Those who practice in or are familiar with the Delaware Court of Chancery are likely aware that it is a court of limited jurisdiction. Unlike most jurisdictions, Delaware never merged its courts of law and equity. “As Delaware’s Constitutional court of equity, the Court of Chancery can acquire subject matter jurisdiction over a cause in only three ways, namely, if: (1) one or more of the plaintiff’s claims for relief is equitable in character, (2) the plaintiff requests relief that is equitable in nature, or (3) subject matter jurisdiction is conferred by statute.” Candlewood Timber Grp., LLC v. Pan Am. Energy, LLC, 859 A.2d 989, 997 (Del. 2004). If the Court of Chancery lacks jurisdiction by statute, it “has only that limited jurisdiction that the Court of Chancery in England possessed at the time of the American Revolution.” El Paso Nat. Gas Co. v. TransAmerican Nat. Gas Corp., 669 A.2d 36, 39 (Del. 1995). Accordingly, parties seeking to take advantage of the Court of Chancery’s expertise in business disputes frequently endeavor to style their claims brought or the relief sought as equitable in nature.

In the past, the Court of Chancery has recognized equitable jurisdiction over claims for the release of money held in escrow. Beginning in Xlete, Inc. v. Willey, 1977 WL 5188 (Del. Ch. June 6, 1977), the Court held that such claims were sufficient to invoke equitable jurisdiction because, even if a party successfully won a judgment in the Delaware Superior Court for the sum held in escrow, the Superior Court (Delaware’s law court) would not have legal authority to actually compel delivery of the money to that party. This holding remained undisturbed for nearly fifty years, and indeed has been relied upon in decisions within the past decade. See, e.g., United BioSource LLC v. Bracket Holding Corp., 2017 WL 2256618, at *4 (Del. Ch. May 23, 2017); East Balt LLC v. East Balt US, LLC, 2015 WL 3473384 (Del. Ch. May 28, 2015); see also Haney v. Blackhawk Network Holdings, Inc., 2017 WL 543347 (Del. Super. Ct. Feb. 8, 2017) (transferring case to Court of Chancery to hear all claims, including claim for the disbursement of disputed funds in escrow).

However, recent decisions from the Court of Chancery have called into question the continued application of Xlete and the equitable jurisdiction over claims for the release of escrowed funds. Cases involving a request for release of escrowed funds create a tension between two different concepts raised in determining equity jurisdiction. On the one hand, equity jurisdiction only exists where there is no adequate remedy at law, and a dispute over the release of escrowed funds is fundamentally a fight over money the plaintiff contends it is owed, usually pursuant to a contract. On the other hand, while the underlying dispute may be one sounding in contract over money owed, the Superior Court lacks the authority to order a party holding particular funds in escrow to actually release them, raising the question of whether equitable relief is necessary. As discussed below, the ruling in Xlete has been construed narrowly in recent months, with the Court of Chancery resolving the tension by finding the cases are really ones for money damages. Consequently, parties and their counsel should be wary of continued reliance on Xlete in cases seeking the release of escrowed funds.

Elavon v. Electronic Transaction Systems Corp.

In Elavon v. Electronic Transaction Systems Corp., 2022 WL 667075 (Del. Ch. Mar. 7, 2022), plaintiff Elavon brought several claims against Electronic Transaction Systems and its former owners, including for release of funds that had been placed in escrow to satisfy potential indemnification claims. After one of the individual defendants moved to dismiss the action, Vice Chancellor Sam Glasscock III raised, sua sponte, the issue of whether the Court had subject matter jurisdiction over Elavon’s claims for release of escrowed funds. Elavon, 2022 WL 667075, at *1.

In arguing in favor of equitable subject matter jurisdiction, Elavon relied upon Xlete, East Balt, and Haney, pointing out that “only the Court of Chancery can issue an [injunction] directing the Escrow Agent to release the funds if it fails to do so.” Id. at *2 (internal quotation marks omitted) (emphasis in original). In response, Vice Chancellor Glasscock distinguished the cases cited by Elavon on their facts and stated that, to the extent Xlete and East Balt indicate that equitable jurisdiction should be had under the circumstances, the Court declined to follow their rationale. Id. at *3.

In particular, the Elavon Court took issue with what it described as the “speculative” nature of the argument in favor of equitable jurisdiction, explaining:

There is nothing in the pleadings that makes it likely that the escrow agent, post-decision in the Superior Court, would defy that Court’s determination of contract rights and breach its duties to the parties by refusing a consistent directive by the parties to release the funds. In other words, a complete and efficient remedy is available at law. The fact that an unexpected subsequent breach by the escrow agent might give rise to a need for equity to act does not make this matter one that requires Chancery jurisdiction. This would not be the tail wagging the dog; it would be an unanticipated second dog biting that tail—the possibility of such a speculative cause of action does not, to my mind, open the kennel of equity.

Id. at *2.

The Court also distinguished Xlete and East Balt because the plaintiffs there sought only the funds in escrow. In Elavon, the Court noted that “the damages sought exceed the value of the Escrow Fund.” Id. at *3.

The Court then dismissed the action for lack of subject matter jurisdiction, subject to transfer to Superior Court pursuant to 10 Del. C. § 1902, concluding that “[a] legal action cannot be transformed into an equitable one merely by suggesting that contingent relief, such as an escrow agent gone rogue, may necessitate an injunction.” Id. at *4.

ISS Facility Services, Inc. v. JanCo FS 2, LLC

For nearly a year, it appeared that Elavon might be an outlier from Xlete and its progeny, distinguishable on its facts. However, on June 20, 2023, Vice Chancellor Glasscock once again declined to find equitable jurisdiction over claims for the release of escrowed funds.

In ISS Facility Services, Inc. v. JanCo FS 2, LLC, 2023 WL 4096014 (Del. Ch. June 20, 2023), plaintiff ISS Facility Services brought three causes of action, including for declaratory judgment and specific performance of the contracts at issue. In arguing in favor of equitable subject matter jurisdiction, ISS Facility Services argued that “injunctive relief via specific performance is necessary to compel Defendants to issue instructions to an escrow agent to disburse those contested funds.” JanCo, 2023 WL 4096014, at *1. The Court disagreed.

In its analysis, the Court looked to the escrow agreement at issue, which provided that “disbursements can occur ‘only pursuant to (i) [Defendants’] written direction, (ii) a Joint Written Direction or (iii) a Final Order.’” Id. (alteration in original). The Court determined that a declaratory judgment issuing from the Superior Court would satisfy (iii) of the escrow agreement, making equitable relief compelling Defendants to comply with (i) unnecessary. Id. at *2. In addition, the computation of the amount owed under the contracts was a matter of contractual interpretation, a “quintessential exercise of law.” Id. As a result, plaintiffs had an adequate remedy at law, and the Court found a lack of equitable jurisdiction.

In contrast to Elavon, the facts in JanCo did not raise any additional issues or damages beyond the release of the funds held in escrow. Thus, JanCo seemingly expanded the reasoning detailed in Evalon to all actions for the release of escrowed funds without narrow factual limitations.

Buescher v. Landsea Homes Corp.

In September of this year, the Court again determined that it lacked subject matter jurisdiction to hear a claim involving the release of funds from escrow. In Buescher v. Landsea Homes Corp., 2023 WL 5994144 (Del. Ch. Sept. 15, 2023), the plaintiff sought an order of specific performance requiring defendant to direct an escrow agent to release $5 million held by the parties arising out of plaintiff’s purchase of defendant’s interest in a Florida LLC. Citing to JanCo, Vice Chancellor Glasscock stated: “Our recent case law has suggested that jurisdiction based solely on a request for the aid of equity to recover funds in escrow is inadequate to invoke subject matter jurisdiction, where the availability of a declaratory judgment at law makes the need for injunctive relief unlikely.” Id. at *1. Accordingly, the Court ordered the parties to brief whether the Court had subject matter jurisdiction. Interestingly, both plaintiff and defendant sought to keep the case in the Court of Chancery and even filed a joint brief. Given the recent case law finding the Court lacked jurisdiction over claims to release escrowed funds, the parties attempted to obtain jurisdiction based on the defendant’s equitable fraud counterclaim. The Court rejected this argument, finding that the parties failed to allege a special relationship between the commercial counterparties to the contract, which is a requirement for equitable fraud. Therefore, the Court dismissed the case, subject to the parties applying for a transfer to Superior Court.

Conclusions

Multiple conclusions can be drawn from the decisions in Elavon, JanCo, and Buescher. First, these cases serve as a reminder that, like the majority of trial courts in the United States, in the Court of Chancery, horizontal stare decisis does not operate as an absolute bar against decisions departing from relevant precedent. However, this should not be viewed, at least without future evidence, as a disagreement among the current members of the Court over whether it has jurisdiction over post-closing escrow release cases. To the contrary, as regular Chancery practitioners know, the decisions of the Court rarely significantly diverge, and it would be unsurprising if other members of the Court continued the trend of Vice Chancellor Glasscock’s recent decisions rejecting escrow release as a basis for equitable jurisdiction.

Second, parties and their counsel should carefully consider the appropriate Delaware court for claims relating to the release of escrow funds, including what potential grounds exist to seek equitable jurisdiction. The Court of Chancery will not hesitate to raise subject matter jurisdiction sua sponte, which could lead to added costs and delays that should be considered when determining choice of venue. Indeed, this occurred shortly after Vice Chancellor Glasscock issued his ruling in JanCo. The day after that decision was issued, Vice Chancellor Paul A. Fioravanti Jr. directed the parties to a pending action for the release of escrowed funds to provide the parties’ positions as to the application of JanCo to that action. See Four Cents Holdings, LLC v. M&E Printing, Inc., 2023 WL 4561491 (Del. Ch. July 14, 2023) (ORDER). The parties in Four Cents Holdings conferred and dismissed the action for lack of subject matter jurisdiction, electing to transfer it to Superior Court pursuant to 10 Del. C. § 1902.

Finally, practitioners have no reason to despair if Chancery jurisdiction over post-closing escrow disputes has become a thing of the past. While the Court of Chancery has well-earned its reputation as the preeminent business court in the country, the Complex Commercial Litigation Division of the Delaware Superior Court (“CCLD”), though much younger in existence having been founded in 2010, has proven to be another excellent venue for the resolution of complex business disputes, such as the ones arising from post-closing litigation and involving escrowed funds. Indeed, the Delaware Supreme Court recently recognized the CCLD’s expertise in complex business disputes by issuing an order, at the request of the Chancellor and President Judge of the Superior Court, allowing for a one-year trial period for the CCLD judges to be “designated with the consent of the Chancellor to sit as a Vice Chancellor on the Court of Chancery for the purpose of hearing and deciding cases filed under Section 111 [of the Delaware General Corporation Law] as selected by the Chancellor and the President Judge.” Accordingly, regardless of whether post-closing disputes over escrowed funds are heard in the Court of Chancery or CCLD, practitioners and their clients can expect timely and skillful resolution of their cases.

Jason C. Jowers is a director and Justin C. Barrett is an associate at Bayard, P.A. in Wilmington, Delaware, where they practice in the areas of corporate, alternative entity, and complex commercial litigation.

Generative AI (artificial intelligence) is going to upend the labor market. This is old news. Every week we see a new analyst publication giving us their numbers.^[1] Lawyers comfort themselves with the view that “a machine will never be able to replace us” in the exercise of professional judgment and interpersonal engagement. But even for those sacred duties, change is coming.

The four professional competencies

For lawyers—and indeed professionals generally—functional competency can be whittled down to the following:

At the core is Knowledge:

• applicable laws and regulations;
• the client’s business: operational features, commercial approach, and priorities; and
• market/industry practice and content standards.

Surrounding this core is what you might call the ring of power—Judgment. The ability to make the right decisions around things such as:

• risk parameters
• content look and feel
• narratives
• interpersonal and organizational dynamics
• how to balance commercial and operational drivers

The next functional competency is Content Creation. Historically, content creation was all about written communications, but these days you can include numerical (e.g., Excel) and graphic (e.g., PowerPoint^[2]) forms as well. And let’s not forget those most fashionable outputs in the legal ops world: workflows and process designs.

Finally, we have Persuasion, which has always been the lawyer’s superpower. Persuasion is the competency that executes with maximum effectiveness the delivery of all that knowledge, judgment, and content and is a more pervasive activity than you might think. Examples of persuasion are:

• counterparties (negotiations);
• clients (pitches, advice);
• colleagues (training, coaching, leadership); and
• market (thought leadership, events, and presentations).

Bringing these competencies together is Experience, which we define as the effective use of judgment based on knowledge acquired through sufficient practice. That’s a functional definition, as distinct from simply having “twenty-five years of experience in reviewing NDAs in the noodle packaging sector.”

Here comes the machine

AI will play an increasingly central role in the performance of all of these competencies, and not just knowledge and content creation, which are the industry’s current focus. As the available datasets grow, and as practitioners and service providers invest in the design and build of new use cases, the ability of AI systems to accumulate, organize, summarize, extract, and pattern-sift information will augment how lawyers come to form their judgments and the tools available for persuasion. For example:

What next?

What does all this mean for junior lawyers looking at the road ahead? In a word: opportunity. AI is going to open up access to new realms of data and new methods of exploiting that information. Exercising legal judgment will be increasingly based on real data rather than precedent, anecdote, or simply years in the field. The skill of persuasion may become ever more artful in the use of infographics, and in tracking what works and what does not. So here are three things the new generation of lawyers should be thinking about as they consider the brave new world of AI-enabled lawyering:

1. If your job is all about risk assessment, ask yourself how much of that risk assessment is currently based on hard data.
2. Can AI increase the amount of hard data that you are using in your risk assessments?
3. Can AI improve the ways you can present your analysis, so that you can be more persuasive?

Understanding the limits of current generative AI tools—and especially the limitations of the data pools which have trained those tools—will be a key skill for the new generation of legal professionals. The AI is not self-aware and is not exercising its own judgment. It has no idea what you intend to do with its output, but its ability to inform your judgment and enhance your persuasiveness will be transformative.

1. Check out, for example, McKinsey Global Institute’s July 2023 report Generative AI and the Future of Work in America. ↑

2. Other office productivity brands are available. ↑

3. See, e.g., World Commerce & Contracting Most Negotiated Terms report, 2022. ↑

What Exactly Is This Private Target Deal Points Study, Anyway?

The Private Target Deal Points Study is a publication of the Market Trends Subcommittee of the Business Law Section’s M&A Committee. It examines the prevalence of certain contract provisions in publicly available, private target M&A transactions during a specified time period. The Private Target Deal Points Study is the preeminent study of M&A transactions and is widely utilized by practitioners, investment bankers, corporate development teams, and other advisors.

What Time Period Will Be Covered by the Study?

The 2023 iteration of the Private Target Deal Points Study will analyze publicly available definitive acquisition agreements for transactions executed and/or completed either during calendar year 2022 or during the first quarter of calendar year 2023.

What Industries Will Be Covered by the Study?

The deals in the Private Target Deal Points Study reflect the broad array of industries of the deals that were conducted in our time period. In this year’s study, the technology, healthcare, and financial services sectors together make up approximately 45 percent of the deals.

What Is the Size of the Transactions in the Study?

The transactions analyzed in the Private Target Deal Points Study were in the “middle market,” with purchase prices ranging between $30 million and $750 million; purchase prices for most deals in the data pool were below $200 million.

Where Are You in the Process of Releasing the Study?

Almost all of our ten issue groups have turned in their data, and we are processing and analyzing it, running quality control checks, and finalizing the slides.

Can You Share Any Sneak Preview Data?

We shared a couple of sneak preview data points with attendees at the meeting of the Market Trends Subcommittee at the ABA Business Law Section’s M&A Committee meeting in September and encourage you to sign up for the M&A Committee and its various subcommittees if you haven’t already—at the following link: Join the BLS M&A Committee.

We can give you a peek ahead (understand, however, that our process is still ongoing, and thus these data points may not be final):

Number of deals referencing RWI has decreased for the first time

• The sneak peek: Representations and warranties insurance (RWI) has been a huge game changer in M&A deals. We measure whether a deal in our study pool utilized RWI by the closest proxy we can access: whether the purchase agreement references RWI. (Of course, RWI may have been obtained without such a reference in the purchase agreement.) The 2021 version of the Private Target Deal Points Study showed RWI references in nearly two-thirds of the deals referencing RWI. The 2023 version of the study will show a drop in RWI references, to 55%.
• What to watch for: Use of RWI in a deal impacts a variety of the negotiated provisions, as evidenced by our prior study data correlations. We are correlating even more data points with RWI references in the 2023 version of the Private Target Deal Points Study, so watch for those.

Please keep an eye out for our study and for an In the Know webinar to be scheduled, during which the chairs and issue group leaders will provide analysis and key takeaways from the results of the 2023 Private Target M&A Deal Points Study.

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

Recoupment of Defense Costs

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

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

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

Eleventh Circuit: No Recoupment Absent an Express Policy Provision

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

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

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

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

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

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

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

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

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

Key Takeaways from Winder Labs

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

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

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

3. 73 F.4th 934 (11th Cir. 2023). ↑

4. Id. at 950. ↑

5. Id. at 942. ↑

6. Id. at 945–47. ↑

7. Id. at 944, 948. ↑

8. Id. at 945–47. ↑

9. Id. ↑

10. Id. at 947. ↑

11. Id. ↑

12. Id. at 946. ↑

13. Id. at 947. ↑

14. Id. ↑

15. Id. ↑

16. Id. at 950–51. ↑

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

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

Understanding the State of the US Cannabis Market

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

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

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

Barriers the Cannabis Industry Faces Daily

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

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

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

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

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

Preventing Barriers from Becoming Risks

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

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

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

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

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

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

Developing an Effective Risk Management Plan

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

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

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

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

Cannabis Insurance Policies and Licensure

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

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

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

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

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

Pace of Play

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

Course Correction

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

No Straight Shot to the Green

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

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

Birdie or Bogey for Golf Popularity

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

The Back Nine?

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

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

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

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

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

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

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

Highlights of the 1987 and 2008 Editions of the MNCA

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

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

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

Fourth Edition of the MNCA

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

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

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

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

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

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

Conclusion

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

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

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

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

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

4. Id. ↑

5. Id. ↑

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

7. Id. at xxxv–xxxvii, xl. ↑

8. Id. at xxi–xxxii. ↑

9. Id. at xxxvii. ↑

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

11. Id. at xxi–xxiv. ↑

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

13. Moody, supra note 10, at xxiv. ↑

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

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

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

17. Id. §§ 120–27. ↑

18. Id. § 207. ↑

19. Id. § 709. ↑

20. Id. § 825(g). ↑

21. Id. § 831(d). ↑

22. Id. §§ 1003, 1105(c), 1203(b). ↑

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

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

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

Background

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

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

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

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

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

The AHG’s Opposition to the Plan

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

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

The English Court’s Decision

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

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

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

Cross-Class Cramdowns and Dissenting Rights: Balancing Stakeholder Interests

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

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

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

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

Relevance to the Cayman Islands’ Restructuring and Insolvency Landscape

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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