Antitrust law helps ensure fair competition and innovation. Under the Biden administration, the FTC had expressed an interest in ensuring that health care markets are competitive to improve costs, care, and innovation. The Trump administration has similarly expressed its intent to protect competition in health care markets. While antitrust enforcement has often been applied to monopolistic practices in industries like pharmaceuticals and technology, recently it has increasingly focused on the clinical trial site landscape, where exclusive agreements, site consolidations, and unfair pricing strategies can limit competition and patient access to trials.
This article introduces the fundamentals of antitrust law as applied to clinical trial sites, including key risks for sponsors, contract research organizations (“CROs”), and sites themselves, as well as compliance strategies to mitigate legal exposure.
Understanding Antitrust Law
Antitrust laws are designed to prevent unfair competition that could harm businesses, consumers, or innovation. In the U.S., the three primary federal antitrust statutes include:
The Sherman Act (1890), which prohibits monopolization and anticompetitive agreements. In the clinical research sector, this could include the use of exclusive contracting.
The Clayton Act (1914), which restricts mergers and acquisitions that may reduce competition or tend to create a monopoly, including excessive consolidation of clinical trial sites by private equity.
The Federal Trade Commission (“FTC”) Act (1914), which prohibits unfair business practices that hinder competition—for example, some kinds of clinical trial site access restrictions.
How Antitrust Law Applies to Clinical Trial Sites
Only 3 percent of the nation’s physicians and patients participate in clinical research. However, these sites are often where patients with no further standard of care options turn to for lifesaving therapy. Accordingly, clinical trial sites function as critical access points for research and patient recruitment. Lack of availability of clinical trial sites can hence present a bottleneck to clinical research sponsors and CROs. The lack of availability of such sites can significantly impact trial costs, innovation, and market competition, as well as access for patient care. Antitrust concerns may arise when trial site networks, CROs, or sponsors engage in behavior that limits reasonable access to trials.
1. Exclusive Contracts and Site Lockout
Sponsors and their representatives such as CROs generally avoid signing exclusive contracts with sites. CROs act on the sponsor’s behalf and therefore, like sponsors, have significant negotiation power. They help sponsors recruit clinical trial sites and manage clinical research projects. Accordingly, clinical trial sites are often beholden to CROs and sponsors and therefore have a power differential with them. However, both sponsors and CROs may have preferred arrangements with clinical trial sites and may hence sign them before other sites. While such preferred site arrangements may not be inherently problematic, if such an arrangement escalates to sponsors or CROs signing exclusive contracts with large site networks or hospital systems, it can rachet up the risk profile of the transaction and may be seen as anticompetitive. This could lead to FTC scrutiny.
For example, if a major CRO only allows trials to take place at sites it owns and it prevents or otherwise blocks the use of independent hospitals or research centers, it could trigger a claim of unfair competition. Similarly, steering by CROs to their wholly owned sites could have similar implications.
2. Price-Fixing Among Clinical Trial Sites
Sites routinely complain about the inadequacy of payment terms, and they routinely address the inadequacy of direct payments by requiring an additional indirect payments fee, which can be as high as 70 percent of the direct payments. This is especially true with large academic institutions that participate in publicly and privately funded research.
The Trump administration recently announced a 15 percent cap on indirect costs as applicable to National Institutes of Health (NIH) grants. Though this policy is currently being challenged and is blocked for the time being, it would represent a direct impact on large academic institutions and also worries smaller commercial clinical trial sites, which are concerned that private sponsors may impose similar limits on them. To battle these downward pricing pressures, trial sites and site networks may feel pressure to discuss sharing pricing strategies, or even discuss minimum site fees. Sites must be cautious that this could be interpreted as improper coordination of collusive price-fixing and a violation of the Sherman Act and FTC Act, since it could be seen to artificially maintain, stabilize, or inflate trial costs.
3. Mergers & Acquisitions in Site Networks
There has recently been an uptick in clinical trial site mergers and acquisitions. As clinical trial site consolidation increases, the FTC and Department of Justice may scrutinize mergers to prevent market dominance that reduces competition, especially if it eliminates regional or treatment-area-related competition or raises clinical trial costs. In such cases, regulators could block or reverse the merger.
4. Site Approval Delays as a Competitive Tactic
There has been significant vertical integration in the clinical trial space, with large private equity companies owning CROs, sites, institutional review boards (“IRBs”), and more. Accordingly, it is possible for such a private equity company to favor its own CROs, sites, and IRBs over independent ones. While some CROs may choose to outright favor an individual site, others could simply slow the approval process for independent sites, including site initiation visits, to effectively render them noncompetitive. If a dominant trial network or a CRO with its own clinical trial site slows approvals for independent sites to gain market advantage, it may be considered an anticompetitive tactic.
Best Practices for Compliance
To avoid antitrust violations, clinical trial stakeholders must proactively implement compliance safeguards, such as the following practices.
PracticeTransparent Site Selection: Develop objective, data-driven site selection criteria and disclose why certain sites are chosen to avoid misunderstandings and exclusionary claims. At a practical level, this must be balanced against the risk of unnecessary liability risk from private malfeasant actors.
Avoid Exclusive Agreements: Exclusive arrangements can harm competition unless justified by efficiency, and such contracts must not substantially foreclose access for independent sites.
Prohibit Price Coordination: Sites must be able to independently negotiate fees. Standardized pricing agreements can lead to assertions of anticompetitive behavior.
Monitor Mergers & Acquisitions: Site acquisitions generally afford greater multiples for larger site networks. Excessive market concentration can significantly impact pricing for a specific disease state or local area. Such an impact may have antitrust risks. To avoid such risks, it is recommended to conduct antitrust impact assessments before acquiring competing sites. It may, in some circumstances, be prudent to offer contractual commitments to maintain market competition.
Avoid Self-Preferencing: CROs should ensure reasonable access to trials for independent sites. Sponsors and CROs should audit CRO site selection processes to avoid allegations of unfair competition or market favoritism. While sometimes difficult to achieve, granting equal access to independent sites is often a preferred, but not required, option to consider.
Conclusion
Regulators, including the FTC, Department of Justice, and Food and Drug Administration, are monitoring how trial sites, CROs, and sponsors interact in ways that affect market access, pricing, and competition. As clinical trial operations evolve, the intersection of antitrust law and research site competition is becoming increasingly important. To mitigate legal risks, stakeholders should adopt transparent, fair business practices and proactively assess contracts, mergers, and trial site selection processes for antitrust compliance.
For policyholders, insurance is meant to provide peace of mind—a promise that when disaster strikes, they’ll have financial support to rebuild and recover. But as two recent cases show, the question of what qualifies as covered “direct physical loss or damage” can lead to drastically different outcomes in court.
In two recent California cases, policyholders sought coverage after wildfire smoke and debris affected their properties. One court, in Bottega, LLC v. National Surety Corporation, ruled in favor of coverage.[1]. The other, in Gharibian v. Wawanesa General Insurance Co., sided with the insurer.[2] These contrasting decisions highlight issues policyholders may encounter in securing coverage for smoke-related damage and the ongoing debate over what constitutes “direct physical loss or damage,” a key phrase in most property insurance policies.
This article explores these cases, the influence of COVID-19 coverage litigation on the interpretation of “direct physical loss or damage,” and what policyholders can learn to better protect their rights.
The Importance of “Direct Physical Loss or Damage” in Insurance Disputes
At the heart of both cases is a fundamental question: What does it mean for a property to suffer “direct physical loss or damage” under an insurance policy?
Insurance companies often take a narrow view, arguing that physical loss requires structural damage, like a collapsed roof. Policyholders, on the other hand, argue that contamination—such as smoke infiltration or toxic debris—permeates property and cannot simply be dusted off or ventilated, rendering property unusable for its intended use and qualifying as a covered physical loss.
Courts struggled with this question in the wake of the COVID-19 pandemic, which sparked thousands of lawsuits over business closures and contamination claims. Some courts have ruled that lasting, tangible physical alteration of property is required, while others have found that loss of use due to the presence of the virus in air or on surfaces is enough.
This debate played out in Bottega and Gharibian, with strikingly different results.
Bottega, LLC v. National Surety Corporation: A Win for the Policyholder
In Bottega, a Napa Valley restaurant faced significant disruptions after the 2017 North Bay Fires. Although the fires did not burn the restaurant itself, thick smoke, soot, and ash inundated the premises, forcing it to close for one day after the fire and for a week shortly thereafter. When the restaurant did reopen, for the next few months, it was temporarily limited to less than one-third of its seating because of the smell of the smoke, soot, and ash. Throughout this period, employees routinely cleaned the walls and upholstery to remove the smell and ultimately replaced the upholstery. The smell of fire remained for two years. The restaurant sought coverage under its commercial property insurance policy, which covered losses due to “direct physical loss of or damage to property.”
The insurer, National Surety, initially made some payments under the policy’s civil authority provision but later denied broader coverage. The insurer argued that because the restaurant was still physically intact, it had not suffered a “physical loss” as required by the policy.
The U.S. District Court for the Northern District of California rejected National Surety’s narrow interpretation, ruling in favor of Bottega. The key findings were:
Smoke and soot contamination rendered the property unfit for normal use, meeting the standard for “direct physical loss.”
The restaurant had to suspend operations, triggering business income coverage under the policy.
The insurer’s own admissions confirmed that the premises had suffered smoke damage, undermining its argument against coverage.
Unlike many COVID-19 coverage cases that relied on the issuance of stay-at-home orders to conclude that the virus did not cause loss or damage, the Bottega court found that the insured reopened during the state of emergency declared for the fire. It also described, in some depth, the nature and extent of the damage caused by the smoke. This decision aligns with prior rulings recognizing that contamination impairing the usability of a property—whether from smoke, chemicals, or other pollutants—can meet the threshold for physical loss. Courts have previously found that asbestos contamination, toxic fumes, and harmful mold all permeated property and constituted physical damage, even if the structure itself remained intact.
In Bottega, the policyholder’s success was largely due to strong evidence showing that smoke infiltration impacted business operations and required extensive remediation, causing the policyholder’s loss.
Gharibian v. Wawanesa General Insurance Co.: A Win for the Insurer
While Bottega marked a win for policyholders, Gharibian v. Wawanesa shows how courts can take a different approach, often to the detriment of policyholders.
Homeowners in Granada Hills sought coverage after the 2019 Saddle Ridge Fire deposited wildfire debris around their home. Although the flames did not reach their property, their property was covered in soot and ash, and plaintiffs asserted that smoke odors lingered within the home.
Their insurer, Wawanesa, paid $23,000 for professional cleaning services that plaintiffs never used, but later denied additional coverage, arguing that there was no “direct physical loss to property” because the home was structurally intact and that removable debris did not qualify.
The California Second District Court of Appeal sided with the insurer, emphasizing:
The smoke and soot did not cause structural damage or permanently alter the property.
The debris did not “alter the property itself in a lasting and persistent manner” and was “easily cleaned or removed from the property.”
The plaintiffs’ own expert concluded that “soot by itself does not physically damage a structure” and that ash only creates physical damage when left on the structure and exposed to water, which did not appear to have happened. He also acknowledged that “the home could be fully cleaned by wiping the surfaces, HEPA vacuuming, and power washing the outside.” It followed that he could not establish that the property suffered lasting harm from the smoke.
The Long Shadow of COVID-19 Litigation: Raising the Bar for “Physical Loss or Damage”
Given the large volume of COVID-19 coverage cases, the courts’ experience doubtless has shaped how they interpret “physical loss or damage” in insurance policies, particularly concerning business interruption claims. Many businesses sought coverage for losses incurred due to (1) government-mandated shutdowns, arguing that the inability to use their properties constituted a direct physical loss, or (2) the presence of COVID-19 in the air or on surfaces, arguing it made properties unsafe for normal use. In the COVID-19 context, courts have largely rejected both arguments.
These decisions effectively raised the threshold for what constitutes “physical loss or damage,” making it more challenging for policyholders to claim coverage for intangible or nonstructural impairments. This heightened standard has significant implications for claims involving smoke contamination from wildfires. The differing rulings in Bottega and Gharibian show the inconsistencies the standard yields.
In Gharibian, a case in which there was no evidence that the insured undertook any remediation yet the insurer still paid considerable monies, the court cited California Supreme Court precedent that held COVID-19 did not cause physical loss because (1) the virus did not physically alter property and (2) it was a temporary condition that could be remedied by cleaning.[3] Applying this logic, the Gharibian court determined that in that particular case, the evidence was (1) soot and char debris did not alter the property in a lasting and persistent manner and (2) the debris was easily cleaned or removed from the property. Therefore, fire debris does not constitute “direct physical loss to property.”
Meanwhile, the Bottega court, with the benefit of a robust showing of how smoke permeated the property of a sympathetic plaintiff, cited another COVID-19 business interruption case, Inns-by-the-Sea v. California Mutual Ins. Co.,[4] to reach the opposite conclusion. The court found that, whereas a virus like COVID-19 can be removed through cleaning and disinfecting, smoke is more like noxious substances and fumes that physically alter property.
To reconcile these results in their favor, policyholders must now provide compelling evidence that such contamination has caused tangible, physical alterations to their property to meet this elevated threshold. This development underscores the importance of thorough documentation and expert testimony in substantiating claims for damage that is not visible.
Policies That Expressly Cover Smoke Damage
Many policies do not specifically address smoke damage, leaving the parties to argue about whether the particular smoke contamination constitutes “direct physical loss or damage.” However, some policies explicitly provide coverage for smoke-related harm. For example, certain property insurance policies specifically list “smoke damage” as a covered peril, which can simplify claims for businesses and homeowners affected by wildfires.
When evaluating coverage, policyholders should:
Review their policy language to determine if smoke damage is explicitly covered.
Consider endorsements or additional riders that may enhance coverage.
Be aware that even with explicit smoke coverage, insurers may still challenge claims by arguing the damage is superficial or remediable. To assess the scope of the insurer remediation proposal, policyholders are encouraged to retain their own remediation consultants to provide their own proposals, which can then serve as the basis for ensuring an apples-to-apples comparison and negotiation.
Having a policy that expressly includes smoke damage can reduce the likelihood of disputes and prolonged litigation.
Key Takeaways
These cases illustrate the fine line courts draw when assessing whether contamination rises to the level of a physical loss.
The nature of the damage matters: In Bottega, the insured proved that smoke infiltration rendered the property temporarily unfit for use. In Gharibian, the court saw the debris as a removable nuisance rather than a physical loss.
Policy wording can be decisive: Policies that explicitly cover smoke damage may provide a simpler path to coverage without protracted legal battles.
Burden of proof is critical: The Bottega plaintiffs provided stronger evidence linking their loss to physical damage, while Gharibian plaintiffs could not show a lasting impact on their property (much less one the insured felt required remediation).
Challenge denials with expert testimony: Some insurers may argue that smoke and soot are “removable” and do not qualify as damage. Policyholders should counter this with expert evidence demonstrating how smoke contamination affects long-term usability and air quality.
Consider the forum for litigation: As seen in Bottega and Gharibian, which court hears the case can significantly affect the outcome. When possible, policyholders should seek a jurisdiction with favorable precedents or challenge insurers’ attempts to move cases to less policyholder-friendly forums.
Final Thoughts
Wildfires raise critical questions about insurance coverage for smoke and debris damage. The rulings in Bottega and Gharibian show the ongoing battle over what counts as “direct physical loss,” with courts reaching different conclusions.
While Bottega is a win for policyholders, Gharibian suggests that insurers will continue to push for restrictive interpretations and to analogize losses to COVID-19. Policyholders must be proactive—documenting their losses, seeking expert opinions and being prepared to challenge denials.
Ultimately, courts and policymakers must recognize that insurance should protect against real-world risks, not just total destruction. Until then, policyholders must be prepared to fight for the coverage they deserve.
Since the new Hart-Scott-Rodino (“HSR”) Rule was finalized in October 2024, there have been dozens of articles summarizing the changes and new requirements. While these articles are helpful and understanding the changes is necessary, for in-house counsel some of the logistical challenges presented by the new HSR regime are as important as the legal ones. This article’s goal is to identify practical solutions for the efficient and compliant collection, review, and production of some of the new categories of documents and information required by the HSR changes.[1]
The changes discussed below fall into two categories: deal-agnostic changes (i.e., those that apply to every deal) and deal-specific changes (i.e., those that only apply when there is an overlapping product or service between the parties).
Deal-agnostic changes include the requirements to provide certain
final documents sent to or from the supervisory deal team lead and
draft documents that are sent to any board member.
Deal-specific changes include the requirements to provide
regularly prepared CEO reports containing relevant information,
board reports containing relevant information,
information about overlapping directorates,
detailed customer information, and
detailed supply relationships information.
Deal-Agnostic Changes
Previously, only “Competition Documents”[2] sent to a director or officer had to be produced with an HSR filing. The new HSR Rule changes that in two significant ways: (1) all final Competition Documents sent to or from the supervisory deal team lead (“SDTL”) are producible, and (2) draft Competition Documents sent to any individual board member are producible.
Final Competition Documents Sent to SDTL
As an initial matter, in-house counsel will want to carefully consider whom to designate as the SDTL for a deal (or for all deals). The new rule defines supervisory deal team lead as “the individual who has primary responsibility for supervising the strategic assessment of the deal, and who would not otherwise qualify as a director or officer.”[3] The rule appears to envision the SDTL as the person who makes the yes/no call on whether to send the deal to the board (or similar entity) for final approval. In some companies, this may also be the person overseeing the deal on a day-to-day basis. As you move into larger companies with more complex corporate development teams, those roles may be separated. For companies that do not have dedicated corporate development teams, potential SDTLs could include a business stakeholder assessing whether the target would be a strategic fit or someone in the Finance Department.
After identifying the SDTL, in-house counsel should orient that person to the new requirements immediately, and together they should design a workable process for collecting and reviewing relevant documents. The goal, of course, is not to significantly disrupt the ongoing work evaluating strategic acquisitions. Some useful practices include the following:
Create a deal-specific mailbox, and put all emails relating to the deal in that mailbox.This will reduce the need for email searches, and the SDTL can simply provide antitrust counsel access to the mailbox so that the SDTL will not have to waste time or energy assessing what is producible.
Inform the SDTL that documents accessed through collaborative platforms/channels will be produced. All final Competition Documents, including communications, housed in collaborative platforms/channels such as Teams, Slack, Google Chat, etc., likely must be produced if accessed by the SDTL. In-house counsel should introduce the SDTL to this requirement proactively so the SDTL can be mindful regarding if and how to use such channels throughout the deal.
Communicate to deal stakeholders that emails sent to the SDTL will be produced. All final Competition Documents sent from or received by the SDTL must be produced. It is therefore important that in-house counsel inform all deal stakeholders of this requirement and remind them to be thoughtful in their email practices. This may include reminders to always use accurate language in emails, to not speculate, and to avoid unnecessarily cc’ing the SDTL on every correspondence.
Separate substantive discussions from drafting discussions in emails. All final Competition Documents sent to the SDTL must be produced. As a general matter, the new rule defines a final document to include an email. An important exception is that emails discussing draft documents are not considered final. For example, an email identifying and explaining the redline edits made in a document is considered a draft and not producible. However, an email that explains redline edits and discusses the competitive dynamics of the deal is likely producible. Separating drafting emails from substantive discussions will avoid this confusion.
These processes and practices work best in conjunction. But even implementing one or two of these practices will make life easier for both the SDTL and in-house counsel.
Draft Competition Documents Sent to Any Single Board Member
Previously, draft Competition Documents were only producible if they went to the entire Board of Directors or subcommittee thereof. Under the new rule, a draft Competition Document is producible if it is sent to any individual member of the board.
In-house counsel will therefore want to investigate the processes the corporate development team uses for document creation to determine if individual board members ever receive documents outside of official channels. For example, does a senior member of the corporate development team bounce ideas off an individual board member before finalizing a document to send to the whole board? To the extent that any such processes exist, in-house counsel will want to inform all stakeholders that these types of draft documents must now be produced to regulators. Similarly, if board members have a day-to-day role on a transaction and are expected to receive documents outside their role, this should also be flagged to help inform production decisions.
Deal-Specific Changes
Many of the changes in the new HSR Rule only apply when there is a competitive overlap between the acquirer and the target. These deal-specific requirements are sufficiently numerous that it is fair to say there are effectively now two different HSR forms: one for deals with overlaps and one for deals without them. Because the HSR submission for deals with overlaps is considerably more onerous, parties should now make the overlap assessment much earlier in the deal process—indeed, it will be difficult to accurately gauge either the timeline or budget for an HSR filing without first making this determination.
After concluding the deal involves an overlap, in-house counsel must begin the process of collecting new categories of information and documents. This section addresses five of the most burdensome and/or tricky of those categories:
Regularly prepared CEO reports that contain information on the competitive dynamics of the overlapping product market or service line
Board reports that contain information on the competitive dynamics of the overlapping product market or service line
Information on individual board members who also serve on the boards of other companies that operate in the same industry
Detailed information about each party’s customers of the overlapping product market or service line
Detailed information about the parties’ supply relationships with regard to the overlapping product market or service line
Regularly Prepared CEO Reports Discussing Competition in the Overlapping Market
The new rule requires parties to produce regularly prepared CEO reports if they (1) discuss competition-related issues involving the overlapping market implicated by the deal and (2) were prepared within one year of filing. Regularly prepared reports are specifically defined as quarterly, biannual, or annual reports. The challenge, therefore, is determining when a report contains information making it responsive, which is amplified by the one-year lookback window. It will not usually be apparent when the report is prepared whether it will be responsive later. The following processes may help mitigate these challenges:
Work with the CEO’s staff ahead of time to understand the full universe of regularly prepared reports the CEO receives, and inform the CEO of the need to collect these documents. The CEO undoubtedly receives reports that do not contain producible information, e.g., a report outlining insurer and benefits administrator options for employees. The CEO is also likely to receive reports that contain information on the competitive dynamics of markets. Understanding ahead of time the full corpus of regularly prepared reports that the CEO receives—and the content of those reports—will allow in-house counsel to more efficiently allocate their attention when reviewing materials for responsiveness for a specific deal.
Determine whether a preemptive review of the regularly prepared CEO reports is necessary. As discussed, it will not be clear in real time whether a CEO report will have to be produced. And parties cannot extract only the responsive information/pages from a report. Thus, in-house counsel should assess whether there are ways to balance the HSR requirements against the burden of producing nonresponsive information. To use the prior example, simply issuing two different reports—one on benefits and one on competitive dynamics—will prevent the company from having to produce totally irrelevant (but highly sensitive) benefits information because it is included in a competitive intelligence overview.
Determine who will review the CEO reports, and train that person. Regardless of whether there is a preemptive review, in-house counsel will have to work with the CEO’s staff to determine who should review the CEO reports when you must file an HSR form. Ideally, this would be in-house or external antitrust counsel. However, given the highly sensitive nature of the reports, the CEO’s office may prefer someone else. This may be a senior staff member, the general counsel, or other trusted adviser. In any event, it will be in-house counsel’s responsibility to thoroughly train the reviewer so that the reviewer can identify the types of competitive information that make a report responsive. This training should include clear instructions to err on the side of flagging for production, and if a nonlawyer conducts the preliminary review, it will have to be confirmed by counsel before filing.
Keep a checklist of regularly prepared reports, and check it before filing. Failing to include a producible document in an HSR filing may lead to, at a minimum, a costly delay in closing. This type of mistake can be avoided by creating and maintaining an up-to-date list of all quarterly, biannual, and annual reports the CEO receives and then checking off each one during the review process.
Organize all regularly prepared CEO reports in real time. The easiest way to miss a CEO report (especially without a checklist) is to scramble to collect them every time you file an HSR form. Even with the soundest of efforts and intentions, if in-house counsel are furiously searching inboxes, platforms, and other storage solutions on an ad hoc basis for each deal, eventually something will be missed. Instead, in-house counsel should work with the CEO’s staff to create separate folders for quarterly, biannual, and annual reports and ensure they are updated in real time. In addition to reducing the risk of missing a report, this will save both in-house counsel and the CEO’s office time when a filing is required by eliminating the need for last-minute searches.
Any Board Report Discussing Competition in the Overlapping Market
The new HSR Rule imposes the same requirements on board reports as CEO reports, with one notable expansion: instead of only requiring regularly prepared reports, the rule requires production of any board report discussing competition in the overlapping market. This requirement also has a one-year lookback window, so companies will not know at the time a board report is created whether it is producible.
The challenges presented by this requirement are akin to CEO reports but may be amplified if processes are not followed because the requirement is not limited to regularly prepared reports. Fortunately, implementing the same process for board reports as for CEO reports may reduce both burden and risk:
Work early with whoever prepares board materials to understand the full universe, and introduce that person to the new requirements.
Determine whether a preemptive review will occur and, if so, who will conduct it.
Determine who will review board reports when an HSR filing is required.
Train the reviewers if they are not dedicated antitrust counsel.
Organize board files in an easily accessible and navigable manner in real time.
Conduct periodic audits of the board’s documentation to ensure compliance with the new rule and identify any gaps.
There are two additional practices that may help with collecting and reviewing board reports and minimize the risk of missing a responsive document:
Consolidate board reports. If one hundred reports are sent to the board every year, it will be exponentially easier to collect and review those reports if twenty-five are bundled at the end of every quarter than if they are sent individually on an ad hoc basis. And although the requirement still applies that if any part of a report is responsive the whole report must be produced, administratively bundling twenty-five independent reports into a zip drive does not magically transform them into one report for HSR purposes. There is, therefore, little downside and significant upside to sending board reports in a routine, standardized, and consolidated manner.
Organize the board’s documents in a workstream or platform. Rather than sending board reports, upload them to a specified platform or portal, ideally at a specific, standard time such as before meetings. Do not send any board reports to the board (or individual members) outside of this platform. If the only way the board can access its reports is by logging onto the platform, in-house counsel can be assured of a single, easily accessible source of truth when an HSR filing occurs.
Providing Information About Overlapping Directorates
Another new category of information required by the new HSR Rule relates to overlapping directorates. Specifically, the acquirer must determine if any of its board members serve on the board of a different company (i.e., not the target) that reports revenue in the same North American Industry Classification System (“NAICS”) codes as the target. For example, if Company A provides cybersecurity services and is acquiring Company B, which provides software, in-house counsel for Company A will have to determine whether any members of its board also sit on the board of any other company that provides software. If so, Company A must disclose the name of the director(s) and the other board(s) on which they sit as part of the HSR filing. Several processes can help with collecting and producing this information:
Implement policies to review board affiliation. There are good legal reasons—beyond just HSR requirements—to enact policies that review not only the number of external board affiliations each director can have but also the types of companies with which they may be affiliated. To explain why, it may be helpful to take a step back.
Many acquirers target companies that operate in the same industry/ecosystem. These companies are likely to report revenues in a limited number of NAICS codes relevant to that ecosystem. Conversely, it is less common for an acquirer to target a company in an unaffiliated industry. Companies in unaffiliated industries are unlikely to report revenues in NAICS codes common to the ecosystem. Accordingly, the more directors a company has who sit on the board of other ecosystem companies, the more likely any individual target hits on a NAICS code that requires disclosure. One way to minimize the need to identify overlapping directors is to enact a policy that curtails the number of board members who can join other for-profit boards in the same ecosystem.
Even outside of HSR, Section 8 of the Clayton Act prohibits directors from sitting on the boards of competing companies. Therefore, having policies in place that prevent overlapping directorates and having mechanisms in place to monitor and track external board membership to ensure compliance serve two goals.
Monitor board memberships in real time. Because NAICS codes can be defined so broadly, some degree of disclosure is likely inevitable even with the above policy. Absent proactive processes, this could impose a substantial burden on in-house counsel and delay the HSR filing (and, consequently, the closing). Imagine having a large board of twenty directors. If board affiliation information is not already available, in-house counsel will first have to determine whether any of the twenty directors are on other for-profit boards, and which ones. If, for example, each is on two additional boards, in-house counsel will then have to research the products and services that all forty of those companies offer and compare them to the target.
To prevent this, the overlapping directorate assessment should be part of the real-time approval process, both for any new member of the company’s board and for any existing member who wants to join an external board. If the company is considering adding someone to the board, in-house counsel should review the candidate’s current board and officer affiliations to determine whether any are with competitors or ecosystem players. Again, this will also help ensure compliance with Section 8. In-house counsel can track this analysis in real time so that when they make an HSR filing, they not only will have a current list of all directors and corresponding affiliations but also will already have done some of the industry analysis.
Customer Information for Overlapping Products/Services
In all deals, both parties now must describe the categories of products and services they offer. Where there is a current or planned overlap, the parties must provide (1) total revenue for each overlapping product/service from the prior fiscal year, (2) the top ten customers by category for each overlapping product/service, and (3) the top ten overall customers for each overlapping product/service.
Figure 1. Customers by Category. See note 4 for a discussion of this chart’s example.
The time needed to respond to this requirement will largely depend on the number of “customer categories” involved[4] and the extent to which in-house counsel have proactively developed processes to collect this information.
The term customer categories is not defined in the rule or guidelines. Unfortunately, neither the rule nor any guidelines published thus far define what customer category means in this context. Some possibilities include categories by industry; by distribution level (retailers, wholesalers, distributors, direct to consumer, etc.); and by geography (local customers, regional customers, national customers, international customers, etc.). Therefore, it will likely be up to in-house counsel to make this determination.
There are various approaches companies can take to define customer categories. As a first step, in-house counsel should consult with business stakeholders in the overlapping products/services to determine whether there is an internal ordinary-course definition of customer categories. If the company has a preestablished definition, in-house counsel should likely use that. If not, in-house counsel may have to look to other sources in defining customer categories for HSR purposes, such as the business’s informal understanding (“we tend to view customers this way”) or external industry standards.
Proactively socialize stakeholders in financial roles, including understanding how these requirements do (or do not) comport with how revenue is tracked in the ordinary course. In-house counsel will likely depend on Finance to collect the above information, so, as with other stakeholders, they will want to orient Finance to these changes beforehand. In particular, in-house counsel will want to determine how long it will take Finance to pull these reports, which is largely a function of whether it tracks revenue data in the manner specified by the reporting requirements. For example, Finance may not track customers “by category,” much less track the top customers in each (nonexistent) category. In this example, Finance would not be pulling a report but creating one, which could take significantly longer. Knowing this at the outset will help in-house counsel manage expectations.
Supply Relationships Information for Overlapping Products/Services
The new HSR Rule requires both parties to identify (1) any products or services it sells to or purchases from the other party and (2) any products or services it sells to or purchases from competitors of the other party.[5] For each such input, the parties must provide detailed sales information and a list of the top ten customers that use each party’s products as an input to compete with the other party. Identifying supply overlaps and producing the requisite information may be particularly laborious. In addition to socializing Finance stakeholders to this requirement (see above), the following actions may help with this task:
Enlist the help of those performing due diligence on the acquisition to help identify overlaps. Unlike with competitive overlaps, it may not be apparent whether the parties have any type of vertical relationship with each other, much less with one of the other party’s competitors. However, the due diligence team should already be reviewing supply relationships/contracts in strategically assessing and valuing the deal. In-house counsel may be able to leverage that work so due diligence can flag any relevant supply relationships in real time.
Use a reasonable definition of input. The new rule requires the above information when either party (1) purchases from or supplies to the other party an input or (2) purchases from or supplies to the other party’s competitors an input that helps them compete. Although in-house counsel will want to err on the side of caution in determining which inputs qualify for the latter, overhead products and services that every company uses likely would not count. Imagine the acquirer is a children’s toy manufacturer and purchases plastic from the target’s competitor for use in its products—that would qualify. Imagine now that the target’s competitor also manufactures and sells bottled water that the acquirer purchases and stocks in its offices. Although this is a “product” supplied by the target’s competitor to the acquirer, it would likely fall outside the scope of this requirement because it is unrelated to competition in the toy manufacturing market. Again, in-house counsel should not take an overly restrictive approach but instead take a good-faith, commonsense approach using their professional judgment, which recognizes that some inputs (food, water, electricity, basic equipment, structures, etc.) are so weakly connected to competition (unless the acquirer operates in that industry) that they are not meant to be subject to this requirement.
Conclusion
The new HSR Rule will add time and expense to filings. However, it will impact deals with overlaps significantly more than deals without overlaps. As a result, in-house counsel must endeavor to make the overlap determination much earlier than under the old regime so they can start the collection-and-review process early and accurately set budget and timing expectations.
Regardless, the amount of additional time and burden the new HSR Rule imposes will be proportional to the number of processes, practices, and socializations in place at the time of filing. The way in-house counsel can most effectively support the business’s acquisition strategy, therefore, is by proactively enacting processes that minimize cost, time, and disruption when an HSR filing is required.
As the Federal Trade Commission (“FTC”) releases additional guidance on the new HSR form, some of the below practices may have to be altered, eliminated, or expanded upon. In-house counsel will therefore want to track any such guidance closely and adjust their practices accordingly. ↑
The new HSR Rule also changed the nomenclature: documents previously referred to as 4(c)documents are now referred to as Competition Documents, while documents previously referred to as 4(d) documents are now referred to as Transaction-Related Documents. For the sake of clarity, and because it is not relevant here, this article refers to all items previously referred to as 4(c) or 4(d)documents as Competition Documents. ↑
Premerger Notification; Reporting and Waiting Period Requirements, 89 Fed. Reg. 89,216, 89,279 (Nov. 12, 2024) (emphasis added). ↑
In the chart above, the company would have to disclose thirty customers to comply with this requirement: twenty for overlap 1 because there are two categories of customers, and ten for overlap 2 because there is one category of customer. This illustrates how the definition of customer category will directly and substantially impact the burden associated with this requirement—if each overlap had ten customer categories, the company would have to disclose two hundred customers. ↑
The rule contains an exception for inputs with less than $10 million in sales. ↑
In my frequent exposures to different federal judicial proceedings as a law student judicial intern in the U.S. District Court for the Southern District of New York, I have witnessed several high-profile proceedings garner heightened interest from the public and the press. During these proceedings, I sit in the courtroom gallery alongside anyone else fortunate enough to get a seat in the room. In most courtrooms, that includes around twenty members of the public and court staff, as well as twenty to thirty members of the press. All of us are barked at by court marshals and given a multitude of instructions for how to properly exist in the courtroom. Instructions including “no hats,” “no phones,” “no food,” and “no chewing gum” remind me of being a child in church. While the hearing is underway, I watch a sketch artist work quickly and tirelessly to complete as much of her sketch as possible in such a short time, capturing as many details as she can, all to have some record of what happened so it can be shared with the rest of the world. The day after the hearing ends, I see her sketches plastered all over newspapers’ websites to give a brief snapshot of what has occurred inside the courtroom.
All of these theatrics, rules, and limitations make the courtroom experience feel like Manhattan’s most secret club that prioritizes exclusivity above all. The implication of these procedures is that in courtrooms, things happen that we want to keep out of the public eye and hide away from any firsthand observers. However, I argue that a judicial system that theoretically values transparency and accountability should not function outside public observation and instead, should put resources toward creating a more accessible, public-facing court system.
A simple but impactful way that federal courts can make hearings and trials more accessible is to allow limited video camera recording in court proceedings. With the feed from court-installed cameras, courts could livestream all hearings, and news outlets could disseminate footage they deem to be of public importance after the hearings conclude. The footage could then be archived, allowing anyone to view the full recording for any reason. Removing unnecessary barriers to access in this way would build more public trust between the courts and members of the public, educate the public about what goes on in courtrooms outside of what they see on television or the internet, and give litigants greater assurance that there are people watching who are not a part of the system, providing a greater sense of accountability.
From the court’s perspective, increased accessibility would allow the public to bear witness to what occurs inside the courtroom, fostering a sense of trust from the public since the proceedings would no longer seem secretive. Although the nature of what occurs in courtrooms is potentially sensitive in nature, there is already an understanding among judges and court staff that anyone is capable of sitting in on nearly any hearing. Therefore, a video recording would hardly be any greater intrusion on the proceedings than is already possible. Further, because viewership would be less exclusive, high-profile proceedings would invite less of a circus of individuals hoping to watch the proceeding in real time, since they would be able to livestream it from anywhere. This would alleviate some of the strain on court marshals who need to control crowds for these proceedings.
From the public’s perspective, this access would offer educational, civically engaging content that is important to hear and observe. Students could watch from classrooms to gain an understanding of courtroom procedure, how lawyers work, and the day-to-day functions of the justice system. Friends and families of the parties could observe from afar and keep up with case progress. Lawyers could observe how specific judges run their courtrooms to prepare for future arguments in front of those judges. When elected officials or government entities are parties to a proceeding, members of the electorate could observe how those officials conduct themselves and what kinds of issues are at stake. If those officials are acting in a way that is unethical or unprofessional during the proceedings, people who vote for them should have the opportunity to observe that conduct.
Finally, from the parties’ perspective, this level of access would add a layer of accountability from the public to ensure that the parties’ day in court is respected. This concern is especially significant for criminal defendants who face systemic challenges to fair treatment throughout the legal process. Although hopefully it is not common, abuses of power do occur inside the courtroom. If court staff, judges, and law enforcement personnel are aware that the public and the press can observe their actions even if observers are not physically present, potential abuses of power may be prevented.
Although court proceedings are technically open to the public, there still remains a great feeling of secrecy and exclusivity. This perception is harmful to the public opinion of the judicial system, makes education and understanding of court proceedings more difficult, and can make litigants, especially criminal defendants, feel isolated and powerless. Increasing access to court proceedings would help mitigate these harmful effects, and I believe procedures to further that goal should be implemented in federal courtrooms in the future. In the meantime, I plan to inform and remind the people around me, both those who are interested in the legal field and those who are not, that they can attend court proceedings whenever they want, as long as there is room.
This article is Part VII of the Musings on Contracts series by Glenn D. West, which explores the unique contract law issues the author has been contemplating, some focused on the specifics of M&A practice, and some just random.
The adjective material is ubiquitous in business acquisition agreements. Designed to ensure that whatever is being represented or covenanted will not be deemed breached unless the impact of any inaccuracy or failure to perform is actually significant (which is itself a word that fails to convey a clear-cut standard), the word material is fraught with an uncertain meaning as applied to a particular set of circumstances.
One of my faithful readers recently asked me whether I had ever written anything about the use of the term material as a qualifier in a purchase agreement. The answer was, “Of course I have.”[1] But perhaps a reminder is necessary. Conveniently, Vice Chancellor Laster, in a recent Delaware Court of Chancery decision, In re Dura Medic Holdings, Inc. Consolidated Litigation,[2]had occasion to reiterate Delaware’s approach to determining the meaning of the word material when it is used as an adjective qualifying a covenant or representation.
It is tempting to view the word material standing alone (or as used in the phrase “in all material respects”) as having a similar meaning to the term material when used in the phrase “material adverse effect.” But legally the two have nothing to do with one another. Caselaw has declared that material when used in the phrase “material adverse effect” requires not only a truly significant (in the sense of really, really bad) negative impact, but also a negative impact that is “durationally significant.”[3] The word material standing alone or as used in the phrase “in all material respects,” however, has a different meaning. In Dura Medic Holdings, Vice Chancellor Laster reminds us:
When used to qualify a representation, the adjective “material” “seeks to exclude small, de minimis, and nitpicky issues that should not derail an acquisition.” For the breach of a representation to be material, there need only be a “substantial likelihood that the . . . fact [of breach] would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information.” That interpretation “strives to limit [a contract term with a materiality qualifier] to issues that are significant in the context of the parties’ contract, even if the breaches are not severe enough to excuse a counterparty’s performance under a common law analysis.”[4]
In other words, a “materiality” qualifier imposes a much lower standard for measuring the significance of a breach than does the term “material adverse effect.” And it specifically serves to lessen the high bar that the common law imposes for permitting a counterparty to treat the other party’s breach as significant enough to excuse that counterparty’s own performance.
But it is far from clear how material, on the one hand, simply means more than de minimis, but on the other, means important enough to have “significantly altered the ‘total mix’ of information” upon which a counterparty relied in entering into the purchase and sale agreement. One could well wonder when a breach would not be deemed “material” as a practical matter.[5] Indeed, according to Ken Adams, one of the foremost authorities on syntactic ambiguity and contract drafting clarity generally, the word “material is not only vague but also ambiguous.”[6]
This is particularly true given the fact that the “significantly altered the ‘total mix’ of information” standard for determining materiality appears to have been borrowed from the U.S. Supreme Court decision of TSC Industries, Inc. v. Northway, Inc.[7]TSC Industries involved the determination of what was material in the context of securities fraud, specifically allegations that a proxy statement “was materially misleading.”[8] In that context, the Court held:
The general standard of materiality that we think best comports with the policies of Rule 14a-9 is as follows: an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. This standard is fully consistent with Mills’ general description of materiality as a requirement that “the defect have a significant propensity to affect the voting process.” It does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. What the standard does contemplate is a showing of a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.[9]
So—important enough to have been significant in the “deliberations” being made by the recipient of the information, but not important enough to have actually affected the decision that was made. Huh?
Adams has suggested that the “significantly altered the ‘total mix’ of information” standard is just another way of saying nontrivial, with the other understanding of material (the common-law definition) being equated to his term dealbreaker—i.e., significant enough to have actually made the counterparty not want to do the deal at all.[10] After all, the whole point of a materiality threshold is to lessen the “dealbreaker” requirement that the common law imposes for a counterparty’s contract breach to excuse the other party’s performance.[11]But that stark dichotomy between material meaning simply “nontrivial” and its common-law meaning of an actual “dealbreaker” is not what most transactional lawyers are seeking to convey with the word material. Instead, it’s something a little more than the merely “nontrivial” meaning and a lot less than the “dealbreaker” meaning.
Another faithful reader of my contract musings pointed out that “[i]n the securities fraud context, courts in [the Second] Circuit have ‘typically’ used five percent as ‘the numerical threshold . . . for quantitative materiality.’”[12] Setting aside that materiality in the securities law context also requires a qualitative analysis,[13] courts have applied the quantitative five percent rule alone in cases not involving securities fraud. Indeed, in Stone Key Partners LLC v. Monster Worldwide, Inc.,[14]the court applied that rule to determine, in a dispute over whether a financial adviser was entitled to a fee, that a sale of less than four percent of a company’s “total assets” did not constitute a “sale of a material portion of the assets or operations of the Company and its subsidiaries taken as a whole.”[15]
Five percent seems intuitively to be well past nontrivial, but well below dealbreaker status. And recall that Vice Chancellor Laster, in Akorn, Inc. v. Fresenius Kabi, AG, used a decline of more than 20 percent of the target’s equity value as sufficient to declare a material adverse effect, for purposes of a bring down condition.[16] And the material required for a material adverse effect seems closer aligned to Adams’s dealbreaker concept.[17] But is 1 percent still trivial and 2 percent nontrivial? Who knows.
So, to repeat what I have in fact said before on this subject:
If a matter will matter it may be best to recast a material liability, a material contract or a material litigation as a liability, contract or litigation involving (or that potentially could involve) [an impact of] more than a specified dollar amount [or specified percentage of equity value, net income, or assets] (below which dollar [or percentage] threshold any such liability, contract or litigation would be considered insignificant [or immaterial]). But, . . . [s]ometimes the vague, if not ambiguous, “material” is all you can get and is perhaps good enough (but at least know that the term is fraught with uncertainty).[18]
Adams, supra note 6, at 92–93 (“Because the TSC Industries standard treats a fact as material if it would have been worth paying attention to, whether or not it would have caused a reasonable investor to change their vote, it’s reasonable to equate that standard with nontrivial.”). ↑
Akorn, Inc. v. Fresenius Kabi AG, 2018 WL 4719347, at *74–76 (Del. Ch. Oct. 1, 2018), aff’d, 198 A.3d 724 (Del. 2018). ↑
See Adams, supra note 6, at 95 (“Given what’s required to establish material breach under common law, it’s reasonable to equate that standard with dealbreaker. The same goes for the IBP standard because it requires ‘a strong showing’ to invoke a MAE exception.”). ↑
Last year, the U.S. Supreme Court struck down the use of nonconsensual third-party releases in Chapter 11 reorganization plans as not authorized under the Bankruptcy Code.[1] While the Harrington v. Purdue Pharma decision involved mass tort liability, the broader curtailment of third-party releases in all contexts should cause directors and officers to reevaluate their personal liability exposure when companies enter the zone of insolvency.
Prior to Purdue, Chapter 11 plans routinely featured broad third-party releases in favor of the debtor’s directors and officers, insulating those individuals from any and all claims associated with the conduct of the business prior to and during the bankruptcy proceeding. The new Purdue prohibition on nonconsensual third-party releases underscores the need for robust risk-management strategies, including comprehensive directors’ and officers’ (“D&O”) liability insurance coverage, to effectively protect boards and executives from personal exposure.
This article explores common claims against directors and officers, including claims likely to arise in the event of corporate insolvency, and addresses best practices for mitigating liability risk in insolvency situations, particularly key D&O policy provisions.
Common Claims Arising from Insolvency
Companies and the people who run them are always subject to new and emerging risks. When a company approaches insolvency or seeks formal court protection from creditors, the actions of the directors and officers before and during such period become subject to even closer scrutiny by the company’s stakeholders. Claims can come from shareholders, lenders, court-appointed trustees or receivers, and individual creditors or creditor committees, to name just a few. It is common for such stakeholders to investigate the conduct of the company’s directors and officers—and to attempt to have the company incur the cost of such investigation—and to pursue a variety of claims if warranted by the results of the investigation. Such claims can take many forms.
Securities Claims
Securities claims against directors and officers can arise from alleged violations of federal or state laws that regulate the issuing, trading, and handling of securities. These claims typically involve allegations of fraud related to the sale of securities, insider trading based on nonpublic information, or failure to comply with disclosure requirements.
Modern D&O policies contain a broad range of protections for both the company (under so-called “Side C” or entity, coverage) and individuals (“Side B” or “Side A,” depending on whether the company indemnifies them) in the event of alleged securities violations. This is particularly crucial during insolvency or bankruptcy, as the company’s ability to indemnify may be impaired due to financial constraints or prohibited by bankruptcy law.
Fiduciary Duty Claims
Directors and officers can also face exposure from derivative suits for alleged self-dealing, corporate waste, failure to act in good faith, or failure to protect the interests of creditors or other stakeholders. These types of claims involve allegations that directors and officers breached their fiduciary duties to the company or its stakeholders in a way that financially harmed the company or diminished the value of its assets.
If directors or officers are accused of mismanagement leading to insolvency, Side A coverage could provide protection for individual directors and officers, even if the company cannot indemnify them due to its bankruptcy status. Additionally, fiduciary liability insurance, sometimes included within D&O policies, may protect directors and officers from claims related to the mismanagement of employee benefit plans, such as pension plans.
The above examples are merely illustrative and do not tell the full picture of potential claims, which also include things like mismanagement that deepens insolvency, fraudulent trading and transfers, and a host of other alleged fiduciary, tort, and statutory violations implicating conduct by individuals.
D&O Risk-Mitigation Tips
While the goal of protecting individual directors and officers is straightforward, securing adequate executive protection in a post-Purdue world can be complex. Below are several risk-mitigation considerations that can be implicated before, during, and after bankruptcy proceedings.
Evaluating Policy Exclusions
D&O policies contain several exclusions that could be implicated in insolvency situations.
The most problematic for companies facing insolvency are bankruptcy or insolvency exclusions, which may be added to policies when a company faces financial distress and can bar directors and officers from accessing D&O coverage during bankruptcy. While rare, these exclusions can significantly limit or eliminate coverage. If the exclusion cannot be avoided, insureds should attempt to limit its scope during the underwriting process.
Another exclusion implicated in bankruptcy is the “insured versus insured” exclusion, which bars coverage for claims brought by or on behalf of one insured against another insured. Issues can arise in bankruptcy when a trustee or creditor committee asserts claims against a director or officer on behalf of the debtor. Without appropriate carveouts to this exclusion, claims may be denied because these claimants are acting on behalf of the debtor company—an insured—against directors or officers, who are also insureds. Negotiating appropriate exceptions to this broad exclusion can protect coverage in the event of bankruptcy.
Insolvency-related claims against directors and officers may also implicate so-called conduct exclusions for deliberate criminal, fraudulent, or dishonest acts. Allegations of reckless or intentional conduct, even if baseless, can pose significant obstacles to advancing legal fees if the exclusion does not have appropriate “final adjudication” language, which can preserve coverage until the offending conduct is established by a final, nonappealable adjudication. As with most D&O policy provisions, exclusionary language is not one-size-fits-all and varies materially among insurers, forms, and endorsements, so policyholders must pay close attention to variations in wording that can have an outsize impact on coverage.
Understanding Runoff Coverage
The time to think about D&O insurance is before potential insolvency proceedings. One important aspect to vet in advance of bankruptcy is the availability and scope of a potential extended reporting period that may be available to the company to report claims in the event coverage is terminated during bankruptcy.
Preserving the ability to report claims—via what is often referred to as “tail” or “runoff” coverage—ensures that directors and officers are protected against claims if the company undergoes a change in ownership or management control during bankruptcy. Without runoff coverage, directors and officers would no longer have access to D&O insurance to defend against claims for actions taken during their tenure. This is important because claims might take time to surface as the bankruptcy process unfolds, or stakeholders may file claims even after the company’s operations end.
Securing Dedicated Side A Coverage
Traditional D&O policies include coverage for both the company and its directors and officers, usually subject to the same set of limits. That means that claims against the company may deplete or extinguish limits that otherwise would be available to protect directors and officers.
In most circumstances when the company is solvent, that structure is not problematic because even if the D&O insurance limits are extinguished, directors and officers can still count on the company to advance their legal fees and indemnify them in connection with claims arising from the decisions made on behalf of the company. In insolvency situations, however, that backstop of advancement and indemnity from the company is gone because the company is not able to pay, leaving D&O insurance as the sole protection for directors and officers facing personal exposure.
For that reason, policies should include dedicated Side A coverage, which sets aside separate limits available solely to protect individual directors and officers when an insolvent company is unable or unwilling to do so. Additional Side A limits are often available as part of the traditional “Side ABC” policy but can also be purchased via a stand-alone Side A–only policy, which can provide additional benefits like broader coverage and fewer exclusions. Finally, bankruptcy courts have held that Side A policy proceeds are not the property of the debtor’s estate.[2] Therefore, the ability of directors and officers to access Side A policy proceeds is not constrained by the automatic stay, providing additional benefits to individuals who need to access that coverage quickly and efficiently to avoid being personally exposed.[3]
Relying on Subcommittees and Outside Examiners
The formation of subcommittees chaired by independent directors or the hiring of outside examiners to evaluate potential claims is an effective strategy for proactively identifying and addressing directors’ and officers’ exposure. These pre-bankruptcy investigations can include a review of existing insurance policy provisions, decisions of directors and officers leading up to insolvency, and analysis of potential claim exposure.
By assessing the potential existence of claims at an early stage, companies can take steps to implement mitigation measures as necessary to minimize exposure to those claims. And the involvement of an outside examiner or independent board member can enhance the credibility of the investigation given their independent and unbiased position. In the event of subsequent litigation, this proactive approach can lay the groundwork for a successful defense through the documentation of key facts concerning D&O actions leading up to bankruptcy.
Implementing Consensual Release Agreements/Plans and Litigation Trusts
The above-described proactive liability-management strategies are best practices to mitigate D&O liability, but in the event of a bankruptcy, additional measures may be required to address potential D&O claims, which may require companies to navigate the issues in Purdue. For example, consensual third-party releases and litigation trusts are tools available for addressing personal liability in bankruptcy court.
Consensual Third-Party Releases: RSAs and Opt-In/Opt-Out Releases
A restructuring support agreement (“RSA”) is a prepetition agreement that a company reaches with its key stakeholders regarding restructuring terms. In exchange for stipulated economic treatment, RSAs can require the stakeholders to agree to third-party releases as part of a bankruptcy plan. These releases differ from those prohibited by Purdue because they are consensual. As a result, the utility of an RSA release turns largely on the company’s organization and the type of liability that directors and officers face.
For certain companies with a few key constituents with potential claims, an RSA that includes a third-party release provision is an effective liability-management strategy. For other companies with many third parties with potential claims, negotiating consensual releases may be untenable. And regardless of a company’s structure, RSA releases are not usually a realistic strategy for addressing mass tort liability, such as in Purdue, due to the massive number of claimants. In those instances, companies may try to obtain consensual releases through plan voting.
Since Purdue came down, litigation has ensued regarding whether “opt-in” and “opt-out” releases in bankruptcy plans constitute consent as part of the plan voting process. Opt-in releases require the releasing party to affirmatively consent to the release. Opt-out releases assume consent to the release unless the releasing party affirmatively opts out. Some courts have held that opt-out releases are acceptable in limited circumstances, depending on the specific facts and circumstances of the case.[4] The Bankruptcy Court for the Southern District of Texas has gone further, approving a plan containing an opt-out release because opt-out consent has long been standard practice in the district.[5] However, the U.S. trustee appealed the confirmation order in In re Container Store Group, Inc., setting the stage for the next potential Supreme Court bankruptcy release battle.
Litigation Trusts
Where consensual releases do not fully address D&O liability, litigation trusts are an additional option. Litigation trusts are created as part of a bankruptcy plan and channel claims of the estate (i.e., derivative claims of shareholders) into the hands of a litigation trustee to pursue on behalf of the estate. While this tactic does not release directors and officers from personal liability, it does make litigation and settlement negotiations efficient given that the trustee has the sole authority to pursue the channeled claims.
Conclusion
As the contours of Purdue continue to unfold, companies should proactively monitor developments in the law to avoid surprise coverage denials, large exposures, and similar issues that arise when a company enters the zone of insolvency. Engaging experienced professionals, such as insurance brokers and outside bankruptcy and coverage counsel, can help establish robust risk-mitigation measures and insulate directors and officers from personal liability.
Harrington v. Purdue Pharma L.P., 603 U.S. 204 (2024). ↑
See, e.g., In re Downey Fin. Corp., 428 B.R. 595 (Bankr. D. Del. 2010); In re Petters Co., 419 B.R. 369 (Bankr. D. Minn. 2009); In re MILA, Inc., 423 B.R. 537 (B.A.P. 9th Cir. 2010). ↑
This article provides a high-level overview of approaches to ESG disclosures in the United States, European Union, and United Kingdom, noting the implications of these differences for investors and global businesses. Beyond shedding more light on the general ESG regulatory landscape under these regimes, the article explores the emerging ESG regulatory frameworks and policy drivers for ESG on both sides of the Atlantic and delves further into the implications of these differences to investors and multinational corporations, and why companies should care about these regulatory requirements and differences.
What Is ESG and ESG Disclosure?
ESG, which stands for “environmental, social, and governance,” refers to metrics often used by analysts to evaluate and vet the non-financial sustainability impact and social consciousness of companies. These metrics can impact a company’s risk profile and public perception—and, ultimately, the bottom line.
“ESG disclosures” are specific metrics used by organizations to report on their ESG performance and initiatives. ESG disclosures are generally broken into three categories:
Environmental: focuses on climate risks, emissions, energy efficiency, use of natural resources, pollution, and biodiversity
Social: focuses on human capital; labor regulations; diversity, equity, and inclusion (“ DEI”); safety; human rights; and community engagement
Governance: focuses on board diversity, corruption and bribery, corporate ethics and compliance, compensation policies, and risk tolerance
The terms ESG disclosure, sustainability report, and corporate social responsibility report are often used interchangeably.
Overview of the ESG Disclosure Regimes in the US
Federal Government
ESG disclosure in the United States (“US”) remains largely voluntary, except for the state of California’s requirements, discussed below. Governmental agencies and shareholder activists, however, continue to advocate for mandatory ESG disclosure. On March 6, 2024, the US Securities and Exchange Commission (“SEC”) adopted climate-related disclosure rules, two years after publishing the proposed rules.[1] Shortly thereafter, on April 4, 2024, the SEC stayed its climate disclosure rules following a flurry of lawsuits by many stakeholders challenging both the rules and the SEC’s authority to issue the rules.[2] A total of forty-three states (twenty-five against and eighteen advocating for the SEC rules as intervenors), as well as interest groups and trade associations, have since filed their petitions for review across different appellate courts, which are now consolidated in a multidistrict litigation in the U.S. Court of Appeals for the Eighth Circuit, dubbed Iowa v. Securities & Exchange Commission.[3] Many opponents to the SEC’s ESG disclosure rules argue that following the Loper Bright decision[4] by the US Supreme Court, which overturned the long-standing Chevron deference doctrine,[5] the SEC lacks authority under federal securities laws to require corporate reporting of greenhouse gas emissions and other climate disclosures. This case remains in litigation and the rules are stayed. In any event, many experts believe that the Trump administration will abandon the rules.[6]
State of California
In 2023, the state of California enacted Senate Bill 253 (“SB 253”) (“Climate Corporate Data Accountability Act”) and Senate Bill 261 (“SB 261”) (“Greenhouse Gases: Climate‐Related Financial Risk”) as part of the Climate Accountability Package. These laws are applicable to both public and private US companies “doing business” in California.[7]
Senate Bill 219 (“SB 219”) was proposed and signed into law on September 27, 2024, amending the Climate Accountability Package by granting the California Air Resources Board (“CARB”) time and discretion to adopt implementing regulations and clarify answers to key implementation questions. While SB 219 extended CARB’s implementation date from January 1, 2025, to July 1, 2025, it does not offer an extension of the date of first reportable data under SB 253 for Scope 1 and Scope 2 emissions, which remains January 1, 2025.[8] This means that US entities required to report under SB 253 may still have to collect Scopes 1 and 2 data for the first half of 2025 and include this in their first report to CARB, due by January 1, 2026.
On December 5, 2024, CARB issued an enforcement notice indicating its intent to exercise “discretion” in enforcing SB 253 during the first 2026 reporting cycle to allow companies additional time to implement data collection necessary to comply with the reporting requirements.
Shortly thereafter, on December 16, 2024, CARB issued a feedback solicitation inviting public comments on the implementation of SB 253 and SB 261, due by February 14, 2025.
Overview of the ESG Disclosure Regimes in the EU and the UK
Prior to 2023, only a relatively small number of large companies (referred to as public-interest entities)[9] within the European Union (“EU”) were required to disclose ESG information under the Non-Financial Reporting Directive (“NFRD”), which came into force in December 2014. Work to substantially expand the scope of the NFRD started in 2017 on the heels of the 2016 COP21 Paris Agreement.[10] In January 2023, the Corporate Sustainability Reporting Directive (“CSRD”) came into force.[11] However, please note our commentary below in relation to changes being proposed to the CSRD.
The CSRD is a mandatory ESG disclosure framework that modernizes and strengthens ESG reporting, requiring companies to report on environmental and social impacts, risks, and opportunities. EU member states were required to transpose the CSRD into domestic legislation by July 6, 2024; however, some countries have not yet done so (e.g., Germany, the Netherlands, and Spain).
The CSRD is broad and reaches a much wider group of companies compared to the NFRD, including some listed small and medium-sized enterprises (“SMEs”); certain non-EU issuers; and non-EU parent companies that generate over EUR 150 million in the EU and have at least one large subsidiary, public interest SME (see definition of public-interest entities in note 9), or branch in the EU. It requires businesses to report and disclose information on their societal and environmental impact and external sustainability factors affecting their operations.
A key feature of the CSRD is the double materiality assessment (“DMA”). The materiality of risks is reportable on two fronts: (1) how sustainability issues may affect the company and (2) how the company may impact people and the environment. The concept of DMA is yet to be established, with no proven or approved methodologies. This is causing some confusion in the marketplace and has been a source of criticism.
Implementation of the CSRD is a phased-in approach, with a rolling timeline (see figure 1). Companies already reporting under NFRD and large issuers with more than 500 employees are required to submit their ESG disclosures under CSRD in 2025, covering FY 2024. Other “large” EU companies or corporate groups (which includes those with two of the following three: (a) EUR 50 million+ in net turnover, (b) EUR 25 million+ in assets, and (c) 250+ employees) are required to submit initial ESG disclosures in 2026, covering FY 2025. Finally, all non-EU ultimate parent companies with “large” EU subsidiaries or operative branches are required to submit their initial ESG disclosures in 2029, covering FY 2028.
Figure 1. Timeline of Implementation of the CSRD.
Upstream of reporting, certain companies (including non-EU businesses) will be required to comply with the EU Corporate Sustainability Due Diligence Directive (“CSDDD”). This regulatory framework provides a process for mapping and conducting an in-depth assessment of a company’s operations and its chain of activities in order to (i) identify and prioritize actual and potential impacts based on the severity and likelihood of occurrence, (ii) prevent potential adverse impacts through an action plan with “reasonable and clearly defined” timelines, and (iii) end any actual adverse impacts by minimizing the impact with corrective action plans.[12] The CSDDD has regulatory enforcement requirements and civil liability for violations.
It is important to note that on February 26, 2025, the European Commission published an “Omnibus package” (“Omnibus”)[13] that seeks to simplify and streamline the requirements under the CSRD, the CSDDD, and the EU Taxonomy Regulation.
Some of the key proposed changes to CSRD include introducing a two-year delay to the reporting requirements applicable to “large” EU companies (from FY 2025 to FY 2027, with the first reports due in 2028 rather than 2026) and amending the thresholds applicable to in-scope EU companies (the reporting requirements would only apply to entities with more than one thousand employees either at the individual or group level and with either (a) EUR 50 million or more in net turnover or (b) EUR 25 million or more in assets). The Omnibus also proposes changes to the thresholds applicable to non-EU ultimate parent companies with “large” EU subsidiaries or operative branches.
The Omnibus also includes changes to the CSDDD, which affect scope and timeline of reporting, as well as potential removal of the requirement for EU member states to introduce civil liability for violations.
It is still unclear whether the changes proposed by the Omnibus will be adopted and what the timing of that would be, although the European Commission has invited EU institutions to treat this matter as a priority in light of the upcoming compliance deadlines under the CSRD.
In the United Kingdom (“UK”), there are also mandatory ESG reporting requirements that apply to certain in-scope companies. Since 2019, listed companies and large companies have been required to disclose energy use and carbon emissions under the Energy and Carbon Report Regulations 2018[14] (“Streamlined Energy and Carbon Reporting” (“SECR”)). Listed companies are required to make disclosures aligned with the Task Force on Climate-Related Financial Disclosures framework. For accounting periods starting from April 2022, the Companies Act 2006 has required UK high-turnover companies with more than 500 employees, as well as traded insurance and banking companies, to produce a non-financial and sustainability information statement as part of their strategic report.
Looking ahead, the UK government is considering whether to introduce new sustainability disclosure requirements (“SDR”) on companies under a new reporting regime based on the standards issued by the International Sustainability Standards Board (“ISSB”), as well as a requirement for certain entities to publish climate transition plans. As these new regimes are still being developed, UK and non-UK entities will need to consider the extent to which any changes will affect their reporting obligations. Alongside the new disclosure requirements, the UK is also developing its own UK Taxonomy Framework for determining which activities can be considered “environmentally sustainable.”
Table 1, below, compares the main reporting frameworks in the EU and the UK.
Table 1. Main Reporting Frameworks in the EU and UK
Streamlined Energy and Carbon Reporting (“SECR”) regulations
Corporate Sustainability Due Diligence Disclosure Directive (“CSDDD”)
Sustainability Disclosure Requirements (“SDR”) and standards aligned with the International Sustainability Standards Board (“ISSB”) (to be confirmed)
Comparing the Disclosure Regimes in the US and the EU/UK
While the topics addressed by ESG regulations vary across regimes, they all include a focus on greenhouse gas emissions and other climate-related matters. It is important to recognize that reporting beyond climate topics—such as biodiversity, pollution, and certain workforce metrics—is also typically required. The reporting frameworks require a description of how risks are identified and managed, as well as corporate board oversight of identified risks. The identification of the applicable risks is fundamental and is an area where it is particularly essential to create a cross-functional approach.[16]
The most significant differentiators between the US and EU/UK disclosure approaches are the “scope and scale” of disclosures and the definition of materiality.
First, with respect to scope and scale, the CSRD covers a broad range of topics and applies to a wide group of entities, including large companies, non-EU parents of large EU subsidiaries, and certain listed SMEs operating in the EU (although this may be subject to change if the Omnibus is adopted). On the other hand, the SEC’s disclosure rules focus specifically on climate-related information, particularly climate-related risks and Scope 1 and 2 emissions, and are applicable to both registered US domestic issuers and foreign issuers. Note, however, that California’s ESG reporting requirements also include Scope 3 emissions disclosure.
Second, the meaning of materiality in each regime is critical since it determines reportability. An incorrect interpretation or an invalid assessment of materiality could be very expensive and detrimental, triggering hefty fines and sanctions. The CSRD applies a double materiality approach, which requires companies to report on how sustainability issues affect their business and how their business impacts society and the environment. The SEC rules focus solely on financial materiality, requiring companies to disclose information that is material to investors. California’s laws require extensive emissions reporting irrespective of materiality.[17]
Conclusion: The Transatlantic Divide and Why Global Companies Should Care
While ESG disclosures in the EU are mandatory, reporting in the US remains voluntary, with the exception of California’s requirements. As such, compliance with evolving ESG disclosure requirements will become more complex for global public companies. In particular, private equity funds and traditional energy players that have an increased interest in energy transition to meet stakeholder demands and regulatory changes will continue to wrestle with varying ESG reporting requirements. These critical interests are coupled with the challenges of addressing escalating climate change risks and supplying the world’s insatiable energy demand. The combination of these factors in a fast-paced business arena presents a ripe environment for ESG-related claims.[18] With more disclosure requirements and a lack of standardization across global jurisdictions, it is likely that there will be more missteps. Noncompliance with the reporting requirements in the applicable jurisdiction(s) may be fatal to potential ventures, investment opportunities, and the public perception of involved parties.
Companies, advisers, funds, and counsel should carefully curate their reviews, vetting, and setting of ESG targets to ensure alignment with required ESG and sustainability reportable information across regimes, while at the same time ensuring alignment with other investment materials, offering documents, and annual reports. In addition, disclosures should be vetted by external experts and legal counsel to ensure consistent, reliable, and accurate reporting.
See Press Release, U.S. Sec. & Exch. Comm’n, SEC Adopts Rules to Enhance and Standardize Climate-Related Disclosures for Investors (Mar. 6, 2024). The SEC disclosure rules—aimed at reducing greenwashing, increasing transparency for investors, and standardizing and harmonizing reporting metrics across all industries—were intended to be effective beginning with the year ending December 31, 2025, and would require disclosure by public companies to include governance issues, risk management strategies, and financial implications of climate-related risks. ↑
See U.S. Sec. & Exch. Comm’n Order Issuing Stay, In re Enhancement and Standardization of Climate-Related Disclosures for Investors, File No. S7-10-22 (Apr. 4, 2024). The SEC disclosure rules were stayed in April 2024 following challenges by several states, investors, interest groups, and trade associations. ↑
Loper Bright Enters. v. Raimondo, 144 S. Ct. 2244 (2024) (providing that courts should use their own judgment when interpreting ambiguity in laws and not rely on agency interpretations). ↑
Chevron U.S.A., Inc. v. Nat. Res. Def. Council, 467 U.S. 837 (1984) (providing that courts were to give deference to agencies where there was ambiguity in the law, as long as the interpretation was reasonable). This case has since been overturned. ↑
See S. 253, 2023 Leg., Reg. Sess. § 1(l) (Cal. 2023); S. 261, 2023 Leg., Reg. Sess. § 1(j) (Cal. 2023). Signed into law in 2023, SB 253 and SB 261 establish greenhouse gas emissions and climate-related financial risk reporting requirements for corporations that meet certain criteria. SB 253 (greenhouse gas emissions disclosure) tasks the California Air Resources Board (“CARB”) with promulgating regulations requiring US-based entities with $1 billion or more in annual revenue to report their greenhouse gas Scope 1 and Scope 2 emissions for 2025 by January 1, 2026, and Scope 3 emissions starting in 2027 for emissions for 2026. SB 261 (climate-related risks reporting) applies to companies with total annual revenues over $500 million and mandates disclosure of climate-related financial risks and measures for risk reduction. ↑
See S. 219, 2024 Leg., Reg. Sess. § 1(c) (Cal. 2024). SB 219 gives CARB six additional months to finalize its rules under SB 253, pushing the CARB implementation deadline to July 1, 2025. Additionally, SB 219 eliminates the filing fee requirement for corporations reporting their greenhouse gas emissions, gives CARB the option (but not the requirement) to contract with an outside organization to develop a program by which the required disclosures would be made public, and authorize any corporate disclosures to be consolidated at the parent company level. ↑
These are defined as EU entities with transferable securities admitted to trading on an EU-regulated market, certain credit institutions, insurance undertakings, or other entities designated as such by EU member states. ↑
The Paris Agreement is a legally binding international treaty on climate change. It was adopted by 196 parties at the UN Climate Change Conference (COP21) in Paris on December 12, 2015, and entered into force on November 4, 2016. ↑
By the end of 2025, more than half of the largest 30 U.S. accounting firms will have either sold an ownership stake or part of their business to private-equity investors, up from zero in 2020, said Allan Koltin, chief executive at advisory firm Koltin Consulting Group.
—Mark Maurer, “Private Equity’s Ties to Companies’ Auditors Have Never Been Closer. That Worries Some Regulators.”[1]
Persistent market volatility, high inflation levels, and lack of investor confidence have challenged, among other things, mergers and acquisitions processes and the debt capital markets over the past few years. Private equity sponsors have responded in part by seeking to penetrate new sectors for platform acquisitions. Professional services firms have become one such target, driven by large profit margins, sustained growth, and strong cash flows. This article focuses on accounting firms, a subset of professional service providers and a popular target of sponsored investment via leveraged buyout (or “LBO”). As competition to acquire quality assets and accordingly, provide related financing, remains fierce, this article will discuss material considerations for lenders in connection with the financing of audit and accountancy businesses.
A Rising Trend
According to S&P Global, November 2024 “saw a surge” in private equity– and venture capital–backed transactions in the accounting and audit sector.[2] In fact, in the period from October 1 through November 30, 2024, seven deals were done in the sector, compared to six deals for the entire fourth quarter of 2023.[3] By way of further example, according to the Financial Times, in 2024 alone, Hellman & Friedman agreed to purchase a controlling portion of the equity interests in Baker Tilly; New Mountain Capital purchased the U.S. operations of Grant Thornton; Investcorp and PSP Investments purchased PKF O’Connor Davies; and a Centerbridge Partners–led consortium of investors purchased a majority of equity in Carr, Riggs & Ingram.[4]
Attractive Targets
Accounting firms are attractive targets for private equity investment for several reasons. The “fragmented”[5] character of the professional accounting industry presents consolidation opportunities as well as the potential to scale business, a hallmark of private equity’s investment thesis. Furthermore, private equity sponsors may be able to strategically acquire and roll up current and future targets, often centralizing shared services and functions, thereby lowering costs and maximizing profits, which, in turn, ultimately maximizes limited partner returns. Accounting firms’ business is also fairly reliable and stable, usually with predictable income streams and the potential to expand into advisory services to augment profits.[6] Some industry observers predict private equity investment in the accounting sector may allow firms to deploy capital into new areas like enhanced technology and artificial intelligence, each of which theoretically might, consequently, promote consistency, efficiency, and lower costs.[7]
Top Three Considerations for Lenders and Their Counsel
In light of popularity of accounting and audit firm acquisitions, we offer the following top three considerations for lenders considering financing the same: (1) structuring, (2) auditor independence and regulatory considerations, and (3) management services agreements (“MSAs”) and/or administrative services agreements (“ASAs”).
1. Structuring
The alternative practice structure is ideal for businesses looking for external investment. Firms governed by alternative practice structure regimes are typically split between the advisory arm (“AdvisoryCo”) and the accounting business (“AttestCo”). Under a credit facility, AdvisoryCo is usually the borrower and AttestCo is a non-guarantor restricted subsidiary. It is therefore crucial for lenders and their counsel to appreciate how transactions between AdvisoryCo and AttestCo are governed and what rights and restrictions apply to targets’ partners and/or employees.
Importantly, accounting firm employment and partnership agreements often contain non-compete, non-solicitation, mandatory retirement, and other similar restrictions on partners and employees. As alternative practice structures may vary from firm to firm, a thorough review of relevant partnership and employment agreements, operating agreements, and other governing documents should be undertaken—most crucially, the MSA and/or the ASA (discussed below).
2. Auditor Independence
Accounting firms are typically subject to the U.S. Securities and Exchange Commission’s (“SEC”) and Public Company Accounting Oversight Board’s auditor independence rules and other similar regulations. Due to the broad reach and scope of such rules, financing arrangements may impair independence. Company and sponsor’s counsel should conduct a thorough independence analysis and confirm no issues; lenders’ counsel should expressly inquire about this during legal diligence. Lenders should push for credit agreement representations and warranties to the effect that the financing transaction does not violate the SEC’s Rule 2-01 under Regulation S-X or other applicable laws, as it may be detrimental to the underlying financing to have AdvisoryCo deemed an “associated entity” of AttestCo.
3. MSAs/ASAs
Alternative practice structures and the two entity silos are governed via MSAs or ASAs. The MSA or ASA, as applicable, spells out the agreements between AdvisoryCo and AttestCo. For example, such agreements will provide that AttestCo provides only accounting services and that AdvisoryCo provides—importantly, for a fee—administrative and “back-office” services to AttestCo (think personnel management, information technology and other tech services, billing and accounts, and so on).
It is imperative that lenders and their counsel obtain, review, and understand the relevant MSA or ASA. Key focus areas of such review include the following:
Fee for services: What is the scope of the fee and related services? When is such fee paid?
Termination fee: To which party is it payable? Are there any exclusions to payment of such fee?
Because MSAs/ASAs are key strategic assets of AdvisoryCo borrowers, credit agreement provisions should be tailored accordingly. For example, lenders should consider appropriate representations and warranties as to the effectiveness of MSAs/ASAs, fulsome events of default for termination of MSAs/ASAs, and a covenant restricting modifications of MSAs/ASAs adverse to the interests of the lenders. Lenders may also wish to consider restrictions on transferring MSAs/ASAs outside the ring-fenced loan party group and include reporting requirements.
Conclusion
As accounting firm LBO financings become increasingly commonplace, the body of relevant credit documentation that may serve as precedent for future transactions is growing. Sponsors, wishing to preserve their forms and ensure consistency across their portfolio companies, may resist bespoke constructs. Yet, lenders must be wary of cookie-cutter approaches and not lose sight of the fact that accounting firms (and other professional services firms) are no ordinary targets. Credit documentation must be diligently negotiated and be grounded in a firm understanding of the often-complex corporate and partnership structures and complex web of regulations to which each unique accounting firm is subject.
Mark Maurer, Private Equity’s Ties to Companies’ Auditors Have Never Been Closer. That Worries Some Regulators, Wall St. J. (Oct. 30, 2024). ↑
Shortly following his inauguration in January, President Donald J. Trump signed a flurry of executive orders implementing a wide array of administration policies. One of the executive orders, entitled “Ending Illegal Discrimination and Restoring Merit-Based Opportunity” (“DEI EO”), is designed to ban both public- and private-sector programs encouraging diversity, equity, and inclusion (“DEI”). Another, entitled “Ending Radical and Wasteful Government DEI Programs and Preferencing” (“EJ EO”), terminates environmental justice programs within the executive branch and targets federal contractors and grant recipients that advance DEI and environmental justice by instructing each federal agency to “terminate, to the maximum extent allowed by law, all . . . ‘equity-related’ grants or contracts.”
Shortly following her confirmation by the U.S. Senate, on February 5, Attorney General Pam Bondi issued a pair of memoranda to U.S. Department of Justice (“DOJ”) personnel, directing the Department to eliminate internal practices related to DEI and environmental justice and directing various elements of the DOJ to “investigate, eliminate, and penalize” private companies and universities (including nonprofits) that have “illegal” DEI programs. She instructed DOJ officials to enforce federal civil rights laws to abandon what she called “illegal discrimination and preferences,” outlining strategies such as launching criminal and civil investigations. These directives were issued to implement the president’s earlier executive orders.
While the concepts of these executive orders and DOJ enforcement memoranda were not surprising, given widespread criticism of DEI and other programs considered “woke” by the political right, the text of the directives surprised many with their explicit mentions of private sector and nonprofit organizations, many of which have long-established programs dedicated to DEI efforts. Some others are organized with DEI as a central tenet or purpose. The new directives have raised many concerns among nonprofit executives about the legality of both legacy and emerging DEI efforts and the status of their organizations’ funding secured through federal grants, cooperative agreements, contracts, and loans.
At a minimum, these directives signal the administration’s intent to pressure private-sector organizations regarding their DEI practices. A more expansive view of them foreshadows an aggressive effort to challenge DEI programs through lawsuits and regulations targeting organizations perceived as ideological and political enemies of the current administration and its policies.
Of immediate concern to many nonprofit recipients of federal grants, cooperative agreements, and contracts are the requirements in the DEI EO for such recipients to affirmatively certify that their organization (i) “does not operate any programs promoting DEI that violate any applicable Federal anti-discrimination laws” and (ii) is in compliance with all federal anti-discrimination laws that are “material to the government’s payment decisions for purposes of” establishing federal False Claims Act liability.
Executive orders carry the force of law. They are legally binding and can be enforced, both within the executive branch and against other entities. Executive orders traditionally carry out existing powers of the president and implement existing law, rather than creating new law, and often dictate how the executive branch will operate by directing departments and agencies to carry out certain initiatives. Given the executive branch’s vast bureaucracy and spending, executive orders have traditionally been a powerful policymaking tool for presidents to test or implement new economic and social policy. Executive orders are subject to judicial review by federal courts and can be revoked by the sitting president (including successors).
DEI Executive Order
The January 21 DEI EO’s stated purpose is to end “pernicious discrimination.” It directs federal departments and agencies to terminate “all discriminatory and illegal” DEI programs and practices and declares that DEI programs and practices are illegal” and “dangerous.” Both the executive orders and the DOJ directives contain cursory citations to the federal Civil Rights Act of 1964 and the U.S. Supreme Court’s 2023 decision in Students for Fair Admissions, Inc. v. President and Fellows of Harvard College as supporting the conclusion that DEI programs, broadly speaking, are illegal.
Notably, the DEI EO and the DOJ directives also took aim at DEI efforts in the private sector, attempting to extend the order’s reach beyond the typical province of executive orders of federal agencies and federal award recipients. The DEI EO directed agency heads to “take all appropriate action” to “advance in the private sector the policy of individual initiative, excellence, and hard work.” The order directs federal agencies to submit recommendations for enforcement of civil rights laws, including by identifying “discriminatory DEI practitioners” and by recommending investigations and potential litigation related to DEI programs of “publicly traded corporations, large non-profit corporations or associations, foundations with assets of 500 million dollars or more, State and local bar and medical associations, and institutions of higher education with endowments over 1 billion dollars.” The explicit reference to nonprofit organizations and associations has generated concern among nonprofit and association executives, and a rush to evaluate whether any DEI practices could be considered “discriminatory.” One of the DOJ directives similarly directed DOJ’s Civil Rights Division to recommend enforcement actions and “other appropriate measures to encourage the private sector to end illegal discrimination and preferences.” Among the recommendations the attorney general requested are “proposals for criminal investigations and for up to nine potential civil compliance investigations.”
Environmental Justice Executive Order
Like the DEI EO, the EJ EO directs federal agencies to terminate federally funded DEI programs and initiatives—including through nonprofits that receive federal grants or contracts—and extends the culling to include agency efforts to promote environmental justice. The intent of the EJ EO seems to be to claw back parts of the Biden administration’s environmental regulations, as well as portions of the federal Infrastructure Investment and Jobs Act and the Inflation Reduction Act that provided funding for environmental justice programs.
Although there is some clear overlap in the subject matter of the EJ EO and the DEI EO, the EJ EO goes further than the DEI EO by targeting federal contractors and grant recipients. It directs agencies to provide the White House Office of Management and Budget (“OMB”) with a list of federal contractors who have provided DEI training to federal agencies, as well as federal grantees who received federal funding “to provide or advance DEI, DEIA, or ‘environmental justice’” programs. Although the EJ EO does not direct that litigation or enforcement actions be taken against these grantees or contractors, the intent of the executive order seems clear: to achieve compliance with its goals by the mere threat of including these organizations on an administration list of supposed transgressors.
Also of note is that on January 27, OMB took the extreme step of “pausing” all federal grants, cooperative agreements, and loans, putting mission-driven nonprofits in critical areas—including public health, environmental protection, immigration, international development, and others—at risk of losing funding that they rely on to carry out their missions. While the administration reversed its “pause” shortly after its issuance, and multiple federal courts have since enjoined the action, the executive orders remain in full force and effect.
Related Litigation
On February 21, a federal judge in Maryland issued a nationwide preliminary injunction against portions of the DEI EO and EJ EO, ruling that portions of the orders were likely to violate the First Amendment’s Free Speech Clause because those portions constituted impermissible content and viewpoint discrimination. The injunction also found that portions of the executive orders were likely to violate the Fifth Amendment because they are unconstitutionally vague.
The trend in private litigation against private-sector DEI programs, which increased in the wake of Students for Fair Admissions, has continued following the president’s executive orders. As a recent example, on March 5, a nonprofit group called Do No Harm, a watchdog group that describes itself as mobilized around “protecting healthcare from the disastrous consequences of identity politics,” filed a complaint in federal district court against the nonprofit 501(c)(3) American Chemical Society (“ACS”), seeking to enjoin ACS from operating the ACS Scholars Program, a scholarship program for students from historically underrepresented groups in the chemical sciences. Only Black, Hispanic, and Indigenous American applicants are eligible for the scholarships. Do No Harm alleged that the program violated Section 1981 of the Civil Rights Act of 1866, which prohibits discrimination on the basis of race in making and enforcing contracts. The suit also alleges violations of Title VI of the Civil Rights Act of 1964, which prohibits discrimination on the basis of race, color, and national origin in programs that receive federal financial assistance. To that end, the suit claims that ACS’s federal tax exemption under Section 501(c)(3) (due to the ability to receive tax-deductible charitable contributions) is a form of federal financial assistance that brings ACS’s scholarship program within the scope of Title VI. Note that the antidiscrimination reach of Title VI is not limited only to race and contracts and is in fact far broader.
Practical Considerations
Unfortunately, the DEI EO and the EJ EO do little to elaborate on what they view as “discriminatory” and “illegal.” Additionally, the EJ EO and DOJ directives somewhat obscure the consequences of being on an administration “list” of organizations providing DEI training or programming for the federal government, although the clear implication is the loss of federal funds. While both executive orders and the DOJ directives make oblique references to statutes and court decisions, they do not examine them in depth, nor do they indicate which elements of a DEI program would make it discriminatory or illegal, adding to the lack of clarity regarding the legal risk and the anxiety of nonprofit leaders. Recent administrative actions have been so broad as to imply that innocuous textual references to diverse groups are evidence of illegal activity prohibited by the executive orders. For instance, according to recent reporting, staff at the National Science Foundation (“NSF”) have reviewed thousands of active science research projects using a list of flagged keywords (such as “women,” “diversity,” “minority,” “institutional,” “historically,” and “socioeconomic,” among dozens of others), to determine if the projects include activities that violate the new executive orders. Scientists who receive NSF funding were already put on notice to cease any activities that do not comply with the executive orders. In this context, nonprofit executives who have concerns about the legality of DEI programs should consult experienced legal counsel to further examine their legal risk and discuss potential mitigation strategies.
Aside from concerns related to federal funding, many nonprofits are concerned that their federal tax-exempt status may be at risk due to DEI-related activities. Although there has not been any evidence of DOJ or the Internal Revenue Service (“IRS”) challenging nonprofit organizations’ federal tax exemptions on this basis, such concerns have been raised by claims made in private litigation framing 501(c)(3) tax-exempt status as a form of federal financial assistance, thus bringing such organizations under the ambit of Title VI of the federal Civil Rights Act of 1964, which has a much broader reach—with even more alarming adverse consequences—for these entities. Beyond this argument, it is not inconceivable that a “weaponized” IRS or DOJ could seek to revoke the tax-exempt status of any tax-exempt organization that it believes is primarily engaged in activities—such as “illegal DEI”— that it believes are contrary to public policy. There is some precedent in case law for such arguments. If the IRS and/or DOJ were to go down this path, the potential adverse implications for some tax-exempt organizations are sweeping.
Even in this time of uncertainty, there are several steps nonprofit executives can take to understand their legal risk related to DEI initiatives. These steps all require a degree of self-awareness of an organization’s values and culture, as well as a careful examination of organizational finances, legal risk, and public profile.
Know your values. Some nonprofits are organized for the specific purpose of supporting certain racial, ethnic, religious, or gender groups, or other groups, in a way that may be considered “DEI” by the Trump administration. For these organizations, there may be a direct conflict between their organizational purposes and the dictates of the executive orders and DOJ directives. Don’t be too quick to abandon a central tenet of your organization without careful consideration, but examine whether certain less drastic steps can be taken to mitigate risk. For instance, many nonprofits are scrubbing their public-facing websites to remove any DEI-related references.
Examine your funding streams. Organizations that do not rely on federal awards for their operations are much more insulated from these executive orders and potential DOJ enforcement than ones that do. If your organization does receive federal funds, and it has a constellation of subsidiaries and affiliates, identify which entity or entities house the federally funded programs and the DEI or environmental justice programs that put you at risk under the executive orders, and do what you can to insulate the other entities accordingly. Also, begin examining funding alternatives, such as private foundation grants, that may allow you to fulfill your mission and meet your funding needs.
Scrutinize your DEI initiatives. Take a hard look at your DEI-related initiatives to ensure that they are consistent with current law, and consult experienced legal counsel for assistance. The federal Civil Rights Act of 1964, mentioned in the DEI EO, is only one of the laws implicated by such programs. As discussed above, also very relevant is Section 1981 of the federal Civil Rights Act of 1866, which has been used to launch legal attacks on programs from nonprofits and other entities that restrict eligibility for certain grants, scholarships, fellowships, and other opportunities to certain races, among other protected characteristics. Other laws implicated could include state public accommodations laws and state education and employment laws. Several states have passed anti-DEI laws covering employment, state grants, and education that need to be taken into account, such as the Florida law that prohibits private nonprofit and other employers from providing any DEI-related training to their Florida-based employees. See our prior article on mitigating risks of DEIA programs for a more expansive discussion of these issues.
Assess your culture. Have a good understanding of the level of support for DEI-related initiatives within your nonprofit organization and among your members, donors, grantors, and other stakeholders. Understand your organization’s risk tolerance, budget, values, public profile, and ability to withstand legal challenges and the significant costs that often accompany them (some of which may not be covered by insurance). Be able to identify any potentially controversial programs as a way to anticipate legal and regulatory challenges, and consider what interim changes can be made in order to mitigate risk and make your organization less of a target in the current climate.
Most of the administration’s directives in this area (and others) are already the subject of legal challenges in the courts—some of which have found early success—but the fate of that litigation, much of which is likely to work its way up to the U.S. Supreme Court, is uncertain. While many legal experts believe that a number of the new directives are unlawful, relying on such presumptions can carry with it a high degree of risk.
Although the new administration’s actions have instilled fear and uncertainty in many in the nonprofit community, these early actions may prove to be the catalysts that encourage nonprofits to take necessary protective actions. The Trump administration has given nonprofit organizations an early opportunity to galvanize themselves against potential adverse legal and regulatory consequences. By taking early prophylactic steps against these threats, nonprofits will be better positioned to defend themselves for the next four years while maintaining progress toward their missions.
The views expressed herein are solely those of the authors and are not necessarily those of the authors’ firm, the American Bar Association, or the Business Law Section.
On February 17, 2025,[2] the U.S. District Court for the Eastern District of Texas, before which is pending the Smith v. U.S. Department of the Treasury dispute, lifted the preliminary injunction it issued January 7, 2025, against the Reporting Rules[3] adopted pursuant to the Corporate Transparency Act (“CTA”),[4] thereby clearing the way for enforcement of the CTA and its filing obligations. With that action, the last pending judicial barrier to broad enforcement of the CTA’s reporting obligations was lifted, and its general enforcement recommenced.
That was, however, far from the final development with respect to the implementation of the CTA. Rather, over the first weekend of March, the government and a variety of public officials, including the current chief executive of the United States, issued a series of pronouncements as to the CTA’s reach and enforcement that ultimately foreshadow the intention to abdicate much of its enforcement. The same week, another federal district court became the first to find that the CTA violates the Fourth Amendment right against unreasonable search and seizure.
The Smith Preliminary Injunction and the New March 21 Filing Deadline
To recap, as previously reviewed in detail,[5] even while the nationwide preliminary injunction issued by the district court in Texas Top Cop Shop, Inc. v. McHenry (formerly Texas Top Cop Shop, Inc. v. Garland) (“TTCS”)[6] was in effect and challenges thereto were proceeding, the Smith court issued a preliminary injunction against enforcement of the CTA, with that relief being restricted to the parties to the suit before the court, and a nationwide injunction against the Reporting Rules.[7] On January 23, 2025, the Supreme Court lifted the TTCS preliminary injunction. In response to the government’s motion to stay the Smith preliminary injunction pending appeal,[8] to which the plaintiffs filed a response,[9] on February 18, 2025, the Smith court lifted its preliminary injunction as to both the CTA and the Reporting Rules.
In furtherance of the undertaking it made in its motion to stay the preliminary injunction pending appeal,[10] the Financial Crimes Enforcement Network (“FinCEN”) announced on February 18, 2025, that it was granting reporting companies until March 21, 2025, to bring current all outstanding filing obligations.[11] Further, the directive as to the new filing deadline “bridges” the companies that would have fallen into any of the gaps that otherwise existed, an example being companies whose obligation to file an initial or an updated beneficial ownership information report (“BOIR”) would have fallen on February 18 or 19, 2025.
Under the Reporting Rules,[12] reporting companies preexisting January 1, 2024, were afforded until “not later than” January 1, 2025, within which to file an initial BOIR.[13] Companies created on or after January 1, 2024, and before January 1, 2025, were afforded ninety days within which to file an initial BOIR.[14] For companies created on or after January 1, 2025, they are afforded thirty days within which to file an initial BOIR.[15] Once a BOIR has been filed, a reporting company has thirty days within which to file an update as to any change in the submitted information.[16]
Between the TTCS and Smith injunctions, except for a brief period while the TTCS injunction was stayed and until that stay was lifted, those deadlines were on hold from the December 3, 2024, granting of the TTCS preliminary injunction through the February 18, 2025, lifting of the Smith injunction. In that period, there arose filing deadlines for companies preexisting January 1, 2024; companies created on or after September 4, 2024; and updates to previously filed BOIRs.[17]
Application of the March 21, 2025, Deadline
The examples below will help to understand how—in the face of these on-again, off-again injunctions and prior reporting periods for initial and updated BOIRs for companies created at various times—the new March 21 deadline was intended to apply. We use the phrase was intended to apply instead of will apply because shortly after the FinCEN Notice dated February 18 that instituted the March 21 deadline, FinCEN published a press release rescinding that deadline (see “And Then the Seventy-Two Hours of Mayhem,” below).
Examples of application of the March 21, 2025, deadline:
ABC Inc. was created on September 4, 2024; its initial BOIR was due not later than December 3, 2024. That day, the TTCS preliminary injunction was issued, and no filing was made. That initial BOIR would have been due not later than March 21, 2025.
XYZ LLC was created on December 31, 2022; its initial BOIR was due not later than January 1, 2025. With the TTCS preliminary injunction then in effect, no filing was made, and after it was lifted, no action was taken with regard to the Smith injunction. That initial BOIR would have been due not later than March 21, 2025.
DEF LLC was created on December 31, 2024; its initial BOIR was due not later than March 31, 2025. The March 21, 2025, deadline is eighty days after its creation, and DEF would have been afforded the full ninety days of the Reporting Rules within which to file its initial BOIR.
GHI Inc. was incorporated on January 1, 2025; its initial BOIR was due before January 31, 2025. However, as of that day, the Smith injunction was in place, and no action was taken. That initial BOIR would have been due not later than March 21, 2025.
JKL Inc. was created on March 1, 2024, and filed its initial BOIR on May 1, 2024; that report identified Laura as a beneficial owner, a position she held as a senior officer of the company. On December 1, 2024, Laura resigned her position, and she ceased to have any relationship with the company; an updated BOIR was due by the end of the month. However, with the TTCS and then the Smith injunctions in place, no updated BOIR was filed. JKL would have had until March 21, 2025, to file an updated BOIR deleting any reference to Laura as a beneficial owner and otherwise updating the filed information to address, if applicable, her replacement in that role.
MNO LLC was created on January 1, 2022; while its initial BOIR was not due until January 1, 2025, it filed its initial BOIR on June 1, 2024. On November 15, 2024, a senior officer of the LLC resigned and ceased to be a beneficial owner of MNO. The company was due to file an updated BOIR not later than December 15, 2024. With the TTCS injunction in place, no filing was made. That BOIR update would have been due not later than March 21, 2025.
“True, Correct, and Complete”
It bears noting that simply filing a report that was held in abeyance during the period that the CTA and Reporting Rules were enjoined is not necessarily the entirety of a company’s obligations. A BOIR must, as of its filing, be “true, correct, and complete.”[18] Counsel and other filers who are “sitting on” filings need to confirm that the information set forth therein remains accurate as of the filing date. If inaccurate information is inadvertently filed, there is a ninety-day period within which to file a correction.[19]
Another application of the requirement that a BOIR be “true, correct, and complete” is that certain changes in already-filed information that took place during the pendency of either or both of the TTCS and Smith preliminary injunctions will never be reported. For example, assume VWX Corp. was created on December 1, 2024, and its initial BOIR would have been due not later than March 1, 2025. Its initial president was Mary, but she resigned from that role on December 31, 2024. Keith took that role on an interim basis on January 1, 2025, and resigned on March 15, 2025, when Laura took the reins. When VWX would have filed its initial BOIR on March 21, it would have identified Laura as a beneficial owner (senior officer) and not reported either Mary or Keith as having been a senior officer of the company.
The Other CTA Cases
Of course, TTCS and Smith are not the only cases in which the constitutionality of the CTA and the Reporting Rules has been challenged; they are simply the cases in which injunctive relief in favor of a group larger than the plaintiffs has been granted. While both TTCS and Smith continue, there are a number of other disputes at various stages.
National Small Business United
The “granddaddy” of suits challenging the CTA is National Small Business United v. Yellen; on March 1, 2024, the district court found that the CTA is unconstitutional as outside the bounds of Congress’s authority under the Commerce Clause.[20] That decision was appealed to the U.S. Court of Appeals for the Eleventh Circuit, and oral argument was held on September 27, 2024. As of this writing, no decision has been delivered. Recently both the government and the plaintiffs delivered letters to the Eleventh Circuit requesting the court to rule in favor of their respective positions.[21]
Firestone and Community Ass’ns Institute
In both Firestone v. Yellen and Community Ass’ns Institute v. Yellen, the respective district courts denied requests for a preliminary injunction against the enforcement of the CTA.[22] These decisions are on appeal to, respectively, the U.S. Court of Appeals for the Ninth and the Fourth Circuits.
Hotze
In Hotze v. U.S. Department of the Treasury, the third of the CTA lawsuits pending in Texas, the district court denied the plaintiffs’ request for a preliminary injunction in part because the TTCS injunction was at the time already in place.[23] As the TTCS and Smith injunctions were seriatim lifted, the plaintiffs returned to the Hotze court and restated their request for injunctive relief,[24] efforts that have been (at least as of this writing) unavailing. On March 6, 2025, the Hotze court issued an order providing in part:
On March 2, 2025, the U.S. Department of the Treasury issued a statement that it will “not enforce any penalties or fines associated with the beneficial ownership information reporting rule under the existing regulatory deadlines,” and would further “not enforce any penalties or fines against U.S. citizens or domestic reporting companies or their beneficial owners after the forthcoming rule changes take effect.” Press Release, U.S. Dep’t Treasury, Treasury Department Announces Suspension of Enforcement of Corporate Transparency Act Against U.S. Citizens and Domestic Reporting Companies (Mar. 2, 2025), https://home.treasury.gov/news/pressreleases/sb0038. The statement also noted that the Treasury “will further be issuing a proposed rulemaking that will narrow the scope of the rule to foreign reporting companies only.” Id.
In light of the foregoing statement, the parties are ORDERED to submit a joint brief, not to exceed five double-spaced pages, addressing how the Treasury’s statement bears on the instant case on or before Friday, March 14, 2025.[25]
Midwest Ass’n of Housing Cooperatives
In Midwest Ass’n of Housing Cooperatives v. Bessent, the plaintiffs seek a declaration that housing cooperatives are exempt from the CTA irrespective of their organizational structure.[26] On November 26, 2024, a curious order was entered in this case. Subsequent to a status conference held to discuss matters including the Plaintiffs’ Emergency Motion for Declaratory Relief, or Alternatively, Preliminary Injunctive Relief,[27] and responding to the government’s request to hold the case in abeyance pending the decision of the Eleventh Circuit in National Small Business United, the court agreed to the request for an abeyance “provided the government refrain from arresting, jailing, imprisoning, or imposing civil penalties against plaintiffs or individuals affiliated with plaintiffs for any violation of the statute during the period of abeyance.”[28]
Boyle
In Boyle v. Bessent, on February 14, 2025, the district court found that the CTA is constitutional and within Congress’s authority under the Commerce Clause.[29] However, in the course of its decision finding that the CTA was enacted within the scope of Congress’s authority under the Commerce Clause, the Boyle court made a number of observations as to the penalty provisions of the Reporting Rules, suggesting that those penalty provisions that are beyond the scope of the statute itself are unauthorized and without authority.[30] The word suggesting rather than holding is important because the case may be made that the entirety of this discussion is dicta in that the Boyle court did not hold that the regulatory penalty provisions are invalid even as it upheld the validity of the CTA itself, and the legitimacy of those regulatory penalty provisions was not an element of the court’s determination as to the statute’s legitimacy.
Small Business Ass’n of Michigan
Then, in Small Business Ass’n of Michigan v. Yellen, on March 3, 2025, the district court struck down the CTA as an unconstitutional violation of the Fourth Amendment protection against unreasonable search and seizure.[31] While this argument had been presented to other courts and either rejected or left undecided as unnecessary to rule upon,[32] the Small Business Ass’n of Michigan court squarely addressed it and determined:
The CTA may have good intentions but the road it chooses to pursue them paves over all reasonable limits. The CTA’s reporting requirements reach indiscriminately across the smallest players in the economy to extract and archive a trove of personal data explicitly for future law enforcement purposes at an expected cost to the reporting players of almost $22 billion in the first year alone. The Fourth Amendment prohibits such an unreasonable search.[33]
The court went on to write: “In the Court’s view, this massive collection of personally identifying data for law enforcement, costing providers billions of dollars, amounts to an unreasonable search in violation of the Fourth Amendment.”[34] The relief granted is restricted to the parties to that action.[35]
In a letter to the Eleventh Circuit in National Small Business United, the government argued that the Small Business Ass’n of Michigan decision is flawed, signaling that an appeal is likely:
We write to respond to plaintiffs’ letter regarding the district court’s decision in Small Business Ass’n of Michigan v. Bessent, No. 24-cv-314, 2025 WL 704287 (W.D. Mich. Mar. 3, 2025) (“SBAM”) and to inform this Court about recent regulatory developments. In SBAM, the Western District of Michigan held that the CTA is inconsistent with the Fourth Amendment and permanently enjoined the government from enforcing the statute against the plaintiffs there. For the reasons given in the government’s briefing in this case, see Reply Br. 17-23, that decision is incorrect. Notably, the district court failed to reconcile its decision with the large number of state and federal reporting requirements that have long been understood as raising no constitutional concern. And the SBAM decision is an outlier: multiple district courts have recognized, in rejecting preliminary injunction motions, that Fourth Amendment challenges to the CTA are unlikely to succeed, and the district court in this case did not reach plaintiffs’ Fourth Amendment claim. See Firestone v. U.S. Dep’t of Treasury, No. 3:24-cv-1034-SI, 2024 WL 4250192, *10 (D. Or. Sept. 20, 2024); Community Ass’ns Inst. v. U.S. Dep’t of Treasury, No. 1:24-cv-1597, 2024 WL 4571412, *8-9 (E.D. Va. Oct. 24, 2024).[36]
And Then the Seventy-Two Hours of Mayhem
All the back-and-forth of injunctions and stays, culminating in the March 21 deadline, was a whiplash of events—but then things got really weird.
February 27 FinCEN Press Release
On Thursday, February 27, 2025, after the close of business in Washington, D.C., FinCEN published the following press release:
FinCEN Not Issuing Fines or Penalties in Connection with Beneficial Ownership Information Reporting Deadlines
WASHINGTON––Today, FinCEN announced that it will not issue any fines or penalties or take any other enforcement actions against any companies based on any failure to file or update beneficial ownership information (BOI) reports pursuant to the Corporate Transparency Act by the current deadlines. No fines or penalties will be issued, and no enforcement actions will be taken, until a forthcoming interim final rule becomes effective and the new relevant due dates in the interim final rule have passed. This announcement continues Treasury’s commitment to reducing regulatory burden on businesses, as well as prioritizing under the Corporate Transparency Act reporting of BOI for those entities that pose the most significant law enforcement and national security risks.
No later than March 21, 2025, FinCEN intends to issue an interim final rule that extends BOI reporting deadlines, recognizing the need to provide new guidance and clarity as quickly as possible, while ensuring that BOI that is highly useful to important national security, intelligence, and law enforcement activities is reported.
FinCEN also intends to solicit public comment on potential revisions to existing BOI reporting requirements. FinCEN will consider those comments as part of a notice of proposed rulemaking anticipated to be issued later this year to minimize burden on small businesses while ensuring that BOI is highly useful to important national security, intelligence, and law enforcement activities, as well to determine what, if any, modifications to the deadlines referenced here should be considered.[37]
The February 27 press release had the immediate effect of setting aside the previously announced March 21 deadline for bringing all filings current while signaling that an as-yet-undefined modification of the reporting regime would be detailed in a forthcoming (stated to be not later than March 21, 2025) “interim final rule.” In addition, while modifications of the existing regulatory scheme would be considered, not once but twice it was said that the view remained that “BOI is highly useful to important national security, intelligence, and law enforcement activities.” This seems entirely reasonable—the authors can easily list any number of changes to the Reporting Rules that would address problems thereunder but that would not impact the efficacy of the desired database.[38]
March 2 Treasury Department Press Release
Then, on Sunday, March 2, 2025, the entire program was unsettled when the U.S. Department of the Treasury (not FinCEN) issued the following press release:
Treasury Department Announces Suspension of Enforcement of Corporate Transparency Act Against U.S. Citizens and Domestic Reporting Companies
The Treasury Department is announcing today that, with respect to the Corporate Transparency Act, not only will it not enforce any penalties or fines associated with the beneficial ownership information reporting rule under the existing regulatory deadlines, but it will further not enforce any penalties or fines against U.S. citizens or domestic reporting companies or their beneficial owners after the forthcoming rule changes take effect either. The Treasury Department will further be issuing a proposed rulemaking that will narrow the scope of the rule to foreign reporting companies only. Treasury takes this step in the interest of supporting hard-working American taxpayers and small businesses and ensuring that the rule is appropriately tailored to advance the public interest.
“This is a victory for common sense,” said U.S. Secretary of the Treasury Scott Bessent. “Today’s action is part of President Trump’s bold agenda to unleash American prosperity by reining in burdensome regulations, in particular for small businesses that are the backbone of the American economy.”[39]
Even while this press release was published, the FinCEN website continued through at least the morning of Monday, March 10, 2025, to feature the February 18 FinCEN Notice setting the March 21 filing deadline, raising clear questions as to what is now the source for authoritative guidance as to the CTA and filing deadlines, if any.
Exactly how would be effected the “proposed rulemaking” pursuant to which the enforcement of the CTA would be “narrow[ed]” to only foreign reporting companies is unclear. At this point in time, it is unknown whether foreign reporting company will continue to have the same meaning as is ascribed by the CTA and the current Reporting Rules.[40] Might it mean instead both an entity formed outside the United States and also a domestic organization with owners (however defined) who are not U.S. persons?[41] If not, a major purpose of the CTA—namely circumscribing the use of domestic U.S.-formed entities for nefarious purposes—will be emasculated. In a March 10, 2025, letter penned by Senators Whitehouse and Grassley, they asked Secretary Bessent that and related questions, including:
We request that you provide us the legal basis for the Treasury Department’s policy decision to categorically suspend enforcement of the CTA’s reporting requirements for all U.S. citizens and domestic reporting companies. In addition, we request that you provide us with information about how you intend to satisfy the policy goals of the CTA. As part of your response, please address the following questions:
Has the Treasury Department followed or initiated the process required by the CTA to exclude an entity or class of entities from its reporting requirements?
What steps has Treasury taken to ensure that any change in the practice or rulemaking governing BOI reporting fulfills the law enforcement and national security purposes of the CTA?[42]
A Statutory Scheme Upended
But there is a broader question—namely, how the Treasury Department and/or FinCEN can publish and apply regulations so at odds with the statutory system. The CTA applies its reporting requirements to “reporting companies,” a set comprised of “domestic reporting companies” and “foreign reporting companies.”[43] Absent abject and intentional blindness to the statutory scheme, application of the CTA’s reporting requirements to only foreign reporting companies does more than substantial violence to the statutory scheme, one whose validity this administration has argued to various courts.[44]
Further, it is not clear that there is a univocal message being conveyed by FinCEN and the Treasury Department—and even the White House. Nearly coincident with the publication of the Treasury Department press release, the current chief executive of the United States published a “Truth” on the Truth Social network:
Exciting news! The Treasury Department has announced that they are suspending all enforcement of the outrageous and invasive Beneficial Ownership Information (BOI) reporting requirement for U.S. Citizens. This Biden rule has been an absolute disaster for Small Businesses Nationwide. Furthermore, Treasury is now finalizing an Emergency Regulation to formally suspend this rule for American businesses. The economic menace of BOI reporting will soon be no more.[45]
With a hat tip to Chip More[46] for this formatting, the various messages convey the following:
Publication
Domestic Reporting Companies
Foreign Reporting Companies
U.S. Citizens as Beneficial Owners
Foreign Citizens as Beneficial Owners
FinCEN Notice of Feb. 18, 2025
Accrued BOIRs due not later than March 21, 2025
Accrued BOIRs due not later than March 21, 2025
Not mentioned
Not mentioned
FinCEN Press Release of Feb. 27, 2025
No penalties, fines, or enforcement actions at least until new rule is published
No penalties, fines, or enforcement actions at least until new rule is published
Not mentioned
Not mentioned
Treasury Department Press Release of March 2, 2025
No penalties/fines
Unclear whether penalties/fines/ enforcement are suspended for foreign reporting companies until revised regulations are issued.
No penalties/fines
New rule will presumably still apply to foreign citizens that are associated with foreign reporting companies. Unclear whether new rule will enforce penalties against foreign citizens that are beneficial owners of domestic reporting companies.
Presidential “Truth” of March 2, 2025
All enforcement suspended on “American businesses”
Not explicitly mentioned
All enforcement suspended on “American businesses”
Not explicitly mentioned
Perhaps by the time this article is published the messages will be reconciled, and it will be clear that there is an adult in the room directing a clear modification of the CTA’s reporting regimen in a format that is consistent with the statute and may be relied upon by those who are advising clients on CTA compliance. For the practicing bar and the millions of companies both subject to and endeavoring to comply with the CTA, it should never have come to this. Regardless, all indications are that the government will continue to argue for the constitutionality of the CTA, irrespective of whether it is in its current or a modified form. For example, in a March 7, 2025, reply brief in TTCS, the government wrote:
The government’s recent announcement that it will “issu[e] a proposed rulemaking that will narrow the scope of the [reporting requirements] to foreign reporting companies only” and that it will not “enforce any penalties or fines against U.S. citizens or domestic reporting companies or their beneficial owners” underscores that an injunction is not warranted. Department of Treasury, Treasury Department Announces Suspension of Enforcement of Corporate Transparency Act Against U.S. Citizens and Domestic Reporting Companies (Mar. 2, 2025), https://perma.cc/73RD-HT6R. The government’s efforts to implement the CTA in a calibrated way do not justify plaintiffs’ request for an injunction stripping the government of authority to implement the statute at all.[47]
What Does It All Mean?
As of now, the CTA is not dead; the various messages that have been released are consistent in promising that it will in some modified form remain in place for foreign entities, a set of filers that, going forward, may be defined differently from the definition with which we are already familiar. As for domestic entities and beneficial owners, the penalty provisions of the law will not be enforced—which leaves unresolved a huge number of questions, not all of which will be addressed in the forthcoming rules (interim or otherwise), including the following:
What is the effect of not enforcing the penalties? There is a marked difference between no penalty and a penalty not enforced. Will the penalties set by the CTA (as contrasted with the penalty provisions of the Reporting Rules, as discussed above in the context of the Boyle decision) continue to accrue[48] to the effect that a future administration may decide to enforce the penalties, particularly against an identified bad actor? Recall that, generally speaking, estoppel may not be asserted against the government.[49] Against that uncertainty, what reserves should companies that do not make a voluntary BOIR filing set aside against the potential exposure, and how is this potential penalty to be treated in due diligence and future acquisitions?
May attorneys, consistent with their ethical obligations, advise that the CTA may be ignored? In response to client inquiries to the effect “So I don’t have to do anything, right?,” attorneys are going to be challenged to explain the legal effect of a “no enforcement” declaration set forth in a press release vis-à-vis an existing statutory penalty. In the face of the obligation to properly advise clients in order for them to make informed decisions,[50] attorneys are going to wrestle with the scope of the discussion and the recommended course of action.
What will be the treatment going forward of the beneficial ownership information already in the CTA database? Attorneys and others have already been fielding the question of whether information filed in the database may be removed and whether the database will be deleted. As of this time, there is no mechanism by which filed information may be removed, and there has been no suggestion that the database will be “wiped.”[51]
If the CTA is invalid in the face of the Fourth Amendment, is reference to the database going to give rise to “fruit of the poisonous tree” defenses? This issue is well beyond the ken of the authors, each of whom practices or teaches in the area of business organization law and is without practical experience in the intricacies of the Fourth Amendment. That said, based upon an at best cursory review of the hornbook law, as an exclusionary rule, evidence derived from improper government action is excludable as evidence in a proceeding brought by the government.[52] While there are exceptions to the principle, if the information in the CTA database is utilized in the course of an investigation, no doubt the defense will seek an exclusion based upon an allegation that the CTA’s database was created in violation of the Fourth Amendment.
How will the database impact the CDD obligations of banks and financial institutions? The intention was that beginning in the spring of 2025, banks and other financial institutions, with customer consent, would be able to access the CTA database in order to discharge their customer due diligence (“know your customer”) (“CDD”) obligations. Whether this facility will have much, if any, utility with a significantly truncated database remains to be seen. If a particular financial institution desired to do so, presumably it could condition opening and maintaining an account upon the customer making a voluntary filing of a BOIR (with a contractual obligation to maintain its accuracy), which it would rely upon to satisfy the CDD obligation.[53] In the absence of such a system, presumably banks and other financial institutions will continue to have direct CDD obligations that entail collecting and maintaining the necessary information. There may also be consideration of expanding the beneficial owner definitions of the extant CDD rules to more closely mimic those currently existing under the CTA and the Reporting Rules.
How will CTA developments affect state beneficial ownership reporting systems? States have considered, and New York has adopted, a state-level reporting system similar in certain respects to the CTA.[54] An analogous proposal is currently pending before the Massachusetts legislature.[55] Whether the significant restriction of the federal CTA will either encourage or discourage the adoption of state-level equivalents remains to be seen. If the reasoning of Small Business Ass’n of Michigan is upheld on appeal (assuming there is an appeal), it may undercut the ability of a state to adopt such a reporting regimen.
In closing, we await word of the new regime promised by March 21.
Samuel Clemens (a/k/a Mark Twain). The quote is often misstated as “The reports of my death are greatly exaggerated.” ↑
While the order was dated February 17, 2025, a federal holiday, it was not electronically posted until February 18, 2025. ↑
31 U.S.C. § 5336. For a review of the CTA generally, see Larry E. Ribstein, Robert R. Keatinge & Thomas E. Rutledge, Ribstein and Keatinge on Limited Liability Companies, at ch. 4A (Nov. 2024). ↑
Plaintiffs’ Response to Motion for Stay Pending Appeal, Smith, No. 6:24-cv-336 (Doc. No. 35). ↑
Defendants’ Motion for Stay Pending Appeal, Smith, No. 6:24-cv-336, at 1 (“If the stay is granted, the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) intends to extend the Corporate Transparency Act (CTA) compliance deadline for thirty days. During that period, FinCEN will assess whether it is appropriate to modify the CTA’s reporting requirements to alleviate the burden on low-risk entities while prioritizing enforcement to address the most significant risks to U.S. national security. Staying the grant of preliminary relief will help facilitate that process.”); id. at 6 (“As a matter of policy, Treasury continues to assess the potential burden of the Final Rule. If this Court grants the stay, FinCEN intends to announce that it will extend the compliance deadline for thirty days. During that period, FinCEN intends to assess its potential options to prioritize reporting for those entities that pose the most significant national security risks while providing relief to lower-risk entities and, if warranted, amending the Final Rule. The existence of the § 705 stay of the Final Rule should not be permitted to frustrate Treasury’s efforts to implement the extant Final Rule or to modify it, as warranted.”). ↑
WASHINGTON, D.C. — With the February 18, 2025, decision by the U.S. District Court for the Eastern District of Texas in Smith, et al. v. U.S. Department of the Treasury, et al., 6:24-cv-00336 (E.D. Tex.), beneficial ownership information (BOI) reporting requirements under the Corporate Transparency Act (CTA) are once again back in effect. However, because the Department of the Treasury (Treasury) recognizes that reporting companies may need additional time to comply with their BOI reporting obligations, FinCEN is generally extending the deadline 30 calendar days from February 19, 2025, for most companies.
Notably, in keeping with Treasury’s commitment to reducing regulatory burden on businesses, during this 30-day period FinCEN will assess its options to further modify deadlines, while prioritizing reporting for those entities that pose the most significant national security risks. FinCEN also intends to initiate a process this year to revise the BOI reporting rule to reduce burden for lower-risk entities, including many U.S. small businesses.
Updated Deadlines
For the vast majority of reporting companies, the new deadline to file an initial, updated, and/or corrected BOI report is now March 21, 2025. FinCEN will provide an update before then of any further modification of this deadline, recognizing that reporting companies may need additional time to comply with their BOI reporting obligations once this update is provided.
Reporting companies that were previously given a reporting deadline later than the March 21, 2025 deadline must file their initial BOI report by that later deadline. For example, if a company’s reporting deadline is in April 2025 because it qualifies for certain disaster relief extensions, it should follow the April deadline, not the March deadline.
As indicated in the alert titled “Notice Regarding National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.)”, Plaintiffs in National Small Business United v. Yellen, No. 5:22-cv01448 (N.D. Ala.)—namely, Isaac Winkles, reporting companies for which Isaac Winkles is the beneficial owner or applicant, the National Small Business Association, and members of the National Small Business Association (as of March 1, 2024)—are not currently required to report their beneficial ownership information to FinCEN at this time.
Reporting companies can report their beneficial ownership information directly to FinCEN, free of charge, using FinCEN’s E-Filing system available at https://boiefiling.fincen.gov. More information is available at fincen.gov/boi. ↑
This summation relates to a domestic reporting company; equivalent requirements apply as to foreign reporting companies first registered in the relevant time period. ↑
Not considered herein are certain federal disaster zone declarations for which additional time has been afforded for CTA submissions. ↑
31 C.F.R. § 1010.380(b) (“Each [BOIR] shall be filed with FinCEN in the form and manner that FinCEN shall prescribe in the forms and instructions for such report or application, and each person filing such report or application shall certify that the report or application is true, correct, and complete.” (emphasis added)). ↑
Nat’l Small Bus. United v. Yellen, 721 F. Supp. 3d 1260 (N.D. Ala. 2024), appeal filed, Nat’l Small Bus. United v. U.S. Dep’t of the Treasury, No. 24-10736 (11th Cir. Mar. 11, 2024). ↑
Feb. 21, 2025, Letter from the Government, Nat’l Small Bus. United, No. 24-10736 (Doc. No. 109-1); Feb. 24, 2025, Letter from the Plaintiffs, Nat’l Small Bus. United, No. 24-10736 (Doc. No. 110-1). ↑
Hotze v. U.S. Dep’t of the Treasury, No. 2:24-cv-00210-Z (N.D. Tex. Dec. 30, 2024) (order denying preliminary injunction). ↑
Plaintiffs’ Brief in Support of Their Renewed Expedited Motion for Preliminary Injunction, Hotze, No. 2:24-cv-00210-Z (Feb. 24, 2025) (Doc. No. 44-1). ↑
Order Setting Deadline/Hearing, Hotze, No. 2:24-cv-00210-Z (Doc. No. 46). ↑
Midwest Ass’n of Hous. Coops. v. Bessent, No. 2:24-cv-12949 (E.D. Mich. filed Nov. 5, 2024). ↑
Plaintiffs’ Emergency Motion for Declaratory Relief, or Alternatively, Preliminary Injunctive Relief, Midwest Ass’n of Hous. Coops., No. 2:24-cv-12949 (Doc. No. 17). ↑
Order Regarding Plaintiff’s Emergency Motion for Declaratory Relief, or Alternatively, Preliminary Injunctive Relief, Midwest Ass’n of Hous. Coops., No. 2:24-cv-12949 (Doc. No. 26). ↑
Boyle v. Bessent, __ F. Supp. 3d__, 2025 WL 509519 (D. Me. Feb. 14, 2025). ↑
Seeid. at *1 (“The Court now addresses the Fourth Amendment issues for the parties in the case and concludes that Plaintiffs are entitled to judgment as a matter of law declaring the CTA Reporting Rules a violation of the Fourth Amendment and enjoining operation of the CTA as to Plaintiffs and their members in the case.”). ↑
Mar. 7, 2025, Letter from the Government, Nat’l Small Bus. United v. U.S. Dep’t of the Treasury, No. 24-10736 (11th Cir. Mar. 11, 2024) (Doc. No. 112). ↑
See,e.g., Robert R. Keatinge & Thomas E. Rutledge, Impossible Things: Compliance with the Corporate Transparency Act When Beneficial Owners or Company Applicants Are Nonresponsive, Bus. L. Today (Dec. 16, 2024). Additional recommendations might include a mechanism for reporting that a beneficial owner does not have and is not in a position to acquire any of the required forms of identification and permitting members of a “group,” as defined in section 414 of the Internal Revenue Code, to aggregate employee counts for purposes of satisfying the large operating company exemption set forth at 31 C.F.R. § 1010.380(c)(2)(xxi)(A). ↑
See Plaintiffs’ Request for an Injunction, Tex. Top Cop Shop, Inc. v. Bondi, No. 24-40792 (5th Cir. Mar. 11, 2024) (Doc. No. 301). ↑
Recall that the statutory $500 per diem civil penalty (31 U.S.C. § 5336((h)(1)) has been adjusted for inflation to be $606 per day. See Houston et al., The Corporate Transparency Act Is Still on Pause, supra note 5, at n.25. ↑
See, e.g., Deborah H. Eisen, Schweiker v. Hansen: Equitable Estoppel Against the Government, 67 Cornell L. Rev. 609 (1982) (“Traditionally, courts have refused to apply [estoppel] against the government, holding that ‘erroneous, unauthorized, or illegal acts or advice’ of government agents are insufficient bases for estoppel.”) (citations omitted); Fred Ansell, Unauthorized Conduct of Government Agents: A Restrictive Rule of Equitable Estoppel Against the Government, 53 U. Chi. L. Rev. 1026, 1027 (1986) (“Although the Court has not categorically stated that equitable estoppel will never be applied against the government, it has consistently and without exception reversed lower court decisions estopping the government in such circumstances.”); see alsoDep’t of Just., Civil Resource Manual § 209 (last visited Mar. 5, 2025):
The general rule is that the federal government may not be equitably estopped from enforcing public laws, even though private parties may suffer hardship as a result in particular cases. Office of Personnel Management v. Richmond, 496 U.S. 414 (1990); Heckler v. Community Health Services of Crawford County, Inc., 467 U.S. 51 (1984); INS v. Miranda, 459 U.S. 14 (1982); Schweiker v. Hansen, 450 U.S. 785 (1981); Federal Crop Ins. Corp. v. Merrill, 332 U.S. 380 (1947). No decision of the Supreme Court holds that equitable estoppel lies against the government in any circumstance. However, in several instances the court has expressly declined to determine whether the government could be estopped in a case involving serious affirmative misconduct by government employees. See, e.g., Heckler v. Community Health Services, supra; INS v. Miranda, supra. ↑
See, e.g., Ky. S. Ct. Rule 3.130(1.4)(b) (“A lawyer shall explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation.”); see also, e.g., Ky. S. Ct. Rule 3.130(1.1) (“A lawyer shall provide competent representation to a client. Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation.”). ↑
According to Alan Stachura and Maria Perez-Hodges of Wolters Kluwer, CT Corporation, FinCEN has reported that of the 15.5 million initial or updated BOIRs received by March 12, 2025, 6.4 million were filed after December 3, 2024 (the date on which the first injunction in the progression of hiatuses that have postponed the obligation to make initial BOIR filings was issued), and five hundred thousand of them were filed after February 28, 2025 (the day after the FinCEN announcement that effectively delayed the March 21, 2025 deadline and a few days before the Treasury press release indicating that that the requirement that domestic companies and individuals file initial and updated BOIRs from domestic companies and individuals will be eliminated). These numbers demonstrate two things. First, that irrespective of the former January 1, 2025, required filing date (which had been announced in November 2022) for the estimated 32 million reporting companies that existed before January 1, 2024, less than a third (considerably less, taking into account that a significant percentage of the 9.1 million BOIRs may have been filed for companies that were created or registered in 2024), had filed. Second, that many companies, perhaps frustrated by the on-again/off-again status of the CTA, had determined to go ahead and file a BOIR notwithstanding the delayed effective date and the advice of many professionals to prepare to file, but hold off on filing, until the final status of the CTA became clear. ↑
See also Nardone v. United States, 308 U.S. 338 (1939). ↑
Likely such a contractual requirement to comply with a filing obligation in order to open an account would satisfy the determination made in Small Business Ass’n of Michigan, but that would need to be litigated in order to have any certainty. ↑
As to the New York statute, see, e.g., Ribstein et al., supra note 4, § 4A:35. Washington, D.C. has a statute that is currently in effect. Id. ↑
