Material adverse effect (MAE) or material adverse change (MAC) clauses are common in acquisition agreements, and yet until recently, no Delaware court has determined that a buyer had ever validly terminated a merger agreement pursuant to such a clause. That all changed on October 1, 2018, when the Delaware Court of Chancery in Akorn, Inc. v. Fresenius Kabi AG, a blockbuster, 246-page opinion, determined for the first time that such a clause was properly evoked.

Due to “overwhelming evidence of widespread regulatory violations and pervasive compliance problems” as well as the fact that target’s financial performance “dropped off a cliff,” the court ruled that a MAE occurred. Although the Akorn decision, as the first decision applying Delaware law that found an MAE warranting a buyer’s exercise of merger termination rights, may embolden future buyers to test the power of their own provisions, commentators are cautioning that the court decided Akorn based on extraordinary facts and that it awaits review by the Delaware Supreme Court.

MAC or MAE clauses appear in merger agreements in several locations. They may be embedded in a representation or warranty, appear as a condition precedent to closing, or sometimes even be a condition to exercise termination rights. Regardless of where they appear, merger agreements usually define the MAC or MAE vaguely as events materially adverse to the business of the seller. The intended purpose of these clauses is to protect the buyer against unanticipated changes in the target’s business between signing and closing.

Moreover, when buyers do try to evoke these provisions, they rarely proceed to litigation. The vagueness of the MAE and MAC provision itself provides incentive for the parties to negotiate and reprice the deal. After all, who knows what a court would hold? (Although with MAE’s and MAC’s judicial track record, one would think that this incentive would favor the target during negotiations).

When the MAE or MAC provision does come before a court determining whether a MAE or MAC occurred, the issue turns on “whether there has been an adverse change in the target’s business that is consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months.” Hexion Specialty Chemicals v. Huntsman, 965 A.2d 715, 738 (Del. Ch. 2008). The Huntsman standard has been historically tough to meet. In Huntsman itself, the seller’s six-month decline in EBITDA, repeated failure to meet EBITDA forecasts, and an increase in debt contrary to projections were all, even in totality, insufficient to meet the standard. It seemed like only a true catastrophe would lead a Delaware court to find a MAC or MAE clause correctly evoked.

Akorn was that catastrophe. Akorn’s conduct and financials were so bad that although the conclusion that an MAE occurred is unprecedented in Delaware, it was not surprising.

On April 24, 2017, Fresenius Kabi AG, a German pharmaceutical company, agreed to acquire Akorn, Inc., an Illinois pharmaceutical manufacturer. Fresenius agreed to buy Akorn in a $4.75 billion transaction, subject to the satisfaction of customary closing conditions. Akorn made the usual representations and warranties about its business and compliance with applicable regulatory requirements. Fresenius’s obligation to close was conditioned on Akorn’s representations being true and correct both at signing and at closing, except where the failure to be true and correct would not reasonably be expected to have an MAE.

Then, during the post-signing period, Akorn experienced consecutive year-over-year declines in quarterly revenue. Akorn’s operating income was down 84, 89, 292, and 134 percent, respectively, in the four quarters after it signed the merger agreement. Akorn’s revenue was down 29, 29, 34, and 27 percent, and earnings per share were down 96, 105, 300, and 170 percent. Akorn’s stock price dropped from $32.13 per share before signing to between $5.00 and $12.00 per share after signing. Commenting on Akorn’s financial decline, Chancellor Stine remarked:

Akorn’s dramatic downturn in performance is durationally significant. It has already persisted for a full year and shows no sign of abating. More importantly, Akorn’s management team has provided reasons for the decline that can reasonably be expected to have durationally significant effects.

Not only had Akorn’s financial situation “dropped off a cliff,” Fresnius soon also learned of serious deficiencies in Akorn’s data integrity processes. Dramatically, these issues were first identified in an anonymous whistleblower letter. Upon review of the letter, Fresnius performed its own investigation. Fresnius discovered that Akorn was “in persistent, serious violation of FDA requirements” and had “a disastrous culture of noncompliance.” The investigation by Fresenius also uncovered the possible use of fabricated data in Akorn’s FDA submissions. Additionally, as soon as the parties signed the merger agreement, Akorn had canceled regular audits, assessments, and inspections of known problems.

Upon these findings, Fresnius attempted to terminate the merger agreement. Akorn argued that the merger agreement should be specifically enforced. Fresnius counterclaimed, seeking a ruling that it properly terminated the merger agreement. The rest, as they say, is history.

The court determined that the unexpected and nonstop drop in Akorn’s business performance constituted a “general MAE” (that is, the company itself had suffered an MAE), and that because Akorn’s representations of regulatory compliance were not true and correct, the deviation between the as-represented condition and its actual condition would also result in an MAE.

Parsing the court’s analysis shows that a buyer claiming that a representation given by the target at closing fails to satisfy the MAE standard must demonstrate such failure, both qualitatively (i.e., the suddenness of the financial decline, whether in revenue or EBITDA, and/or the presence of factors suggesting “durational significance”) and quantitatively (i.e., the magnitude and length of the downturn). Merely showing qualitative failure without quantative failure, or vice versa, would not be enough given the court’s discussion in Akorn. Throughout the opinion, the court cautioned buyers in regard to evoking a MAE or MAC clause. The court emphasized the steep climb and heavy burden faced by a buyer in establishing an MAE or MAC.

The court reaffirmed that “short-term hiccups in earnings” do not suffice; rather, the adverse change must be “consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months.” Akorn’s data integrity problem was not directly relevant upon the court’s finding of a MAE, but it most certainly informed the court’s overarching conclusion that this was not a case of buyer’s remorse. The compliance issues in effect presented the qualitative failure the court was looking for.

As previously stated, the conclusion that an MAE occurred in Akorn was not that surprising given the facts, and although significant, the decision is unlikely to lower the already high bar to proving a MAC or MAE had occurred. Yet, Akorn importantly shows that, yes, such a bar could be met, and that MACs or MAEs are not mere hypotheticals over which lawyers spend hours negotiating. Moreover, Akorn provides some additional lessons.

Akorn tried to advance the argument that an MAE could not have occurred because the purchaser would have generated synergies through the combination, which would have generated profits from the merger. The court rejected this argument, finding that the MAE clause itself was focused on the results of operations and the financial condition of the target and its subsidiaries, instead of the results of operations and financial condition of the surviving corporation or the combined entity. The court determined that the MAE clause in Akorn carved out any effects arising from the “negotiation, execution, announcement or performance” of the merger agreement or the merger itself, including “the generation of synergies.” The drafting lesson learned is that buyers going forward should consider including express references to synergies in defining the concept of an MAE in their merger agreements.

Next, Akorn tried to claim that it faced “industry headwinds” that caused its decline in performance. Akorn pointed to heightened competition and pricing pressure as well as regulatory actions that increased costs. The court rejected this argument as well. However, the court’s rejection was not due to the argument itself, but rather the fact that evidence was provided showing that Akorn’s EBITDA decline vastly exceeded its peers. Presumably, if Akorn’s decline were similar to its competitors, the court would have accepted that Akorn’s failure was an industry-wide failure, which would not have been a MAE. The drafting lesson learned from this is that buyers should think of including “disproportionate effects” qualifications in MAE carve-outs with respect to industry-wide events.

Finally, less of a drafting lesson and more of a philosophical lesson, the court seemed to conceive of the MAE clause as a negotiating tool. The court delved into existentialism and examined why MAE or MAC clauses exist. Vice Chancellor Laster wrote:

Despite the attention that contracting parties give to these provisions, MAE clauses typically do not define what is “material.” . . . [P]arties find it efficient to leave the term undefined because the resulting uncertainty generates productive opportunities for renegotiation. . . . What constitutes an MAE, then, is a question that arises only when the clause is invoked and must be answered by the presiding Court.

The court essentially determined that MAE or MAC clauses exist in order to create incentives for both sides to reprice the deal and stay out of court. MAE and MAC clauses essentially recognize that mergers are less about strict legal rights and more about relationships. The drafting of a MAE or MAC should keep that in mind.

On October 1, 2018, two law school professors—Cynthia Williams of York University and Jill Fisch of the University of Pennsylvania—together with numerous institutional investors that collectively manage more than $5 trillion in assets submitted a petition for rulemaking to the Securities and Exchange Commission (“SEC”) calling for the SEC to develop a standardized comprehensive framework under which public companies would be required to disclose identified environmental, social, and governance (“ESG”) factors relating to their operations. 

The Petition

The petition represents the latest in a series of concerted efforts over the past decade to pressure the SEC to adopt mandatory disclosure requirements for certain ESG matters, which would bring the United States in line with the nearly two dozen other countries that require public companies to provide such disclosures to investors. In addition, seven stock exchanges already require ESG disclosures as part of their listing requirements, and many other countries, including the U.K. and Sweden, require public pension funds to disclose the extent to which the fund incorporates ESG information into their investment decisions.   

The petition references the SEC’s 2016 Concept Release that requested public comment on various potential disclosure reforms, including potential new requirements for disclosures related to sustainability, public policy, and climate change, and the comments responding to the questions about enhanced climate change. The petition also cites public comments to the Concept Release to support the need for a mandatory disclosure framework for ESG disclosures in SEC filings. The petitioners argue that the SEC has the express statutory authority to create ESG disclosure rules under Sections 2(b) of the Securities Act of 1933 and Section 23(a)(2) of the Securities Exchange Act of 1934, both of which provide that the SEC may engage in broad rulemaking that “promote[s] efficiency, competition, and capital formation.” Because ESG issues have potentially huge impacts on large swathes of the national economy, the petitioners posit that they implicate the ability of public companies to be globally competitive and to efficiently form capital. For example, the petitioners note that the Sustainability Accounting Standards Board (“SASB”) concluded that 72 of 79 industries, representing 93% of U.S. capital market value, are vulnerable to material financial implications from climate change.

The petition argues that ESG disclosures not only impact a large cross-section of the U.S. economy but are also currently the subject of a patchwork of poorly-organized corporate disclosures that magnify the burden on public companies while inhibiting the flow of useful information to the investing public. Leading institutional investors have noted that the inconsistent and haphazard nature of corporate ESG disclosures makes it difficult to compare and analyze this information for companies in the same industry. Michael Bloomberg encapsulated the concern of many such investors when he stated in his 2015 Impact Report:“[F]or the most part, the sustainability information that is disclosed by corporations today is not useful for investors or other decision-makers… The market cannot accurately value companies, and investors cannot efficiently allocate capital, without comparable, reliable and useful data on increasingly relevant climate-related issues.”

SEC Disclosure Framework

There is reason to be skeptical about any forthcoming ESG rulemaking from the SEC, at least in the immediate future. The adoption of specific rules governing ESG disclosures runs counter to the SEC’s long-standing principles-based disclosure framework which centers almost entirely on materiality. The Supreme Court defined materiality in TSC v. Northway, stating that information is material if it is information that a “reasonable shareholder might consider important” to his or her investment decision. In Basic v. Levinson, the Supreme Court held that the standard for materiality is whether a reasonable investor would have viewed the undisclosed information as having significantly altered the total mix of information made available. Materiality forms the core of information required to be disclosed in periodic filings and registration statements pursuant to SEC Regulation S-K. Therefore, unless a specific ESG issue is material to a public company’s investors, its disclosure would not be required under the current statutory framework and rules and regulations dictating disclosure requirements in filings with the SEC.

This deference to materiality is the approach previously applied by the SEC in 2010 when it published interpretive guidance on the issue of climate change. While this guidance provided some clarity around the types of issues that companies should consider when crafting their disclosures concerning climate change, the SEC ultimately left it up to the individual companies to decide what information should be disclosed on the basis of materiality. In the absence of a mandatory SEC statutory framework for reporting on climate change or other ESG metrics, a number of other reporting frameworks have been used by U.S. public companies to report certain ESG metrics on a voluntary basis. As a result, disclosures vary greatly within each industry, with some opting to make limited ESG disclosures in periodic reports, while others issue stand-alone sustainability and corporate social responsibility reports (“CSRs”). For example, while some oil and gas companies disclose a proxy carbon cost estimate that factors in the anticipated costs of future regulation related to the extraction, transportation, and refinement of hydrocarbons, there is no uniform methodology for calculating such estimates, and companies report a wide range of different metrics which are difficult to compare.  

The petition asks the SEC to develop a “comprehensive framework for clearer, more consistent, more complete, and more easily comparable information relevant to companies’ long-term risks and frameworks” to provide clarity on ESG reporting for U.S. public companies; additionally, the petition argues that ESG disclosures should be required under the existing SEC reporting framework because such disclosures are per se material to the decision-making of investors. The petitioners cite a litany of recent reports and analyses performed by top-tier investment banks, research institutes and scholars that suggest that ESG information is material under the existing case law interpreting the materiality standard and form the type of information that a reasonable shareholder would consider important when making investment decisions. The petition also notes the substantial amount of capital—$64.8 trillion—managed by investors that are committed to incorporating ESG factors in their investing and voting decisions under the United Nations Principles for Responsible Investment and growing investor interest in non-financial information across all sectors as further support for specific ESG disclosure requirements.

A decision by the SEC to create specific rules for ESG disclosures would not be entirely unprecedented. In 2011 and 2018, the SEC issued interpretative guidance related specifically to cybersecurity that went beyond the standard materiality analysis in response to increased investor concerns on disclosure of cybersecurity risks. This is an example of the SEC maintaining materiality as its key principle while providing specific guidance on an issue that it believes is per se material to investors. Accordingly, it is possible that such an approach could be applied by the SEC to require disclosure regarding certain ESG issues.

However, given the current political climate, the SEC is unlikely to initiate a special rulemaking process addressing ESG disclosures. Although key issues such as sustainability and global climate change remain at the forefront of many investors’ minds, it is no secret that the Trump administration does not consider these top policy priorities. Recent actions such as withdrawal from the Paris Climate Agreement and repeal of the Clean Power Plan make it clear that the current political environment may not be favorable for enhanced ESG disclosures. Comments from SEC commissioners and staff since the filing of the petition also indicates that specific ESG rulemaking is unlikely to happen any time soon and that the SEC will continue to evaluate the need for specific ESG disclosures by public companies based on the standard of materiality.

Practical Guidance

In the absence of additional SEC guidance, as companies look to the future and consider the adequacy of their own disclosures, it is paramount to consider the material risks relating to ESG factors on the operations and financial results of the company. ESG issues will continue to prove important to both investors and regulators. Whether or not the SEC responds to this particular call for rulemaking concerning ESG disclosures, the impact of global climate change and related issues are not going away. One market report estimates that the number of investors who fully integrate ESG into their investment process are managing more than 10% of the shares in listed companies globally, and that this percentage is above 50% when investors that consider some aspects of a company’s ESG performance are included. Investor support for ESG shareholder proposals, particularly environmental and social proposals, also continues to rise. Only days after the petition was submitted to the SEC, the United Nations Intergovernmental Panel on Climate Change released a major new report warning that global temperatures could reach an irreversible tipping point as soon as 2030. And in late fall 2018, Senator Elizabeth Warren introduced the Climate Risk Disclosure Act of 2018, which would require public companies to disclose a substantial amount of new climate-related information in their SEC filings. While this legislation is unlikely to pass during the Trump administration, private ordering may still result in enhanced ESG disclosures on a company-by-company basis even without legislation or SEC rulemaking action.

In the wake of the petition and given the current environment, public companies should evaluate their current sustainability and CSR reporting as well as their SEC reports to avoid pitfalls.

• Carefully review sustainability and CSR reports, website disclosures, and other materials prepared for investors to ensure that these materials do not conflict with prior disclosures or internal analyses. Any discrepancy may form the basis for a lawsuit, as in the recent high-profile case brought by the New York State Attorney General against Exxon alleging that it essentially kept two separate sets of books when accounting for the potential impacts of climate change.
• Similarly, review SEC filings and other public statements for consistency with sustainability and CSR reports and other public statements on ESG factors. A company’s SEC filings should address all material risks to the company’s business, including ESG-related risks. The anti-fraud provisions of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder prohibit companies from making any untrue statement of material fact, or failing to state a material fact necessary to make a statement not misleading, and the anti-fraud provisions apply to all corporate communications, and not just SEC filings. 
• Review the company’s process for preparing sustainability and CSR reports. The need for public companies to maintain effective disclosure controls extends beyond the corners of the company’s SEC filings. Ensure that legal, operations, and all other internal stakeholders who collect data and respond to requests for information or questions on ESG topics are represented in the review process.
• Verify the data in sustainability and CSR reports, particularly specific statistics (such as carbon or greenhouse gas emissions or targets) contained in such reports. Sustainability and CSR reporting documents should be vetted through internal audit or some other independent fact check process to guard against inadvertent errors that may give rise to claims if investors rely on the inaccurate data in making an investment decision.

Conclusion

The petition for ESG rulemaking is the latest in a series of efforts to require mandatory ESG disclosures for U.S. public companies. While it is unlikely that the SEC will act on the petition, given the focus on ESG factors by investors in the current environment, companies should carefully review their ESG voluntary reporting and SEC filings under the lens of the heightened investor scrutiny on ESG issues to minimize potential liability under the federal securities laws.

Planning for the sale of a business must extend beyond the close of the actual transaction. Preparations must be made to simplify the resolution of disputes that could arise between buyers and sellers. Litigation in connection with the sale may occur over a variety of reasons, including breaches of the seller’s representations and warranties, or determining post-sale milestones that trigger contingent purchase price payments. The most common post-sale dispute, however, involves determining the working capital of the sold business. The difference between a buyer’s determination of working capital at closing and the amount perceived by a seller is often tens or hundreds of thousands of dollars. The poster child for the importance of this issue is the 2015 dispute between Westinghouse Electric and Chicago Bridge & Iron, where the dollar differential was in excess of $2 billion. Litigation lasted over two years.

To operate a business in its traditional manner, whether the sale of the enterprise is an equity or asset sale, all buyers expect that the business will be left with sufficient working capital to operate on a day-to-day basis. The parties must recognize that a business is not a stagnant creature. Every day, products are shipped, receivables are collected, and invoices are paid. The sale price should not be affected by the happenstance of a day’s collection of receivables or that the closing occurs the day prior to the weekly check run. The absolute value of the business doesn’t change; therefore, neither should the purchase price.

In planning for the sale, the parties should agree on what is a normal working capital amount, as well as the elements of working capital. Working capital generally consists of accounts receivables, inventory, and other current assets less accounts payables, accrued payroll, customer deposits, and other current liabilities. Cash is generally retained by a seller, even in equity sales. Accordingly, cash is excluded from the working capital calculation.

The parties often average the month’s ending working capital amount over a six- to twelve-month period. The seasonality of a business may necessarily be factored into account. Further, in a fast-growing business, a working capital target based on anticipated growth may be more appropriate than one based on historic performance. This is especially true if the purchase price is primarily based on anticipated future revenues or profits. The parties agree that if the actual working capital is over the predetermined amount, the buyer will pay the difference. However, if the actual working capital is below the target, the purchase price is reduced. Recognizing that working capital will change daily, rather than agreeing on a fixed number, parties may agree on an average range. This eliminates the need for a seller to micro-manage the business in the days preceding the sale. Moreover, it may also negate a seller’s tendency to accelerate the shipment of product to a date before closing and convert inventory into higher-valued receivables. For example, if the range is between $1 million and $1.2 million, then a price adjustment occurs only if the actual number is above or below the range.

In many instances, a buyer in an asset transaction will not want to acquire any liabilities (other than contracted obligations for future performance). In those instances, the working capital adjustment will look only at current assets. In some instances, however, a buyer may assume vacation and sick-day accruals to employees. Otherwise, although the seller may make these payments at closing, when the employee takes the time off, there will be no payments to him or her, potentially creating an employee morale issue.

In setting both the working capital target and the closing date working capital amount, it is critical that the parties utilize the same measurements. Measurements utilized by the seller in its operation of the business are often not used by the buyer in determining the closing date amount. To illustrate, a buyer will insist on utilizing GAAP accounting practices. These rules would impose bad-debt reserves and/or inventory reserves for slow-moving or obsolete items that were not factored in setting the target number. Many private or small businesses do not utilize such reserves. The inclusion of these reserves would then artificially reduce the purchase price amount where there has been no true change in the business. Other adjustments may be proposed by a buyer that depart from the practices used by a seller. On the other side of the equation, if a buyer accepts that there will be no bad-debt reserve, the seller may be asked to guaranty collections. If a receivable isn’t collected within, for example, 90 days from closing, the seller will pay the buyer the receivable amount, and the receivable is transferred back to the seller.

I have found it extremely useful to include as an exhibit to the purchase agreement an example of working capital as of a prior historical date and a statement that the closing date working capital must be determined utilizing the exact same accounting principles as were used in determining the example’s working capital. The example may also show all categories of current assets and current liabilities used in the calculation, even if the dollar amount in a category in the example is zero. By listing all categories, disputes are eliminated as to whether a current asset or liability is to be included.

Once the buyer prepares the closing date working capital statement, the seller generally is given 20 to 30 days to review the statement. If the seller agrees with the conclusions, the closing adjustment amount is paid either by the buyer (if the working capital target is exceeded), or by the seller (if there is a deficiency). If the seller disputes these calculations, the buyer and seller generally are provided a few weeks to see whether they can resolve the dispute themselves. If they can’t, the matter should be referred to a neutral accountant for resolution.

Due to the nature of the conflict, a working capital dispute is best resolved by an accountant rather than by a judge in a lawsuit or by an arbitrator. Restrictions are often placed on the accountant to decide wholly in favor of one side or the other on individual matters and not to try and mediate a compromise. Selection of the accountant should be made before a dispute arises, and the name of the independent accountant should be specified in the purchase agreement. Accountant fees can be either split equally between the parties, or paid by the party who fails to prevail in the dispute resolution.

Finally, sellers must be aware that, similar to a holdback or escrow utilized by buyers to protect themselves against breaches of the representatives and warranties, buyers generally want a short-term holdback or escrow for the working capital adjustments. Buyers generally do not want to chase sellers for monies owed. If there is already an escrow established for the buyer’s benefit for breaches of representations or warranties, then including the working capital holdback should not be an issue. However, if there is no existing escrow, then a short-term holdback is likely more cash efficient.

As noted at the beginning of this article, controversies on working capital adjustments are the most common dispute between buyers and sellers. Careful planning in the purchase agreements can greatly diminish such issues.

In-house counsel is responsible for advising internal clients on a wide variety of risks associated with day-to-day business operations, including the insolvency and bankruptcy of a business partner. These risks are inherent—and often hidden—in nearly every transaction. It is important that in-house counsel is familiar with certain fundamental bankruptcy concepts to effectively counsel their business teams and, if at all possible, mitigate those risks. Among the most common insolvency and bankruptcy concepts are the scope of the automatic stay, the treatment of executory contracts (assumption and rejection), “free and clear” asset sales, fraudulent conveyances, and preferences. Counsel can address the uncertainty associated with these concepts by following the five simple rules set forth below, each of which allows in-house counsel to educate their business teams, set appropriate expectations with stakeholders, and improve documentation, and all of which lessen the impact of an insolvency event or bankruptcy case.

Five Bankruptcy Risk Factors to Consider with Each Transaction

1. Automatic Stay

Know the impact of the automatic stay on property rights. When a party (a debtor) files for bankruptcy, the filing automatically triggers an extremely broad stay provision. Under 11 U.S.C. § 362, an automatic stay immediately enjoins the commencement (or continuation) on any process or action against the debtor or its assets. Analyzing the consequences of the contract being stayed at each phase of performance will help you assess the risks associated with the agreement. For example, (a) if your contract requires notice, you may be stayed from giving the notice; (b) if the counterparty has property of yours in its possession or has knowledge (e.g., provides operational support) critical to your operations, you may be unable to quickly gain access to the property or force compliance with the agreement or turnover of the critical information; (c) you will be unable to sue to enforce your rights; and (d) you may be unable to stop performance. Analyzing the consequences of the contract being stayed at each phase of performance will also allow you to consider whether there are means for mitigating the risk. Counsel should consider mitigating the company’s risks by establishing mechanisms that are enforceable in the event of a bankruptcy and are outside of the scope of the automatic stay, including certain automatic triggering events that do not require pre-notice, escrow agreements, letters of credit, and rights against guarantors.

2. Treatment of Contracts in Bankruptcy

In bankruptcy, with very limited exception, a debtor has the right to reject, or assume and assign, a contract. The decision to reject or assume a contract often does not occur until plan confirmation, creating uncertainty for the contract counterparty.

Rejection. Know how to protect ongoing business operations if a contract is rejected. Outline each phase or provision of the contract and consider what happens if the contract counterparty files bankruptcy and rejects the contract under 11 U.S.C. § 365. For example, although suppliers often consider the risk factors associated with a customer filing bankruptcy and failing to pay, customers that rely on the supplier for critical materials or information often do not give equal weight to the possibility that the critical supplier could reject the contract. This can be particularly disruptive when the customer relies heavily on the specialized knowledge of the supplier or holds confidential or proprietary information critical to the customer’s operations. If the contract is rejected, the customer may be forced to seek alternative services, providers, and other resources to operate its business without the ability to enforce transition service provisions and purchase options. A grant of security, escrow agreements, and letters of credit can mitigate the risks associated with rejected contracts.

Assumption and Assignment Rights. Know how an assigned contract may impact business interests and proprietary information. Under 11 U.S.C. § 365, a debtor also has the right to seek to assume a contract for its own continued performance, or assume and assign a contract to a third party. Although the debtor may assume or reaffirm its obligation under the contract, the debtor/assignee must cure any outstanding payment defaults as well as provide adequate assurance of the assignee’s ability to continue performing under the contract. Counsel should consider a debtor’s right to assign the contract to a competitor or a third party and whether a termination provision will be effective to protect those proprietary interests. This is an inherent risk and one difficult to protect against at the outset of a relationship, but may be worth a warning to the business team as a risk factor. In some circumstances and jurisdictions, a debtor cannot assume or assign a license without the licensor’s consent. Well-crafted termination and assignment provisions in license agreements may allow the licensor to obtain greater protections than an ordinary vendor. Fortunately, there are processes and notices that must be given, which will afford the nondebtor counterparty an opportunity to evaluate the effect of the proposed assumption and consider whether there are protections available before the contract is assumed.

3. Sales “Free and Clear”

Know how to protect your interests if the debtor intends to sell your property. 11 U.S.C. § 363 allows the debtor to sell its assets (which can include all assets as a going concern) “free and clear” of existing liens, claims, and encumbrances (commonly referred to as “363 sales” in chapter 11 cases). An order approving a 363 sale typically contains numerous “bells and whistles” that will further protect and benefit the purchaser while at the same time potentially jeopardizing the interests of the nondebtor, including loss of a real property interest (tenant lease rights) and lost or delayed recovery of personal property interests critical to business operations (molds, plans, and specifications). For this reason, 363 sales can be both a benefit and a curse. Buyers interested in purchasing assets can often better insulate themselves from some risks inherent in purchasing from a distressed seller. For entities doing business with a debtor whose assets are sold in bankruptcy, it is critical to obtain advice on how the sale may impact your interests and determine whether proactive measures must be taken. Some courts have held, for example, that real property could be sold “free and clear” of leasehold interests. As a result, tenants who thought they could rely on a notice provision associated with assumption or assignment of leases in a bankruptcy suddenly find themselves out in the cold. In addition, if the debtor holds your proprietary information, you may find that the debtor is selling that information to a competitor. Suppliers to the debtor often agree to enter into new contracts with the purchaser and afterward learn that they are now subject to claims by the selling debtor. Had the supplier been proactive, it might have arranged to protect against those claims in the sale process. Counsel should consider whether a properly perfected security interest would improve the business’s controls over its interests. Counsel should also be aware that, under most circumstances, it will be unable to prevent the sale of property, but that other means of protecting interests, like termination rights, might be effective even after a sale is consummated.

4. Fraudulent Conveyances

Know the indices of fraudulent conveyances/transfers when assessing a prebankruptcy asset purchase. A transfer for less than reasonably equivalent value made while the transferor was insolvent or caused it to become insolvent may be subject to later claims for recovery of losses associated with that transaction under 11 U.S.C. § 548. In-house counsel should be cautious when a deal sounds too good to be true and weigh the risks against the business goals. Specifically, counsel should be aware that in the event the counterparty to a transaction later files bankruptcy, prior transactions with that entity might be closely scrutinized. Be mindful that creditors’ committees and trustees may obtain broad authority from a bankruptcy court to examine transactions involving a debtor and determine whether actions prejudicial to creditors (whether by wrongdoing or otherwise) have occurred. For example, what if your company pays or provides value to the “wrong party”? In that instance, your company purchases assets from company “A,” but the owner of company A asks you to transfer the purchase price to the related company “B.” This transaction will almost certainly be scrutinized by a committee or trustee. As a result, one should always consider whether the “right party”—the entity that provided the value—is paid. Another indicia of concern is if the deal sounds too good to be true, it may be. Assume, for instance, a company is in financial trouble and begins selling noncritical assets and is desperate for cash, and your company is keen to buy the undervalued asset (a “great deal”). In-house counsel will be wary of interfering with the deal, but if one or more of the indices of a fraudulent transfer are present, discuss the potential risks with the deal team and allow them to make an informed business decision. Also consider options for reducing risk, such as obtaining a fairness opinion from a third-party expert to evaluate the value of the asset and the price to be paid. The business team should also be advised to conduct diligence carefully with respect to indemnified claims to ensure that any indemnity is funded to an escrow with a financially stable third party pursuant to a negotiated escrow agreement. Another option is considering whether it is feasible and beneficial to purchase through a 363 sale, discussed above.

5. Preferences

Know how to make informed decisions about preference risks and mitigate the impact on the business. A preference is a payment or other transfer of value of the debtor that may be subject to avoidance (clawed back) under 11 U.S.C. § 547. For noninsiders to the debtor, a payment made by an insolvent entity 90 days before the bankruptcy case is filed (or 120 for “insiders”) on an “antecedent debt” is subject to claw-back provisions as part of the bankruptcy process. In-house counsel often ask whether they should accept such payments or transfers even if they are likely to be avoidable as a preference; the short answer is “yes.” It is almost always advisable to take the money and use it as leverage in the event a committee or trustee seeks to recover the transfer. Although there are defenses to preference claims, asserting defenses can be costly, both in the value of time spent by in-house counsel and the business teams, and in attorney’s fees. Consider strategies to avoid preference exposure altogether. For example, payments received in advance of providing goods or services are not subject to preference recovery because they are not payments on an antecedent debt. Conversely, a prebankruptcy settlement may seem innocuous, but the payments are, by their nature, almost always susceptible to attack. Structure the settlement agreement so that unless and until the last payment is made and 91 days has passed, no claims or consideration are released. As with other bankruptcy risks, establishing protections in advance of bankruptcy filing, such as letters of credit, security interests, or guarantees, can mitigate against the potential pecuniary loss associated with preferences.

By familiarizing yourself with these five fundamental bankruptcy concepts, you can counsel your business teams and mitigate those risks, if not eliminate them. A practical guide for spotting and analyzing these issues follows.

PRACTICAL GUIDE FOR ISSUE SPOTTING AND PRACTICE POINTERS

1. Automatic Stay and Rejection rights: Consider each “phase” of the contract and consider what happens if the contract counterparty files bankruptcy and the automatic stay takes effect and/or the contract is rejected.

(a) Examples of automatic stay considerations and warnings:

(i) All actions against debtor or its assets including the right by the nondebtor party to send notices to terminate the contract will be stayed.

(ii) Creditor will not be able to recover property in the debtor’s possession without relief from the court.

(iii) If written notices are required in order for parties to implement rights or interests, the stay will likely prevent the notice from being sent.

(b) Example of impact of rejection warnings:

(i) Transition service provisions may not be protected.

(c) Will the party be in possession of property rights or knowledge critical to your ongoing operations?

(i) Can you mitigate risks through an escrow?

(ii) Note: in context of licenses, escrow of source codes help, but often you need much more information in order to make use of the source code. Passwords/subsupplier/other operational info.

(d) Purchase options may be terminated.

(e) Debtor’s assets can be sold free and clear of all interests.

2. Assignment rights: Consider Debtors right to assign the contract to a competitor.

3. Fraudulent conveyances:

(a) Does the deal sound too good to be true? Why is that?

(i) Fairness opinions. Although not dispositive, a fairness opinion is considered by many courts to be strong evidence of value that can be considered.

(ii) Due diligence regarding seller solvency?

(iii) Strong arms-length proofs?

(b) Is the entity entering into the transaction (e.g., a sale transaction) the recipient of the value for the transaction? For example, is the purchase price directed to be made to an entity other than seller?

(c) Indemnified claims: Advise potential purchasers to conduct diligence carefully with respect to indemnified claims to insure that any indemnity is funded to an escrow with a reputable, financially stable third party, pursuant to a negotiated escrow agreement.

(d) General warning: If counterparty to transaction files, there is always a risk that the purchase will be investigated. Bankruptcy Rule 2004 permits extensive discovery of third parties, which can quickly become time-consuming and costly.

(i) Discovery can include depositions, written discovery, and production of documents.

(ii) Rule 2004 was intended to provide opportunities for “discovering assets, examining transactions, and determining whether wrongdoing has occurred.” Washington Mutual, 408 B.R. 45, 49 (Bankr. D. Del. 2009) (citing In re Enron Corp., 281 B.R. 836, 840 (Bankr. S.D.N.Y. 2002)).

(e) Mitigation of risk through bankruptcy sales. Should a purchase of seller’s assets through a bankruptcy sale be considered?

(i) Purchasers acquire assets free and clear of existing liens, claims, and encumbrances.

(ii) A sale in bankruptcy is subject to higher and better offers and the approval of a bankruptcy court nullifying fraudulent conveyance risk to a good-faith, arm’s-length purchaser.

(iii) Sale orders typically contain numerous “bells and whistles” that further protect and benefit purchasers.

(f) Note: Clients often ask whether they should take the money even though it may be subject to preference exposure. Most often the answer will be to take the money. Better to have been paid and have to give back then never to have been paid at all.

(g) Payments under a settlement agreement likely constitute prima facie preference payments, and a debtor or trustee in bankruptcy is likely to seek to avoid payment.

(h) Are there ways to mitigate risk? Think:

(i) Payments in advance

(ii) Guarantees

(1) Bankruptcy typically does not preclude a party from seeking to enforce its rights against a nondebtor third party, such as a parent entity, an affiliate, or individual owners.

(2) Guarantees are only as valuable as the guarantor giving them. Often entire enterprises (related entities) seek protection simultaneously in a jointly administered proceeding.

(3) There is a risk that an avoidance action could be brought to recover payment by insolvent guarantors (preference or fraudulent conveyance discussed below).

(4) Upstream guaranty payments are typically more susceptible to challenge than downstream.

(iii) Letter of credit (LC):

(1) Note: given that an LC is issued by a third-party bank, the automatic stay is not implicated, and the creditor may go directly to the LC issuer to be made whole.

(2) An LC is only as good as its language for the draw down.

(3) Carefully watch LC expiration provisions and try to set up notification system.

(4) Supply agreement should either expire prior to LC, or contain default provisions conditioning continued performance requiring LC’s maintenance (but if the contract is not terminated, the prepetition stay will likely prevent termination).

(iv) Security interests: Note: A security interest granted in the 90 days prior to bankruptcy on an antecedent debt will be subject to avoidance actions but generally better to take than not to take.

(v) Shorten credit terms (may minimize overall exposure depending on timing, but can destroy ordinary course defense).

(vi) Is it a commodity sale agreement and can it be formed as a forward contract? Seek front-end documentation bankruptcy consulting advice if you may fall into this business category for sales.

(vii) Retention of title until xyz occurs.

(1) Consider whether a purchase lease back/escrow of critical manufacturing items such as IP and manufacturing “know how” will help.

(2) Needs to be properly documented and monitored.

(3) Automatic stay will still prevent removal of property from debtor’s possession and thus creditor must seek relief from the stay.

(i) Assumption of contracts: Given that a debtor must cure monetary defaults in order to assume the contract, the debtor would have had to pay the supplier “in full.” Therefore, the prepetition payments to the creditor should not be considered a preference.

(i) Often the debtor or the purchaser of debtors assets seek to enter into new amended contracts upon the sale of debtor’s assets or emergence of debtor from bankruptcy. Often this is because the goal is to avoid paying the supplier in full. Warn clients at outset of bankruptcy case not to agree to new contract. Often sales team trying to sell to “new company” is unaware of desire of in-house counsel to have contract assume. Instead of entering into a new contract, suppliers should attempt to require assumption and amendment of the contract and waiver of cure amounts (negotiate the cure if the issue is the cure payment) rather than entering into a new contract.

(j) Earmarking: Payment made by a third party that is specifically designated as a payment of the debtor’s antecedent debt.

(i) The transaction should not negatively affect the debtor’s balance sheet, for example, by replacing an unsecured obligation with a secured obligation.

(ii) Involves a number of complex bankruptcy issues. Bankruptcy counsel should be consulted if client intends to receive an “earmarked” payment from a third party.

(k) Settlement agreement practice pointers and preferences:

(i) Preserve the claims being released for at least the 90-day preference period:

(ii) Springing release. Delay the reduction and effectiveness of any release of claims (and the dismissal of any pending litigation) until 91 days after the last payment is made and no insolvency proceedings filed.

(iii) Preservation of the claim: Provide for the preservation and reinstitution of the full amount of the client’s claim in the event any claw back is sought.

(iv) Escrow: Can be helpful in some circumstances (e.g., parties agree to mutual releases and X agrees to transfer an asset in exchange for Y payment).

I. Overview of the Attorney-Client Privilege and the Work Product Doctrine

Most attorneys are familiar with the basics of the attorney-client privilege, the attorney work product doctrine and attorney ethics rules to maintain client confidentiality. Although these precepts are governed by the law of the jurisdiction, the general protections are similar regardless of the jurisdiction.  The attorney-client privilege protects communications between a client and an attorney when the communication was made for the purpose of the client obtaining legal advice.[1] The work product doctrine generally prohibits discovering documents and other tangible items that were prepared in anticipation.[2] Attorney ethics rules require lawyers to keep confidential communications with their clients.[3]

It is particularly crucial to identify and protect these privileges when a client is under investigation by the government whether that investigation is a criminal or regulatory matter or a congressional investigation.  Privilege is treated differently in the context of congressional investigations. Recent developments illustrate the importance of being aware of privilege considerations at every stage of an investigation.  With the change of power in the U.S. House of Representatives after the 2018 midterm elections, congressional investigations and oversight hearings likely will thrive –  requiring corporate counsel to focus on the applicability of privilege in congressional investigations. Either way, it is important for both internal and external corporate counsel to be aware of and maintain these protections.

II. Government Investigations – Recent Developments

Recent court decisions and governmental guidance continue to shape the parameters of privilege in government investigations, and the considerations outside counsel should make and discuss with clients before and during investigations.  First, a recent decision in a United States Securities and Exchange Commission (“SEC”) investigation found waiver of work product privilege where information was shared with the government during the course of an investigation.^[4] 

In 2012, General Cable Corporation (“GCC”) retained Morgan Lewis & Bockius (“Morgan Lewis”) to advise on accounting issues.  Morgan Lewis conducted an internal investigation, and informed the SEC of the investigation.  As part of the SEC discussions, Morgan Lewis gave an oral briefing of witness interviews it conducted during the internal investigation.  GCC settled with the SEC in December 2016 and shortly thereafter, the SEC filed suit against three former GCC directors.  These directors attempted to subpoena Morgan Lewis documents relating to the internal investigation.  Morgan Lewis declined to produce the materials, stating they were protected by work product.  A court decision found that the “oral download” of the interviews to the SEC constituted a waiver of work product protection.^[5]

The court in Herrera stated that the waiver issue turned on whether the oral briefing to the SEC constituted a “sufficiently detailed” summary such that it was effectively the “functional equivalent” of the interview memoranda. The court stated that Morgan Lewis’ work product argument would be stronger if it had provided only “vague references,” “detail-free conclusions” or “general impressions” to the SEC staff.^[6]

Second, recent government guidance, including the Department of Justice’s Yates memo,^[7] gave rise to new concerns for the corporate client when it faces a government investigation. The Yates memo in particular, requires companies to disclose ‘‘all relevant facts about individual misconduct’’ to receive ‘‘any consideration for cooperation.^[8]’’  Furthermore, corporations must actively investigate wrongdoing to receive cooperation credit.^[9]  As a result, the corporate client may be in conflict with its executives or employees who the corporation has identified as engaging in the misconduct.  This will impact how the corporate client assesses the decision to cooperate with the government and the decision to participate in a joint defense or common-interest agreement.

III. Congressional Investigations – Recent Developments

Congressional investigations are distinct from other government investigations in meaningful ways.  A key distinguishing factor is the treatment of the attorney-client privilege, a common law privilege that Congress generally does not recognize.

Congress maintains that it is not obligated to recognize common law privileges established by courts, such as the attorney-client privilege, work product doctrine, or other non-constitutional privileges.[10]  Congress bases this assertion on (1) the separation of powers, dictating that Congress is not bound by courts’ common law practices and (2) Congress’s inherent legislative right to investigate.  Congress has nearly limitless powers to investigate anything within the “legitimate legislative sphere.”[11]

Yet, Congress often respects the right of private parties to maintain the confidentiality of legal advice, and rarely compels the production of clearly privileged documents.  Congressional investigators typically use the threat of compelled production of privileged documents as leverage to extract other things from the corporation under investigation, such as an agreement to make witnesses available or to pursue far-ranging e-discovery.

Courts have never directly addressed the scope of attorney-client privilege in congressional investigations.  And, Congress has little desire to see the point tested, corporations often lack the will to test it, and courts often dodge resolving the question.

The most recent court challenge involving an assertion of privilege in a congressional investigation was in 2017 by Backpage CEO Carl Ferrer.  The D.C. Circuit dismissed Ferrer’s challenge to a subpoena issued by the United States Senate’s Permanent Subcommittee on Investigations (“PSI”) for mootness, and vacated a series of district court rulings in the case that seemed to open the door to an adjudication of Congress’s ability to compel privileged documents.[12]

Backpage withheld several documents from its production to PSI, citing attorney-client privilege. The Committee contended that the company had not explicitly asserted attorney-client privilege until late in the investigation, and the district court agreed, finding that Backpage waived its ability to object on privilege grounds.  PSI’s argument that Backpage asserted privilege too late opened potentially dangerous ground.  In finding that Ferrer had waived privilege, the court’s ruling seemed to suggest that attorney-client privilege existed before Congress.

But while the litigation and appeal developed, PSI completed its investigation into Backpage and subsequently informed the D.C. Circuit that it would not certify its continued interest in enforcing the subpoena.  The court dismissed the case for mootness and vacated the lower courts’ decisions.[13]  The Backpage case essentially restores the status quo ante, in which congressional investigation committees and those under investigation will bargain around Congress’s position on the attorney-client privilege without much guidance from a controlling court decision.

IV.  Key Considerations When Advising the Corporate Client on Protecting Privilege and Work Product

Given these recent developments, external and internal counsel should take certain steps when advising the corporate client on these protections.

First, counsel should brief corporate clients on the operation and importance of attorney-client and work product privilege as quickly as possible once the client is alerted to a government investigation.  In addition to explaining to the corporate client how both the privilege and work-product work and why these protections exist, counsel should be sure to advise clients that neither the privilege or work product is sacrosanct.  There are many scenarios, often not fathomable at the beginning of an investigation, that may lead to a later disclosure and the loss of privilege, such as disclosure to cooperate in a government investigation, to preserve the reputation of the company, a change in control at the client, or later conduct that waives the privilege.

Second, lawyers should work to develop a communication structure to ensure that privileges and work product are protected.  One area that should be clearly resolved when determining the communication structure is the role of a client’s general counsel or other internal counsel.  In-house counsel often wear two hats, leaving privilege at risk.  In the corporate context, the privilege applies to employee communications with corporate counsel “concern[ing] matters within the scope of the employees’ corporate duties,” where the employees are “aware that they were being questioned in order that the corporation could obtain legal advice.[14]”  If corporate counsel also discusses business matters with employees, privilege claims may be weaker. 

Further, as part of this communication structure, lawyers should work with clients to  establish a centralized communication structure at the beginning of an investigation, with outside counsel included on all key communications to ensure the efficacy of the privileges. 

Third, as is often the case in government investigations, lawyers must involve third parties such as auditors, experts, or public relations consultants.  Whether information and documents shared with these third parties will retain privilege or be afforded work-product protections depends on the circumstances.  The best practice in these situations is to execute a written common interest agreement between the third-party and outside counsel that clearly sets out, at a minimum, (1) the scope of the engagement; (2) the existence of a common interest; (3) the lawyer’s need for services in delivery of specified legal advice to client; (4) an agreement that the third-party will maintain confidentiality, including by safeguarding and marking records; and (5) an agreement that the third-party will direct substantive communications to the lawyer.

Similarly, lobbyists can be another tricky issue with respect to attorney-client privilege.  Many lobbyists were dual hats, as both lobbyists and lawyers.  Whether communications between a lawyer-lobbyist and a client are protected by the attorney-client privilege depends on a fact-specific inquiry of whether “legal advice” is being given.[15]  

Attorney-client privilege protects communications in which the lawyer-lobbyist is “acting as a lawyer.”[16]  The types of communications that likely would be protected include the legal analysis of legislation,[17] such as the interpretation and application of legislation to factual scenarios; legal advice on pending legislation;[18] and legal advice on how to proceed with lobbying efforts.[19]  Conversely, the attorney-client privilege does not protect communications with lawyer-lobbyists that do not provide legal advice.[20] Examples of communications that likely would not be protected include summaries of legislative meetings;[21] updates on legislative or lobbying activity; and updates on the progress of certain legislation.[22]

As a result, when corporate clients work with lobbyists, it is important to define the scope of work, particularly in what capacity the lobbyist will be advising the client.  A well-defined statement of work with a lawyer-lobbyist may faciliate protecting attorney-client communications in the instance that the lawyer-lobbyist is providing legal analysis on legislation.  However, if the lobbyist is not providing legal counsel, then, the engagement letter should be clear on that as well.

Fourth, when the government, whether prosecutors, regulators, or Congress request information that requires the client to waive its protections, outside counsel should carefully consider government requests for information balanced against the risk of waiver.  Usually, counsel can work with the government to negotiate waiver concerns; neither the United States Department of Justice nor the SEC require a privilege waiver in connection with cooperation credit.  To the extent a client decides to share information, keep it as high-level as possible. 

Fifth, counsel should advise clients to proceed cautiously with joint defense and common-interest agreements.  Joint defense or common-interest agreements allow parties to mount a common defense in civil or criminal matters while maintaining privilege over communications.^[23]  These can be with other investigated parties (e.g., other suspected co-conspirators), other co-investigators (e.g., Audit Committee or an outside audit firm), or client constituents (e.g., officers or employees).  Lawyers should work with corporate clients to assess balancing the benefits of joint defense and common-interest agreements against potential loss of cooperation credit.  If a client enters into any such agreement, counsel should reinforce for the client that privilege is vulnerable to attack, and anything shared as a result of the shared defense could end up in the government’s hands.

As these examples illustrate, privilege and work product considerations may conflict with a client’s ability to fully defend itself in the face of a government investigation.  It is important to discuss privilege issues with clients regularly, assess potential concerns at each stage of a government investigation, and develop both strategic and tactical approaches to either maintaining these protections or strategically determining to waive them.

[1] See eg. Upjohn Co. v. United States, 449 U.S. 383 (1981).

[2] Fed. Rules Civ. Pro. R. 26(b)(3)(a).

[3] See eg. ABA Model Rule 1.6.

[4] Order on Defendants’ Motion to Compel Production from Non-Party Law Firm, SEC v. Herrera, et al., No. 17- 20301 (S.D. Fl. Dec. 5, 2017)

[5] Order on Defendants’ Motion to Compel Production from Non-Party Law Firm, SEC v. Herrera, et al., No. 17- 20301 (S.D. Fl. Dec. 5, 2017)

[6] Id.

[7] Memorandum from Sally Quillian Yates, Deputy Attorney General, U.S. Dep’t of Justice (Sept. 9, 2015) (‘‘Yates Memo’’), available at http://www.justice.gov/dag/file/769036/download

[8] Id.

[9] Id.

[10] D. Jean Veta & Brian D. Smith, Congressional Investigations: Bank of America and Recent Developments in Attorney-Client Privilege, Bloomberg Law Reports (Nov. 6, 2010).

[11] Eastland v. United States Servicemen’s Fund, 421 U.S. 491 (1975).

[12] Senate Permanent Subcomm. on Investigations v. Ferrer, 856 F.3d 1080 (D.C. Cir. 2017).

[13] Id.

[14] Upjohn Co. v. United States, 449 U.S. 383 (1981). 

[15] In re Grand Jury Subpoenas dated March 9, 2001, 179 F. Supp. 2d 270, 285 (S.D.N.Y. 2001); U.S. Postal Serv. v. Phelps Dodge Refining Corp., 852 F. Supp. 156, 164 (E.D.N.Y. 1994); Todd Presnell, The In-House Attorney-Client Privilege, 9 No. 1 In-House Def. Q. 6 (2014).

[16] Todd Presnell, The In-House Attorney-Client Privilege, 9 No. 1 In-House Def. Q. 6 (2014); In re Grand Jury Subpoenas, 179 F. Supp. 2d at 285.

[17] Robinson v. Texas Auto. Dealers Ass’n, 214 F.R.D. 432, 446 (E.D. Tex. 2003); vacated in other part, No. 03–10860, 2003 WL 21911333, at *1 (5th Cir. July 25, 2003).

[18] Weissman v. Fruchtman, No. 83 Civ. 8958(PKL), 1986 WL 15669, at *15 (S.D.N.Y. Oct. 31, 1986).

[19] Black v. Southwestern Water Conservation Dist., 74 P. 3d 462, 468-69 (Colo. App. 2003).

[20] Presnell, supra 15; In Re Grand Jury Subpoenas, 179 F. Supp. 2d, 285 (S.D.N.Y. 2001).

[21] North Carolina Elec. Membership Corp. v. Carolina Power & Light Co., 110 F.R.D. 511, 517 (M.D.N.C. 1986); Todd Presnell, supra 15.

[22] Presnell, supra 15.

[23] “The rule . . . is that where two or more persons who are subject to possible indictment in connection with the same transactions make confidential statements to their attorneys, these statements, even though they are exchanged between attorneys, should be privileged to the extent that they concern common issues and are intended to facilitate representation in possible subsequent proceedings.’’  Hunydee v. United States, 355 F.2d 183, 185 (9th Cir. 1965)

As individuals and institutions around the world are implementing a variety of strategies to combat climate change, investors are contributing to those efforts with their capital. Although not an exclusive list, two investor-led strategies that seek to combat climate change include impact investing and divestment. The following highlights the key aspects of these approaches.

Impact Investing

Per the Global Impact Investing Network (GIIN), “[i]mpact investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.” Notably, these investments provide capital “to address the world’s most pressing challenges in sectors such as sustainable agriculture, renewable energy, conservation, microfinance, and affordable and accessible basic services including housing, healthcare, and education.” With regard to climate change specifically, the GIIN created a Climate Investing Track, which allows investors to focus on areas such as clean energy access and sustainable forestry, and the organization has future plans related to food, agriculture, and resilient infrastructure. Moreover, the GIIN also created ImpactBase, which is an online search tool that brings together fund managers, investors, and the greater impact investing community.

With respect to the origins of the term “impact investing,” the Rockefeller Foundation claims to have coined the term back in 2007, and its impact investing team has made a variety of environmental and climate-related investments around the world. It is also worth noting that foundations with impact investing practices, such as the MacArthur Foundation, also fund climate solutions projects through their grant-making programs. (The author gained exposure to worlds of impact investing and climate solutions during a law school internship with the MacArthur Foundation.) Additionally, because foundations play a crucial role in growing the impact investing community, networks such as Mission Investors Exchange are providing these philanthropic organizations with resources and connections to help “increase the scale and impact of their impact investing practice.”

Banks and other financial institutions are also facilitating climate-related investments. Goldman Sachs’s Environmental Policy Framework, for example, seeks environmental market opportunities related to clean energy, water, and other areas affected by climate change. Other investment vehicles include World Bank Green Bonds, which “specifically focus on tackling climate change issues that directly impact developing countries.” These bonds fund projects related to renewables, transportation, water and waste management, land use and forestry, among others. The United Nations also must attract capital to achieve its Sustainable Development Goals, some of which focus on clean energy, climate action, sustainable use of land and sea, and responsible consumption and production. With that said, however, although some investors are deploying their capital to support enterprises mitigating the effects of climate change, others are withdrawing their capital from enterprises contributing to it.

Divestment Strategies

The divestment movement began in 2011 when students at Swarthmore College advocated “that their school divest its billion-dollar endowment out of the largest companies that profit from drilling for and distributing fossil fuels.” Since then, this movement that began on U.S. college campuses has spread to 37 countries and has resulted in more than $6 trillion committed to fossil fuel divestment. With over 1,000 institutional investors pledging to divest, a significant amount of capital is on track to be diverted away from the coal, oil, and gas industries.

Nonetheless, questions remain as to the effectiveness of divestment, as well as the fiduciary duties of large institutional investors. In a Wall Street Journal article, New York University Professor Paul Tice wrote about the futility of the fossil fuel divestment movement, stating that “[i]n the long run, the effort to starve energy companies of capital will only make the oil and gas sector more attractive to investors.” With regard to fiduciary duties, the initial concern of institutional investors—who have a responsibility to maximize financial returns—was that the divestment from fossil fuels stocks might lead to a breach of those duties. With respect to the latter, however, “[t]he mounting financial risks associated with climate change and the prospect that a significant proportion of existing fossil fuel reserves will be stranded have led regulators to be explicit that climate change poses a threat to investor value and that fund fiduciaries have a legal duty to manage this risk.”

Finally, a notable alternative (or supplement) to divestment is shareholder advocacy. For example, As You Sow is a nonprofit located in Northern California that helps investors of public companies craft shareholder proposals related to carbon risk, methane reduction, fossil fuel funding, and energy section transition. Unlike divestment of stock holdings, “[s]hareholder advocacy leverages the power of stock ownership in publicly-traded companies to promote environmental, social, and governance change from within.” Such shareholder engagement exemplifies how environment, social, and governance issues are becoming more material to investors, and standard-setting organizations like the Sustainability Accounting Standards Board are helping those investors find “sustainability data to enhance their understanding of related risks and opportunities.” However, with respect to the divestment movement specifically, the key question looms: “What is the goal of such advocacy?” Is it to make fossil fuels companies transform into renewable energy companies, or is the goal to have these companies wind down their business and liquidate the profits to existing shareholders?

Conclusion

As the world tries to mitigate and adapt to changes in the environment, investors are playing a key role in combatting climate change. Impact investments are supporting enterprises in fields such as renewable energy, sustainable agriculture, and resilient infrastructure. Alternatively, divestment strategies are withdrawing financial support from fossil fuel industries. Thus, it is evident that investors across the globe are trying to combat climate change, and only time will tell whether these strategies lead to their desired financial, social, and environmental returns.

Josh Gutter is an attorney at Carlton Fields and member of the ABA Business Law Section’s Subcommittee on Governance and Sustainability. His practice focuses on corporate and transactional matters, including representations and warranties insurance. Mr. Gutter is also a certified public accountant. He can be reached at [email protected]

This article is excerpted from the forthcoming, multi-volume Financing Renewable Energy Projects: A Global Analysis and Review of Related Power Purchase Agreements, published by the Business Law Section.

The Paris Agreement and Its Consequences

In December 2015, the Conference of the Parties (COP21) to the U.N. Framework Convention on Climate Change convened in Paris to address threats posed by climate change. During the conference, 195 nations signed an agreement (the Paris Agreement) and pledged to limit the global average temperature rise to as close as possible to a maximum two degrees Celsius. The Paris Agreement is seen as the cornerstone of a global approach to preventing catastrophic climate change. (The United States has withdrawn from the Paris Agreement.)

The successor to the Kyoto Protocol, this agreement is the first universal, legally binding climate change deal designed to spur global growth of renewable energy development and provide the foundation for a low-carbon, sustainable future. The Paris Agreement unites not only nations, but also cities, regions, businesses, and investors toward a common goal to reduce carbon emissions and mitigate increasing global temperatures.

In July 2017 it was estimated that clean or renewable energy could achieve 90 percent of the energy-related carbon dioxide emission reductions required to meet the central goals of the Paris Agreement. This target requires reducing energy-related carbon dioxide emissions by 70 percent by 2050 compared to 2015 levels, which can be achieved only with the massive deployment of renewable forms of energy such as wind, solar, and hydro, combined with energy efficiency.

Based on the current and future needs for low-carbon technologies in 13 distinct sectors, renewables could account for two-thirds of primary energy supply in 2050, up from just 16 percent today. The transition to renewables will help limit global warming.

Scientists have recognized that the electricity sector must be completely carbon-free by 2050 and that clean and renewable energy sources must become the dominant source of electricity powering buildings, industry, and transportation to avoid the worst effects of climate change. Doubling the share of renewable energy by 2030 could deliver around half of the emissions reductions needed and, in combination with energy efficiency, keep the rise in average global temperatures within two degrees Celsius—the target of the Paris Agreement.

Financing Issues

One uncertainty ahead for renewable energy is the manner in which investors will react to the coming period in which project revenues have no government price support and instead depend on private-sector power purchase agreements or merchant power structures.

Another potential issue may be rising interest rates. Record low rates of recent years have helped to reduce overall costs per megawatt (MW) and also attracted new capital from institutional investors into the financing of projects.

Private sources provide the bulk of renewable energy investment globally—over 90 percent in 2016—but public finance can play a key enabling role by covering early-stage project risk and getting new markets to maturity. Public spending on policy implementation far outweighs direct public investments. Project developers account for about two-fifths of private investment in the sector. Institutional investors—pension funds, insurance companies, sovereign wealth funds, and others—make up less than five percent of new investments.

Private investors overwhelmingly favor domestic renewable energy projects (93 percent of the private portfolio in 2013–2015), whereas public investment is more balanced between in-country and international financing.

Domestic Issues

Renewable goals and mandates in the United States are powerful mechanisms to encourage construction of renewable energy-generating facilities. For a quarter century the most significant renewable energy mandate was the Public Utility Regulatory Policies Act of 1978, which was passed in the wake of the oil crisis in the 1970s.

Since the mid-2000s, that role has been supplanted by state renewable energy mandates often known as renewable portfolio standards (RPS) or renewable electricity standards (RES). These terms are used interchangeably. The most common method for requiring the use of renewable energy sources is the imposition of a renewable electricity mandate in the form of an RPS or RES.

An RPS requires covered electricity suppliers to procure a certain percentage of their electricity from renewable resources or purchase renewable energy credits (RECs) from other sources to meet the statutory (or regulatory) standard. Such plans typically set a mid- to long-range goal and then phase in the mandate over time. Given that the RPS is a mandate, the law typically prescribes the use of sanctions and/or waivers (permission for temporary noncompliance) for shortfalls (i.e., failures to meet the RPS requirements).

The RPS imposes a reporting requirement on the covered electricity supplier, and the supplier then reports compliance through the delivery of RECs, which are earned through electricity generation from qualified renewable sources. If a covered supplier cannot acquire the required number of RECs, programs usually offer the option of making alternative compliance payments.

An RPS covers any entity stated in the statute and will specify what constitutes “renewable energy.” An RPS provides the mandate for bringing renewable energy online; however, other critical issues must be addressed to bring renewable energy to market, e.g., financing issues and transmission infrastructure.

Renewable energy projects are often dependent on tax credits and tax incentives to compete with other forms of energy. RPS programs are often proposed along with other programs, such as cap-and-trade programs, to reduce greenhouse gas emissions. RPS programs focus on increasing the mix of renewable sources of electricity; cap-and-trade programs are focused on emissions reduction strategies, i.e., whether to reduce pollution, climate-impacting emissions, or both.

More recent variations on RPSs involve energy efficiency resource standards under which utilities must spend certain amounts of money on energy efficiency measures or achieve a certain amount of demand reduction.

International Issues

The year 2017 was the eighth in a row in which global investment in renewables exceeded $200 billion, and since 2004 the world has invested $2.9 trillion in green energy sources. Overall, China was by far the world’s largest investing country in renewables at a record $126.6 billion, up 31 percent in 2016.

Solar energy dominated global investment in new power generation in 2017. The world installed a record 98 GW of new solar capacity, far more than the net additions of any other technology—renewable, fossil fuel, or nuclear. Solar power attracted far more investment at $160.8 billion (up 18 percent) than any other technology.

In total, $279.8 billion was invested in renewables, excluding large hydro, and a record 157 GW of renewable power was commissioned in 2017, up from 143 GW in 2016 and far out-stripping the net 70 GW of fossil-fuel generating capacity added (after adjusting for the closure of some existing plants) over the same period.

In the next five years, wind and solar will jointly represent more than 80 percent of global renewable capacity growth. With almost 70 percent of its electricity generation coming from various renewables, by 2022 Denmark is expected to be a world leader. In some countries such as Ireland, Germany, and the United Kingdom, the share of wind and solar in total generation will exceed 25 percent.

Between 2017 and 2022, global renewable electricity capacity is projected to expand by over 920 GW, an increase of 43 percent. This forecast is more optimistic than last year, but in all likelihood will be affected by a cut in solar tariffs by China.

Renewable energy investment in the United States was far below China at $40.5 billion, down six percent. It was relatively resilient in the face of policy uncertainties, although changing business strategies affected small-scale solar. China, India, and Brazil accounted for just over half of global investment in renewables, excluding large hydro last year, with China alone representing 45 percent, up from 35 percent in 2016.

Europe suffered a bigger decline of 36 percent to $40.9 billion. The biggest reason was a fall of 65 percent in the United Kingdom. Investment of $7.6 billion reflected an end to subsidies for onshore wind and utility-scale solar and a big gap between auctions for offshore wind projects. Germany also saw a reduction in investment of 35 percent to $10.4 billion, on lower costs per MW for offshore wind and uncertainty over a shift to auctions for onshore wind. The latter change was also one reason, along with grid connection issues, for a fall in Japanese outlays of 28 percent to $13.4 billion.

A recent decision from the U.S. District Court for the Southern District of New York dramatizes the ongoing legal liability to which banking and other financial institutions are exposed when an economic fraud and resulting scandal occur. In this longstanding matter, Defendants Credit Suisse, Deutsche Bank, and Merrill Lynch remain very much in harm’s way due to allegations relating to their conduct in connection with certain debt securities issued by the now infamous Enron Corporation—nearly 17 years ago.

This case was originally filed in the Southern District of New York in 2002: Silvercreek Management, Inc. v. Citigroup, Inc. The case was transferred to the Southern District of Texas as part of the Enron multidistrict litigation. Discovery was completed in 2006. Later that year, the court certified a plaintiff class, of which Silvercreek opted out. Upon opting out, the court stayed Silvercreek’s claim pending the outcome of the class action. The class action concluded in 2010, the stay was lifted that year, and Silvercreek filed its complaint in 2011. Silvercreek moved to remand to the Southern District of New York in 2016. The motion was granted, and after a settlement with JP Morgan Chase and Barclays, the remaining defendants filed a motion to dismiss in 2017. The court denied this motion, leading to the current motion for summary judgment.

Victims of financial deceit routinely and directly seek recompense from banks sitting close to or in the chain of an economic fraud, and especially when the perpetrator is in bankruptcy. Such was the case here.

Background

In late 2001, investment group Silvercreek Management Inc. purchased nearly $120M of debt securities from Enron mere months prior to Enron’s high-profile December 2001 bankruptcy filing. Silvercreek alleged that the defendants each knew of, and substantially assisted, Enron’s deceit by designing, marketing, funding, implementing, and distributing numerous transactions utilized and deployed by Enron to essentially “cook its books.” Silvercreek sued the defendants for aiding and abetting Enron’s fraud and negligent misrepresentations, conspiring with Enron to commit fraud, their own negligent misrepresentations, and claims under state and federal securities laws. The defendants moved for summary judgment on all claims.

The Opinion

Judge Oetken denied the defendants’ summary judgment motions on Silvercreek’s claims for aiding and abetting Enron’s fraud. The court held that fact questions existed for a jury as to whether defendants had actual knowledge and substantially assisted with Enron’s fraud. The court stressed that although “red flags” or “warning signs” were not an acceptable substitute for actual knowledge, circumstantial evidence could be sufficient to allow plaintiffs’ claims to get to a jury and, as to each of the defendants, held that such evidence in fact existed in this case. The record included statements by Deutsche Bank employees that they should “torch” Enron files because of “something funky . . . in those [Enron] books.” Similarly, a Credit Suisse employee allegedly referred to Enron as a “house of cards.” In contrast, the record against Merrill Lynch was “devoid of blunt statements.” Still, the court ruled that a jury could find, given the totality of the circumstances, that Merrill Lynch substantially and knowingly assisted in Enron’s fraud.

Likewise, the court denied summary judgment against all defendants as to plaintiff’s civil conspiracy claims: “[t]o establish a claim of civil conspiracy, plaintiff must demonstrate the underlying tort [here, fraud], plus the following four elements: (1) an agreement between two or more parties; (2) an overt act in furtherance of the agreement; (3) the parties’ intentional participation in the furtherance of a common purpose or plan; and (4) resulting damage or injury.” The court ruled that a “reasonable jury [could] find that Defendants knowingly agreed to further Enron’s underlying fraud in conducting certain transactions.”

The court also went through an instructive defendant-by-defendant analysis of the record and Silvercreek’s claims that both Merrill Lynch and Credit Suisse made negligent misrepresentations when marketing certain of the notes at issue. The court reaffirmed New York’s requirement that the liability for negligent misrepresentation can exist only when a “special relationship” of trust and confidence exists between the parties, and where the injured party plaintiffs relied on that relationship. As a general principle, a broker-customer relationship typically does not qualify as a “special relationship” trigger for a viable claim of negligent misrepresentation; however, the court noted that the existence of such a relationship is always fact intensive, with each case being different. Therefore, if defendants recommended Silvercreek make the Enron purchases knowing Silvercreek would rely on the information provided, and that the defendants’ conduct linked them to Silvercreek’s reliance, such a relationship could be established.

Ultimately, the court found that Credit Suisse (but not Merrill Lynch) would have to answer the claims of negligent misrepresentation at trial. Specifically, the court held that there was evidence that could allow a reasonable jury to conclude that Credit Suisse directly solicited plaintiff’s investments, acted as broker for those purchases, and misrepresented existing facts as to Enron’s creditworthiness to establish the relationship required to sustain negligent misrepresentation claims. Although the relationship with Merrill Lynch was long standing, Silvercreek could not point to any specific facts distinguishing this relationship from the half-dozen other brokers and banks with which Silvercreek dealt. Notwithstanding dealing with other brokers and banks, the court would still have entertained the claim if Silvercreek had been able to show, with specificity, its reliance on Merrill Lynch’s statements.

What Does It Mean?

The decision and analysis in the Silvercreek case reinforces that banks will almost always be in the direct line of fire from plaintiffs whenever and wherever economic fraud strikes. The passage of time in the Enron scandal, or any “fatigue” that might have existed as a result of it, was of no moment to the court. These banks, absent a settlement or legal reversal, are now looking down the barrel of a jury trial on whether they knew of, aided, substantially assisted, conspired, and/or (in the case of Credit Suisse) made their own misrepresentations in connection with Enron’s fraud. This case should serve as a loud reminder to all financial institutions that their internal policies, procedures, supervision, and compliance protocols when making representations or soliciting investments must be robust. Personnel must also react to suspicions or concerns they see in e-mails, and must be equally mindful that such e-mails could form the basis of “evidence” against the bank—even 17 years later.

Mark A. Kornfeld is the co-chair of Quarles & Brady LLP Securities and Shareholder Litigation Practice Group, and is a partner resident in their Tampa office. Mark was one of the core attorneys contributing to the Madoff Recovery Initiative, where he served the Trustee and his lead counsel as the first chair of the Settlement and Expert Committees, and was one of the handful of attorneys to have interviewed Bernard L. Madoff in prison. Nicholas D’Amico is an associate in the Tampa office of Quarles & Brady LLP and is a member of the Business Law Group.

Although the legal industry understands the importance of sales and marketing efforts, there appears to be a disconnect between key decision makers and sales and marketing teams. According to the Legal Sales and Service Organization’s annual report, which tracks the emerging field of sales in law firms, 80 percent of legal sales professionals have an impact on revenue through sales; however, only 14 percent of survey respondents reported having a marketing/sales/business development seat on the firm’s management committee. How can a law firm effectively reach prospects and clients when it lacks resources or organizational structure to support sales and marketing efforts? Technology.

Technology has completely transformed the client intake process for law firms. Twenty years ago, the process looked very different than it does now—an individual in need of legal services would likely call a law firm, speak to a secretary or legal assistant, and then be connected with a lawyer or member of the legal team who could provide further assistance. There was no concrete process for determining who received the lead, and there was rarely any insight into how the individual connected with the law firm in the first place.

Law firms can now utilize customer relationship management (CRM) software, such as Salesforce, to assist with the client intake process. The ultimate goal of a CRM platform for the legal industry is simple: to help improve the relationship between law firms and clients. An American Bar Association (ABA) study found that 42 percent of the time, law firms take three or more days to reply to a voicemail or web-generated form from a prospective client. This delayed response time can be harmful when trying to build a relationship.

CRM platforms provide the ability to capture a lead, whether originating through a phone call or interaction with a law firm’s website, and help law firms keep track of where the lead is in the sales cycle. Understanding the status of each lead will help firms recognize trends that can improve the overall customer experience. For example, if the implementation of a CRM system helped a law firm identify that the longest step in the process was between initial contact and a follow-up from a member of the legal team, the firm could take necessary measures to shorten that timeframe.

Call-tracking and analytics systems are another technology platform helping law firms optimize the client intake process. Forty-nine percent of consumers expect a response from an attorney within a 24-hour window, according to FindLaw research; therefore, it is vital that firms use technology to shorten response time to a potential client’s phone call. Many call-tracking tools, such as Invoca, can integrate with CRM systems, allowing the data collected on those calls to be stored in an easily accessed platform.

If a law firm is trying to implement many different platforms, it can become overwhelming for the marketing or sales team to manage all the collected data. By partnering with technology companies that specialize in automating the sales and marketing process, law firms can streamline the lead generation and analysis process. These companies can build customized solutions that integrate the multiple platforms used by the firm.

In addition to customized solutions, technology companies can help law firms understand lead origination and, in turn, attribute the value of marketing efforts. A law firm will likely use a variety of different advertising or marketing efforts at once, so the ability to attribute how a lead came to the firm is extremely valuable in determining further marketing budgets. When firms can allocate the marketing budget in the communication channels that are most effective for clients, the overall relationship improves once again.

When law firms embrace technology, the overall client experience improves. With the help of a few tools—namely, a CRM platform and call-tracking systems—and a trusted partner to integrate various solutions, law firms will begin to understand clients and the intake process on a deeper level.