the potency, and the expiration date. Failure to do so can mislead consumers and could result in legal liability.
• Comply with advertising regulations. Cannabis businesses are subject to strict advertising regulations, which vary from state to state. Failing to comply with these regulations can result in fines, penalties, or even the loss of a business license.
• Practice fair employment. Cannabis businesses are prohibited from discriminating against employees based on race, color, religion, sex, national origin, age, disability, or other protected categories. Failing to comply with these antidiscrimination laws can result in legal liability.
• Provide safe working conditions. Cannabis businesses are required to provide safe working conditions for their employees. This includes providing adequate ventilation, lighting, and safety equipment. Failure to do so could result in employee injuries and legal liability.

These are just some of the ways that cannabis companies must attend to legal requirements. It is essential for cannabis businesses to stay up-to-date on the latest regulations and to take steps to ensure compliance. By doing so, they can avoid fines, penalties, and legal liability risks.

On top of industry-specific risks, canna-businesses must also navigate amplified traditional exposures. Leaving the cash box outside the vault one night might not cause alarm for other brick-and-mortar retailers, but cannabis companies have to answer to a cash-only industry and few financial institutions backing them; cannabis has a thinner line to walk.

Developing an Effective Risk Management Plan

In response to a tough landscape, cannabis risk management plans typically follow five steps:

1. Identify: Pinpoint exposures the company faces.
2. Analyze: Determining how costly a specific loss would be.
3. Evaluate: Figure out the likelihood of particular risks.
4. Track: Map out vulnerability patterns in the company.
5. Treat: Decide whether to avoid, transfer, mitigate, or accept the risk.

Effective risk management isn’t only to help scaling companies by protecting them. This strategy also legitimizes canna-businesses.

Insurance typically plays a vital role in risk management, particularly in the treatment step. Keep in mind, however, that risk management is multi-tiered.

Cannabis Insurance Policies and Licensure

Applying for a license to operate a cannabis business often requires founders to have a plan regarding insuring the operation. Otherwise, regulatory bodies might reject the license application. Some commercial insurance brokers provide a “letter of commitment,” reflecting a partnership between the canna-business and broker that will provide specific coverage upon license approval.

Usually, state cannabis laws require standard insurance policies, such as workers’ compensation, unemployment, and sometimes general liability. Aside from these three coverage lines, some other foundational insurance recommended for scaling cannabis companies includes the following:

• Property: When a canna-business is hit with direct property loss, like a fire or vandalism, this policy responds by reimbursing the company for the financial damage.
• Professional Liability: Also called errors & omissions insurance, this “malpractice” coverage protects cannabis companies against third-party or client lawsuits claiming substandard work or service, which often occur via work errors or a product’s failed performance.
• Product Liability: Regardless of whether the cannabis company is plant-touching, it can still be liable for bodily injury or property damage allegedly caused by the product. This policy protects against such third-party claims.
• Cyber: With a 38% increase in cyberattacks in 2022 compared to 2021, this liability policy protects canna-businesses against third-party lawsuits related to electronic activity, such as phishing, ransomware, and data breaches.
• Employment Practices Liability: This policy protects companies against costs of employment-related lawsuits, such as wage and hour disputes and harassment and discrimination suits, to name a few.
• Crime: As mentioned, theft is undoubtedly a primary concern for cannabis companies. In response to this significant threat, crime insurance protects businesses against theft, whether internal or external.

A successful risk management strategy requires companies to facilitate a multi-tiered approach, combining insurance with best practices and insider knowledge. Scaling cannabis companies don’t always have a clear-cut path laid out for them—but they have a fighting chance.

As many golfers know from firsthand experience, a missed tee shot is not necessarily fatal, but it certainly increases the pressure. Since the announcement of its framework agreement with Saudi Arabia’s Public Investment Fund (“PIF”) on June 6, 2023, to form an alliance with LIV Golf, the PGA Tour has continued to face backlash from lawmakers, its players, and fans of the sport. PGA Tour Commissioner Jay Monahan has openly stated that, in hindsight, certain aspects of the deal should have been handled differently—for example, recognizing that the shock announcement “put [the PGA Tour’s] players on their back foot.” But, true to the sport, there are no mulligans—the PGA Tour must play the ball where it lies. And this lie has put the PGA Tour in a particularly difficult position.

Pace of Play

Since Business Law Today’s last article on professional golf’s shifting landscape, there have been several developments worthy of mention, especially in light of the fast-approaching December 31 deadline. If the so-called protections outlined in the framework agreement are to stand, the PGA Tour and PIF must maintain a brisk pace of play and strike a definitive agreement before the year’s end. Under the framework agreement, the PGA Tour, DP World Tour, and LIV Golf would merge commercial operations into a new for-profit entity, with PIF serving as the entity’s exclusive investor. The agreement would allow the PGA Tour to maintain its tax-exempt status and, according to the PGA Tour itself, to control the new subsidiary through majority representation on the board, have “full decision-making authority with respect to all strategy and operational matters related to competition in golf,” and “oversee the commercial assets of the competitions and concentrate on making strategic investments into the game.” On August 22, while at East Lake Golf Club for the FedEx Cup finale, Monahan said he was “confident that we will reach an agreement that achieves a positive outcome for the PGA Tour and our fans—I see it and I’m certain of it.”

Course Correction

In August, the PGA Tour agreed to new transparency and governance measures, granting authority to its policy board’s Player Directors over potential changes to the tour arising from the framework agreement with LIV Golf, including any definitive agreement. Under these new measures, the Player Directors must be kept apprised of the status of negotiations contemplated by the framework agreement, with their special adviser to be granted full access to any necessary documents and information to keep the players informed. No major decisions concerning changes to the tour will be permitted without the approval of the Player Directors, now consisting of Tiger Woods, Patrick Cantlay, Charley Hoffman, Peter Malnati, Rory McIlory, and Webb Simpson. The policy board also includes five independent directors, including Jimmy Dunne, who played an instrumental role in brokering the framework agreement.

No Straight Shot to the Green

Far from a straight shot to the green, the PGA Tour and PIF must still clear certain hazards. For example, the alliance continues to face antitrust scrutiny from the Department of Justice—Monahan did not help the PGA Tour’s case when, following the June 6 announcement, he said the agreement with PIF was a means of taking a “competitor off of the board.” The Justice Department is examining whether the PGA Tour’s policy of barring members from playing in LIV Golf events constitutes monopolistic behavior, in contravention of federal antitrust law. Antitrust specialists have also pointed to other areas of possible antitrust concern, including the Official World Golf Rankings and the PGA Tour’s increased stake in the DP World Tour. But the analysis may not be as straightforward as in other probes, in light of the fact that LIV Golf may not necessarily be driven purely by economic motivations.

Congress has also stepped up its scrutiny. On June 12, the Senate’s Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs opened a probe into the PGA Tour’s agreement with PIF and its implications for the United States. The subcommittee held a hearing on July 11, at which PGA Tour Chief Operating Officer Ron Price and PGA Tour Board Member Jimmy Dunne testified. During the hearing, Price testified that a PIF investment “north of $1 billion” in the potential new PGA Tour-controlled subsidiary had been discussed. After multiple attempts to obtain information and testimony from PIF, Senator Richard Blumenthal (D-CT), who chairs the subcommittee, issued a subpoena on September 13 for documents related to PIF’s U.S. expansion plans and testimony from PIF’s U.S. subsidiary, USSA International LLC. The subpoena cites Article 1, Section 8, Clause 3 of the U.S. Constitution, which grants Congress the power “to regulate commerce with foreign nations [and] among states,” explaining that this power “has been held to include the authority to legislate regarding the channels and instrumentalities of commerce, persons or things involved in interstate commerce, and activities that substantially affect interstate commerce.” The subpoena orders Jason Chung, senior director of USSA International LLC, to appear before the subcommittee’s slated October 13 hearing.

Birdie or Bogey for Golf Popularity

Despite the continuing saga surrounding the alliance, golf’s popularity in general does not appear to have suffered; and, interestingly, LIV Golf’s popularity appears to have strengthened, according to LIV Golf staffers, executives, and players, who describe increased interest from fans, media executives, and advertisers following announcement of the deal. Critics of the deal persist and tend to invoke principles and values that transcend the sport.

The Back Nine?

Ultimately, as those of us who love the game know, golf, after all, is a business sport. Many deals have been struck and relationships forged and mended on the golf course. Perhaps what critics and proponents of the alliance between the PGA Tour and LIV Golf need is a day out on the links together—followed, of course, by a couple rounds at the nineteenth hole. Regardless, the final outcome of the alliance remains uncertain. Only time will tell whether we are finally on the back nine of this business drama.

The fourth edition of the Model Nonprofit Corporation Act (“MNCA”), adopted by the Committee on Nonprofit Organizations of the Business Law Section, is based in large measure on the Model Business Corporation Act (“MBCA”) adopted by the Corporate Laws Committee of the Section.^[1] The Fourth Edition includes the new and revised provisions of the 2016 revision of the MBCA and some changes to the MBCA since the 2016 revision.^[2] As a result, states adopting the Fourth Edition will have a statute that includes important, up-to-date provisions relating to nonprofit corporations that are consistent with the provisions of the MBCA, as well as revised and updated Official Comment.

Brief History of Prior Editions of the MNCA and the MNCA’s Close Relationship to the MBCA

The MNCA has a long relationship with the MBCA. The original MNCA was drafted in 1952 by the Corporate Laws Committee as a model act, along the lines of the MBCA, providing uniform provisions in contrast to the welter of conflicting statutes that existed at that time in various states.^[3] Subsequently, a growing interest in nonprofit corporation law led to the creation of the Committee on Nonprofit Corporations (now known as the Committee on Nonprofit Organizations) of the Business Law Section, which issued an update in 1957 for the primary purpose of bringing the text of the MNCA into closer alignment with the MBCA.^[4] This policy of parallelism proved of paramount importance; consequently, the MNCA was submitted to the Corporate Laws Committee, which prepared a 1964 version.^[5] Since that time, drafting committees of the Nonprofit Organizations Committee have prepared subsequent versions of the MNCA, which were finalized in 1987 and 2008.

There are various benefits to having the MNCA track the MBCA. Among other things, nonprofit corporations have developed to be more like business corporations than charitable trusts, and as a result, many of the MBCA provisions work equally well for nonprofit corporations. Also, as case law interpreting nonprofit corporation statutes is generally limited, having provisions in the MNCA that are the same as or similar to the MBCA should be useful to practitioners in advising nonprofit corporations because they can consider case law interpreting similar MBCA provisions. In addition, having the MNCA track the MBCA makes it easier for states that have adopted the MBCA to adopt the MNCA because they will not have to review or work with an unfamiliar structure.^[6]

While an objective of each of the drafting committees has been to generally track the MBCA, the MNCA diverges from the MBCA where appropriate given the unique aspects of nonprofit corporation law. For instance, the MNCA does not have provisions on shareholders because nonprofit corporations do not have equity owners. Instead, the MNCA provides for nonequity members, delegates, and designated bodies, each of which can have governance rights similar to shareholders. Notably, the MNCA prohibits the payment of dividends or distributions to members or members of a designated body except in very limited circumstances. It also provides that a person who is a member of or otherwise affiliated with a charitable corporation may not receive a direct or indirect financial benefit in connection with the dissolution of the corporation unless the person is a charitable corporation, a charitable trust, or an unincorporated entity that has a charitable purpose.

The MNCA provides flexibility for the various types of nonprofit corporations and their different structures. It allows a nonprofit corporation to have members or no members; it requires the membership corporation to have a board of directors that is elected either by the members or as otherwise provided in the articles or bylaws, or, in the case of a nonmembership corporation, it requires a board elected as provided in the articles or bylaws. It also allows for a designated body to assume some of the functions of a board of directors.

Highlights of the 1987 and 2008 Editions of the MNCA

The 1987 MNCA (referred to as the “Revised Model Nonprofit Corporation Act”) included important updates that brought it closer in form and content to the provisions of the 1984 revision of the MBCA. Provisions not previously contained in the MNCA were added, including provisions addressing the duties, liabilities, and indemnification rights of directors and officers, with some unique features given the nature of nonprofit corporations.^[7] In addition, following developments in New York and California, the 1987 MNCA adopted a scheme of classifying nonprofit corporations into three categories: (1) public benefit, (2) mutual benefit, and (3) religious—with the mutual benefit category being the default classification for any nonprofit corporation that was not a public benefit or religious corporation. Although many of the provisions of the 1987 MNCA applied to all types of nonprofit corporations, there were different rules depending on the classification as they related to different topics, including member rights, board duties, and fundamental changes of the nonprofit corporation.^[8] The 1987 MNCA also added more detailed provisions addressing the role of the state attorney general, particularly with regard to public benefit corporations and religious corporations. These provisions were included in recognition of the fact that in some states the state attorney general has a role in the oversight of charitable organizations. In addition, the 1987 MNCA included provisions on derivative proceedings and provisions on records and financial reporting, all of which were based in large part on the MBCA.^[9]

The 2008 MNCA (referred to as the “Model Nonprofit Corporation Act, Third Edition”) was a product of a drafting task force of the Nonprofit Organizations Committee chaired by Lizabeth A. Moody. The 2008 MNCA continued to follow the provisions of the MBCA to the extent possible. As states were not widely adopting the classification scheme adopted in the 1987 MNCA, the 2008 MNCA eliminated the classification system while still recognizing that there are some situations where a charitable or religious nonprofit corporation should be treated differently.^[10]

The 2008 MNCA added new provisions unique to nonprofit corporations, including those addressing in more detail the concept of a “designated body,” which is a person or group other than a committee of the board of directors that has been vested by the articles or bylaws with powers that would otherwise be exercised by the board or the members. The concept of a designated body was included in recognition that some nonprofits use that governance model.^[11] In addition, the 2008 MNCA eliminated the detailed provisions addressing the authority of the state attorney general and replaced them with provisions acknowledging the authority of the state attorney general (some of which are optional) but recognizing that more detailed provisions regarding the power of the state attorney general would be more appropriately addressed in a different statute.^[12] The 2008 MNCA also eliminated cumulative voting by members in the election of directors based on a determination that the voting power of members should not be tied to their economic contributions and based on the fact that directors of a nonprofit corporation are often chosen on a basis other than furthering the financial interests of the corporation.^[13]

Fourth Edition of the MNCA

After the publication of the 2008 MNCA, a subcommittee of the Nonprofit Organizations Committee worked on updates to the 2008 MNCA. It followed a process that is similar to the process followed by the Corporate Laws Committee for the MBCA. Changes to the 2008 MNCA were published in The Business Lawyer and then adopted on a third reading.^[14] With the Corporate Laws Committee’s adoption of the 2016 revision of the MBCA, it was an easy decision for the subcommittee to move forward with a new edition of the MNCA. Lawrence J. Beaser chaired the MNCA task force, and William H. Clark Jr., who also served as the reporter for the 2008 MNCA, served as the reporter for the Fourth Edition.^[15]

Except in circumstances where substantive issues require a different rule for nonprofit corporations, the Fourth Edition continues to closely track the MBCA. In addition, it generally follows the numbering system and sequence of the MBCA provisions, with the most important substantive provisions retaining section numbers similar to those of the MBCA provisions. These include chapter 2 (Incorporation), chapter 6 (Memberships and Financial Provisions), chapter 7 (Member Meetings), chapter 8 (Directors and Officers), and chapter 9 (Amendment of Articles of Incorporation and Bylaws). The provisions of the Fourth Edition have been renumbered in certain places to eliminate gaps in the numbering sequence.

Following the approach taken by the Corporate Laws Committee in the 2016 revision of the MBCA, the Fourth Edition includes an Official Comment that has been simplified, with elimination of portions that merely restated or paraphrased an MNCA provision. As with the MBCA, the Official Comment for the Fourth Edition should be helpful to practitioners and judges in interpreting provisions of state statutes based on the MNCA. The Fourth Edition also includes source notes that set forth citations to the provisions of the MBCA that were the source for specific provisions of the Fourth Edition.

Many of the new provisions in the 2016 revision of the MBCA are included in the Fourth Edition with some modifications based on the unique nature of nonprofit corporations. These include (1) provisions authorizing articles of incorporation to limit or eliminate the liability of directors relating to corporate opportunities;^[16] (2) provisions similar to the MBCA on ratification of defective corporate actions, which should be very useful to nonprofits that may have previously taken actions that did not comply with the applicable state statute;^[17] (3) provisions permitting forum-selection provisions to be included in the bylaws;^[18] and (4) provisions for virtual member meetings that are based on the MBCA virtual shareholder meeting provisions.^[19]

Unique provisions of the 2008 MNCA continue in the Fourth Edition, including, for example, provisions on members (and the option of having no members), delegates, and designated bodies. In terms of incorporating documents, the Fourth Edition contemplates that the articles may include provisions complying with applicable Internal Revenue Code requirements for tax-exempt organizations. Like the 2008 MNCA, the Fourth Edition includes a provision allowing for advisory committees made up of nondirectors.^[20] Although the Fourth Edition—like the 2016 revision of the MBCA—allows for the articles to include a director liability-shield provision (as well as an indemnification provision that follows the shield language), a liability-shield provision in the articles is not necessary for a charitable corporation because the directors of those corporations receive statutory liability protection under the MNCA, with certain limited exceptions.^[21] The Fourth Edition retains provisions to protect the charitable assets of a nonprofit corporation in the event of a sale of assets or dissolution, as well as in the event of any entity transaction, such as a merger, interest exchange, domestication, or conversion.^[22]

It is expected that, like the 2016 revision of the MBCA, there will be a “spoke” version of the Fourth Edition that can be adopted as a “spoke” by states using the Uniform Law Commission’s Uniform Business Organization Code (“UBOC”) hub-and-spoke structure.^[23]

Conclusion

A substantial number of states’ nonprofit acts are based on the first and second editions of the Model Nonprofit Corporation Act, which were published in the 1960s and 1980s. As noted above, significant changes have been made to the Model Nonprofit Corporation Act since that time. The Fourth Edition should prove to be very helpful to states by having an up-to-date model statute that provides the structure and flexibility necessary for the various types of nonprofit corporations that exist today.

An earlier version of this article appeared in the September 2021 issue of the Model Business Corporation Act Newsletter, the newsletter of the ABA Business Law Section’s Corporate Laws Committee. Read the full issue and previous issues on the Corporate Laws Committee web page. The views expressed in this article are solely those of the author and not his law firm or clients. No legal advice is being given in this article.

1. Model Nonprofit Corporation Act, Fourth Edition (Am. Bar Ass’n 2022) [hereinafter MNCA Fourth Edition]. ↑

2. The fourth edition of the MNCA is referred to herein as the “Fourth Edition.” ↑

3. Model Non-Profit Corp. Act, at vii (Am. L. Inst. 1964). ↑

4. Id. ↑

5. Id. ↑

6. Michael C. Hone, Introduction to Revised Model Nonprofit Corporation Act, at xxxv (1988). ↑

7. Id. at xxxv–xxxvii, xl. ↑

8. Id. at xxi–xxxii. ↑

9. Id. at xxxvii. ↑

10. Lizabeth A. Moody, Foreword to Model Business Corporation Act: Third Edition, at xxiii–xxiv (Am. Bar Ass’n 2009). ↑

11. Id. at xxi–xxiv. ↑

12. Id. at xxiii; see also MNCA Fourth Edition, supra note 1, § 140 (“Nothing in this Act affects the role of the attorney general with respect to nonprofit corporations under other law.”). ↑

13. Moody, supra note 10, at xxiv. ↑

14. The Model Nonprofit Corporation Act Subcommittee, Committee on Nonprofit Organizations, ABA Section of Business Law, Adoption of Changes to the Model Nonprofit Corporation Act – Miscellaneous and Technical Amendments, 68 Bus. Law. 821 (May 2013). ↑

15. See Lawrence J. Beaser & William H. Clark Jr., Foreword to Model Nonprofit Corporation Act, Fourth Edition, at xx (Am. Bar Ass’n 2022). ↑

16. MNCA Fourth Edition, supra note 1, § 202(b)(10). ↑

17. Id. §§ 120–27. ↑

18. Id. § 207. ↑

19. Id. § 709. ↑

20. Id. § 825(g). ↑

21. Id. § 831(d). ↑

22. Id. §§ 1003, 1105(c), 1203(b). ↑

23. See Bus. Orgs. Code (Unif. L. Comm’n 2011); Beaser & Clark, supra note 15. ↑

On April 21, 2023, the English High Court handed down its written reasons for sanctioning the Adler Group restructuring plan proposed under the new Part 26A regime of the UK’s Companies Act 2006, which raises questions regarding the jurisdiction of the court, cross-class cramdowns, pari passu issues, and competing valuations.

Following the introduction of a new restructuring regime in the Cayman Islands, we delve into the ramifications of the recent Adler Group decision and its potential impact on further revisions to the Cayman Islands Companies Act.

Background

The Adler Group, a prominent German property group owning a rental property portfolio valued at approximately €8 billion, faced a myriad of liquidity challenges following the impact of ratings downgrades, regulatory/bondholder scrutiny, and short-selling pressure. The Adler Group had six series of unsecured notes maturing in 2024, 2025, 2026, 2027, 2028, and 2029 (“Notes”). One of the Adler Group’s subsidiaries had Notes with a maturity date of April 27, 2023, which it was not going to be able to meet and was likely to trigger default of the Notes under their various covenants.

Following an unsuccessful attempt to implement a restructure contractually with the noteholders, the Adler Group incorporated a new company under English law and substituted that new company as the issuer of the Notes in order to launch a restructuring plan under Part 26A of the Companies Act 2006. The restructuring plan, among other things, proposed to do the following (together, the “Plan”):

• introduce €937 million of new senior secured debt to repay the Notes maturing on April 27, 2023, and the 2024 Notes, in exchange for a super-senior first-ranking lien and a 22.5 percent equity interest post-restructure;
• extend the maturity date of the 2024 Notes until July 31, 2025, in exchange for priority over other noteholders in terms of repayment (maturity of all other Notes to remain the same); and
• amend the remaining Notes to allow refinancing and receive payment-in-kind (“PIK”) interest and a subordinated security interest.

The Plan was not aimed at continuing the Adler Group as a going concern but was designed to keep the Adler Group solvent for a sufficient period of time to allow for a solvent winding-down and sale of its real estate assets by the end of 2026, as opposed to a compulsory liquidation (which was agreed by the parties to be the relevant alternative to the Plan).

An ad hoc group of 2029 noteholders (“AHG”) opposed the Plan and emphatically challenged the Plan in the English High Court at both the convening hearing and the sanction hearing, which involved conflicting expert valuation evidence and cross-examination.

The AHG’s Opposition to the Plan

The AHG argued that there was no nexus to the UK for the court to have jurisdiction to sanction the Plan other than the recently established subsidiary that was substituted as the issuer of the Notes. Furthermore, the AHG argued that the Plan was in direct conflict with the pari passu principle as the Plan, if sanctioned, would create differential treatment between noteholders and was unfairly prejudicial to 2029 noteholders in particular as the holders of the Notes with the latest maturity date, ranking last in repayment due to subordination.

The AHG argued that the position of 2029 noteholders was further unfairly impacted by the fact that now €937 million of new debt would need to be repaid before any money would be distributed to noteholders, as opposed to a liquidation (without the Plan) where all Notes would rank pari passu in repayment.

The English Court’s Decision

The court ultimately rejected the AHG’s objections and sanctioned the Plan, acknowledging the complexion of the evidence submitted by each party and the time sensitivity of the restructure due to the April 27, 2023, maturity of some of the Notes.

In reaching its decision, the court made a number of findings (some of which were the first of its kind for a Part 26A proceeding).

• It had jurisdiction to sanction the Plan. Notwithstanding the lack of nexus to English law, the court found that the substitution of the newly incorporated English company as the issuer of the Notes was sufficient for the court to consider the sanction of the Plan under Part 26A of the Companies Act 2006. The AHG has brought a claim in a German court to challenge the validity of this point.
• The valuation evidence provided by the Adler Group regarding the sale value of the Adler Group was more persuasive than the evidence provided by the AHG. This was the first time that a dissenting party to a Part 26A proceeding actually submitted competing evidence with regard to the valuation of the relevant company in the event of liquidation (including likely discounts). The court acknowledged the uncertainty of the valuations provided by both parties, but ultimately preferred the Adler Group’s valuation and noted that upon implementation of the Plan, the most likely outcome (but not necessarily the definite outcome) would be that noteholders are paid in full.
• The Plan was not a departure from the pari passu principle. The court noted that even if the Plan failed and the Notes had to be accelerated, the noteholders would then be paid in accordance with the pari passu principle. It also noted that if the Plan succeeded, then all noteholders would most likely be paid in full, as opposed to the alternative (liquidation), where noteholders would receive a fraction of their debt.
• The 2029 noteholders assumed the risks involved with Notes maturing in 2029, which was a commercial decision. It was noted that the terms of the 2029 Notes reflect the commercial risks that the AHG (along with the other 2029 noteholders, the majority of which supported the Plan) assumed and that, therefore, it could not argue that the maturity date of the 2029 Notes should be amended.
• The court had discretion to enforce a cross-class cramdown notwithstanding that both conditions weren’t met. The court noted that each class of noteholder approved the Plan with the requisite majority (75 percent), except for the 2029 noteholders (62 percent). However, it took into account the fact that the majority of 2029 noteholders did approve of the Plan and that the noteholders would not be any worse off by the Plan, as the most likely scenario was that they would be paid in full.

Cross-Class Cramdowns and Dissenting Rights: Balancing Stakeholder Interests

Within the restructuring arena, the concept of cross-class cramdowns (common in US Chapter 11 proceedings and now part of the UK restructuring regime) emerges as a crucial tool for striking a balance between conflicting stakeholder interests. Cross-class cramdowns empower courts to approve a restructuring plan, even in the face of objections from dissenting creditors. In the Adler Group case, the court leveraged this mechanism to sanction the Plan notwithstanding the AHG’s dissent, the AHG’s conflicting valuation expert evidence, and the fact that both conditions under section 901G of the Companies Act 2006 were not strictly satisfied.

In order to sanction the Plan while there were dissenting creditors, the court had to consider whether the following conditions were met:

• The dissenting class (the AHG) would not be any worse off than they would be in a liquidation (as the accepted “relevant alternative” by all parties if the Plan wasn’t sanctioned)—that is, the No Worse Off Test.
• At least 75 percent (in value) of each class of creditors agreed to the Plan—that is, the Genuine Economic Interest Test.

Despite falling short of the 75 percent approval requirement under section 901G of the Companies Act 2006 with regard to the 2029 noteholders, the court exercised its discretion by taking into account that the No Worse Off Test was satisfied and that 62 percent of 2029 noteholders did approve the Plan.

Relevance to the Cayman Islands’ Restructuring and Insolvency Landscape

Against the backdrop of recent developments and revisions to the Cayman Islands Companies Act to introduce the “Restructuring Officer” regime, the Adler Group decision is important and may provide hints of what is likely to be the next area for revision. Under the Cayman Islands Companies Act, there are no prescribed dissenting or appraisal rights in this context. While the legislature and/or courts are unlikely to be persuaded to introduce a new dissenting rights regime similar to that of the US, the flexibility of the Part 26A tool, as showcased in the Adler Group decision, may be the pragmatic middle ground.

Richard “Dick” Duesenberg, former chair of the ABA Business Law Section in 1987–1988, passed away in August 2023. During his tenure as chair, the Section changed its name from the Corporation, Banking, and Business Law Section to the more simple: Business Law Section.

“Dick was the general counsel of Monsanto Corporation, where he assembled what was considered then to be one of the best in-house legal departments in the country,” said Maury B. Poscover, former chair of the ABA Business Law Section, 1997–98. “He was dedicated to his alma mater, Valparaiso University. Both Dick and his twin brother, Bob, were significant financial supporters to Valparaiso.”

Mr. Duesenberg earned his undergraduate and law degrees from Valparaiso University and a Master of Laws degree from Yale Law School.

Mr. Duesenberg joined the law department of the Monsanto Company in 1962 and, from 1977 to 1995, served as Senior Vice President, General Counsel & Secretary of Monsanto.

Besides his active involvement in and proud affiliation with the ABA’s Business Law Section, Mr. Duesenberg served as chairman of the American Society of Corporate Secretaries and vice president of the Association of General Counsels, and he was on the boards of directors of the National Judicial College and the American Arbitration Association. He was a Life Member of the American Law Institute and a Fellow of the American Bar Foundation.

As author of many legal articles, treatises, book chapters, and editorials, Mr. Duesenberg leaves behind impressive writing contributions on many substantive business law topics.

In 2022, I moved from the Kent County business court to the Michigan Court of Appeals, where I now serve as one of twenty-five judges on our state’s intermediate appellate court. Since I made that move, many friends have asked me how the change has gone. I tell them that I used to have real power because I could issue an opinion or order any time I wanted and it could say anything I liked, but now I can’t do anything without getting someone to agree with me.

That lighthearted description of my new role downplays the profound impact that my responsibility these days in writing precedential opinions has had on my concern about the rule of law. The job of serving on an appellate court is dramatically different from serving as a trial-court judge. I no longer exist in a vacuum. Now, everything must be done by consensus, and the goal is getting to an agreement that expeditiously moves appeals through the system. And it’s all about counting votes.

Justice William Brennan once remarked of the U.S. Supreme Court that “five votes can do anything around here.” Sadly, history has proven that aphorism to be true. In the early days of the Supreme Court, Chief Justice John Marshall somehow convinced all of his colleagues that it was inadvisable to dissent. What resulted was a steady flow of unanimous decisions largely written by Chief Justice Marshall that created the appearance of consistent consensus. To be sure, the legal world was largely deprived of the genius of Justice Joseph Story because of that arrangement that too often kept him out of the writing business of the Supreme Court, but there was real value in unanimity in the major cases of the era.

Comparing that type of unanimity in major cases with the muddled mess in narrowly divided decisions reveals why the Supreme Court works most effectively when it speaks with one voice. In Brown v. Board of Education, Chief Justice Earl Warren patiently and diligently worked to produce a unanimous opinion that would leave no doubt that the Supreme Court was committed to desegregation as a matter of constitutional imperative. Compare that to one of the most poorly conceived opinions in Supreme Court history, Lochner v. New York, where a closely divided Supreme Court relied upon substantive due process to enshrine the economic right to freedom from workplace regulations as an ineluctable constitutional mandate. Justice Oliver Wendell Holmes wrote a blistering dissent warning the majority of the error of its ways, and you know you’re probably on the wrong side of the constitution if Justice Holmes vigorously opposes what you’re doing. Indeed, it took thirty-two years and a full-blown constitutional court-packing crisis to clean up the mess that Lochner made.

Which brings me back to my humble role on the Michigan Court of Appeals. There’s a school of thought that an effective appellate judge is someone who waits for the right panel configuration to write the judge’s preferences into law, knowing that a second vote for any outcome is readily available. That’s not me. Some ideological judges may regard their work on the bench as painting on a blank canvas. I see myself as a technician, working to reach the correct result in every single case by faithfully applying precedent and neutral principles, no matter what my personal preferences may be. Some might characterize that approach as relegating me to the status of a pedestrian purveyor of judicial authority—neither a visionary nor a groundbreaker. But that view served me well as a business-court judge, and I’m now perfectly comfortable in that role on the Michigan Court of Appeals because I’m such a devout believer in judicial modesty.

The power of judicial review is a dangerous concept in the wrong hands. It can insulate policy preferences from the salutary process of debate, deliberation, and collective decision-making in our constitutional republic. Judicial activism through the extravagant use of the power of judicial review cuts off that entire process.

That’s why my commitment to judicial modesty discourages me from thinking about counting to two when I write an opinion for our court. Instead, I always do my best to count to three. When I am sitting with two colleagues who rarely agree on much of anything, I could easily write an opinion based on my personal preference, knowing that I’ll have a second vote no matter how I analyze the case. But I much prefer to write opinions that can garner the support of both of my colleagues, comfortable in the understanding that a consensus among those of us with divergent judicial philosophies almost certainly will be the correct answer to the issue presented on appeal.

In my first year on the Michigan Court of Appeals, I wrote only one separate opinion. It was a dissent in a case that was assigned to me in the first instance as the lead writer. When my colleagues and I discussed the case in our post-argument conference, I realized that my view was the minority approach. That left the three of us in the awkward position of deciding who would write the majority opinion. To my colleagues’ bemusement, I volunteered to write the majority opinion as well as my own dissent. I’m pleased to report that the majority opinion I drafted not only won the approval of both of my colleagues but also nearly convinced me to change my own vote. And that, in my view, is how an appellate court protects and preserves the rule of law.

So, when I am next up for election, if the voters are looking for a culture warrior who is ready to storm the battlements in developing precedent, I’m not their judge. But if the voting public wants somebody who will work tirelessly for consensus even when it is hard to find, I’m probably their cup of tea, even though I’ll never be part of a judicial Boston Tea Party. That, in my view, is what best sustains and fortifies the rule of law that we all rightfully cherish.

The cannabis industry, just like any other industry, requires insurance coverage. Insurance is often required for plant-touching businesses such as growers, processors, and dispensaries and is well-advised for ancillary cannabis businesses, such as real estate brokerages, transportation companies, and payment processors. While the cannabis industry is rapidly making its mark on the U.S. economy as more states pass laws to legalize its use (both medicinally and recreationally), the cannabis insurance industry, by comparison, has been slow to adapt to the expanding need for cannabis insurance. As a result, cannabis businesses are oftentimes left with spotty coverage, high premiums, and more questions than answers. 

Insurance Basics

Insurance products are generally offered in two markets: the admitted market and the surplus lines market.

Insurance products offered in the admitted market are typical, also known as “off the shelf” products, e.g., insurance for personal use vehicles, residential housing, life and health, travel, and more. These products are easily accessible, and most national insurance companies sell these products to the general public with ease of marketing.

The surplus insurance market, in contrast, is meant to fill the gaps for insurance products and offerings that are not readily available in the admitted market. Products in the surplus lines market can cover unique items of value or certain risks that require individualized underwriting to determine the value. Tom Brady’s arm during the many seasons in which he played and Beyoncé’s voice are examples of unique “risks” covered by a specialized insurance product not offered in the general marketplace.

In order for an insurance product to be considered in the surplus lines market, most states will require that at least three insurance companies turn down writing this type of coverage in the general admitted market. 

Finding Cannabis Insurance

With the emergence of businesses newly operating in the small-to-medium markets of the cannabis industry, so too has emerged the need for insurance coverage. In fact, many states’ regulatory schemes require insurance policies meeting specific coverage guidelines in order to obtain the requisite licensing for storefronts, cannabis-related services, transportation, etc.

Unfortunately, in most jurisdictions, insurance (especially competitively priced insurance) is difficult to find. Brokers who sell insurance are less likely, depending on the state, to advertise they can offer insurance for cannabis-related businesses.

However, some states—such as California, which has a more mature cannabis market—publish a list of brokers and insurance companies that offer insurance products for cannabis-related industries so they may be more readily accessible to cannabis licensees and ancillary businesses. Ultimately, if coverage can be located, it will most likely be surplus lines coverage.

A Look Forward

The insurance industry has an express interest in covering these higher risks and business-related activities, but due to factors such as the potential higher premium-to-loss ratios, insurance companies often find themselves unsure of what insurance products to offer and how to offer cannabis insurance products in the admitted market.

How products for the cannabis industry will be underwritten and how premiums are determined in most cases is a black box of strategy. Due to the nascent nature of the legal cannabis industry, there are relatively few historical metrics on which to rely for creating such pricing compared to other high-risk industries. This is yet another reason insurance products for the cannabis industry are most commonly offered in the surplus lines market: because the cannabis industry rates are not yet regulated by states, there is typically little to no state guidance on how to set relevant rates or underwrite these specific kinds of risks.

While how to offer insurance-related products to marijuana and marijuana-related businesses is on the minds of regulators throughout the United States, regulators are unsure of how to propose such regulations in light of these challenges and when the industry is still illegal under federal law.

Alabama Takes Action

As explained above, cannabis insurance—to the extent it is offered—is typically packaged as a surplus line, and states have been slow to roll out relevant guidance. However, changes are on the horizon.

Recently, the Alabama Department of Insurance (DOI) issued Bulletin No. 2023-03 titled “Creation of a Medical Cannabis Insurance Market in Alabama.” The Bulletin is a future directive that all “commercial property and casualty medical cannabis-related rate, rule, or combination filings” be filed with the Alabama DOI. The Bulletin’s future directives are procedural in nature: “encourag[ing]” insurers to “submit rates and forms” for use with marijuana licensees. The relevant submissions “will” (future tense) be made under Ala. Admin. Code r. 481-1-123-.03 (File and Use System).

There was no date of implementation, or deadline for compliance, provided in the Bulletin. Once implemented, however, the Bulletin states File and Use Rates will continue for three years or until the DOI can properly forecast rates based on statewide experience.

Alabama legalized the medicinal use of marijuana in 2021. The Alabama DOI likely took this step to issue the Bulletin in May 2023 because the state closed its cannabis license application window at the end of 2022, and the Alabama Medical Cannabis Commission awarded medical cannabis business licenses in June 2023 and August 2023. The state required applicants to submit, as part of their Applicant’s Verified Business Plan, “[a]n insurance plan, including declarations pages and letters of intent, if any, from an A-rated insurer as to, at a minimum, casualty, workers’ compensation, liability, and (as applicable) auto or fleet policy.” Ala. Admin. Code r. 538-x-3-.05(3)(m)(15)(k), Contents of Application. Alabama’s regulations also deem applicants ineligible to receive a license if “[t]he Applicant fails to demonstrate the ability to maintain adequate minimum levels of liability and casualty insurance or other financial guarantees for its proposed facility.” Ala. Admin. Code r. 538-x-3-.14, Ineligibility for License. Thus, the need for cannabis-related insurance in Alabama is surging.

The DOI’s likely intent in implementing this procedure through the issuance of the Bulletin is to allow the DOI to gather facts at present and, later, administer and enact laws and regulations regarding marijuana-related insurance products and coverage, rates, and more.

Next Steps

Changes to the cannabis insurance landscape, such as the emergence of admitted market lines, are on the horizon and will likely be implemented in the future. As more states pass laws to legalize the use of marijuana, it is expected that the transition from surplus lines to the admitted market will accelerate. Businesses involved in the cannabis industry—including direct, plant-touching companies as well as ancillary product or service providers—must be mindful of their insurance obligations in each jurisdiction in which they operate and should keep their fingers on the pulse of these issues as the cannabis market continues to expand and mature.

Committee on Foreign Investment in the United States (“CFIUS”) regulations have increasingly been in the news. There is good reason—CFIUS regulations have become more robust to address U.S. national security concerns. Given this, business lawyers should consider CFIUS implications when advising on any transactions or investments, to include real estate transactions, involving foreign persons.^[1] Below is a brief summary of ten things a business lawyer should know when working on transactions involving foreign entities or persons.

1. What Is CFIUS? CFIUS is an interagency committee, chaired by the Secretary of the Treasury, charged with the duty to review certain foreign investment in the United States to assess whether the transaction may impact U.S. national security.^[2] Since Treasury chairs the committee, Treasury maintains a website with useful information on CFIUS and manages the CFIUS Case Management System used for CFIUS filings.^[3]

   Other CFIUS members include the Departments of Justice, Commerce, Defense, State, and Energy as well as the Office of the U.S. Trade Representative and the Office of Science & Technology Policy.^[4] White House offices, such as the National Security Council and the Council for Economic Advisors, as well as the Director of National Intelligence and the Department of Labor, may also provide input during the review process.^[5]

2. What Is the Purpose of CFIUS? Although CFIUS reviews foreign investment in the U.S., CFIUS is not designed to limit or impede foreign investment in the U.S. Its mission is to protect U.S. national security.^[6] Through the years, the U.S. government has made this clear by explaining that foreign investment is welcomed, and, given the strength of the U.S. economy; U.S. policies encouraging economic growth; the U.S. spirit of innovation; and the sophistication of U.S. financial markets, it is the best place in the world to invest.^[7]

3. What Is the Legal Construct for CFIUS? Through executive orders, laws, and regulations dating back to 1975, the president is given authority to suspend or prohibit foreign investment that may impact U.S. national security.^[8] CFIUS regulations implement these requirements.^[9] The Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”) updated CFIUS regulations to address U.S. national security risks as a result of the changing geopolitical landscape to include, among other things, expanding the types of transactions that must be disclosed to CFIUS.^[10]

4. What Types of Real Estate Transactions Must CFIUS Review? CFIUS reviews “covered real estate transactions” as that term and related terms are defined in CFIUS regulations.^[11] Generally, these regulations require CFIUS review of real estate transactions involving foreign persons related to real estate in and around certain airports, ports, and military bases that are either listed by name in the regulations or published by the Department of Transportation.^[12]

5. What Types of Transactions and Investments Are Subject to CFIUS Jurisdiction? CFIUS has jurisdiction over “covered control transactions” and “covered investments,” which are transactions and investments that could result in a foreign person controlling a U.S. business.^[13] CFIUS regulations broadly define “control” and may even include minority investment in some situations.^[14] CFIUS also has jurisdiction over direct or indirect investment by a foreign person in a U.S. Technology, Infrastructure, Data (“TID”) U.S. business, even if non-controlling, if a foreign person will have access to material non-public technical information in the possession of the TID U.S. business; board membership; observer rights; rights to nominate individuals to the governing body of the TID U.S. business; or involvement in substantive decision-making of the TID U.S. business regarding sensitive personal data of U.S. citizens maintained or collected by the TID U.S. business, or critical technologies, or covered investment in critical infrastructure.^[15]

   For purposes of CFIUS, critical technology includes producing, designing, testing, manufacturing, fabricating, or developing technology or critical components that are essential to U.S. national security.^[16] Covered infrastructure transactions include foreign investment in systems or assets, whether physical or virtual, so vital to the U.S. that their incapacity or destruction would be debilitating, like energy infrastructure or major telecommunications infrastructure.^[17] Data is sensitive personal data on U.S. persons that the business maintains or collects directly or indirectly.^[18]

   Only certain transactions mandate disclosure to CFIUS. A disclosure to CFIUS is mandatory if the transaction involves a foreign person and TID U.S. business that produces, designs, tests, manufactures, fabricates, or develops “critical technologies” that are controlled by U.S. export regulations.^[19] CFIUS disclosure is also mandatory if a foreign government, even if indirectly, will obtain “substantial interest,” as that term is defined in CFIUS regulations, in a TID U.S. business.^[20]

   Other than these situations, disclosing to CFIUS is voluntary. Since CFIUS may unwind a transaction, even after closing, if the transaction impacts national security, parties should assess whether filing a voluntary notice with CFIUS would be prudent. Voluntary notices allow for the possibility of CFIUS clearing the transaction, thus for the most part mitigating the risk that CFIUS will review, and possibly unwind, the transaction at a later date in the interest of national security.

   CFIUS regulations include some exemptions for certain passive investment and for transactions involving close U.S. allies.

6. What Is the Process for CFIUS Review? Filings are submitted to the Treasury through its online system. Generally, the parties work together to file with CFIUS. Parties may choose to file a declaration, which is an abbreviated disclosure form.^[21] CFIUS has thirty days to act on declarations by clearing the transaction; requiring the parties to file a notice, which requires more information than a declaration and extends the review period; or ending review without a formal clearance.^[22] If parties do not receive formal clearance or direction to file the longer notice, it conveys that CFIUS did not have concerns with the transaction, but it is not as definitive as if CFIUS had cleared the transaction. For mandatory declarations, the parties must file their declaration with CFIUS at least thirty days before the transaction’s expected completion date.^[23]

   Parties to a transaction may elect to file a voluntary notice.^[24] Generally, notices require far more information than does a declaration, and notices have a longer review process. Once CFIUS has what it considers a complete filing, it has forty-five days to assess the filed notice.^[25] If CFIUS cannot make its assessment on a notice within the forty-five-day review period, CFIUS will initiate an investigation, which it has forty-five days to complete. If needed, after an investigation, CFIUS has fifteen days to obtain presidential review of the transaction.

   The CFIUS review takes longer than regulations suggest. For purposes of starting the CFIUS review clock, Day 1 is not the day a CFIUS notice is filed. Instead, the clock starts on the day Treasury accepts a notice. which is the day after Treasury has determined that the notice complies with filing requirements; confirmed that the filing fee has either been paid or was waived; and all CFIUS members have received the notice. The time it takes to get to Day 1 depends on a number of factors, including whether the notice included all required information and whether CFIUS decides to ask for additional information.

7. Are There Other Legal Considerations When a Transaction Involves Foreign Investment? CFIUS regulations may not be the only disclosures a U.S. business must file when it is involved in transactions with foreign persons. For example, export regulations International Traffic in Arms Regulations (ITAR) and Export Administration Regulations (EAR),^[26] and the National Industrial Security Program Operating Manual (NISPOM),^[27] which regulates U.S. government contractors with classified contracts, also require notice to designated government agencies for review and approval of transactions involving foreign entities. Notifying CFIUS of a transaction does not fulfill these legal obligations. Finally, review by the agencies that manage export regulations and the NISPOM may actually take longer than the CFIUS review.

8. Does CFIUS Accept Risk Mitigation Strategies to Blunt National Security Risks in a Transaction? CFIUS may approve a transaction but require the parties to implement mitigation strategies that may limit foreign control or limit or prohibit access to a business’s critical technology in the interest of national security. ^[28] Treasury’s Office of CFIUS Monitoring and Enforcement has the authority to monitor mitigation plans. Further, other agencies charged with protecting national security through export regulations or through the NISPOM may independently require that a business obtain export licenses or implement other controls pursuant to export and NISPOM regulations.

9. Are CFIUS Filings Confidential? Information provided to CFIUS must be maintained in confidence.^[29] CFIUS may not disclose whether a transaction has been submitted for review. Given the nature of CFIUS filings, the information filed is exempt from public disclosure under the Freedom of Information Act. If parties to a transaction reveal they have submitted a transaction to CFIUS for review, CFIUS may then comment publicly.

10. What Are CFIUS Penalties? CFIUS requirements give the president authority to prohibit certain foreign investment in the United States, to include the authority to suspend or unwind a transaction that implicates national security. There are also financial penalties up to $250,000 per violation for intentionally or negligently submitting a material misstatement or omitting material information in a CFIUS filing. If CFIUS orders an entity to implement a mitigation plan and the entity either intentionally or negligently violates the plan, the entity may incur a civil penalty up to $ 250,000 per violation or for the value of the transaction, whichever is greater. Since mitigation agreements may include liquidated or actual damages for breaches, offending entities may be liable for damages in addition to the civil penalties.^[30]

1. Foreign person is a defined term in CFIUS regulations. 31 CFR 800.224, Foreign person. ↑

2. U.S. Department of Treasury, CFIUS Overview (last visited Sept. 20, 2023). ↑

3. Id.; U.S. Department of Treasury, CFIUS Case Management System (last visited Sept. 20, 2023). ↑

4. Id. ↑

5. Id. ↑

6. U.S. Department of Treasury, CFIUS FAQs, Background Information on FIRRMA (last visited Sept. 20, 2023); 31 CFR 800.101, Scope. ↑

7. See, e.g., U.S. Department of Treasury, CFIUS FAQs, Background Information on FIRRMA (last visited Sept. 20, 2023); 73 FR 74567, 74568 (Dec. 8, 2008); “Treasury Issues Proposed CFIUS Regulations; Lowery to Hold Briefing Today,” Apr. 21, 2008; Foreign Investment Risk Modernization Act of 2018. ↑

8. See, e.g., Executive Order 11858 (May 1975) as amended by Executive Order 13456 (Jan. 2008); Executive Order 14083 (Sept. 15, 2022); § 721 of the Defense Production Act of 1950, as amended; 31 CFR Part 800. ↑

9. Id. ↑

10. 31 CFR Part 800; Foreign Investment Risk Modernization Act of 2018. ↑

11. 31 C.F.R. Part 802, Regulations Pertaining to Certain Transactions by Foreign Persons Involving Real Estate in the United States. ↑

12. Id. ↑

13. 31 CFR 800.210, Covered Control Transaction; 31 CFR 800.301, Transactions that are covered control transactions; 31 CFR 800.211, Covered investment. ↑

14. 31 CFR 800.208, Control. ↑

15. 31 CFR 800.248, TID U.S. Business. ↑

16. Id.; 31 CFR 800.215. ↑

17. 31 CFR 800.214, Critical Infrastructure. ↑

18. 31 CFR 800.248, TID Business; 31 CFR 800.241, Sensitive Personal Data. ↑

19. 31 CFR 800.401, Mandatory disclosures. ↑

20. 31 CFR 800.401, Mandatory disclosures; 31 CFR 800.244, Substantial Interest. ↑

21. 31 CFR Subpart D, Declarations. ↑

22. Id. ↑

23. Id. ↑

24. 31 CFR Subpart E, Notices. ↑

25. Id. ↑

26. U.S. International Traffic in Arms Regulations (22 C.F.R. §§120–130); U.S. Export Administration Regulations (15 C.F.R. §§730–774) (together “U.S. export regulations”). ↑

27. 32 CFR Part 117, National Industrial Security Program Operating Manual. ↑

28. U.S. Department of Treasury, CFIUS Monitoring and Enforcement (last visited Sept. 20, 2023). ↑

29. 31 CFR 800.802, Confidentiality. ↑

30. 31 CFR 800 Subpart I, Penalties and Damages. ↑

Make-whole provisions in most debt instruments traditionally are structured either as a make-whole based on simple interest or a straight percentage premium that ratchets down over time. In the current market, in which many private equity sponsors and other investors are leveraging debt as a means of avoiding repricing their investments, we are noticing a convergence of the characteristics of debt and equity return hurdles: debt financing parties are now more likely than ever to dip into the private equity toolkit by utilizing equity-like economic sweeteners for lenders. These provisions can appeal to both borrowers and lenders because they enable borrowers to conserve near-term cash and incentivize debt investments while hardwiring lenders’ returns on their debt investments in anticipation of a near-term exit or other realization event. While equity-like sweeteners can be useful tools under the right circumstances, they may pose heightened risks for lenders in a downside scenario. These risks, as well as the tax implications of such equity-like sweeteners, should be taken into account when negotiating debt financing transactions.

This article will examine some of these equity-like sweeteners, why they have become popular, and the risks and structuring considerations for investors considering including such provisions in their financing terms.

What Are the Most Common Equity-Like Sweeteners?

Multiple on invested capital (“MOIC”) and internal rate of return (“IRR”) are two of the most common metrics used to calculate return on investment in private equity, and they are also two of the most common equity-like sweeteners gaining popularity among lenders. An investor modeling for a near-term exit event will likely prefer to employ a MOIC, whereas an investor anticipating a longer exit timeline might prefer to include an IRR make-whole because it takes into account the time value of money invested.

Why Have Equity-Like Sweeteners Become Popular?

Equity-like sweeteners are a natural development in the evolution of the private equity and venture capital worlds’ business model of highly leveraged investing. Debt secured by future cash flows is now common. The idea is to use leverage to invest in a company’s balance sheet and infrastructure at a fixed coupon until the investment reaches a threshold value—and at that point, use funds received in a realization event (e.g., an exit) rather than from operations to refinance or repay the debt.

While these financings may be more expensive than traditional cash pay investments, they are often cheaper than another round of equity raising and, as a result, have become popular tools to allow companies to harness growth, avoid down rounds, and improve the returns for their management team and equity investors. An equity-like kicker allows the business to use tomorrow’s upside to finance current growth and pay a present-day cash coupon that it can support based on current revenue. While lenders may not receive regular cash flow income at a high interest rate during the life of the investment, locking in a fixed return is an attractive outcome, particularly for debt investors such as insurance companies and private credit funds, and allows the sourcing parties to be compensated for work, time, and cost involved with sourcing the investment.

Downside Case Considerations

It is presently unclear how equity-like sweeteners will fare in a downside case (which may be precipitated or exacerbated by the stress of the current market conditions, in which timelines for exits are being extended, real costs and cash burn are increasing, and valuation multiples are being compressed). Equity-like sweeteners have yet to be fully tested in bankruptcy. They share certain attributes with traditional make-wholes, and there is consequently a real concern that in light of the recent decisions on make-wholes in the Ultra Petroleum Corp. v. Ad Hoc Committee of OpCo Unsecured Creditors^[1] and Wells Fargo Bank, N.A. v. Hertz Corp.^[2] bankruptcy cases, they may be vulnerable to disallowance in a downside case, including based on treatment as “unmatured interest” under section 502(b)(2) of the Bankruptcy Code.

Section 502(b)(2) of the Bankruptcy Code generally disallows claims for “unmatured interest.” While this term is not formally defined in the Bankruptcy Code, it has been construed by courts to mean interest that is not yet earned or due and payable as of the date of a bankruptcy filing. Historically, a majority of courts allowed make-whole premiums to the extent validly triggered under the applicable debt documents (which issue was frequently subject to dispute), finding that such premiums constituted reasonable liquidated damages designed to compensate lenders for the cost of reinvesting in a less favorable market, rather than unmatured interest.

However, in Ultra and Hertz, the courts rejected the distinction between liquidated damages and unmatured interest and adopted an expansive view under section 502(b)(2) of the Bankruptcy Code. In Ultra, the U.S. Court of Appeals for the Fifth Circuit found that the make-whole at issue was the “economic equivalent” of unmatured interest. In Hertz, the U.S. Bankruptcy Court for the District of Delaware reached the same conclusion after examining the “economic substance” of the applicable make-whole. Both courts acknowledged that make-wholes may be allowable in some instances but found that the premiums at issue, which were calculated using interest-based formulas, represented claims for unmatured interest rather than noninterest damages such as reinvestment costs. While the full impact of the Ultra and Hertz decisions—the latter of which is subject to ongoing appeal—remains to be determined, the decisions increase the risk that a debt investor who agreed to price a deal up front based on a fixed-return hurdle may now find its borrowers considering bankruptcy as a way to avoid paying a significant piece of the investor’s expected compensation for its debt investment. Investors may become more circumspect about the likelihood of achieving that return in a downside case as a result.

Given the expansive view of unmatured interest taken by the Ultra and Hertz courts, it is possible that if the same courts were presented with an equity-like sweetener, claims for amounts owed under such provisions (or for other amounts not expressly calculated by reference to future interest, such as exit fees and other fixed fees) may also be viewed as the economic equivalent of unmatured interest.^[3] Alternatively, a court might distinguish such equity-like sweeteners as less directly tethered to future unearned interest than the make-wholes in Ultra and Hertz, but investors should be mindful that the existing case law leaves room for debate.

In addition, equity-like sweeteners may be challenged as unenforceable penalties/unreasonable fees even where they do not constitute unmatured interest, especially if the borrower is under financial distress or facing imminent financial distress when such consideration is negotiated.^[4] Debtors and/or creditors’ committees often challenge make-wholes as unenforceable penalties subject to disallowance. Equity-like sweeteners that are perceived as overly aggressive may risk disallowance under section 502(b)(1) of the Bankruptcy Code^[5] (and/or, if the claim for the premium is fully secured such that section 506(b) of the Bankruptcy Code applies, as an unreasonable fee^[6]).

Tax Efficiency Considerations

Equity-like sweeteners based on a MOIC or IRR hurdle may result in “phantom income” for an investor because debt instruments with these terms provide for a payment at an unknown future date for an unknown amount. As a result, such debt instruments may be treated as “contingent payment debt instruments” (“CPDIs”) under the Internal Revenue Code unless an exception applies. Additionally, any gain resulting from the MOIC or IRR hurdle is generally taxed as ordinary income instead of capital gains.

A debt instrument is treated as a CPDI if it provides for one or more payments that are not fixed as to time or amount and that are not “remote” or “incidental.”^[7] A contingency is treated as “remote” if the likelihood that it will occur (or not occur) is remote.^[8] A contingency is treated as “incidental” if the amount of the contingent payment under all reasonably expected market conditions is insignificant relative to the total expected payments on the debt instrument.^[9]

To avoid having a debt instrument with a MOIC or IRR or similar equity-like sweetener treated as a CPDI, the borrower would need to be able to represent to the satisfaction of the investor and its tax return preparers that the likelihood of a triggering event is remote and that the CPDI rules should not apply. Context matters, and debt instruments containing equity-like sweeteners ideally should be structured in a way that utilizes one of the exceptions. For example, in the circumstance where a borrower is an investment grade company, a default that triggers traditional make-whole, MOIC, or IRR payments will likely be treated as a remote contingency that will not cause a debt instrument to be treated as a CPDI at the time of issuance.

However, if no exception applies, a borrower would construct a hypothetical payment schedule for the CPDI based on a “comparable yield,” which generally is the rate at which the applicable issuer could issue a fixed-rate debt instrument with terms and conditions similar to the applicable debt. The investor holding such debt instrument would agree upon such schedule with the borrower and accrue interest income from the initial issuance date based on the projected payment schedule, with adjustments if the actual contingent payments differ from the projected payments.^[10]

While such phantom income is not unusual in a CPDI, in light of the Ultra and Hertz decisions, investors should be aware that if the equity-like sweetener contained in their debt instrument is disallowed in bankruptcy, the investor not only would be exposed to the lost investment upside but also would possibly have current tax liabilities to pay (and may have potentially passed such tax liabilities on to its own investors) without ever realizing any cash return on the investment. Additionally, income would be taxed at ordinary income rates, while any losses realized on the debt instrument would be capital losses.

Balancing Downside Case and Tax Considerations in Protecting Investor Economics

Even if an equity-like sweetener is potentially unenforceable in bankruptcy, it may still serve as a valuable means of preserving upside for lenders not only in out-of-court exit scenarios such as a sale, refinancing, or prepayment but also by giving companies runway to grow. To avoid the outcome described immediately above, debt investors need to balance the desire to preserve upside recoveries against the desire to manage tax liabilities and maximize the chances of the equity-like sweetener being enforceable in a downside scenario.

Investors should carefully consider the default and acceleration provisions in proposed debt documents to ensure that any equity-like sweetener will be validly triggered if the debt is accelerated before the anticipated exit event—but should also bear in mind that the ability to accelerate an equity-like sweetener will not necessarily ensure its collectibility in bankruptcy. Bankruptcy-triggered acceleration is generally disregarded for purposes of determining whether a claim for interest has matured under section 502(b)(2) of the Bankruptcy Code,^[11] and courts have reached differing conclusions as to whether prepetition acceleration suffices to protect against disallowance under section 502(b)(2) where the claim is for the economic equivalent of unmatured postpetition interest.^[12]

Having the equity-like sweetener earned up front and paid later rather than earned at the time of a realization event may help to mitigate the risk of disallowance under section 502(b)(2) of the Bankruptcy Code. However, the efficacy of this largely untested tactic is uncertain given that (1) a court may not accept the contractual characterization of the equity-like sweetener as “earned” to the extent the court finds that such amount is intended to compensate for future interest; and (2) even if fully earned, the equity-like sweetener may still be deemed “unmatured” to the extent that it is not due and payable as of the bankruptcy filing. In addition, there is a cost to this approach: upon recognition of this revenue (at the time so earned), the investor (and its own investors) would need to treat the whole amount as fee income for tax purposes without having commensurate cash flows to offset the liability, and the investor (and its own investors) would carry the risk that the amount is never actually paid.

Another potential way to reduce challenge risk in bankruptcy is to include language in the debt documents clarifying the intent of the parties and the specific rationale for the equity-like sweetener—i.e., that the equity-like sweetener is designed to compensate for damages other than future interest streams and is reasonable under the circumstances. While there is no guarantee that such language will be persuasive to a court (both the Ultra and Hertz courts emphasized that the economic reality rather than the labels given by the parties in their agreement dictated whether a given claim was for unmatured interest), it may at least create additional room for argument by providing evidence of the parties’ understanding at the time of the transaction. The persuasive force of such argument may depend, in part, on the ability to credibly articulate the specific noninterest damages for which the equity-like sweetener is designed to compensate the investor (as well as on the underlying economic terms and financial condition of the borrower at the time such financing is entered into). It remains to be seen whether equity-like sweeteners will face other bankruptcy risks (e.g., recharacterization) in addition to implicating the risks faced by traditional make-whole claims.

In addition to addressing bankruptcy challenge risk in the up-front structuring for equity-like sweeteners, lenders may also mitigate such risk at the time of the bankruptcy filing by negotiating debtor-in-possession financing that refinances the equity-like sweetener at the outset of the bankruptcy case and/or by making favorable treatment of the equity-like sweetener part of a comprehensive restructuring support agreement—assuming the debtor is willing to agree to such terms. These later-stage mitigation strategies can be subject to challenge by creditors’ committees and other interested parties but may enhance lenders’ chances of recovering potentially controversial claims.

What Should I Do If I Have an Equity-Like Sweetener in My Debt Documents?

1. Ultra Petroleum Corp. v. Ad Hoc Comm. of OpCo Unsecured Creditors (In re Ultra Petroleum Corp.), 51 F.4th 138 (5th Cir. 2022), cert. denied, No. 22-772, 2023 WL 3571513 (May 22, 2023). ↑

2. See Wells Fargo Bank, N.A. v. Hertz Corp. (In re Hertz Corp.), Adv. No. 21-50995 (MFW), at 6–12 (Bankr. D. Del. Nov. 21, 2022), ECF No. 71; see also Wells Fargo Bank, N.A. v. Hertz Corp. (In re Hertz Corp.), 637 B.R. 781, 785 (Bankr. D. Del. 2021). ↑

3. A similar argument was raised by the creditors’ committee in In re Talen Energy Supply, LLC, another recent bankruptcy case, prior to the Ultra and Hertz decisions. See Objection of the Official Committee of Unsecured Creditors to Proof of Claim by Alter Domus (US) LLC, as Administrative Agent, In re Talen Energy Supply, LLC, No. 22-90054 (MI), ¶¶ 61–64 (Bankr. S.D. Tex. Aug. 22, 2022), ECF No. 1088 (arguing that MOIC premium should be disallowed under section 502(b)(2) to the extent it incorporated a make-whole that was allegedly subject to disallowance as unmatured interest). ↑

4. In both Talen and another recent case involving a contractual premium negotiated shortly before the borrowers’ bankruptcy filing, the creditors’ committee argued that the premium at issue was an unenforceable penalty and/or unreasonable because the bankruptcy filing was foreseeable when the debtors committed to pay the premium. Therefore, the creditors’ committee asserted, the lenders had no real expectation of the future interest stream that the premium was ostensibly intended to protect and were instead seeking to improperly inflate their recoveries in the borrowers’ bankruptcy cases. See id. ¶¶ 38, 44–51; Notice of Filing Proposed Redacted Version of the Official Committee of Unsecured Creditors of TPC Group et al., for Entry of an Order Granting (I) Leave, Standing, and Authority to Commence and Prosecute Certain Claims on Behalf of the Debtors’ Estates and (II) Exclusive Settlement Authority in Respect of Such Claims, In re TPC Group Inc., No. 22-10493 (CTG), ¶¶ 99–104 (Bankr. D. Del. Sept. 6, 2022), ECF No. 725. In both cases, the disputes were settled prior to adjudication. ↑

5. Section 502(b)(1) generally disallows claims to the extent unenforceable under the applicable agreement or nonbankruptcy law. ↑

6. Section 506(b) permits fully secured creditors to recover “reasonable fees, costs, or charges” provided for under the applicable agreement or state law under which the claim arose. ↑

7. Treas. Reg. §§ 1.1275-4(a)(1), 1.1275-4(a)(1)(5). ↑

8. Id. § 1.1275-2(h)(2). ↑

9. Id. § 1.1275-2(h)(3)(i). ↑

10. If the actual amount of the equity-like kicker payment equals the projected payment amount, then there are no additional taxes paid at the time of receipt. If the actual amount of the payment differs, the difference, if positive, will be treated as additional interest income; and if negative, it will reduce interest income in the year of payment, and the excess will be treated as ordinary loss to the extent of prior interest inclusions. Thus, in certain circumstances, amounts that are not actually interest can be treated as taxable interest income in earlier years, with corresponding losses in later years. Depending on the structure of the lender, losses may be subject to limitations. ↑

11. Some debtors and creditors’ committees have further argued that enforcement of bankruptcy-based acceleration triggers for make-wholes is prohibited under sections 365(e)(1), 541(c)(1)(B), and 363(l) of the Bankruptcy Code (which restrict enforcement of ipso facto clauses, i.e., contractual rights conditioned on the debtor’s bankruptcy, insolvency, or financial condition). There is limited case law on this issue, which remains subject to debate. ↑

12. Compare, e.g., In re Harris, No. 18-16598, 2022 WL 198852, at *7 (Bankr. N.D. Ohio Jan. 21, 2022) (finding that prepayment premium triggered prepetition was “fully matured” and thus not “unmatured interest” under section 502(b)(2), and collecting supporting cases), aff’d sub nom. Harris v. Synovus Bank, No. 1:22-cv-00247, 2022 WL 17750281 (N.D. Ohio Dec. 19, 2022), with, e.g., Ultra Petroleum Corp. v. Ad Hoc Comm. of OpCo Unsecured Creditors (In re Ultra Petroleum Corp.), 51 F.4th 138, 147 (5th Cir. 2022) (stating that even if creditors could establish that make-whole premium was not technically “unmatured” and/or not technically “interest,” make-whole premium claim may nevertheless be subject to disallowance as economic equivalent of unmatured interest under section 502(b)(2)). ↑