Companies must consider environmental, social and governance (“ESG”) factors in their mergers and acquisitions (“M&A”) transactions to achieve maximum value and monitor risks. ESG matters are becoming increasingly significant in M&A transactions as businesses are facing mounting scrutiny and pressure for transparency on climate risk, social justice, sustainability, and corporate governance.

To address ESG considerations in the context of an M&A transaction, buyers—including private equity funds and strategic acquirers—should conduct ESG-focused due diligence, allocate ESG risk in the transaction agreement, and perform post-close ESG integration. This article addresses factors contributing to the increased focus on ESG along with commentary on how purchasers can integrate ESG factors in their next M&A deal.

Importance of ESG in M&A

A focus on ESG can be a competitive advantage for companies, private equity funds, and other strategic acquirers. It assists organizations in creating value, mitigating risk, and becoming more resilient. Consideration of ESG factors in M&A transactions is undeniably rising. Bain & Company recently conducted a global survey that found 65% of M&A executives expect their own company’s focus on ESG to increase over the next three years, with 11% stating that they currently regularly assess ESG extensively in the deal-making process. Failing to account for critical ESG elements can undermine success and lead to poor business outcomes.

Reputational Risk

Shareholders and investors are becoming increasingly attuned to ESG issues. By directing their investments to companies with comprehensive and established ESG disclosures, shareholders and investors globally are a key driving force behind growing ESG disclosure. Since ESG factors overlap with core corporate values, failure to address ESG issues may have a disproportionately negative reputational impact on a business. When considering a transaction, buyers should understand all ESG matters associated with the transaction, evaluate how to mitigate any reputational risks, and ensure that processes are in place to monitor the business’s reporting method.

Fiduciary Duties

Directors have a fiduciary duty to act in the best interests of the corporation, which has generally been thought of as a duty to act in the shareholders’ interests. The duty of care requires directors to exercise the care, diligence, and skill that a reasonably prudent person would exercise in comparable circumstances. To fulfill their fiduciary duties, directors must consider what will maximize shareholder value in the long term. Businesses must account for ESG risks to achieve lasting commercial viability. Shareholders have been more vocal and involved in the governance of a business, demanding changes to leadership and the board of directors. We are starting to also see examples of shareholders successfully removing directors as a result of their discontent with the company’s approach to climate change. This surge of ESG-related activity is driving corporations to urgently transform their core strategies.

Financial Implications

Considerable shifts in consumer awareness, spending patterns, employee expectations, regulatory frameworks, and industry perception have prompted investors to reallocate a notable amount of investments in light of ESG trends. Climate change has significantly impacted the operations and value of numerous companies, and we believe this trend will continue as the frequency and scale of natural disasters continues to increase. Natural disasters have caused an estimated US$280 billion worth of losses in 2021. ESG factors pose a real risk to shareholders now that losses are tangible and quantifiable, directly impacting M&A activity. Businesses must also consider the effects of ESG on financing. Access to capital for businesses may be limited by poor ESG ratings and performance. Lenders and institutional investors have made it clear that businesses must make ESG a priority or risk losing financing.

Regulatory Compliance

Across jurisdictions, the ESG regulatory landscape is steadily evolving. Regulators along with other oversight bodies have been expending resources to monitor and create rules and guidance on ESG matters. For example, in Canada, the Canadian Securities Administrators (“CSA”) recently published guidance for investment funds on their disclosure practices as they relate to ESG factors. The CSA has indicated that it will monitor ESG-related disclosure as part of its ongoing continuous disclosure review program. The US Securities and Exchange Commission (“SEC”) is evaluating current disclosure practices of climate-related risks. Recently, the SEC issued a press release on proposed rule changes that would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on business, operations, and financial condition, and certain climate-related financial statement metrics. ESG factors will be a key consideration for both the buyer and target, as various regulatory bodies continue to bring additional ESG rules and regulations into force.

ESG Considerations in M&A

ESG Due Diligence

Buyers should consider broadening the scope of their due diligence to include performing targeted ESG investigations. ESG due diligence will look different for each transaction and will depend on the nature and type of business the target is conducting and the relevant operating jurisdictions. Due diligence should go beyond a routine examination of organizational performance and consider wide-ranging impacts and dependencies across the global value chain.

The due diligence process must integrate ESG into each stage of the deal and should inform the buyer of any potential impact of the merger or acquisition on its sustainability strategy and the long-term value of the combined entity. Red flag checks may include assessing the future fitness of the target and relevant assets and media scans to understand any major ESG-related risks. Due diligence should identify any human rights violations, corruption, environmental degradation, privacy breaches, data breaches, harassment, workplace misconduct, workplace diversity, gender inequity, greenhouse gas emissions, previous instances of non-compliance, the target’s ESG ratings, the use of ESG standards, and the target’s level community engagement. This will identify potential liabilities or cultural concerns that can be investigated further. Other due diligence considerations may also flag physical and transitional risks associated with climate change.

Targeted ESG due diligence will assist buyers in identifying ESG risks that may influence a target’s price and overall deal structure. Once fully cognizant of the potential liabilities and risks of a transaction, companies may mitigate ESG risk through the transaction agreement.

Transaction Agreement

M&A transaction agreements, such as share purchase agreements and asset purchase agreements, are already reflecting the growing importance of ESG factors. Since the beginning of the COVID-19 pandemic, the majority of M&A agreements adopted provisions for COVID-19 in material adverse effect clauses and interim operating covenants. COVID-19 tested the resilience of corporations, globally, and has shown investors that ESG matters now more than ever.

Through ESG diligence, buyers can understand the potential risks and pitfalls that relate to the target’s operations and industry. The buyer can then look to address any ESG risks in the transaction agreement through specific indemnities, targeted representations and warranties addressing ESG matters, or through various pre-closing conditions or post-closing covenants of the sellers. The transaction agreement will typically contain customary representations and warranties relating to the various aspects of the operations of the business and the regulatory environment in which it operates. These customary representations and warranties may address several ESG factors. Yet, these representations and warranties should be reviewed and revised in light of specific regulations or codes of conduct that apply to the operations of the business and any ESG factors. Buyers should therefore consider and look to negotiate the inclusion of applicable ESG representations, which may include “MeToo” representations requiring targets to disclose misconduct allegations, compliance with specific codes or principles that the target has voluntarily complied with, or compliance with recommendations of applicable codes of conduct or guidelines issued by oversight bodies.

For ESG risks that are identified in diligence, buyers should consider the materiality of these identified risks and consider how these issues can be addressed. The purchase agreement should be tailored to suit the needs of each transaction. Depending on the issue identified, the vendors may be able to address the concerns pre-closing. This could include adding provisions such as special pre-closing covenants requiring detailed reporting and disclosure of any new ESG issues that may arise.

If the issue cannot be addressed pre-closing, such as non-compliance with ESG-related regulations, the buyer may wish to negotiate a reduction in the purchase price to reflect the risk assumed. In addition, the buyer may wish to consider a specific indemnity to address the risk for known ESG issues and holdback of a portion of the purchase price that the purchaser can set off against any losses it incurs due to the issues identified. The parties may also look to restructure the transaction to assist in mitigating the risk.

Post-closing Matters

Post-close, the buyer should continue its review of ESG factors while looking to integrate the target into the buyer’s operations. The integration process should aim to align the target’s ESG policies and values with those of the buyer. To ensure that the target’s ESG culture and values meet the expectations of the buyer, the buyer should confirm that the proper policies are in place and communicated to all employees, suppliers, and contractors. If the target has ESG policies that are more robust in certain areas compared to the buyer’s existing policies, the buyer may use this as an opportunity to grow and strengthen their reputation and performance.

The buyer should also develop an action plan to address any material ESG risk of the target that was identified through the due diligence process. The buyer will be better positioned to monitor and track future remedial efforts and compliance.

Conclusion

As companies, investors, and shareholders are becoming increasingly conscious of social and environmental factors, it is critical to evaluate investment opportunities through an ESG lens. For the foreseeable future, ESG-assessed M&A will be an important tool to generate growth and provide companies with a competitive edge. It will also be crucial in establishing stakeholder trust. For corporate and fund-based dealmakers, decisive steps are needed in risk reduction and long-term value generation. Organizations that take initiative and embrace ESG in M&A will be better positioned to achieve sustainable growth and adapt to constantly evolving expectations.

As the company’s information treasure trove grew, two things were clear: With more information in more places, with more value, traveling across the globe at the speed of light, something bad was eventually bound to happen. And the consequences of failing to manage information assets began to have greater implications for stock value, reputation, executive’s careers, customers, regulators, courts, and the court of public opinion.

The US Department of Justice recently updated its “Evaluation of Corporate Compliance Programs,” which guides prosecutors and courts in the adequacy and effectiveness of a corporation’s compliance program. Implicit in a good compliance program is that companies can’t babysit all their employees all day, every day. But if a company constructs an artifice to help employees comply with company policy, for example, the consequences of failure may be reduced or nothing at all. In that sense, good compliance is like insurance—you may never need it, but it provides solace just knowing it exists and is good. So, knowing the criteria a company may be evaluated against someday should help it bolster its corporate compliance programs. More specifically, this article is about information governance compliance programs that are becoming increasingly important with corporate information growing at 23% each year (per IDC), the increase in privacy regulations, and the adoption of big data projects.

We live in a world that requires companies to use data to better to understand their customers’ needs, improve products and services, reduce costs, and improve business efficiency, all while complying with laws and regulations that dictate how long information must be retained among other things. According to The Economist, data is one of the most valuable resources in the world today.

Organizations are generating as much as 7.5 septillion gigabytes of data per day, which is why laws and regulations that govern the management of data are increasing. To put that in context, we create roughly the data equivalent of 50,000 years of continuous movies every few hours, all day, every day. Now more than ever you should consider creating or reviewing your information governance policies and practices to ensure they address the information your organization generates, receives, and manages. This might sound like a daunting task, but it doesn’t have to be.

Let’s start with defining information governance: It is the management, retention, and disposition of information that an organization creates and collects. Information is the lifeblood of most companies today and should be managed as a valuable asset. Given the overlapping influences of contractual obligations, preserving customer trust, and laws and regulations, companies can’t afford to ignore information governance.

Many confuse information governance with records management, but there is a huge difference. Traditional records management compliance programs typically had policies that outlined the official records (purchase orders, personnel files, contracts, etc.) that needed to be retained in accordance with laws and regulations and business needs. Typically, most programs had “minimum” retention periods established to ensure records were not disposed of too quickly in case a regulator wanted to inspect them. Addressing official records by imposing a minimum retention is no longer considered reasonable or good enough. Instead, companies must govern all information that the organization generates, receives, and manages regardless of the medium or storage location (e.g., onsite, AWS, SAS provider, mobile device) and if it is the official record or not. For most organizations, a vast amount of information that is under their management may not have any law or regulation mandating its retention or disposal and may have short-term business value. This vast amount of information requires governance and management, too. It must have a predictable end of life, especially if it contains high-risk data.

Over two decades ago, the Kahn Consulting firm developed the Seven Keys to Information Management Compliance based on Federal Sentencing Guidelines. The Seven Keys takes the Federal Sentencing Guidelines and adapts them for the information space. The Department of Justice guidance to prosecutors can be used as a roadmap to implement or validate the key components of your company’s information governance compliance program. Summarized below is a roadmap to implement or augment your compliance programs, focusing specifically on information governance.

Summary of Roadmap

1. Risk Assessments

A compliance program’s key components should consist of a risk assessment process to identify, analyze, and address particular risks. This process should be documented and consist of metrics that will be used to address compliance. Based on the risk profile, there should be resources, funding, and scrutiny allocated appropriately based on the level of risk. Risk assessments should be conducted routinely and based upon operational data.

Actions taken to address risk (policy modifications, training, etc.) should be documented and monitored. The risk assessment process should incorporate lessons learned from actions taken within the company and other companies with similar business profiles. As it relates to information governance, a risk assessment should include structured information, unstructured information, third parties storing information, outsourced business processes that have an information component (i.e., benefits, 401(k), retirement), communications and messaging environments, end user productivity environments such as Microsoft 365 and Google Workspace including collaboration and meetings, robotic generated data, etc.

2. Policies and Procedures

Policies and procedures must be part of a well-designed compliance program. Policies and procedures should address identified risks and directives that must be followed, as well as strive to establish a culture that promotes compliance. The company should have a policy management process in place that dictates how corporate policies should be designed, approved, published, implemented, and maintained over time. Information management policies and procedures should address the retention of information (records and non-records), disposition rules, preservation obligations, and protection of specific classes of information.

3. Training and Communications

A key component of a well-designed compliance program is the training of employees and the communications used to integrate the policies within the company. Training and communication messages should be tailored for specific audiences. High-risk areas may require more training and/or more detailed examples during training. The training should take into consideration the form and language(s) that are used. Training should be an ongoing activity and incorporate lessons learned from past noncompliance events. Communications should include the leadership’s position on misconduct or non-compliance (i.e., warning, termination, discipline). Training and communications should provide guidance for employees to identify when they should seek assistance and where they can get that assistance.

Information management programs should have an annual required training program, and periodic communications should be sent out from senior leadership reminding the organization of the value of information and the potential risk of non-compliance with policies and procedures. Furthermore, training and communications should be targeted for specific audiences such as application owners, Google Workspace users, network/fileshare users, email users, third-party contract business owners, etc. The messages and training must be specific to the actions that are required. For example, if the company’s policy is to purge email after one year, define the specific action that must be taken in the rare event that an email would rise to the level of a record requiring longer retention.

4. Confidential Reporting Structures and Investigation Processes

Confidential reporting structures and investigation processes are essential in compliance programs. Employees must be able to report non-compliance and misconduct anonymously and confidentially. The company’s culture and processes should promote and measure the workplace environment to ensure that fear of retaliation doesn’t exist. Processes need to route issues quickly to a few, appropriate people so they may be dealt with in a timely manner. Employees must be made aware of how to report non-compliance and what happens once they report it. There should be a robust process including metrics, to investigate, manage, and discipline non-compliance.

The information gathered during non-compliance should be tracked, analyzed, and used for lessons learned. Information governance non-compliance can have serious consequences to the organization. The over-retention of private information can have reputational damage and financial consequences. Destruction of potentially relevant information that has been placed on a legal hold may not only cause fines and penalties but may also impact the outcome of litigation or a regulatory investigation.

5. Management of Third-Party Relationships

Third-party relationships should include a strong risk-based diligence process. The diligence should be appropriately aligned with the level of risk. As part of the risk assessment, sub-contractors to the third party should be assessed, and contract terms and conditions should be reviewed. Ongoing monitoring of the third-party relationship should be documented, audited, and tracked. Specifically related to information governance, any third party storing, managing, or accessing information on behalf of your company should have a risk assessment completed. Third parties with personal information, highly confidential information, or IP should have additional scrutiny and corresponding controls established.

Real actions and consequences need to take place when non-compliance exists. Follow up to non-compliance is required to ensure that the third party has addressed the issues. As it relates to information governance, all contracts should clearly identify the third party’s roles and responsibilities as they relate to retention, disposal, and preservation of information, including the redaction or anonymization of personal information.

6. Mergers and Acquisitions

Mergers and acquisitions need to be included in a well-designed compliance program to ensure timely and orderly integration of any acquired entity into the company’s compliance regime. Divestitures need to be evaluated to ensure the appropriate compliance activities are moved to the acquiring company in a timely manner. There should be a due diligence process, integration process, and implementation plan prepared prior to the actual transaction taking place. Information governance responsibilities need to be clearly outlined so the segregation of information can take place, claw-back clauses can be incorporated into contracts as necessary, and information related to open litigation, audits, or investigations can be addressed. Identification of all the information that is impacted by an acquisition or divestiture is becoming more complex as it relates to big data projects, privacy laws, and the expanding number of third parties storing the information.

7. Adequate Resources and Empowerment

Companies must adequately resource and empower their compliance programs. Issuing policies is no longer good enough. Compliance programs must have implementation plans to ensure appropriate staffing is in place to audit, document, analyze, and continuously improve compliance programs. This key component can be time-consuming when it comes to information governance compliance programs.

A few examples of areas requiring automated or manual plans for managing information are: applications, third parties managing information on the company’s behalf, end user information storage locations, communication systems, and off-site storage boxes. You should automate as much as you can, but there are realities where rules cannot be automated and will require manual intervention. Implementation cannot start until the company develops and enacts a documented retention schedule that outlines the rules for retaining specific categories of data. The retention schedule needs to be based on up-to-date legal research for each jurisdiction where the company conducts business. It must also address the business value of the information.

8. Commitment from Senior and Middle Management

For a compliance program to be successful, senior and middle management commitment and messaging is a necessity to foster a culture of compliance within the company. The C-suite and the board set the tone for the rest of the organization by messaging the importance of compliance and by demonstrating adherence. All leaders in the company need to take ownership and accountability for their employees when it comes to monitoring and checking for compliance with policies. When management finds non-compliance, management needs to address the matter and perhaps use it as a teaching moment for the rest of the staff.

9. Autonomy and Effective Resources

Program autonomy and effective resources are essential in a well-designed compliance program. Compliance programs need to have day-to-day oversight, and those responsible for that oversight must have adequate autonomy authority, seniority, and access to the Board of Directors. Team members should have the appropriate experience to address non-compliance issues. Internal audits should also be conducted to ensure that compliance personnel are in fact empowered and positioned to detect and prevent non-compliance. As for information governance programs, there should be a governance board that is represented by Legal, IT, Security, Privacy, Compliance, Audit, and select business units.

10. Incentives for Compliance and Disincentives for Non-Compliance

Implementation of a compliance program should consist of incentives for compliance and disincentives for non-compliance. Clear disciplinary procedures should be in place, consistently enforced across the organization, and commensurate with the violations. Communications from senior leadership should inform employees that unethical conduct and policy violations will not be tolerated and will have consequences. A company can consider implementing an incentive system that rewards compliance and ethical behavior. Information governance programs should be treated as equally as important as other compliance program.

11. Proof that the Compliance Program Works in Place

A compliance program should have the ability to prove that is it working, and more importantly, that it was working when a violation occurred. Documentation and evidence of actions taken is important—always document how a misconduct was detected, how the investigation was conducted, what resources participated in the investigation, and the remediation efforts. The compliance program should also document how the program has evolved over time and maintain an audit trail of changing risks and continuous improvements to the program to address new risks or non-compliance issues. The following should be part of a well-designed compliance program to prove that the program was working at the time of a non-compliance event:

• Continuous Improvement, Periodic Testing, and Review: An effective compliance program must have the ability to improve and evolve.
• Internal Audit: Internal audits must have a rigorous process that is followed and routinely conducted.
• Control Testing: Testing controls should be established, and collection of compliance data must be routinely collected and analyzed, and necessary actions taken.
• Evolving Updates: Risk assessments, policies, procedures, practices should routinely be improved to reflect the current risk profile and based on lessons learned.
• Culture of Compliance: Companies should routinely measure their culture of compliance through all levels of the organization.

12. Investigations of Misconduct

All examinations of allegations and suspicions of misconduct by the company, its employees, or third-party agents must work effectively and be appropriately funded to ensure a timely and thorough investigation that includes a documented response of its findings, disciplinary actions, and remediation measures. Investigations must be conducted by an objective party. For information governance compliance, automating monitoring for non-compliance should be considered. As an example, monitoring the volume of data leaving your organization can be an indication of an employee transferring data to a private account outside of the company. You can use tools such as MS 365 to both automate compliance and detect non-compliance. After evidence determines a questionable act, people, process, and technology should be in place to assess the alleged infraction and take necessary action.

13. Analysis and Remediation of Any Underlying Misconduct

Lastly, a well-designed compliance program that is working in practice must have a thoughtful root cause analysis of misconduct, and the company must timely and appropriately take action to remediate the root cause. Root cause analysis should consider what control failed (policy, procedure, training, etc.), the amount of funding provided, what vendors were involved, any prior indications of failure, what prior remediation efforts were taken to address a similar compliance issue, and any failures in supervision of employees. Information governance compliance often finds failures in generalized “off-the-shelf” training programs. Training programs must be 100% aligned with policy directives, practices, and procedures. Employees need to clearly understand where they are allowed to store certain types of information and how disposal of the information will happen in accordance with policy and business unit or IT practices and procedures.

Summary

Now more than ever, companies need to make an honest effort to do the right thing and comply with laws and regulations. However, in the event that employees or third parties managing data on your company’s behalf inadvertently (or intentionally) violate a law or regulation, a well-designed information governance compliance program can be used to demonstrate “reasonableness” and the company’s good faith efforts to comply with laws and regulations, which ultimately may be the difference between winning and losing.

In September 2021, Rohit Chopra was confirmed as the third Director of the Consumer Financial Protection Bureau (CFPB). After receiving his bachelor’s degree from Harvard as well an MBA from Wharton, Director Chopra worked in management consulting with McKinsey & Company, previously served as a Federal Trade Commission (FTC) Commissioner, and was the CFPB’s first Student Loan Ombudsman. Senate Banking Committee Chair Sherrod Brown (D-OH) praised Director Chopra as a “bold and experienced” nominee who would return the agency to its “central mission.” Senator Elizabeth Warren (D-MA) offered similar comments, hailing Director Chopra as a “terrific” pick to lead the CFPB. Accordingly, Director Chopra is widely viewed as an assertive regulator who will seek to leverage the full authority of the CFPB, and he has assembled a leadership team that includes several CFPB alumni and veterans.

The early days of the Chopra CFPB have been especially active, with the agency issuing marketing monitoring orders to several Big Tech players about their payments businesses and inquiries directed to leaders in the rapidly growing “Buy Now Pay Later” space. The agency has also issued research reports on overdraft fees and a Request for Information on so-called “junk fees” charged by financial institutions. However, fair lending issues are widely perceived to be on the forefront of Director Chopra’s policy priorities.

In that vein, and consistent with his focus on Big Tech, data privacy, and algorithmic bias at the FTC, Director Chopra has made crystal clear that fair lending—and in particular, algorithmic discrimination—and other practices that adversely impact communities of color will be a top agency priority. For example, in remarks announcing the settlement of a traditional redlining case, Director Chopra focused largely on “digital redlining.” He specifically called out companies that gather “massive amounts of data and use it to make more and more decisions about our lives, including loan underwriting and advertising” and encouraged data scientists, engineers, and others with “detailed knowledge of the algorithms and technologies used by those companies and who know of potential discrimination or other misconduct” to report potential fair lending violations to the CFPB. These comments have led many to believe that Director Chopra may potentially pursue new or novel fair lending theories related to artificial intelligence, machine learning, and related underwriting with algorithms.

Similarly, the Biden Administration’s focus on racial equity and the racial wealth gap could lead Director Chopra to focus his efforts on a variety of fair lending concerns, including collections and services issues, foreclosures, evictions, and credit reporting, or issues specifically stemming from the pandemic, such as potential discrimination in the issuance of PPP loans. And many industry observers believe the CFPB will pursue somewhat controversial “disparate impact” theories to pursue fair lending violations.^[1]

Indeed, Director Chopra has also made clear that the agency will focus on large companies and market players, seek to pursue a broad range of remedial measures—including individual liability where appropriate—to redress consumer harms, and partner closely with state authorities in enforcing consumer financial protection laws. The latter likely includes exploring ways to expand the CFPB’s authority to enforce federal consumer protection laws and access remedies such as the civil monetary penalty funds authorized under the Consumer Financial Protection Act.

Additionally, comments by the CFPB at an industry fair lending conference in November of 2021 restated its goals of using its authority to narrow the racial wealth gap and ensure markets are clear, transparent, and competitive. In addition to the areas noted above, the comments indicated an intent to specifically focus on:

• Appraisal bias in home valuation;
• Special purpose credit programs or “SPCPs”;
• Small business lending and the implementation of Section 1071 of Dodd-Frank;
• Limited English Proficiency consumers; and
• Unfair and discriminatory practices, including illegal practices outside of the ECOA and the HMDA.

If his initial actions and related commentary from the CFPB are any indication, Director Chopra will pursue a bold new approach to CFPB rulemaking, supervision, and enforcement in the areas of fair lending and beyond.

At the ABA Business Law Section’s 2022 Hybrid Spring Meeting, the CLE program “There’s a New Sheriff in the Beltway: Potential Areas of Focus of Director Chopra’s Fair Lending Regulatory Agenda” (now available for viewing as on-demand CLE) identified and discussed Director Chopra’s fair lending and anti-discrimination priorities and how they may impact financial services providers of all stripes, from traditional financial institutions to fintechs and Big Tech players. A panel of experts offered their views on Director Chopra’s priorities in this space, including their predictions for supervisory, enforcement, and rulemaking activity on AI-based underwriting, digital marketing, fair lending compliance in the PPP program, and small business lending; opportunities for collaboration with state and federal authorities; and potential legal headwinds and opportunities.

1. See, e.g., CFPB Blog, “The Bureau is taking much-needed action to protect consumers, particularly the most economically vulnerable,” January 28, 2021. ↑

This article is based on a CLE program that took place during the ABA Business Law Section’s 2022 Hybrid Spring Meeting. To learn more about this topic, view the program as on-demand CLE, free for members.

In November 2021, ASTM International (formerly known as the American Society for Testing and Materials) published its E1527-21 (-21 Standard), its 2021 update to its Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process. The -21 Standard is intended to satisfy the requirements of the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA)’s All Appropriate Inquiries Rule (AAI). The ASTM submitted a formal request for the Environmental Protection Agency (EPA) to reference the -21 Standard as compliant with AAI.

On March 14, 2022, the EPA published both a preliminary rule and a direct final rule setting forth the EPA’s intent to amend AAI to permit use of the -21 Standard in satisfaction of the AAI. Had the EPA not received adverse comments on the rule, the direct final rule would have gone into effect on May 13, 2022. The EPA did, however, receive adverse comments and, therefore, withdrew the direct final rule on May 2, 2022. It now intends to address adverse comments in a subsequent final action.

Of the adverse comments received, the majority objected to the rule permitting the -13 standard to remain as an acceptable alternative to comply with AAI. In other words, under the proposed rule, Phase I studies conducted under either the -13 standard or the -21 standard would be deemed sufficient to satisfy AAI. Because ASTM’s -21 standard improves upon the shortfalls of the -13 standard and brings the practice in line with “good commercial and customary practices,” as required by AAI, permitting the continued use of the historical (-13) standard does not make a great deal of sense. As noted in the comments, EPA attempted this method when it proposed the -13 standard as complying with AAI by providing that the then-current standard (E1527-05) would also be sufficient to satisfy AAI. After similar adverse comments, EPA eventually removed its reference to the -05 standard. Given this, it is likely that EPA will remove similar reference to the -13 standard in its final regulation.

Updating “Good Commercial and Customary Practice”

In developing its published -21 Standard, the ASTM sought input from users and environmental consultants nationwide. One of the ASTM’s primary goals in crafting the -21 Standard was to ensure production of quality Phase I Environmental Site Assessments (ESAs) and their resulting reports. The ASTM’s objectives in crafting the -21 Standard were threefold:

• Clarify and improve existing language
• Update the standard to reflect current customary practice
• Strengthen the deliverable (report)

The ASTM has clearly met these objectives.

What Are the Significant Changes from E1527-13?

The -21 Standard contains revised and new definitions, making the requirements stronger and clearer than those in the 2013 version, such as:

• Rewording the definition of Recognized Environmental Condition (REC). The prior definition of REC covered three examples, two of which used the term “likely,” without defining it, leaving it to a wide array of interpretations. The -21 Standard now defines the word “likely” to mean “that which is neither certain nor proved, but can be expected or believed by a reasonable observer based on the logic and/or experience of the environmental professional, and/or available evidence, as stated in the report to support the opinions given therein.”
• Clarifying that Historical Recognized Environmental Conditions (HRECs) and Controlled Recognized Environmental Conditions (CRECs) are only those conditions that affect the subject property, and that current regulatory standards be considered to determine whether the controls meet those standards as concerns unrestricted use.
• Replacing E1527-13’s use of the broader term “property use restrictions” (which was not previously defined) with the term “property use limitations,” to capture a wider variety of risk-based mitigation end points.
• Providing a definition of “significant data gap,” which E1527-13 required to be identified, but failed to define.

The -21 Standard includes clearer emphasis on property identification, specifically by:

• Providing that the subject property is defined by its current boundaries (boundaries commonly change throughout the years).
• Pointing out that properties may be different in use, size, configuration, and/or address than in the past.
• Providing that research of additional addresses may provide further information to meet objectives.

The -21 Standard also specifies two methods users may employ to satisfy their responsibility to search for environmental liens and activity and use limitations:

• Method 1 provides that a user may satisfy its requirements by relying upon customary title insurance documentation such as preliminary title reports or title commitments.
• Method 2 provides an alternative process, whereby a user may rely upon title search information reports such as condition of title, title abstracts, and activity and use limitation/environmental lien reports as long as the information identifies environmental covenants, environmental easements, land use covenants and agreements, environmental liens, and other environmental land use restrictions and controls. Search information reports must review land titles records dating back to 1980. If judicial records are not reviewed, the report must include a statement that the law of custom of the jurisdiction at issue does not require a search for judicial records in order to identify environmental liens.

Further, the -21 Standard:

• Requires that the subject property’s use be more specifically identified. For example, if the subject property’s purpose is retail, industrial, or manufacturing, additional standard resources must be reviewed if they are likely to identify a more specific use and are reasonably ascertainable.
• Provides additional clarity with respect to identification of RECs and discusses the multi-step process for identification of CRECs and HRECs. The -21 Standard includes a helpful appendix that breaks down their definitions and provides a flowchart diagram and simple examples.
• Requires more specific information in connection with historical research of the subject property, adjoining properties and the surrounding area. This puts a clearer emphasis on current property identification, more specific information on property use, etc.
• Requires review of aerials, topographic maps, fire insurance maps, and city directories, if reasonably available, and if not, requiring a reason for that omission.
• Adds a new section addressing historical research of adjoining properties. In particular, during research of the subject property, obvious past uses of adjoining properties must be identified to evaluate the likelihood that past uses may have led to RECs. If aerials, topographic maps, fire insurance maps, and city directories have been researched for the subject property, if they provide coverage for the adjoining properties, and if that research is likely to be useful in meeting the objective, those documents must also be reviewed for the adjoining properties.
• Significantly, adds “Emerging Contaminants” to the list of non-scope considerations, the most currently significant of which are per- and poly-fluoroalkyl substances (PFAS), many of which are likely to be brought within CERCLA’s definition of hazardous substances in the near future. Given this, prudence would suggest that Phase I ESAs include assessment for PFAS and other emerging contaminants, such as 1,4 dioxane, where appropriate.

Which Standard Should Be Applied?

Of course, until the -21 Standard is officially adopted, ASTM E1527-13 remains the applicable standard. Assuming the EPA revises its proposed rule to remove reference to the -13 standard, upon its adoption of the -21 standard, the -13 standard will become a historical one. Until then, there is no requirement that the -21 Standard be employed; however, it is the author’s preference that environmental professionals use and cite ASTM E1527-13, but ensure (and note in the report) that the Phase I ESA also satisfies the requirements of the -21 Standard.

This year, the American Bar Association has chosen “a more perfect union” as the theme for Law Day. In furtherance of this theme, the Business Law Section has asked attorneys to volunteer to talk about the rule of law in some forum. I am excited to be part of this conversation and to share some perspectives from the book Law and Poetry: Promises from the Preamble, which was published by the Association earlier this year. The book is an anthology that explores the themes presented in the Preamble to the United States Constitution. The anthology includes the work of poets from around the world.

In preparing the anthology, I had the opportunity to connect with many of these poets and to learn more about them. Cecil Rajendra was one of the poets who impressed me most. Mr. Rajendra is both a poet and an accomplished human rights attorney. Below, you will find his poem “The Dark Side of Trees,” together with some introductory information and a short biographical sketch that provides a little bit more information about Mr. Rajendra. This material is reproduced from the anthology.

This poem resonated with me for the way in which it emphasizes the responsibility we as individual citizens have to hold our government accountable. We are called upon to notice—and not to turn away—when our legal system and our institutions of government are threatened. In doing so, we help to uphold the rule of law, and, ultimately, we help to build a more perfect union.

The poem below was reprinted in the June 1984 issue of the International Commission of Jurists’ journal The Review. The ICJ is a non-governmental organization, founded in 1952 in Geneva, which is focused on international human rights. Mr. Rajendra’s poem followed updates on human rights throughout the world, from East Timor, to Haiti, to Japan, Pakistan, South Africa, and Western Sahara. As you read this poem, you might consider the world-wide applicability of its themes.

~ The Dark Side of Trees

Cecil Rajendra

The truth burns
so they turned
their faces away
from the sun . . .
When small liberties
began to fray . . .
When their constitution
was being chipped away
When their newspapers
were shut down . . .
When their rule of law
was twisted round . . .
When might became right
and their friends
Were carried off screaming
in the pitch of night . . .
They chose silence
feigned blindness
pleaded ignorance.
And now when the shadow
of the jackboot hangs
ominous over their beloved land
they walk as zombies
unable to distinguish right from
wrong from right
their minds furred with lichens
like the dark side of trees.
The truth burns
so they turned
their faces away
from the sun . . .

Cecil Rajendra is a poet, lawyer, and human rights activist who has lived by the mantra, “Seek out the little guy and help if you can.” He was born in 1941 in Penang, Malaysia and received his formal education at St. Xavier’s Institution, the University of Singapore and Lincoln’s Inn (London) where he qualified as a barrister-at-law. Throughout his lengthy and distinguished career, he has earned numerous distinctions in poetry, law, and human rights. As an attorney, in 1980 he co-founded the Penang Legal Aid Centre (PLAC), which was the first rural legal aid clinic in Malaysia. In 2000, he created Malaysia’s first-ever mobile legal aid clinic. For this work, Rajendra earned the Malaysian Bar’s 2019 Lifetime Achievement Award as well as the International Bar Association’s 2019 Pro Bono Award. As a poet, he has published dozens of volumes of poetry and was nominated for the 2004 Nobel Prize in Literature for his collection By Trial & Terror. His work has been published in more than fifty countries and translated into a number of languages. As a human rights activist, he has initiated campaigns against detention without trial and in support of an independent judiciary. He was awarded the first-ever Malaysian Lifetime Humanitarian Award in 2004, in recognition of both his outstanding work in law and his exemplary poetry; and in 2015 was declared a Living Heritage Treasure by the Penang Heritage Trust.

From Hour of Assassins and Other Poems by Cecil Rajendra. London: Bogle- L’Ouverture Publications, 1982.

I am always struck by the universality of the images and themes that Mr. Rajendra raises in this poem. Here are a few examples that come to mind:

When small liberties began to fray . . . . In St. Petersburg, Florida, where I live, the Florida Holocaust Museum has a permanent display that I have always found to be particularly important, as a lawyer, because it reminds me that the law can be used to cause great harm. This display includes a timeline showing how the laws in pre-war Nazi Germany were changed over a period of six years to disenfranchise, restrict, persecute, and isolate Jewish people. The first wave of what would ultimately be more than four hundred antisemitic laws and regulations was focused on restricting Jewish citizens from civil service and other aspects of public life.

When their newspapers were shut down. Thomas Jefferson recognized the importance of the free press to American democracy: “No government ought to be without censors: and where the press is free, no one ever will.” Even prior to the pandemic, more than twenty percent of the newspapers in the United States went out of business during the prior fifteen years, according to an article in the New York Times. In addition, the past few months have brought attention to the serious crackdown on independent media and access to online information in Russia.

When might became right and their friends were carried off screaming in the pitch of night. Every day, we read about individuals in Ukraine being forcibly deported to Russia. In our own country, more than one hundred thousand Japanese Americans were forced to leave their homes to be incarcerated in internment camps that were euphemistically called “relocation centers” during World War II.

These images—both historical and contemporary—are so bleak and so painful that sometimes, hope is in short supply. Mr. Rajendra reminds us that our hope is in not turning away, even when “the truth burns.”

In preparing this anthology, I found—and was inspired by—a number of examples, both historical and contemporary, of what not turning away might look like. Some of these voices come from the past and are quite famous: Elizabeth Barrett Browning denounced slavery at great personal and professional cost. Langston Hughes powerfully invoked images of crushing poverty. Edna St. Vincent Millay dared to suggest that “America the beautiful” could become an America that is “beautiful nowhere” if apathy toward the American “cause” continues to prevail. Other voices may be unfamiliar to many readers but are, thankfully, still with us: Naomi Ortiz and Stephen Lightbown are strong voices in the disability justice movement. John Brandi challenges us to see incarcerated persons as persons. Dee Allen requires us to reckon with homelessness through the eyes of a person who has experienced it.

As we continue to have conversations about what it means for us to strive toward “a more perfect union,” I hope some of these voices will serve to inspire and challenge you, as they have me.

Almost every bankruptcy practitioner has counseled a client who was on the receiving end of a complaint seeking to avoid a transfer as a preference.^[1] But one of the little-heralded aspects of the Small Business Reorganization Act of 2019 (SBRA)^[2] was an amendment to 11 U.S.C. 547(b) that places additional pre-suit burdens on trustees, debtors-in-possession, committees, or any other plaintiff in a preference case.^[3]

Specifically, Congress amended § 547(b) to include the italicized language below:

(b) Except as provided in subsections (c), (i), and (j) of this section, the trustee may, based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection (c), avoid any transfer of an interest of the debtor in property—

As Collier has noted, “it is unclear whether the ‘reasonable due diligence’ requirement is an element of the preference claim.”^[4] Since the SBRA became effective on 20 February 2020, a few courts have had an occasion to review what the new language means and how it affects the prosecution and defense of preference claims.

One of the first cases to consider this issue was Husted v. Taggart (In re ECS Refining, Inc.).^[5] The court found that the new language in § 547(b) “now requires that the trustee satisfy a condition precedent, i.e., reasonable due diligence and consideration of known or knowable affirmative defenses.”^[6] The court analyzed these conditions as having three prongs: “(1) reasonable due diligence under ‘the circumstances of the case’; (2) consideration as to whether a prima facie case for a preference action may be stated; and (3) review of the known or ‘reasonably knowable’ affirmative defenses that the prospective defendant may interpose.”^[7] The court also noted that the section “is silent on whether satisfaction of the condition precedent is an element or an affirmative defense and on whether satisfaction is a pleading requirement.”^[8] The court further noted that the due diligence requirement was in the same section which gave rise to the trustee’s substantive claims^[9] and that Congress had specifically laid the burden of proving the avoidability of a transfer at the feet of the trustee under § 547(g).^[10]

Accordingly, the court held that “due diligence and consideration of affirmative defenses, is an element of the trustee’s prima facie case.”^[11] Turning to the pleadings themselves, the court found that the trustee’s “use of pre-Iqbal/Twombly notice style pleadings and a very general nature of the allegations in the First Amended Complaint suggest a lack of pre-filing due diligence,”^[12] and that reasonable inferences did not suggest that the trustee had fulfilled the three prongs required by the new statutory language. Based on that and other deficiencies, the court granted the defendants’ motion to dismiss the trustee’s claim with leave to amend.^[13]

The court in Sommers v. Anixter, Inc. (In re Trailhead Engineering)^[14] took a slightly different path. In its motion to dismiss, the defendant contended that the complaint had no allegations regarding the trustee’s due diligence, or review of the defendant’s affirmative defenses, and therefore failed to plead all of the elements of a preference claim.^[15] The court found that it did not have to determine whether “reasonable due diligence” was an element of a preference claim because the complaint contained sufficient allegations.^[16] The court noted that the complaint specifically alleged that the trustee had examined documents including the debtor’s bank records, invoices between the parties, correspondence, and the operative contract.^[17] The trustee had also included a chart of the relationships between the relevant entities.^[18]

Accordingly, the court found that the complaint contained sufficient allegations relating to the trustee’s reasonable due diligence. So, while the court did not explicitly find that the new language created a new element, it nevertheless implicitly found that the complaint needed to contain sufficient allegations to satisfy the requirement.

The decision in Faulkner v. Lone Star Car Brokering, LLC (In re Reagor-Dykes Motors, LP)^[19] covered three complaints filed against separate defendants; all three defendants filed motions to dismiss, contending that the trustee failed to allege sufficient facts to carry its burden of “reasonable due diligence.” The court acknowledged that the SBRA was intended to deter the filing of abusive lawsuits.^[20] It also recognized the lack of clarity regarding the new requirement: “Whether the due diligence language creates an additional pleading requirement is unclear. But a trustee (or debtor-in-possession) must, in bringing a preference action, exercise due diligence and consider the party’s ‘known or reasonably knowable affirmative defenses under subsection (c).’ § 547(b).”^[21]

As to the first defendant, the court cited to Sommers and noted that the complaint at issue contained some allegations relating to that defendant’s prepetition relationship with the debtor.^[22] These allegations included “a description of the relationship between the Debtors and [Defendant] Lone Star—transport services on credit­—and details of the specific transactions….”^[23] The court declined to dismiss the complaint against that defendant because the “allegations—or lack thereof—do not reflect an abusive filing. Lone Star has not answered the suit; its affirmative defenses are unknown.”^[24] As for the other two defendants, however, the court noted that the complaint failed “to provide any information beyond conclusory allegations that the Trustee performed reasonable due diligence under the circumstances and that the transfers were for antecedent debt.”^[25] The court stated:

The transfers lack context—what kind of services or goods did either Earl Owen or Meyer Distributing provide? How were these business relationships structured? It appears the Trustee considered only what was reflected on a bank statement. Were these transfers on account of ordinary business practices, simultaneous value, a cash on delivery agreement, or was new value provided for these transfers? None of those questions can be answered with any certainty since there is no information in the complaints about the nature of these transfers.^[26] 

The court then dismissed the complaint against those two defendants, granting the trustee leave to amend.^[27]

Weinman v. Garton (In re Matt Garton & Associates, LLC)^[28] followed the Husted court’s reasoning and stated that “[a]rguably, the new due diligence requirement is an element of a preference claim under Section 547.”^[29] In the operative complaint, the trustee alleged he had: reviewed pleadings and conducted an informal interview with the defendant; listened to the defendant’s views on the litigation; conferred with counsel for the debtor’s bank (from which some of the transfers had been made on behalf of the defendant); reviewed the books and records of the debtor; subpoenaed bank and credit card statements and other materials; and, after the filing of the initial complaint, undertook additional investigation and requested additional documents after identifying new potential transfers.^[30] The court found that these allegations satisfied the trustee’s burdens under § 547(b).^[31]

In Insys Liquidation Trust v. Quinn Emmanuel Urquhart & Sullivan, LLP (In re Insys Therapeutics, Inc.),^[32] the court followed Sommers and Weinman and declined to rule on whether the revisions to the statute created a new element for preference claims. The court did find, however, that if the new statutory language regarding due diligence was an element, it was met by the trustee. Here, the trustee allegedly sent a letter to the defendant prior to initiating the complaint demanding return of the transfers at issue and invited the defendant to advise the trustee of its defenses; the trustee further alleged that, to the extent any defenses were presented, the trustee took them into account while also reviewing the debtor’s books and records.^[33]

The court in Arete Creditors Litigation Trust v. TriCounty Fam. Medical Care Group, LLC (In re Arete Healthcare LLC)^[34] also declined to decide whether due diligence is an element for a claim under 547(b); however, the court did note that if due diligence is an element, then the allegations in that particular complaint were insufficient.^[35] The court found that “[t]he Trust merely stated that it had performed ‘reasonable due diligence’, ‘investigat[ed] into the circumstances of the case’ and ‘[took] into account the Defendant’s reasonably knowable affirmative defenses under 11 U.S.C. § 547(c).’ The Amended Complaint also ‘acknowledges that some of the transfers might be subject to defenses.’”^[36] The court then dismissed the amended complaint, stating: “If due diligence is an element, merely paraphrasing the element will not satisfy Rule 8.”^[37]

Taken as a whole, courts have uniformly required trustees to allege facts reflecting their due diligence. This is likely to differ from case to case because some debtors have records that are in much better shape than others. Simply filing suit against every entity that received a check from the debtor in the last 90 days prepetition would be problematic under any of these cases; something more is now required. Whether that “something” is the minimally accepted allegation in Lone Star, or the more fulsome descriptions in Sommers and Weinman, may vary from court to court.

From the defense side, however, it is unclear whether the trustee’s obligation to conduct due diligence truly presents a new and fruitful line of defense on its own. The authors could not identify any cases where a defendant sought sanctions under Rule 11 for a trustee’s failure to allege due diligence. It is notable that only two of the three defendants in In re Reagor-Dykes Motors prevailed on their motion to dismiss; and in each of those actions, the trustee filed amended complaints that the defendants ultimately answered and filed motions for summary judgment. Neither motion, however, made any mention of the trustee’s duty to conduct due diligence.

It seems highly unlikely that “due diligence” alone could be the basis for a motion for summary judgment. Even if a court was inclined to grant summary judgment based on the trustee’s lack of due diligence, the court necessarily would have to be entering summary judgment on whatever grounds the trustee should have discovered but for its lack of due diligence. Ultimately, if defendants keep pressing trustees to meet this new burden, the real measure of its effectiveness will be how many adversary proceedings are not filed.

1. Jeff Kucera, Partner, K&L Gates LLP, Miami, Florida, https://www.klgates.com/Jeffrey-T-Kucera. Carly Everhardt, Associate, K&L Gates LLP, Miami, Florida, https://www.klgates.com/Carly-S-Everhardt. Frank Eaton, Of Counsel, Linda Leali P.A., https://lealilaw.com/attorney/frank-eaton/. ↑

2. For general information on the SBRA, please see https://businesslawtoday.org/2020/02/small-business-reorganization-act-big-changes-small-businesses/. ↑

3. For the sake of simplicity, this article will refer to all such parties as “trustee.” ↑

4. 5 MYRON M. SHEINFELD ET AL., COLLIER ON BANKRUPTCY ¶ 547.02A (16th ed. 2020). ↑

5. 625 B.R. 425 (Bankr. E.D. Cal. 2020). ↑

6. Id. at 453. ↑

7. Id. at 454. ↑

8. Id. at 455. ↑

9. Id. at 456. ↑

10. Id. ↑

11. Id. at 454. ↑

12. Id. at 458. ↑

13. Id. at 459. ↑

14. Case No. 18-32414, 2020 WL 7501938 (Bankr. S.D. Tex. 2020). ↑

15. Id. at *7. ↑

16. Id. ↑

17. Id. ↑

18. Id. ↑

19. Case No. 18-50214-RLJ-11 (Bankr. N.D. Tex. 2021). ↑

20. Id. at *6. ↑

21. Id. ↑

22. Id. at *7. ↑

23. Id. ↑

24. Id. ↑

25. Id. at *11–12. ↑

26. Id. at *12. ↑

27. Id. at *15. ↑

28. Case No. 19-18917 TBM, 2022 WL 711518 (Bankr. D. Colo. Feb. 14, 2022). ↑

29. Id. at *31. ↑

30. See id. at *31–33. ↑

31. Id. at *33–34. ↑

32. Case No. 19-11292 (JTD), 2021 WL 5016127 (Bankr. D. Del. 2021). ↑

33. See id. at *10, n.9. ↑

34. Case No. 19-52578-CAG, 2022 WL 362924 (Bankr. W.D. Tex. 2022). ↑

35. Id. at *29. ↑

36. Id. ↑

37. Id. ↑

Plenty has changed since January 2022, when we last examined developing trends in the SPAC market. Since then, the macroeconomic environment shifted dramatically due to rising inflation, increasing interest rates, and the war in Ukraine; the PIPE market collapsed; traditional IPOs dried up; and the SEC came out with a set of controversial proposed SPAC rules.

All these factors have led to a drastic slowdown in SPAC activity. We’ve seen more withdrawals, an increase in liquidations, longer SEC review periods, more extensions and delays, more lawsuits, more bankers scaling down their SPAC operations, more attorney fees to address market uncertainty, and more negative shifts in sponsor economics and target valuation.

Still, this is not the time to throw your arms up in frustration and jump off the SPAC ship; it’s a time to learn, examine, correct, and improve.

With these goals in mind, we’ve identified a few interesting trends that may inform current and future plans for our SPAC clients and friends.

1. The number of securities class actions is holding steady.

When it comes to SPACs, Securities Class Actions (SCAs) are the elephants of lawsuits. These suits are the heavy hitters in terms of time spent and defense costs incurred. They are what companies most look to avoid and what ultimately drive their decisions on Directors and Officers (D&O) insurance. We track them closely because they inform the terms and pricing in the D&O insurance market and the structuring of the D&O policies we offer to our clients.

 Despite a larger number of deals in the market, and taking into consideration the lag between the merger and the filing of the lawsuit, the number of these suits is holding steady as compared to 2021. If the current trend continues, the number of SCAs should be about the same this year as what we observed in 2021.

2. The likelihood of a SPAC getting hit with an SCA post-merger is also holding steady.

A common question we hear is about the percentage of all de-SPACs that get hit with lawsuits. According to our data, 16% of companies that went through a de-SPAC in 2020 and 14% of companies that went through a de-SPAC in 2021 have been sued so far.

Interestingly, if we look at companies that went public via a traditional IPO, about 3% of those that IPOed in 2020 and 5% of those that IPOed in 2021 were sued within the first year of the IPO. That percentage is significantly lower than the rate at which de-SPACed companies are being sued. This means that it is considerably more likely that a de-SPACed company will be caught up in an SCA in its first year out of the gate than a traditional IPO company.

Why? Increased negative media and regulatory attention on SPACs might have something to do with it. Rushed deals at the height of the SPAC craze in 2020 and 2021 could have contributed to a few colorful SPAC missteps. A new, lucrative avenue of activity for the plaintiffs’ bar could also be a reason.

SPACs have also been targets of many short sellers’ reports. Many of these reports spurred an SCA shortly after their publication. In 2021, thirteen of the thirty-three SCAs filed that year (40%) stemmed from a short-seller report. By mid-May of this year, five out of sixteen suits (31%) have been based on short-seller activity.

It is worth noting that while these suits have been filed against SPAC entities in larger numbers than in previous years—whether prompted by a short-seller report or not—few of them have gone far enough through the legal process to determine whether they have merit.

3. The SPAC’s team is named in two-thirds of SPAC lawsuits.

Although there have been instances of SCAs brought against SPACs prior to the merger, most are filed after the merger. Many of our clients ask whether the SPAC’s original team of directors and officers is home free (meaning out of danger of a lawsuit) once the merger is closed. The response to that question is usually not.

In fact, about two-thirds of the SCAs filed in 2021 and 2022 named directors and officers of the SPAC entity as defendants in the lawsuit. Here is where the tail (aka run-off) on the SPAC’s D&O insurance policy comes into play.

As many of our readers know, the insurance policy that covers the SPAC is claims-made in nature. That distinction means that if the policy is not in place when the lawsuit is filed and the claim is made, it won’t respond. Since many of the lawsuits are filed after the merger, terminating the SPAC’s policy at the time of the merger without electing tail coverage leaves the SPAC’s directors and officers exposed.

How often are they exposed? Two-thirds of the time. Here are the numbers.

4. RWI for a SPAC could lead to post-merger D&O enhancements/savings.

More and more SPACs are looking to address claims of insufficient or shoddy diligence through the representations and warranties insurance (RWI) policy placement process.

At its core, the RWI policy is designed to protect the buyer (in this case, the SPAC) against two things: (i) the seller’s (in this case, the target’s) breaches of reps in the merger agreement and (ii) the target’s fraud. However, a valuable side benefit of these policies, especially now that the number of SPAC cases alleging insufficient diligence is growing, is the insurer’s close examination of the SPAC team’s due diligence.

This second layer of diligence by a disinterested third party over the SPAC team’s diligence is important for at least two reasons. First, it either validates the SPAC team’s diligence process or points out potential problems that could be corrected and properly disclosed between the signing of the merger agreement and the close of the deal.

Second, it is conducted by an experienced underwriting team and their top-tier legal counsel, who are usually well versed in the industry of the target and very knowledgeable about the array of potential risks present in that industry.

Many SPAC teams have explored and obtained RWI policies in the last two years. Some of the deals that come to mind include the acquisitions of Utz, Opendoor, and Paysafe. And recently, D&O insurers have started taking note of teams and deals that are willing to go through the process of obtaining an RWI policy.

Like any additional vetting, diligence, or compliance process, the steps involved and the willingness of the team to go through them signal the maturity, veracity, and sophistication of the SPAC team and its acquisition target. All those factors reduce litigation risk and add to the comfort level of the insurer that is looking to insure the post-merger entity.

In fact, very recently, at least one of the leading SPAC D&O insurers, realizing the benefits of an RWI policy for a SPAC, has started to offer price reduction options on D&O premiums for SPACs that choose to obtain an RWI policy ahead of their merger. Additional D&O insurance breaks and better terms for the post-merger combined company may also become available.

Like the ever-evolving SPAC market, the insurance market for SPACs is also evolving and adapting. We are expecting to see additional new, creative solutions to SPAC risks before the year is out.

An earlier version of this article appeared in the Woodruff Sawyer SPAC Notebook.

We know it’s essential to keep as up to date as possible in the reps and warranties (RWI) market, which is both relatively small and rapidly developing.

This month we witnessed a very substantial drop in pricing as well as an equally substantial increase in the number of quotes and competitiveness of the market. In this article, we will update the data and look at emerging trends.

What New RWI Deal Activity in April Means Going Forward

Although the M&A market continues to flourish, we saw a drop in activity in the first quarter. That is entirely common in the M&A cycle, with the first quarter traditionally being the slowest. You will see below the Euclid Transactional submission rate analysis for the first quarter. This shows a marked decrease from 2021 last quarter but slightly above par with 2021 first quarter.

However, we do believe that around mid-March an air of hesitancy entered the market, which we believe is due to interest rate–related financing concerns and geopolitical instability. As reported by Paul Weiss, “March was the second consecutive month of decline in the number of transactions.” M&A at a Glance (April 2021) | Paul, Weiss (paulweiss.com)

Comparing Year over Year and Quarter to Quarter: An Historical View of Trends

The RWI Statistics

As we can see from the below data, the market has responded with alacrity to this change in conditions. While the activity may be on par with the first quarter of 2021, underwriters and markets ramped up in response to the growing activity last year and so face the level of activity in 2022 with more capacity and more staff.

Overall, the news was very good for our clients and those needing reps and warranties insurance. The average number of quotes went through the roof and the premium prices we are seeing are on par with the beginning of 2021, if not slightly more competitive.

The lowest quote we saw was 2.98%, a return to early last year in terms of pricing. Unlike last month this low number was not as much of an outlier as previously seen. We are pretty much in the 3.5–4.5% range for most quotes right now.

The average quote was down from 5.1% to 3.5% which is a substantial decrease and shows the market’s ability to quickly adapt to changing circumstances. To put this in context, if you bought a $10 million policy in March, you would have paid roughly $510,000, and if you bought that same policy in April, it was more likely to cost $350,000.

The average number of quotes went from just over four to ten per risk, showing the continued excess supply of underwriting capacity either due to reduced deal flow, increases in human capital, or new entrants to the market.

As we saw above, the lowest price came in at 2.98%, which is a significant drop. What’s just as noteworthy is that the highest pricing has also dropped from 5.9% in March to 4% in April, again a substantial saving for deals priced this month as opposed to the previous month.

Trends in RWI “Heightened Risk” You Should Know

Anyone experienced in the process of placing an RWI policy should be familiar with the areas of heightened risk listed on every NBIL. These are the deal-specific areas on which underwriters will focus during their review of the diligence conducted by the buyer’s team of advisors. Should diligence be lacking in one of these areas, underwriters will likely seek to incorporate an exclusion in the policy for that portion of the risk.

Ukraine and Russia continue to be an area of heightened risk. However, we have seen underwriters drop the blanket approach and focus on those deals where it’s likely to be an actual issue rather than wanting to dig deep on every deal.

Three Cases of RWI Litigation

Arbitration as the first port of call is standard in RWI policies. Litigation around RWI has historically been difficult to find. There are currently three active cases in the court system right now. They have been around for a while, but we think it’s worth exploring them a little.

The three cases are:

Novolex Holdings, LLC v. Illinois Union Ins. Co, Index No. 656825

This dispute centers around the seller’s knowledge of the intention of its third-largest customer to significantly reduce business. This is currently pending a decision on the Insured’s summary judgment motion.

You can find a more thorough analysis here: Novolex Case Brings Lessons On R&W Insurance – Lexology

WPP Group USA, Inc. v. RB/TDM Investors, LLC, Index No. 656825

This case centers on whether financial projections were misrepresented and is currently in discovery. It’s interesting to note that in the WPP case the insured had the right to decide between arbitration and litigation and chose litigation.

You can find a more thorough analysis here: WPP Grp. U.S. v. RB/TDM Inv’rs , 2021 N.Y. Slip Op. 30160 | Casetext Search + Citator

pH Beauty Holdings III, inc. v. Certain underwriters at Lloyd’s, case no 21-1586 BLS

This case centers on the failure to account for millions of dollars in promotion expenses, which resulted in an inflation of the purchase price.

You may find more details of the case here: PH Beauty sues insurers to cover losses of ‘inflated’ deal | Reuters

None of these cases are resolved at this point, and extensive discovery is expected. We, therefore, anticipate that unless a settlement can be achieved quickly or through arbitration, long-term disputes are likely to be the norm.

All relate to claims of more than $10 million. We would expect to see litigation come into play for higher limit claims and don’t see this trend moving down to smaller claims. All three cases relate either to the accuracy of financial statements or material customers. We hear from the market that claims around material customers are much more prevalent and rising recently. While this is not relevant to the above, we expect this cause of conflict to continue. Material contract claims are where we see Covid issues materialize in the sense that Covid is often the inciting incident leading to a failure of a supplier or the customer to be able to maintain existing conditions.

What does this mean for you? While these go through the courts, it will be interesting to see how this impacts the buyer’s desire to maintain the right to litigate in court, whether expressly or by remaining silent on venue options. We imagine insurers will resist, because by and large they want to arbitrate as the first port of call. In some cases, arbitration is the only method of dispute resolution.

Going Forward: RWI Trends to Keep an Eye On

The market has returned to early 2021 levels in terms of pricing and competition. We imagine this will continue into the foreseeable future as the war in Ukraine and domestic economics play out, affecting the M&A market and the number of submissions.

The market has come to terms with the Ukrainian situation far more nimbly than it did COVID-19 and we also expect this to continue.

We anticipate more negotiation and pressure on dispute resolution clauses and more diligence on material contract reps going forward.

An earlier version of this article appeared in the Woodruff Sawyer M&A Notebook.

On May 25, 2022, the Federal Trade Commission (“FTC”) filed in the U.S. District Court, Northern District of California, a Complaint against Twitter, Inc., and a Joint Motion For Entry Of Stipulated Order (signed by representatives for both parties), for civil penalties, permanent injunction, monetary relief, and other equitable relief. The primary underlying problem stemmed from Twitter’s allegedly deceptive use of account security data for targeting advertising: Twitter asked users to provide their phone numbers and e-mail addresses in order to protect the user’s account, and then Twitter profited by allowing advertisers to use this customer data to target specific users. As discussed below, Twitter, among other things, agreed to pay a $150 million penalty and agreed to stop profiting from its deceptively collected user data.

As alleged in the Complaint (¶27), “Twitter has prompted users to provide a telephone number or email address for the express purpose of securing or authenticating their Twitter accounts. … Twitter collected telephone numbers and email addresses from users specifically for purposes of allowing users to enable two-factor authentication, to assist with account recovery (e.g., to provide access to accounts when users have forgotten their passwords), and to re-authenticate users (e.g., to re-enable full access to an account after Twitter has detected suspicious or malicious activity). From at least May 2013 through at least September 2019, Twitter did not disclose, or did not disclose adequately, that it used these telephone numbers and email addresses to target advertisements to those users through its Tailored Audiences and Partner Audiences services.”

The Complaint references a 2011 FTC settlement Decision and Order concerning Twitter in which Twitter settled allegations that it had misrepresented the extent to which Twitter protected the privacy and security of nonpublic consumer information. That FTC Order, among other things, prohibited Twitter from misrepresenting the extent to which Twitter maintains and protects the security, privacy, confidentiality, or integrity of any nonpublic consumer information. Premised on that 2011 FTC order, the Complaint alleges (¶29): “More than 140 million Twitter users provided email addresses or telephone numbers to Twitter based on Twitter’s deceptive statements that their information would be used for specific purposes related to account security. Twitter knew or should have known that its conduct violated the 2011 Order, which prohibits misrepresentations concerning how Twitter maintains email addresses and telephone numbers collected from users.”

In addition to the $150 million penalty, the Agreed Stipulated Order provides, among other things:

• Prohibitions against Twitter misrepresenting its data collection purposes and practices.
• Limitations on Twitter of the use of phone numbers or e-mail addresses specifically provided by users to Twitter to enable account security features.
• Requirement of notices to consumers concerning “Twitter’s Use of Your Personal Information for Tailored Advertising” alerting them that Twitter misused phone numbers and email addresses collected for account security to also target ads to the consumers, and to also provide information about Twitter’s privacy and security controls.
• Requirement that multi-factor authentication options be made available to access the customer’s Twitter account. There are many other widely adopted industry authentication options that do not require the consumer to provide a phone number (e.g., authentication apps, security keys, etc.).
• Requirement that Twitter maintain a comprehensive privacy and information security program that protects the privacy, security, confidentiality, and integrity of certain personal information (“Covered Information” as defined in the Order, ¶B) from the customer (e.g., first or last name, geolocation information, e-mail address, phone number, photos/videos, Internet Protocol address, User ID, Social Security number, driver’s license or other government issued ID, financial account number, credit/debit information, date of birth, biometric information, any combination of the above).
• Twenty (20) years oversight by the FTC.

The bottom line is this FTC Stipulated Order should serve as a caution to businesses: (1) be crystal clear about the purposes for which they are requesting consumer information; (2) only collect such information consistent with applicable privacy laws; and (3) have strong internal compliance controls in place to ensure that the use of that information is limited to those lawful purposes.

© 2022 Alan S. Wernick and Aronberg Goldgehn.

Introduction and Process

The Loan Syndications and Trading Association was formed more than twenty-five years ago, and since that time its mission has been to create a fair, orderly, efficient, and growing corporate loan market that provides leadership in advancing and balancing the interests of all market participants. As part of that core mission, the LSTA’s legal team works to standardize agreements that are typically used by loan market participants. Over the years, the LSTA’s suite of documents has grown, and it currently stands in excess of 200 documents, all of which are available to members on the LSTA website.

The agreements in that library must, of course, periodically be updated to reflect the latest legal, regulatory, and market trends and developments. At times, the LSTA staff initiates a project to create or update one of the LSTA’s forms, and at other times, ideas percolate up from members. That is how the project to update the LSTA 2017 Form of Revolving Credit Agreement (the “Revolver”), which includes a letter of credit subfacility, arose. Once an idea is approved as a new project, the LSTA then works with one of its committees, comprised of interested members, to create or update a form. The process is typically lengthy because all members have a voice in the project. Once the committee has agreed to the draft, it is circulated as an Exposure Draft to all individual LSTA members (currently, about 25,000 people). At that stage, no substantive comments are expected, but often numerous questions about the form are submitted to the LSTA. After about approximately six weeks, the draft agreement is then published in final form.

Antitrust Concerns

As the LSTA is a trade association, LSTA staff are very aware of antitrust concerns as they work with members, many of whom are competitors in the loan market, to develop a new form, because the courts have deemed trade associations to be possible “hotbeds of conspiracy.” The antitrust laws are designed to ensure that business is conducted in an open, competitive atmosphere and that competition is not unreasonably restricted. The challenging aspect of complying with antitrust laws is that the general language in which the statutes are written does not specify the exact conduct that would be considered a violation. When the LSTA works to create a new form for members, it is well aware of these concerns and always bears them mind as the consensus-building process gets underway.

New members often query how we can create and agree on new forms without violating the antitrust laws. LSTA members are permitted to negotiate and even ultimately agree on the language in a finalized LSTA form and view the published language as acceptable. However, they are always free to negotiate that form for their individual deals. That is the key distinction, and that is why we can successfully standardize language and agreements for the market and not violate antitrust laws.

The Updated Revolver Letter of Credit Subfacility

The 2017 Revolver was the first complete credit agreement published by the LSTA. The real impetus to update that form came from an LSTA member who was also Chair of the American Bar Association Business Law Section’s Letters of Credit Subcommittee. Working closely with him and other LSTA members, the LSTA was able to agree on certain letter of credit–related modifications to the form. At the April 2022 CLE program on this topic presented at the ABA Business Law Section’s Hybrid Spring Meeting (now available for viewing as on-demand CLE), the panel explained the background as to how letter of credit subfacilities came to be included in syndicated revolving credit agreements and reviewed the modifications. Among other things, the modifications address a greater recognition of the role of the Issuing Banks as distinct from the Administrative Agent, Swingline Lenders, and Lenders, and emphasize the independence of letters of credit as separate from the credit agreement and other loan documents. The letter of credit–related modifications also include clarification of the availability of letters of credit for subsidiaries of the main borrower and provide express mention of the separate entity or branch separateness doctrine that treats branches of banks as if they were separate legal entities for certain purposes, including with respect to letters of credit.

LIBOR SOFR Transition

In addition, the LSTA form includes very important modifications to reflect the termination of LIBOR and the adoption of Term SOFR in the loan market. The form includes various options to allow for usage of spread adjustments for Term SOFR, when applicable and selected. Drafters have provided new definitions of Term SOFR and changes to operational provisions to reflect the rate change. Standard yield maintenance provisions, such as the breakage indemnity, increased cost provision, inability to determine rates section, and illegality provision, have been updated as a result of the usage of Term SOFR. Finally, the Term SOFR–referencing form includes updated benchmark replacement language (in the unlikely event that Term SOFR ceases or becomes non-representative).

This article is based on a CLE program that took place during the ABA Business Law Section’s Hybrid Spring Meeting 2022. To learn more about this topic, view the program as on-demand CLE, free for members.